What’s the secret to Warren Buffett’s investment success? It’s a question I’ve asked ever since I began peering into the business pages looking for data on the latest stock I’d been following. And I’ve been doing that since I was a young boy.

But to Buffett, there is no secret. The Oracle of Omaha, a nickname he earned as a result of his Midwestern upbringing, puts it this way: “All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.”

Buffett has done that in spades over the past 50 years—at the helm of Berkshire Hathaway (NYSE: BRK.A, BRK.B), one of the most successful investment companies in the history of Wall Street. The $48 billion company is like a block of granite in an otherwise fragile environment. Astute investments in brand-name value plays such as Coca-Cola (NYSE: KO), H&R Block (NYSE: HRB), and American Express (NYSE: AXB) have fueled Berkshire Hathaway’s rise to the top of the global investment period. They’re all solid, no-nonsense companies that offer investors the three things that Buffett prizes in his picks—steady growth, good management and no surprises.

A man who’s known for “slow and steady wins the race,” he doesn’t look for instant gratification but, rather, big returns down the road. It comes as no shock, then, that he advocates “index investing”—a buy-and-hold passive approach that involves assembling, and then holding, a broadly diversified portfolio of common stocks designed to mimic the behavior of a specific benchmark index, such as the Standard and Poor’s 500.

Using this and other time-proven investment tools, Buffett’s results speak for themselves. A $10,000 investment in Berkshire Hathaway in 1965 would be worth nearly $50 million today. And Buffett himself is by most counts the second richest man in America (the richest is Bill Gates) with a fortune estimated by Forbes Magazine at more than $40 billion.

The only United States billionaire to have made his money entirely through investment, he is a living legend. A CEO for the nation. A man admired by Wall Street and Main Street alike. Along with Former Federal Reserve Chairmen Alan Greenspan, Ben Bernanke and Paul Volcker, he is also arguably the most respected voice of financial America.

In this article, we’ll examine how Buffett became that voice, the investment philosophies that brought him here and why index investing is a strategy he believes viable for success. As a 401k saver, you’re wise to emulate his philosophy and methods.

Buffett’s Rise as Investor

The road to legend was paved early for Warren Buffett. The son of a stockbroker and Republican congressman, he made his first trade in 1941 when he was just 11, buying three shares in a company for $38 a piece. They dropped to $27 then rose to $40, when the already-cautious Buffett sold them. He earned a tiny profit but missed out when the stock later climbed to $200. That’s when he realized that share-buying is for the long haul. It was an important lesson and one that would carry him throughout his career.

As a child, sources say he was industrious to the extreme. He ran two paper routes and collected and sold found golf balls, using the proceeds to buy 40 acres of farmland, which he rented out for extra money. After earning a college degree in Omaha, he got a graduate degree at Columbia University in New York City, where he met Benjamin Graham. The author of The Intelligent Investor would soon become one of Buffett’s greatest mentors.

After all, it was Graham who taught Buffett how to search for something called “cigar butt” companies—those no longer of interest to the market and thus undervalued, but with a few “puffs of life left in them.” And in 1962, Buffett not only found one, he bought it: A rundown Massachusetts textile company called Berkshire Hathaway. He poured whatever resources it had into other businesses, notably insurance.

The move was a stroke of genius. While insurance companies may not be hugely profitable, they do have a “float.” Policyholders would front premium payments to the insurance company who would then use them to settle claims later.

Fortunately for Buffett, the cash pile on those premiums grew during the early 1970s bear market, giving him the money he needed to buy stakes in companies at bargain prices. Hence, the Berkshire Hathaway phenomenon was born.

Today, Berkshire Hathaway is a behemoth and Buffett is a self-made man who continues to earn his fortune honestly. He lives true to his Midwestern values—on the same Missouri River bank where he was born and raised and in the same gray stucco house he bought for $31,500 back in 1956. His is a quintessentially American story that has not gone unnoticed.

