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2 Key Criteria Warren Buffett Looks For In His Investments

Credit: Fool Editorial Photos

Warren Buffett’s track record makes him one of the investing community’s all-time greats. From 1965 to 2016, he generated an incredible annual return of 19%. In Buffett’s 1989 letter to his shareholders, he shared his key considerations when evaluating a company as an acquisition opportunity.

Given his accomplishments, it would be useful for any investor to learn from Buffett. (Since Buffett looks at stocks as a piece of a business, stock market investors can still benefit from understanding how Buffett thinks through whole acquisitions.) There are six criteria in Buffett’s checklist.

In a previous article, I’ve looked at the first criterion. In this article, let’s study the second criterion:

“Demonstrated consistent earnings power (future projections are of little interest to us, nor are “turnaround” situations).”

Buffett is known to like businesses that have strong pricing and earnings power, so the second criterion should come as no surprise. But why is this so important to him?

Pricing power is defined as the effect that a change in the price of a company’s product has on the demand for that product. Businesses with strong and consistent pricing power should see stable or even growing demand over time even when the price of its product is increasing steadily.

Higher prices combined with stable or growing demand would equate to more revenue. If the company’s costs are kept in check, higher revenue would then lead to higher profits. This is what Buffett wants in the businesses he invests in. Over the long term, a company that has strong pricing power has a better chance of success.

The other interesting point in this criterion is that Buffett is not interested in future projections or turnarounds. This is because the future is hard to predict accurately; this includes a positive change in customer behaviour toward a company. As such, future projections or turnarounds just don’t make the cut for Buffett, who is looking for a business which already has a superior product and strong pricing power. These two characteristics together can tilt the probability of success in our favour over the long-term.

If you enjoyed this, stay tuned for more on Buffett’s acquisition criteria in the coming weeks! [Editor’s note: Articles on Buffett’s third, fourth, fifth, and sixth criteria have been published. They can be found hereherehere, and here.]

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