Warren Buffett plans to retire at the close of 2025 after an impressive 60 years leading Berkshire Hathaway. His investment achievements are remarkable—if you’d invested $100 in Berkshire in 1965, it would now be around $5.5 million, whereas the S&P 500 would have barely reached $39,000. However, a recent research paper by Kai Wu, titled Buffett’s Intangible Moat, reveals unexpected insights into how he achieved this success, challenging the conventional view of his investment strategy.
The classic value investor myth
Many perceive Buffett as a traditional value investor like his mentor, Ben Graham, who favored stocks priced below their book value. Yet, the data suggests a different reality.
Wu’s examination of Buffett’s major investments from 1978 to 2024 highlights that just 8% of these were purchased below book value. The median price/book ratio stood at 3.1, with an average of 7.9, indicating that Buffett often paid premiums for high-quality firms instead of seeking bargain stocks.
Take a look at his investments in major companies:
- Geico (1976): Acquired when it was nearing bankruptcy at 0.44 times book value and held until it went private in 1996 at 3.0 times book value.
- Coca-Cola (1988): Bought at 4.1 times book value and continued to hold even as its book value soared to 22.0 times.
- Apple (2016): Initially purchased at 4.6 times book value, it returned tenfold and remains above 57.0 times book value today.
These moves suggest that Buffett isn’t just sticking to traditional metrics. Instead, he seems to have adapted to significant changes in how value is created today.
Buffett’s three eras
Wu has identified three distinct phases in Buffett’s career that correspond with broader economic shifts.
Industrial Era (1950s-1970s): During this time, Buffett followed Graham’s playbook, buying companies like Geico for less than their liquidation value, utilizing tangible assets as a proxy for intrinsic value.
The Age of the Consumer (1980s-2000s): With brand-centric firms like Coca-Cola showcasing the significance of intangible assets, Buffett adjusted his strategy. In a 1983 letter, he expressed a “strong preference for companies that possess significant amounts of durable goodwill.”
Information Age (2010s to 2020s): Buffett embraced tech investments, aligning himself with companies like Apple. In a 2018 meeting, he noted that the leading four firms by market cap “do not require net tangible assets.”
Wu’s analysis tracked this evolution via Buffett’s investment portfolios, noting a shift from tangible assets to intangible ones, such as brand equity and human capital.
The real secret: two factors, not magic, in stock picking
Using sophisticated factor analysis, Wu assessed the sources of Buffett’s returns, casting doubt on the idea that he’s an elusive stock-picking genius. He found that factor exposure accounted for 87% of Buffett’s 3% annual outperformance over the S&P 500 since 1978.
Three principal factors were identified as contributing to this outperformance:
- Intangible value (1.1% per year): Companies with strong brands, intellectual property, and network effects.
- Quality (1.1% per year): Focus on highly profitable businesses demonstrating strong fundamentals.
- Traditional values (0.7% per year): Firms priced low relative to their tangible book value.
When considering these factors, Buffett’s residual alpha—representing his unique stock-picking capabilities—drops to a mere 0.4% annually. Since 1995, this alpha has even shown negative performance at -1.9% yearly, indicating an underperformance compared to a straightforward strategy based on these key factors.
This isn’t meant to disparage Buffett; rather, it emphasizes the effectiveness of systematic, factor-based investing. It’s worth noting that Buffett implemented these strategies long before they gained traction in the wider investment community.
Why intangible value and quality work together
Wu eloquently discussed the interplay between intangible value and quality. Both focus on companies with significant competitive advantages derived from intangible assets, though they differ slightly in perspective.
Quality looks at companies that are currently profitable, which possess a competitive edge, while intangible value focuses on firms heavily investing in future profitability through R&D and brand development.
Research suggests that firms with substantial intangible value are poised for profitable returns in the coming years. Ultimately, these factors align with Buffett’s pursuit of businesses possessing enduring advantages, whether they are established or still developing.
Key points for investors
1. You don’t need Berkshire to invest like Buffett.
Wu’s findings indicate that a simple portfolio divvying 50% between top stocks by intangible value and the top stocks by quality could mirror Buffett’s returns since 1978, applicable across various markets.
2. Intangible assets will become a new competitive moat
In our current landscape, elements like brand equity and intellectual property are gaining prominence over physical assets. Wu’s framework provides a quantitative approach for identifying companies with robust intangible moats.
3. Traditional value investing needs an update
While price/book ratios have their place in tangible asset-driven domains, they’re becoming less relevant in asset-light sectors dominated by technology.
4. Large size creates challenges even for the best investors
Berkshire hasn’t outperformed the S&P 500 since 2008—not due to Buffett’s decline but because managing a $1 trillion capital base is far more complex than investing smaller amounts. With a significant cash reserve but limited investment opportunities, individual investors should recognize the advantages of smaller portfolios.
5. Principles are universal and timeless.
Wu’s methods were verified across various market segments from 2010 to 2024, proving that Buffett’s principles are broader than just his area of expertise.
6. A factor-based approach can democratize Buffett’s wisdom
Instead of trying to find the next big stock through pure analysis, investors can identify firms with high intangible value and quality systematically, embracing the fundamental principles that contributed to Buffett’s achievements without needing his specific insights.
The road ahead
As Greg Abel steps into the role of Berkshire’s president, he faces numerous challenges, including high valuations and a vast capital base. The scope of appealing investments has dwindled down largely to large-cap U.S. stocks, making it more crucial than ever to tread carefully to mitigate market impacts.
For individual investors, it’s clear that they don’t need to replicate Buffett’s exact holdings. Instead, the successful factors of intangible value and quality are quantifiable, relevant across global markets. By applying these insights, investors can embody Buffett’s investment philosophy while circumventing the limitations that come with Berkshire’s significant size.
Ultimately, Buffett’s most crucial legacy may not be his stock choices, but rather the framework he created for identifying lasting competitive strengths in a fluid economic landscape. Wu’s research affirms that this framework remains significantly applicable today.