Business writers and stock market analysts who have watched his rise in awe jot down his every utterance. Every May, a cult of some 22,000 people, including Berkshire investors and Buffett zealots, head to Omaha to hang on his every word at the Berkshire Hathaway annual meetings, which he himself calls the “Woodstock of capitalism.”

If his “Woodstock” is the stuff of legends, his annual letters to shareholders are his sacred texts. Pithy and wise, they are studied at business schools across the country and, in 1998, were published as essays.

In them, Buffett displays the probity, modesty and common sense that Americans like to think of as part of the national character—and that are the hallmarks of his reputation. Consider, for the example, in a recent edition, in which he quotes Horace, something you seldom see in a shareholder letter. It also includes a huge mea culpa for his failure to protect General Re, one of Berkshire Hathaway’s re-insurance units, from the shockwaves of the September 11 terrorist attacks. Buffett well knew a mega-catastrophe  was possible (albeit more likely natural than man-made).

“I violated the Noah rule,” he wrote, “Predicting rain doesn’t count; building arks does.”

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Buffett-isms . . .

“In the business world, the rearview mirror is always clearer than the windshield”

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Buffett’s Keys to Profitable Investing

So what does Buffett’s ark look like? A steel vessel made up of sensible, proven and comprehensive investment strategies that he uses as armor for investing wisely.

For starters, he looks for companies with solid financial performance that are managed by seasoned and savvy executives. He favors companies with histories of above-average earnings growth, like American Express and Coca-Cola. 

 Other things that draw Buffett to a good investment are businesses that: 


           Keep things simple. He shies away from technology and telecom stocks, since they’re much too young, risky and difficult to valuate. Instead, he uses a 10-year evaluation tool to choose stocks, examining their past and their potential 10 years down the road.

           Guarantee a return on equity: Companies that can’t look out 10 years to be accurately gauged don’t make it into his portfolio. Neither do companies that require a lot of capital. To the contrary, he believes companies with low capital needs generate significantly higher returns.

           Have cash on the barrel: Deep pockets and ample cash flow appeal to Buffett since they have plenty of financial resources to pay their bills and keep growing.

           Maintain low debt: Insurance companies (he owns both Geico and General Re) are his particular favorites when it comes to investing in businesses that minimize what they owe. Buffett believes that low debt leaves a company significant room for growth and allows earnings to grow based on shareholders’ equity versus having to borrow money.

           Emphasize value: Buffett tends to target investments in undervalued companies with good long-term growth potential. Identifying such companies isn’t easy but, he’s has mastered the methodology by favoring stocks that are unjustifiably low based on their intrinsic worth–according to an analysis of a company’s fundamentals. He looks for good revenue producers that, despite being underpriced, are capably managed.

           Have long-term potential: Famous for his aversion to reading stock market tea leaves, he selects stocks solely on the basis of their overall potential as a company. Once he adds a stock to his portfolio, he will hang on to it for years–even decades. He doesn’t worry whether other investors recognize the stocks’ value, but whether the stock earns money in the long term.

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Sidebar: The “Big Six”

There are other highly-visible cues to take from the Sage on his investing philosophy. In fact, Buffett’s investing criteria are outlined in his yearly reports to shareholders.  They are:

1. Large purchases (at least $50 million of before-tax earnings).

2. Demonstrated consistent earning power (future projections without a proven track record are of no interest to him, nor are “turnaround” situations).

3. Businesses earning good returns on equity while employing little or no debt.

4. Management in place (he can’t supply it).

5. Simple businesses (if there’s lots of technology, he won’t understand it).

6. An offering price (he doesn’t want to waste time or the seller’s by talking, even preliminarily, about a transaction when the price is unknown).

Source: Berkshire Hathaway annual report

Buffett has said candidly that, if a company falls within these criteria, don’t call an investment banker, call him.

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Following Warren Buffett’s rules is a good way to become a 401k Millionaire – they’re as true today as they were 50 years ago.