Warren Buffett (Trades, Portfolio) is regarded as one of the most successful investors that’s ever lived, and for good reason. Buffett went from taking odd jobs as a child to a billionaire guru, known for his incredible insight on the market. So it’s no surprise that so many people want to learn how to assess the basic fundamentals of a business, just as Buffett does. The good news is it is not all that difficult to do. In fact, there are a few basic principles Buffett follows when assessing businesses that can make a huge difference. Here’s what I’ve learned from following how he assesses his options.
Is it a business or a concept?
One of the biggest questions Buffett asks himself when evaluating a business is whether or not the business is actually a business. Does the business have a product that’s being sold? Are revenues being created? Is there anything protecting the company’s assets? All of these questions are important.
In fact, Buffett has made it clear that he enjoys investing in businesses that have what he considers to be a “moat.” In his teachings, the guru has explained that a castle isn’t a castle if it doesn’t have a moat to help defend it from the bad guys. The same goes for a business. Terms like patents, proprietary technology and intellectual property are very important to Buffett. After all, businesses that have these things happen to be more secure. The following quote from the guru himself sums it up pretty well:
“But all the time, if you’ve got a wonderful castle, there are people out there who are going to try and attack it and take it away from you. And I want a castle that I can understand, but I want a castle with a moat around it.”
Invest in what you know
If you know nothing about medicine, investing in a clinical-stage biotechnology company probably isn’t a good idea. While the company may have several drugs it is testing, without an understanding of the trials and their outcomes, the investment is purely based on speculation.
The "Oracle of Omaha" has always been clear about the fact he only invests in what he understands well. Ultimately, this makes assessing the value of the business a much more accurate concept. In fact, Buffett has been quoted for simply saying:
“Never invest in a business you cannot understand.”
Look for a history of success
You probably know the term, “Tried and true is better than bold and new.” Well, when it comes to investing, Buffett is known to take this term to heart. In fact, one of the key concepts in the Buffett investment checklist is a consistent operating history. At the end of the day, the guru hasn't shown much interest in new companies with new products. Instead, he looks to stocks like Coca-Cola (KO, Financial), which have a consistent track record of growth. In his experience, doing so has paid off handsomely.
Final thoughts
While assessing a business may seem like a daunting task, if you follow the guidelines set by Buffett, it’s actually pretty simple. First and foremost, start with what you know. Once you’ve found a few options, dig into the business and look for a history of success from a sales and financial standpoint. Doing so could help you become a more Buffett-like investor.
