A 63% Quicker Method to Pick Stocks with Less Work

Did you know, there are more than 1,837 Indian stocks you can buy from?

Yes.

And each company, in turn, produces hundreds of pages of financial reports and news stories.

Every. Single. Year.

All of which you can study.

Phew!

Where do you even start?

It’s just too much work.

Here’s the surprise: Not only can you manage this overload, but you can actually tweak it to your benefit!

Look at Warren Buffett, for example. He had bought from 6,364 stocks in 1997. Today, that number is lower at around 3,200, but still massive. And yet he doesn’t even break a sweat!

How does he buy stocks from soooo many of them?

You’ll know soon.

And with it, you’ll discover one of the vital secrets of value investing like Warren Buffett. What’s more, you can learn it fairly easily.

In this lesson you’ll find out:

  • How Warren Buffett tears through 6,364 stocks
  • 3 key words that will improve your chances of investment success
  • How to apply Warren Buffett’s value investing secret to Indian stocks
  • Your edge over the big boys when you invest like Warren Buffett
  • 2 practical excel templates for you to start right now

Keep on reading to find out.

How Warren Buffett Tears Through 6,364 Stocks?

Here’s what Buffett wrote to his shareholders in this 1996 letter:

What an investor needs is the ability to correctly evaluate selected businesses. Note that word ‘selected’ : You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.

There they are.

The three golden words: Circle of Competence.

One of the billion dollar secrets of value investing like Warren Buffett.

And I’m not saying this for the heck of it.

Here’s Warren Buffett again, in his 1999 letter, stressing upon exactly how important the concept of circle of competence is:

“If we have a strength, it is in recognizing when we are operating well within our circle of competence and when we are approaching the perimeter…We just stick with what we understand.”

So, the next time you feel overwhelmed with the 1,837 stocks to chose from — realize that you have to deeply study only a few of those.

That’s right – a few selected stocks.

You must devote your full attention and time to only those selected stocks.

And surprisingly, it is as true when you’re new to value investing, as it is for Warren Buffett.

How to Quickly Pick Stocks For Further Study?

The first thing to note, is that we are talking of shortlisting stocks for further study. We are not talking at all about the final selection of which stocks to buy.

So, that’s the first thing.

Secondly, remember, you can select on any reasonable basis that you feel like.

Why?

Because you’re not a professional investor. Those guys have all kinds of constraints and pressures. Do this, do that. A lot of that pressure, frankly, is quite silly.

As a individual investor, you can do as you please. When you try value investing, you give yourself a fighting chance to beat the big boys.

Third, here are some practical ideas on how you can use Warren Buffett’s secret (which is ‘circle of competence’) to select stocks for further study:

  • Can you understand the company’s basic product and business model? If it is too complex, reject the stock.
  • Can you understand its financial statements? If the accounting is too complicated, reject it.
  • Does the underlying technology in the business change too rapidly? If it does, reject it.
  • Is the industry in which the business operates, subject to a lot of churn and destructive competition? Choose stocks only where you feel the industry conditions are relatively stable.

Finally, note that these selection criteria are not sacrosanct. You may use them or any other basis for shortlisting. Just make sure it reflects your strengths and your comfort zone. Not someone else’s.

Be true to yourself.

How to Invest 63% Faster With This Warren Buffett Method?

So, let’s say you start with the 30 stocks in the BSE Sensex. These stocks are:

  1. Adani Ports
  2. Asian Paints
  3. Axis Bank
  4. Bajaj Auto
  5. Bharti Airtel
  6. Cipla
  7. Coal India
  8. Dr Reddy’s
  9. HDFC Bank
  10. Hero MotoCorp
  11. HUL
  12. HDFC
  13. ICICI Bank
  14. Infosys
  15. ITC
  16. Kotak Mahindra Bank
  17. L&T
  18. Lupin
  19. M&M
  20. Maruti Suzuki
  21. NTPC
  22. ONGC
  23. Power Grid
  24. Reliance Industries
  25. SBI
  26. Sun Pharma
  27. TCS
  28. Tata Motors
  29. Tata Steel
  30. Wipro

Let us attempt a classification based on the four criteria that defined our circle of competence above. Here goes:

Rejected: The financial statements of these stocks can be complex and difficult to understand.

  1. Axis Bank
  2. HDFC Bank
  3. HDFC
  4. ICICI Bank
  5. Kotak Mahindra Bank
  6. SBI

Rejected: The business suffers from rapidly changing technology and industry conditions. We’ll get stumped.

  1. Bharti Airtel
  2. Tata Steel

Rejected: The business model is highly technical and will go over our head.

  1. Cipla
  2. Dr Reddy’s
  3. Lupin
  4. ONGC
  5. Sun Pharma

Rejected: The business model perhaps can be understood by others, but we just can’t seem to get a feel for it.

  1. Infosys
  2. TCS
  3. Wipro

Rejected: The corporate structure seems complicated. We will have to do a lot of analysis of government policies and political intrigue. We don’t want to struggle with it.

