2 Key Points on Finding Winning Investments from Warren Buffett

Credit: Sacks08

Editor’s note: A chart and paragraph on Vicom’s earnings growth has been added to this article. The Fool regrets the initial omission. 

Finding winning investments may seem like a challenging task. After all, there are more than 700 companies listed in Singapore – how can we separate the wheat from the chaff?

For some answers, we could perhaps turn to Warren Buffett.

Buffett’s someone worth listening to in investing matters. He assumed leadership of Berkshire Hathaway 50 years ago in 1965 when it was just a struggling textile manufacturer.

Today, Berkshire’s a sprawling conglomerate worth some US$355 billion. And all because of Buffett’s work in growing the company’s book value – through astute investments in both publicly-listed and private companies – by an astonishing compounded annual rate of 19.4% over the past five decades.

The important keys

In Buffett’s latest 2014 Berkshire annual shareholder’s letter, he laid out six criteria that he uses to evaluate private businesses for potential acquisitions.

Keeping in mind that it’s the business performance of a company that drives its share price over the long-term, what makes for a great private business may just lead us to winning investments in the stock market too.

With that, here’re two of Buffett’s six criteria which happen to be particularly applicable for stock market investors:

“(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),

(3) Businesses earning good returns on equity while employing little or no debt,”

A company which can grow and remain profitable over long periods of time suggests that its business may have a certain resiliency to it, and that’s a good thing for shareholders.

Meanwhile, a company that can consistently earn a high return on equity without having to borrow much is a sign that its businesses may possess lucrative economic characteristics – that’s also a wonderful thing to have too.

A fine example

In Singapore, Vicom Ltd (SGX: V01) would be a great example of a company that fits the two key criteria to a tee.

Vicom's return on equity (ROE), total cash, and total borrowings

Source: S&P Capital IQ

As you can see in the chart above, Vicom’s return on equity has never been below 15% in the decade between 2004 and 2014. And remarkably, the company’s been able to achieve that with zero borrowings since 2005.

The next chart below shows Vicom’s earnings growth over the same period as above; for the decade ended 2014, the company had been consistently profitable and had even seen its earnings per share rise in each consecutive year.

Vicom's earnings per share

Source: S&P Capital IQ

Given Vicom’s impressive business performance, it’s perhaps no real surprise to find that it has been a solid long-term market-beater. Since the start of 2004, Vicom’s shares have gained some 680% in price to S$6.63 today, far outpacing the Straits Times Index’s (SGX: ^STI) return of just 94% over the same period.

A Fool’s take

None of the above is meant to suggest that Vicom would be a great investment going forward as the issues of valuation and the company’s future prospects would also have to come into play.

The same goes for any other company that would meet those two key characteristics which Buffett had shared.

Finding companies with a history of consistent profit growth and solid returns on equity is a big step in the right direction for investors who are looking for winning investments. But, more work still needs to be done beyond that.

For more investing analyses and important updates about the stock market, sign up to The Motley Fool Singapore's free weekly investing newsletter, Take Stock Singapore. Written by David Kuo, it can help you grow your wealth in the years ahead.

Like us on Facebook to follow our latest hot articles.

The Motley Fool's purpose is to help the world invest, better.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway and Vicom.