Warren Buffett’s 5-Step Guide to Valuing a Company: The Core of Value Investing

“Stocks Are Not Just Prices, They Represent Business Value.” – Warren Buffett

Warren Buffett, often regarded as the world’s greatest value investor, has built his fortune not by chasing price movements but by carefully assessing a company’s intrinsic value and committing to long-term investments.
Today, let’s break down the five key principles Buffett emphasizes when evaluating a company.

Table of Contents

1. Is it a business you truly understand? (Circle of Competence)

Buffett often says: “Never invest in a business you don’t understand.”
If you can’t clearly explain how a company makes money, its business model, and competitive structure, it’s best to stay away.
For example, during the dot-com bubble, Buffett avoided most internet companies, but invested heavily in Coca-Cola and American Express—businesses he could fully understand and trust.

Personal note: As an engineer working in process technology, I focus on companies where accumulated expertise and know-how are the core strengths. That’s why I invest in contract manufacturing leaders like TSMC and SK Hynix, whose process technology is their true competitive advantage.

2. Does the company have a sustainable competitive advantage (Moat)?

A Moat represents the protective barrier that keeps competitors from easily eroding a company’s market position.
Examples include strong brand power, patents, network effects, or high entry barriers. Companies like Apple or Coca-Cola have built strong customer loyalty that acts as a wide moat.

Personal note: Finding true moats in Korean companies is difficult. The domestic market is small, and global competition is intense, making it hard for Korean firms to maintain long-lasting competitive advantages.

3. Financial strength and profitability

Buffett closely examines metrics such as ROE (Return on Equity), debt ratios, and Free Cash Flow (FCF).
The goal is to identify companies with consistent cash-generating ability, not those fueled by excessive leverage.
As Buffett put it: “Building a business on debt is like building a castle on sand.”

Personal note: In Korea’s top-market-cap companies, it’s rare to find firms maintaining a high ROE for three consecutive years. This is largely because domestic companies tend to have low payout ratios. If future corporate law reforms increase dividend payouts, ROEs across Korean firms may rise as well.

4. The quality and integrity of management

For Buffett, trustworthy, shareholder-friendly management is essential. He values companies that distribute profits fairly through dividends, engage in sensible share buybacks, and have a long-term growth vision.
He often reviews shareholder letters and executive interviews to assess management’s philosophy.

Personal note: Assessing management quality is not easy. Personally, I use dividend policies and foreign ownership ratios as key indicators when selecting companies.

5. Margin of Safety

Following Benjamin Graham’s philosophy, Buffett always insists on a “Margin of Safety.”
He buys only when a company is trading well below its intrinsic value, thereby minimizing downside risk.
For instance, if a stock’s intrinsic value is estimated at $100, Buffett might buy only when it trades at $70–$80.

Did Buffett use the Dividend Discount Model (DDM)?

While Buffett has referred to the DDM, he does not strictly rely on it.
Instead, he evaluates intrinsic value by focusing on Free Cash Flow, reinvestment capacity, and ROE.
In other words, he values qualitative factors—competitive edge, brand, and management quality— more than just dividend numbers.

Personal note: In Korea, many retail investors pick stocks solely based on dividends. But in our market, true returns come when dividends are considered alongside a company’s fundamental strength.

Final Thoughts: Buy a Wonderful Company at a Fair Price

Buffett’s investing philosophy can be summarized simply:
“Find great companies that can endure for decades, buy them at a fair (or discounted) price, and hold them long term.”

This principle applies not only to stock pickers but also to ETF investors who want to build wealth steadily over time.

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