  1. Adani Ports
  2. Coal India, and
  3. Reliance Industries

Selected: Looks like we can understand the business if we study the company’s documents thoroughly and research the sector. Financial statements will also perhaps be relatively simple.

  1. Asian Paints
  2. Bajaj Auto
  3. Hero MotoCorp
  4. HUL
  5. ITC
  6. L&T
  7. M&M
  8. Maruti Suzuki
  9. NTPC
  10. Power Grid
  11. Tata Motors

So there you are.

19 stocks – which is 63% of the total – have been rejected, outright. That saves 63% of the time you devote to value investing.

(By the way, I did not decide in advance to shortlist any particular percentage of stocks. It just turned out to be 63%. It could be more or lesser, depending on the list.)

Now you can focus on the selected 37% of the stocks and devote time to study them in detail.

Please note that you need not necessarily agree with this classification. You may want to define your circle of competence using different criteria.

In fact, that’s exactly what you should do. Just make sure you are comfortable with the criteria you set.

What Should I Do Next?

Now you know where to start, in your quest of value investing like Warren Buffett.

Try this exercise with a larger set of stocks like the BSE 100 or BSE 500.

The process is the same.

You can start working on them instantly using the two templates I have kept for you.

So go ahead, log in to the Value Investing Library and download them.

 

Disclosure: From the stocks mentioned above, I own Axis Bank. Have held the shares for 12 years now. Your own circle of competence is the key to value investing like Warren Buffett. That’s why I don’t give investment advice or equity research recommendations at all. It won’t work.

22 thoughts on “A 63% Quicker Method to Pick Stocks with Less Work”

  1. Good article sir. I want to do this exercise with a larger set of stocks like small cap 100 shares. So can u help me do this?

  2. Amit Singh Rahul

    Thanks for your very easy and illustrated example. It will be help me for sorting Companies name for Investment purpose.

  3. I think WB used to go through each and every company in the Moody’s or S&P manual and start from A down to Z. When asked how a normal person would do this, he said start with the companies with names beginning from A. I think he build his circle of competence by reading and filtering out…

    1. “I went through the Moody’s Manuals page by page. Ten thousand pages in the Moody’s Industrial, Transportation, Banks and Finance Manuals—twice. I actually looked at every business—although I didn’t look very hard at some.”

      1. Hi Bhaskar,

        Very valid observation.

        Correct me if I’m wrong – the ‘A-to-Z’ quote is from a television program Warren Buffett did with the author ‘Adam Smith’, in 1993.

        At first glance, there seems to be a contradiction between the Adam Smith quote and the quote from the Berkshire letters. A deeper analysis shows otherwise.

        The context in which Buffett has said them holds the key.

        Warren Buffett began his value investing career as a quantitative (Grahamite) type of investor, chasing cigar butt stocks. He later developed more qualitative leanings, and now waits for economic franchises.

        The former requires that you intensely turn over every little rock to find the undervalued cigar butt. The latter requires that you be selective and patient for the easy-to-understand franchise to hit you on the head.

        Does Warren Buffett’s years of hard work with cigar butts inform his selections today?

        Of course.

        But, if you are new to value investing, do you necessarily have to exhaust all the 5,000+ stocks available on the BSE & NSE?

        Nope. Your circle of competence comes to your rescue.

        Does a truly dedicated value investor have to pick one approach over the other?

        Nope. He should use both the ‘circle of competence’ approach as well as the ‘A-to-Z’ approach. Though, the latter will require time and much intensity.

        1. Good points sir. I was just adding my thoughts that for a lay investor knowing his circle of competence itself is a blindspot. So reading broadly and widely is the way to go. If you already have a well defined circle of competence then having laser like focus makes more sense. There is no right or wrong approach in investing as we all know. For me reading widely has helped.

          On sidenote, you are doing a awesome work here. Please continue publishing more thought provoking articles on value investing. All the best !!

          1. Excellent point about circle of competence being a blind spot. 🙂

            The thing about this exercise, Bhaskar, is that it is iterative. A beginner to value investing can take the following steps:

            Step 1. Start with your present state of knowledge. Be very honest (bravado proves to be costly here) and stick to an extremely narrow circle, if need be.

            Step 2. Gain experience and build upon your knowledge base.

            Step 3. Revisit your circle of competence often and see if it has expanded.

            After all, Warren Buffett himself has expanded his circle of competence over the years – his purchase of IBM being a great case in point.

            Thus, the blind spot can be managed if we are completely honest to ourselves.

            Should a beginner to value investing focus on reading instead? Is reading a great idea for value investors?

            As you know, in value investing, we are big fans of reading ‘everything in sight’ (to lift one of Buffett’s many phrases). And we will discuss the point about reading very soon. The only issue is, studying will take time. So, it is a long term solution. Albeit a mighty effective solution!

            Thus, the realistic approach is to think of our tiny little circle of competence as a starting place. And to keep expanding on it by diligent study.

  4. Hi Satyajeet,

    Amazing article, very useful for starters like me.

