Warren Buffett once said that one of the best ways not to lose money is to buy “good companies.
The company has an understandable business. Essentially, the company has a history of producing strong earnings performance. We can show a company has an “understandable business” by verifying the following:
The company has predictable and proven earnings. We define a predictable company as one with consistent revenue and earnings growth.
The company has strong “economic moat,” i.e., the company has high gross margins and thus able to grow its business with little or no debt.
The company’s shares can be bought at a reasonable price, e.g., at an attractive price-earnings to growth ratio.
To determine good companies, we can consider four fundamental factors: quality, value, growth and momentum. Warren Buffett’s strategy focus on just quality and value: companies with strong quality also tend to have strong growth.
The quality rank captures the company’s earnings predictability and profit margin growth. Companies with high quality meet Buffett’s key criteria on “proven earnings” and “strong economic moat.”
Buffett’s “good companies” not only have high quality ranks, but also have high value ranks. The QV rank, which blends the quality and value ranks, can determine how “good” a company is. The “best companies” should have high QV ranks..
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