The Beginner’s Guide to Investing

2 simple ways Warren Buffett decides what to invest in

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Warren Buffett
Bloomberg | Getty

It seems like every week there's a new flashy Silicon Valley start-up announcing its IPO, and it's tempting to want to get in on the action. But is buying stock in a newly public company the best idea? When it comes to investing, Berkshire Hathaway CEO Warren Buffett doesn't have a complicated method for choosing what to buy. Instead, he keeps things simple by following a few steadfast guidelines.

After all, "the fundamentals won't change," he told CNBC's Becky Quick during an interview on "Squawk Box" in February. "You're not going to discover anything new about investments in the next 50 or 100 years."

Here are two ways the Oracle of Omaha decides a business is worth investing in.

1. The company has long-term value

Buffett looks for businesses that will continue to have a competitive advantage decades down the line, not just in the moment. "Nobody buys a farm based on whether they think it's going to rain next year," he said on "Squawk Box" in 2018. "They buy it because they think it's a good investment over 10 or 20 years."

For example, he purchased See's Candies with longtime business partner Charlie Munger in 1972 and spent more than $1 billion on Coca-Cola stock in 1988 — both of which turned out to be good bets he still owns today.

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"Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value," Buffett wrote in his 1996 letter to shareholders. "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."

2. He understands how the business works

Buffett doesn't put money into anything he doesn't understand. "You have to learn how to value businesses and know the ones that are within your circle of competence and the ones that are outside," Buffett told Quick in February.

That's because it's crucial for investors to be able to confidently assess the businesses they hold. "Intelligent investing is not complex, though that is far from saying that it is easy," Buffett wrote in his 1996 annual shareholders' letter. "What an investor needs is the ability to correctly evaluate selected businesses. Note that word 'selected': You don't have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence.

"The size of that circle is not very important; knowing its boundaries, however, is vital."

You have to learn how to value businesses and know the ones that are within your circle of competence and the ones that are outside.
Warren Buffett
CEO of Berkshire Hathaway

It's important to remember that investing in the stock market always carries risk and for many people, investing in individual companies isn't the smartest choice. You should talk to a trusted financial advisor before making any major decisions.

For many investors, Buffett recommends low-risk index funds, which he calls the "thing that makes the most sense practically all of the time" for retirement savings.

He favors index funds, in part, because they take the guesswork out of investing. "The trick is not to pick the right company," Buffett told CNBC's "On The Money" in 2017. "The trick is to essentially buy all the big companies through the S&P 500 and to do it consistently."

In fact, after he's gone, he has said that he's instructed the trustee in charge of his estate to invest 90% of his money into the S&P 500 for his wife.

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