For more than half a century, from 1965 to 2020, Warren Buffett’s Berkshire Hathaway had generated annualized returns of 20% for its shareholders! Here are stocks with the characteristics that Buffett looks for when seeking stocks to invest in.
Stocks with competitive advantages
Companies with sustainable competitive advantages rise above their peers and generate high profits for years to come. There are different kinds of competitive advantages. Switching costs is one that Shopify (TSX:SHOP)(NYSE:SHOP) has.
Entrepreneurs and businesses that are already using the Shopify e-commerce platform are reluctant to switch to another system because it’s costly to do so.
First, there would be down time in between the switch. Second, there could be problems that arise from switching because their businesses are already intertwined with Shopify’s services.
Not only does Shopify provide a frontend that allows businesses to display, manage, and sell products over multiple channels, it also provides the backend that lets businesses manage their operations across those channels, including sourcing, inventory management, order processing, payments, and shipping.
In other words, businesses that use Shopify are likely to stick to it. As Shopify has advanced businesses’ capabilities with its expanding offerings over time, it has only added to the stickiness. That’s why Shopify’s five-year revenue climbed by about 67% per year, while it maintained gross margins in the 50% range.
Warren Buffett also loves cash cows. Subsequently, he acquired Dominion Energy’s natural gas transmission and storage assets in a deal that totaled US$10 billion including the assumption of debt through Berkshire, which also owns one of America’s largest railroads.
Brookfield Asset Management (TSX:BAM.A)(NYSE:BAM) primarily owns, invests, and operates cash cow assets, including the kinds mentioned just now.
The company generates tonnes of cash. Even in a pandemic-disrupted economy last year, BAM incredibly posted a record free cash flow generation of US$3.1 billion.
The company has a long-term track record of generating market-beating returns of 12-15% on its investments that institutional and retail investors keep coming back to trust BAM with their hard-earned investment capital.
As the global alternative asset manager grows the size of its assets under management, it’s been growing its management and performance fees as well as its dividend paid to shareholders every quarter.
There’s nothing to not like about BAM, as the wonderful business trades at a nice discount of about 20% from the analyst 12-month average price target.
Warren Buffett doesn’t pay out dividends at Berkshire Hathaway, but he loves receiving them. Many Berkshire stock holdings pay dividends, including top holdings like Bank of America, Apple, Coca Cola, American Express, and Verizon.
While it’s reassuring to earn a nice yield on your investments, investors should look for safe dividends that are able to grow at an above-average pace. So, consider dividend stocks with sustainable payout ratios and profit growth that is leading their industries.
The Foolish takeaway
It would be fabulous to only invest in cash-cow, dividend-growth stocks that have durable competitive advantages over their peers. However, they’re not that easy to come by, especially at the right price.
As Warren Buffett shows, Berkshire also owns stocks that don’t pay dividends, such as DaVita and Snowflake. So, don’t be too stringent on any one of these characteristics. However, if a company has all three characteristics, then you should put it at the top of your watch list!
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Fool contributor Kay Ng owns shares of Brookfield Asset Management and Shopify. David Gardner owns shares of Apple. Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Apple, Berkshire Hathaway (B shares), Brookfield Asset Management, Shopify, Shopify, and Snowflake Inc. The Motley Fool recommends BROOKFIELD ASSET MANAGEMENT INC. CL.A LV, Dominion Energy, Inc, and Verizon Communications and recommends the following options: short January 2023 $200 puts on Berkshire Hathaway (B shares), short March 2023 $130 calls on Apple, short March 2021 $225 calls on Berkshire Hathaway (B shares), long March 2023 $120 calls on Apple, and long January 2023 $200 calls on Berkshire Hathaway (B shares).
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