    Filters/areas of selection i believe could start from circle of competence, but can include few beliefs/metrics like zero debt stock, honest management, ethical business areas. This to an extent will reduce the workable universe.

    I would like to point out that the downloadable material is very nice. Thanks for this initiative, and I hope you continue doing this going forward.

    All the best!

    1. Hi Praveen,

      Always nice to hear from you! You’ve been highly supportive from the start – despite my many bumbling efforts.

      Hope you’re doing good. 🙂

      Honest management, ethical business etc. can definitely be included as criteria in ‘circle of competence’.

      Debt-equity ratio (or zero debt for that matter), however, belongs to an entirely separately topic – ‘stock screening’.

      While both are closely related, ‘circle of competence’ is a Warren Buffett invention with a slightly more qualitative flavor to it. It embraces our limitations, foibles and idiosyncrasies and takes it from there. Behavioral finance guys would approve!

      ‘Stock screening’ is a more quantitative thing and its spirit can be traced back to the great Benjamin Graham. Of course, Warren Buffett did a lot of that in the 1950s and 1960s, when he began his value investing career.

      I’ll devote a separate article to the topic.

      Many thanks again!

  5. Hi,

    I chanced upon your blog and must say that it struck to me as a very sincere effort in educating the novice investor, myself included. Thanks very much.

    I think it would help to include a “share this” option in your articles and website to make it more popular and widen its reach through FB, Twitter etc.

    Looking forward to a rewarding relationship with your work/website. 🙂

  6. Thanks for the wonderful article as well as the PDF file illustrating WB guide to investing.

    However I have one question though. While WB rightly mentioned that we should look at Cigar Butt companies to diversify our investment in the initial period, don’t you think that we should look at the very definition of Cigar Butt companies with relation to the current times.

    As you rightly mentioned in the article – Buffetts First Million; during those times there were asset heavy companies however in the current times, the composition of asset heavy companies is shrinking and there are more business which are asset light.

    If you permit me, my opinion would be to look at the very definition of a Cigar Butt company ( a stock which has a last puff remaining – a puff for free). If we apply this definition then there are stocks in market which are asset light but also are under valued since they are hit by the broader issue of Capital outflow, Economy issues etc. I woud list a penny worth suggestion that we should look at stocks which has greater liquidity, stock which has leadership in the category – Number one or two and it’s current stock value is low because of broad issues affecting.

    One such stock I can point out is Sun Pharma (disclaimer : I own stocks of Sun pharma) which is a market leader in its category, has given stellar performance over a period of time, has done some strategic acquisitions but the value is beaten down due to broader issues affecting the stock market, economy as well as the major investor selling stock. However the future of the company is well placed and I think this stock qualifies as a Cigar Butt company although the stock price seems high.
    Other stocks would be software stocks e.g. TCS, Wipro (Disclaimer : I hold these stocks in my portfolio) which are asset light but they are available cheap today due to suspected lower income in the future.

    I believe we need to look at the very definition of Cigar Butt companies in light of the current times and availability. This of course is my opinion.

    Thanks

    Regards
    Waman

    1. Hi Waman,

      Thanks for writing in!

      I understand your concern.

      Buffett did indeed look at the definition again. But the definition that he looked at again was ‘good investment’ in general and not ‘cigar butt’ specifically.

      In other words, he moved beyond cigar butts and started looking at better quality companies with economic moats around them. They tend be light on tangible assets and have a lot of intangible assets/goodwill. This happened from the late 1960s onwards.

      So, your point is well taken. The definition of a good investment has indeed changed with time. And that is the genius of Warren Buffett!

      The definition of ‘cigar butt’, however, is what it always was. And there’s no harm done.

  7. Nice one !!!

    Rejecting stocks basis complexity may be good for people who do not have adequate time but still wish to do their own research. However the value is always found when the complexity gets simplified through restructuring.

  8. mr. snerhal Vankudre

    just joined the community, thanks for provising essential inputs to investor.

  9. mr. snerhal Vankudre

    Dear Satyajeet.

    Discovered the blog today.

    Really fantastic effort put in by you. i went through your all articles in single day. Loved so much cant resist to continue reading. Thanks my vision of value investing has been polished.

  10. Hello Satyajeet,

    Nice blog :))

    Just like HUL balance sheet analysis, can you write up on Analysis of BHEL Balance sheet from 2014-15 annual report??

    Also how do you add quarterly numbers to annual numbers for e.g in case of BHEL for September 2015 quarter it made a net loss, so how to merge this data with annual balance sheet to reflect complete current picture??

    Thanks

  11. Dear friend i am new to this blog, learnt about the art of value investing.

    Totally i failed in share investment. your article taught me to understand the mistake what i have done and what i should not do.

    I will buy the stock with the aim of value investing and i will not loose money further. I will get success.

    Thanks for giving essential information for the value investor.

  12. I came across your site through Google search yesterday. I appreciate your efforts to make novice people like us the fundamentals of value investing. I am enjoying the articles presented by your site.

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