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3 Valuable Lessons from Warren Buffett’s Portfolio

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Warren Buffett, the Oracle of Omaha, is perhaps the most famous long-term investor in history, and for good reason. Buffett's stock picks are closely followed by value investors, and his portfolio is tracked religiously by many.

With that in mind, here are three lessons you can learn from the stocks currently in Buffett's portfolio.

Invest in what you know

Warren Buffett doesn't understand new technologies too well -- so he's not going to invest in any of them. Sure, IBM is one of Berkshire Hathaway's (NYSE: BRK-A) (NYSE: BRK-B) largest stock investments, but that is a long-established and mature company, and Buffett loves IBM's shareholder-friendly management. And Apple is a Berkshire stock, but that was the choice of one of Buffett's stock pickers, not the Oracle of Omaha himself.

Taking a close look, we can see that most of Berkshire's portfolio is filled with easy-to-understand investments. With bank stocks such as Wells Fargo and U.S. Bancorp, the business can be summed up in one sentence -- they lend money for more than they pay to borrow it, and profit from the difference. Other Berkshire stocks like Coca-Cola, Kraft Heinz, and Wal-Mart are engaged in similarly simple businesses.

The point is not that you should stick to extremely simple businesses, but that you should invest in what you understand. If you're tech-savvy and are proficient at evaluating tech stocks, go for it. As a personal example, I know real estate and banking quite well, so those industries are well-represented in my portfolio. Biotech and retail -- not so much.

If your reasons for buying no longer apply, sell

We can learn just as much from the stocks that used to be in Buffett's portfolio as we can from those that are still there. Buffett is famous for his winning long-term approach to investing, and has said "our favorite holding period is forever." Still, there are some appropriate situations for selling stocks. Here are two great Buffett examples:

In the late 1990s, Berkshire owned a massive stake in Freddie Mac, which was worth as much as $3.9 billion in 1998. Then, in 2000, Berkshire unloaded essentially all of its shares. Buffett noticed that Freddie Mac's management was becoming far too focused on its quarterly results, and had been taking excessive risks in efforts to keep the numbers high. As Buffett put it, "I figure if you see just one cockroach, there's probably a lot." In a nutshell, his reasons for buying Freddie Mac in the first place (good valuation, low risk) no longer applied, so he got rid of it. It's a good thing he did -- Buffett's stake would be worth just over $100 million today.

For a more current example, Berkshire owned a substantial stake in DirecTV, which proved to be an excellent investment. DirecTV dominates its industry, and has high international growth potential. However, when AT&T acquired DirecTV, Berkshire found itself with a bundle of AT&T stock. AT&T, while a great company, is simply not a "Buffett stock." Growth potential is limited, and it doesn't have a dominant market position. In the quarters following the merger, Berkshire unloaded its AT&T shares rather quickly.

What makes a good long-term investment?

As I mentioned, Buffett buys stocks with the intention of holding them forever. So, by taking a close look at the stocks in Berkshire's portfolio, we can get a good sense of what makes a good "forever stock."

There are several common themes among the stocks in Berkshire's portfolio, and while not all of these apply to every stock, we can generally say the following about Buffett's stock investments:

  • A leader in its industry -- Companies like Coca-Cola, Wal-Mart, and Wells Fargo are the biggest and arguably the most recognizable in their respective industries. With size comes certain cost advantages, as well as brand recognition.
  • An identifiable competitive advantage -- Buffett refers to this as a "wide moat." As an example, Wal-Mart's competitive advantage is its ability to charge less for goods than most competitors, even online retailers.
  • A "margin of safety" -- a low valuation or other factor that should keep the company's stock up, even in bad times. For example, Berkshire owns shares of Goldman Sachs, which trades for less than the value of its assets. This means that even if Goldman's profits plunge, its shares are intrinsically worth more than their current price.
  • Little or no debt -- Low debt levels allow companies financial flexibility, as well as the ability to survive a decline in profits if the economy turns sour.
  • Shareholder-friendly management -- Buffett looks for managers who own substantial amounts of the company's stock, and have a good record of returning capital to shareholders through dividends and buybacks.

Important lessons, but do your own thing

As a final thought, I'm not telling you to recreate Buffett's stock portfolio in your own, or buy the same stocks he does. If that's what you want, you're better off simply buying shares of Berkshire Hathaway. Rather, I'm encouraging you to apply the reasons behind Buffett's investments to your own strategy and investment goals in order to create your own rock-solid portfolio.

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Matthew Frankel owns shares of Apple, AT and T, Berkshire Hathaway (B shares), and Goldman Sachs. The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), and Wells Fargo. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.