Warren Buffett, renowned as the finest stock investor globally, has been quite inactive in selecting new stocks lately. For eight straight quarters, he has taken a net selling stance on stocks. The rationale behind his cautious approach is tied to what has made him one of history’s most successful investors: his strict criteria for stock selection.
In his 2013 communication to shareholders of Berkshire Hathaway, Buffett disclosed a two-step process he utilizes to pinpoint viable investment opportunities. Initially, he assesses whether he can reasonably project earnings for the next five years or beyond. This process involves a comprehensive analysis of a company’s operations and industry dynamics to formulate the most accurate earnings forecast possible.
If creating a future earnings estimate proves too challenging, Buffett simply passes on the stock. The second part of his process involves investing in a stock only if its market price is deemed reasonable relative to the lower threshold of his earnings projections. Should a stock fail this criterion, he will also disregard it.
While this test may appear straightforward, executing it can be more complex than anticipated. Forecasting a company’s profits over a five-year horizon is inherently difficult.
Buffett’s meticulous approach to stock selection
Buffett emphasized the necessity of recognizing the boundaries of his “circle of competence” and remaining firmly within it. He understands the critical role that comprehending a business and its sector plays in accurately estimating future earnings. Additionally, in certain market conditions, it becomes particularly challenging to identify stocks that are attractively valued enough to pass his rigorous criteria. This challenge has been evident in recent times, leading Buffett to amass a cash reserve exceeding $325 billion for Berkshire instead of pursuing new stock purchases.
Potential stocks that might meet Buffett’s criteria in 2025 include Energy Transfer, a leading player in North American midstream energy. Despite the growing shift towards renewable energy, Energy Transfer’s infrastructure will continue to transport natural gas, natural gas liquids, and crude oil for the foreseeable future. The firm also offers a distribution yield approaching 6.5%.
An average annual growth rate hovering between 3% and 5% appears quite feasible. Additionally, Buffett considers Occidental Petroleum as one of the select few stocks that align with his standards, regularly acquiring shares of this oil and gas company.
However, it’s important for investors to recognize that Berkshire holds warrants, allowing it to acquire shares at a predetermined price, rendering the stock more enticing for Buffett than it might be for typical investors lacking such an arrangement. Warren Buffett’s dual-step methodology for selecting stocks underscores the necessity for meticulous earnings forecasts and judicious valuations. As the year 2025 approaches, investors might benefit from adopting a similarly disciplined strategy, enhancing their potential for long-term success by following Buffett’s proven framework.
