Warren Buffett
Quality Compounder
Warren Buffett evolved Graham's value framework to focus on business quality over statistical cheapness. He seeks companies with durable competitive advantages ("moats"), consistent earnings power, and shareholder-oriented management. Buffett uses a discounted cash flow model based on "owner earnings" and requires a margin of safety to the resulting intrinsic value.
Valuation Method
Owner Earnings DCF
Discounted cash flow using Owner Earnings (Net Income + Depreciation - Maintenance CapEx). Projects 10 years of cash flows using historical growth rates, with a terminal value. Discounts at 9% to arrive at per-share intrinsic value.
Checklist (9 Criteria)
| # | Criterion | Metric | Threshold | Data Source |
|---|---|---|---|---|
| 1 | Consistent Earnings | Net Income Positive | Every year for 10+ years | Income Statement: Net Income |
| 2 | Return on Equity | ROE | > 15% consistently (5-yr avg) | Net Income / Shareholders' Equity |
| 3 | Return on Invested Capital | ROIC | > 10% trailing 3-5 yr avg | NOPAT / (Total Debt + Equity - Excess Cash) |
| 4 | ROIC vs. WACC Spread | ROIC - WACC | Positive and stable or growing | Derived: ROIC minus calculated WACC |
| 5 | Profit Margin Stability | Operating Margin | Stable or rising over 10 years | Income Statement: Operating Income / Revenue |
| 6 | Owner Earnings | FCF Proxy | Positive and growing | Net Income + Depreciation - Maintenance CapEx |
| 7 | Low Leverage | Debt/Equity | < 0.5; Interest Coverage > 5x | Balance Sheet: Total Debt / Equity; EBIT / Interest Expense |
| 8 | Earnings Predictability | Earnings Variance | Low coefficient of variation over 10 years | Std dev of EPS / Mean EPS |
| 9 | Capital Allocation | Retained Earnings Effectiveness | $1 retained creates > $1 market value | Change in Market Cap vs. Cumulative Retained Earnings over 5 years |
Intrinsic Value Method
Owner Earnings DCF
Sum of [Owner Earnings * (1+g)^t / (1+r)^t] for t=1..10 + Terminal Value / (1+r)^10Buffett's preferred valuation method. Owner Earnings = Net Income + Depreciation - Maintenance CapEx. Uses conservative growth rate (lower of historical, analyst consensus, or GDP + inflation) and discount rate (higher of 10-yr Treasury or 10%). Requires >= 25% margin of safety.
Verdict Logic
BUY if >= 7/9 criteria pass AND price is >= 25% below Owner Earnings DCF intrinsic value. HOLD if >= 7/9 criteria pass but margin of safety < 25%. FAIL if fewer than 7/9 criteria pass.
What Would Warren Buffett Buy Today?
Sources
Berkshire Hathaway Annual Letters
1977-2024Warren Buffett
Buffett's annual letters to shareholders are the primary source for his investment philosophy. They detail his criteria for evaluating businesses, including the importance of owner earnings, return on equity, and competitive moats.
The Warren Buffett Way
1994 (3rd ed. 2013)Robert G. Hagstrom
A systematic breakdown of Buffett's investment tenets organized into business, management, financial, and market categories. Provides the framework for quantifying Buffett's qualitative principles.