Analyze Stocks Like Warren Buffett

Warren Buffett is the greatest investor alive.

He's averaged over 20% annual returns for ~60 years.

But how does he do it?

He specializes in one investment strategy and sticks to his process rigorously.

Today, I’m going to do deep dive on the strategy so you can replicate it in your portfolio.

Let’s get into it.

The strategy Warren Buffett uses is called Fundamental Analysis.

It’s an investment strategy that primarily focuses on a company’s intrinsic value.

A company’s intrinsic value is mostly made up of the business model, market, financials, and relationship with current economic conditions.

The goal is to take all these aspects into consideration so you can determine what a particular business is truly worth.

This “true worth” (intrinsic value) should lead you to what the stock price should be trading at.

This part is key.

Because once you’ve come up with the price the stock should be trading you, you want to compare it to the price the stock is actually trading at.

If the intrinsic value is greater than the actual stock price, this is a signal to buy the stock.

Conversely, if the intrinsic value is lower than the current stock price, this is a signal to sell (or don’t buy) the stock.

Now, there are 7 major components to fundamental analysis:

1. Understand the stock

2. Management

3. Financial reports

4. Discounted cash flow

5. Debt

6. Competition

7. Future prospects

I’m going to break down each.

1. Understand The Stock

This cannot be overstated.

When you understand an investment, you’ll understand how you can make and lose money with that investment.

So, to understand a stock, you must under these 3 questions:

1. Is this valuation realistic?

2. What risks does the stock have?

3. Is this a dividend play or a capital appreciation play?

These are not the only applicable questions, but these will take you in the right direction.

For a more comprehensive list of questions every investor needs to ask about a stock before they invest in it, check out this thread I wrote here:

2. Management

It doesn’t matter what company it is.

Strong management can turn a bad business into a great one.

And poor management can turn a great business into a bad one.

So with this in mind, look for a management team that:

• Has decades of experience

• Is compensated appropriately

• Personally invests in the company they manage

There’s nothing I love more than a management team who actually believes in the work they’re doing.

3. Financial Reports

When it comes to understand a company’s intrinsic value, you need to understand their financial statements.

There are 3 financial statements every investor needs to understand:

1. Balance sheet

2. Income statement

3. Cash flow statement

Here’s a thread I wrote breaking down all 3:

4. Discounted Cash Flow

This is how to determine an investments value in today’s dollars with a projection of how much the company will make in the future.

If the discounted cash flow is higher than the stock price today, then this is a signal to invest in the company.

If the discounted cash flow is lower than the stock price today, this is a signal to not invest.

5. Debt

Every investor will have their preferences on whether or not its acceptable for an attractive investment to contain debt.

However, here’s how I like to think about it:

Little debt means the company grows with its own resources.

Lots of debt means the company grows with other people’s resources.

If you’re going to invest in a company with lots of debt, take note of their plan to maintain their debt payments.

6. Competition

A company’s success is determined by its competitiveness.

If they have a strong brand name, intellectual property, the industry has a high barrier to entry, or any other competitive advantages…

It’s easier for the company to gain market share instead of losing it.

7. Future Prospects

What’s the company’s future look like?

Pay attention to a company’s innovative tendencies, new market entries, and the industry’s growth.

A company with a bright future makes for a great long-term hold.

So there you have it!

How to understand fundamental analysis in 7 simple steps.

This isn’t meant to be a comprehensive process.

This is meant to be a comprehensive guide.

Now you know what topics you need to research so you can eventually master fundamental analysis.