Warren Buffett, one of the most successful investors of his time, explains that most of his success is due to his thorough compliance with the investment formula. As a value investor, Buffett evaluates investment opportunities in a strictly limited manner. It is not surprising that many investors are looking to Buffett's success and try to follow his investment style.
However, applying his philosophy in evaluating stocks is not easy. Much more difficult when evaluating startups.
Because startup ventures generally have little or no revenue, it is very difficult to assess the inherent value of a firm by applying Buffett's model. Moreover, start-up companies have no track record to understand stability. The result is that investors who are looking for a place to invest using Buffett's principles, aka Burrito Tolostians, are forced to apply Buffett's model when evaluating startups.
The following outline investment advice based on Buffett's investment philosophy will help you identify promising start-up investment opportunities.
Invest in a great team
One of Buffett's key investment principles is that management invests in good companies. This principle of Buffett may seem like an objective benchmark, but it can be a quantitative factor in measuring the likelihood of a company's success.
John P. Lees explains that in "Genius investors," the company that Buffett looks for is a 10-year average return on equity (ROE) of at least 15%. Buffett says this is a direct indicator of management's ability to handle corporate finances. For Buffett, companies with ROE below 15% are a signal to avoid.
Investing in entrepreneurs who continue to set up new businesses also helps to identify start-ups that are potentially successful. According to a study published in the Harvard Business Review, an experienced entrepreneur (including a failed entrepreneur) has a much higher chance of success than an entrepreneur who is first started.
When you invest in a start-up, you have to invest in the management of that company. Finding a company that has a responsible, experienced leader meets Buffett's criteria for investing in good management.
Invest in what you know
Warren Buffett is known for his business model as a simple investment. Good examples of companies that are easy to understand in Buffett's portfolio are Coca-Cola, Wal-Mart and ExxonMobil. This basic Buffett investment strategy has been applied to angel investing and it has been statistically proven that it can improve the ROI of startup investment. According to Kaufman Report, the largest study of angel investing, investing in familiar industries has doubled the number of investments.
Knowing about a particular industry helps investors differentiate between a simple general enterprise and a truly amazing enterprise. Peter Lynch, a renowned equity investor and former manager of the Fidelity Magellanic Fund, advised investors to "pick up undervalued stocks in an industry he knows well," he said.
Investing in a simple business model means that it is easy to understand what a company is going to make money for.
Find a company with sustainable sales
If you choose one of the metrics that Buffett will look at before investing in a company, it's a consistent annual revenue and a clear predictability of revenue. A definite way for a company to generate sustained sales is to sell products with permanent demand in large markets.
Take the razor blade as an example. In 1989, Berkshire Hathaway bought $ 600 million worth of preferred stock from Gillette, the leading shaver manufacturer. Gillette was acquired by Procter & Gamble in 2005 for $ 57 billion, while Berkshire's Gillette stake valued at $ 4 billion.
Today's emerging / technology companies will typically be service-based software companies that receive monthly fees for their customers. Continuous monthly revenue is a great way to show potential revenue sources to potential investors, as opposed to relying on one-off massive sales.
If you are a start-up investor, you need to find a firm that shows a clear and predictable future outlook through a solid (and simple) business plan.