Many people think Warren Buffett has some magical ability to pick stocks. The truth is that while he’s earned his legendary stock-picking status, his method is surprisingly straightforward—and you can learn it too. The Oracle of Omaha, worth over $150 billion, follows a systematic approach that prioritizes learning about businesses before you buy their stock over chasing the hottest stocks.
“Charlie and I are not stock-pickers; we are business-pickers,” Buffett wrote in his 2022 letter to Berkshire Hathaway Inc. (BRK.A, BRK.B) shareholders, referring to Charlie Munger, his long-time business partner. This fundamental shift in thinking—from stocks to businesses—is what has long grounded his prodigious success.
Think Like a Business Owner, Not a Trader
Buffett’s first rule, if followed too widely, would put a major dent in the ratings for the financial news channels: ignore the daily stock market noise. “In the short run, the market is a voting machine, but in the long run, it is a weighing machine,” he has said, paraphrasing a famous quote from his mentor Benjamin Graham.
For Buffett, short-term price shifts often reflect emotion and speculation, while stock prices over the long term should reflect whether a business is actually a good one.
“It’s crucial to understand that stocks often trade at truly foolish prices, both high and low,” Buffett wrote in 2022. “In truth, marketable stocks and bonds are baffling, their behavior usually understandable only in retrospect. Controlled businesses are a different breed.”
Five Questions Buffett Asks Before Buying a Company’s Stock
Buffett evaluates potential investments using five key questions to reveal a company’s true quality:
1. Does the Company Generate Strong Returns?
Buffett examines return on equity over five to 10 years, not just the latest quarter. He wants to see consistent performance that beats industry competitors.
2. How Much Debt Does the Company Carry?
“We prefer businesses earning good returns on equity while employing little or no debt,” Buffett has written. He prefers companies that grow through retained earnings rather than borrowing. High debt levels can crush a business during tough times—something Buffett learned early in his career.
“At rare and unpredictable intervals…credit vanishes and debt becomes financially fatal,” he wrote in 2019. “Rational people don’t risk what they have and need for what they don’t have and don’t need.
3. Are Profit Margins Growing?
Companies that consistently expand their profit margins show they have good managers and are in a solid competitive position. Buffett looks for businesses where margins improve year after year, indicating strong cost control and pricing power.
4. Does the Business Have a ‘Moat’?
This is one of Buffett’s best-known concepts: competitive advantages that protect a company like the ring of water around a medieval castle. “A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital,” he wrote in 2008. “The dynamics of capitalism guarantee that competitors will repeatedly assault any business ‘castle’ that is earning high returns.”
5. Is the Stock Undervalued?
Finally, Buffett compares his estimate of the company’s intrinsic value to its value in the stock market. Even the best business is going to be a poor investment if you pay too much.
Tip
While Buffett suggests looking for companies with moats, he warns investors to be wary of those that only appear to have them. “Business history is filled with ‘Roman Candles,’ companies whose moats proved illusory and were soon crossed,” he wrote in 2008.
How To Apply Buffett’s Approach to Your Portfolio
You don’t need Buffett’s billions to apply his principles. Start by researching companies in industries you understand—Buffett famously avoided tech stocks for years because he didn’t know enough about their business models.
Look for businesses with consistent earnings, reasonable debt levels, and products or services that would be difficult for competitors to replicate. Then, be patient, but keep your eyes open for prospects, especially if the stock market has taken a beating.
“Just keep buying,” Buffett has advised during market downturns. “American business is going to do fine over time.”
Most importantly, remember that investing isn’t about instant gratification. As Buffett puts it, successful investing requires the temperament to resist both euphoria and panic while staying focused on business fundamentals.
Tip
Worried you need Buffett’s stock picking acumen to succeed? Buffett himself has advised most investors to buy up shares in broad market index funds. That way, you’re betting on the market to do well over time, not just a few companies.
The Bottom Line
Warren Buffett’s stock analysis method focuses on a disciplined approach to evaluating businesses, combined with the patience to earn your gains over the long term.
By focusing on company fundamentals rather than stock prices, seeking competitive advantages, and maintaining a long-term perspective, you can apply the same principles that built one of history’s greatest fortunes.