Warren Buffett’s annual shareholder letter for Berkshire Hathaway was released on February 28. Each year, investors far and wide comb the letter for its insights and wisdom, and this year is no exception. There is one passage that—more than any other—reveals how Buffett thinks about attractive investment options: his list detailing requirements for acquisitions. It is excerpted below:
Berkshire Hathaway Inc. Acquisition Criteria
We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
3) Businesses earning good return on equity while employing little or no debt,
4) Management in place (we can’t supply it),
5) Simple businesses (if there’s lots of technology, we won’t understand it),
6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).
The key phrase I’m focused on is “businesses earning good returns on equity while employing little or no debt.”
I liked this phrase particularly because WisdomTree offers a series of Indexes—our “Dividend Growth” family—that employs this “Buffett factor” of return on equity (ROE) and return on assets (ROA) as a driving force for stock selection. The reason we included ROA in powering stock selection is that it penalizes the use of debt (leverage) in delivering ROE; therefore, the resulting list of companies that qualify for our Indexes tend to also employ little debt.
Getting Diversified Exposure That Passes Buffett’s ROE Rule
Warren Buffett is always going to be a master stock picker, and he is able to get special acquisitions due to the terms he can offer. As he said in this year’s letter, he can usually tell within five minutes if he is interested in a company’s acquisition terms. For the rest of us, getting diversified exposure to stocks that have those characteristics via an index-based strategy can be a compelling strategy.