In partnership with

DISCLOSURE: THIS POST MAY CONTAIN AFFILIATE LINKS, MEANING I GET A COMMISSION IF YOU DECIDE TO MAKE A PURCHASE THROUGH MY LINKS, AT NO COST TO YOU. PLEASE READ MY DISCLOSURE FOR MORE INFO.

RIIQ Newsletter

Good morning investors!

If this is your first time reading, welcome to Raising InvestorIQ!

Every Sunday morning, we publish a free write-up within our RIIQ Newsletter with leading insight and analysis — the aim is to help investors of all skill levels focus on key fundamentals, gain confidence in developing an investment strategy, and gain an edge in the push to generate true wealth.

Grab your coffee and let’s dive in!

Embrace Volatility

Eliminate Risk with Buffett's Wisdom

Intro

When you hear the name Warren Buffett, what comes to mind? Decades of market wisdom? Massive returns? The unwavering ability to cut through financial jargon and focus on what truly matters?

At the core of Buffett’s investment strategy lies a bold and often misunderstood truth: volatility doesn’t particularly equate to risk. In fact, if emotions are kept in check, volatility can create opportunity.

While traditional finance often equates wild price swings with danger, Buffett sees opportunity. Risk, for him, is not about the stock market's mood swings but about whether the business behind the stock can generate consistent, predictable earnings.

Let’s unpack this philosophy, explore the financial metrics Buffett uses to assess companies, and dive into why Coca-Cola and Johnson & Johnson can be shining examples of this strategy.

Volatility: the Misunderstood Villain

In finance, beta is often used as a shorthand for risk. This metric measures a stock's price volatility compared to the market as a whole. A stock with a beta of 1 moves in line with the market, while a beta above 1 is deemed more volatile—and supposedly riskier.

However, Buffett dismisses this thinking outright. He once quipped, "A wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses." For Buffett, volatility isn’t something to fear; it’s almost an invitation, in a way!

Imagine a stock price falling significantly in a bear market. Does this mean the company’s ability to generate earnings has suddenly evaporated? Of course not. Volatility, Buffett argues, becomes a problem only when it drives poor decisions, like selling prematurely or ignoring the underlying business. Instead, he advises investors to see these fluctuations as opportunities to buy great companies at a discount. If you know the business is solid, why not take advantage of an irrationally low price?

Take the Washington Post example. In the 1970s, its stock plummeted due to market pessimism, even though its core business remained robust. Buffett, recognizing its earning potential, ignored the market panic and invested heavily. Over time, this decision paid off immensely, proving that volatility is only risky if you let it influence your judgment.

The Buffett Playbook: Earnings First, Everything Else Later

For Buffett, investing is about owning a piece of a business—not speculating on price movements. His focus is on companies with consistent, predictable earnings because they signal strong business fundamentals, robust management, and a sustainable competitive advantage. Let’s break down the key metrics Buffett uses to identify these companies.

First, a high return on equity (ROE)…

ROE is one of Buffett’s favorite metrics because it measures how effectively a company uses its equity to generate profits. A high ROE—typically above 15%—is a sign of efficient management and a competitive business model. But it’s not just about the number; Buffett digs deeper to understand why a company’s ROE is high. Is it due to genuine operational efficiency, or is it artificially inflated by excessive leverage?

Consider Coca-Cola. Its ROE consistently exceeds the 15% benchmark, thanks to its strong brand, global distribution network, and cost-efficient operations. This level of profitability demonstrates that Coca-Cola doesn’t just generate high earnings—it does so with remarkable efficiency. For Buffett, a company with a high ROE is like a car that delivers maximum mileage per gallon of fuel—it indicates a well-tuned engine capable of enduring the long haul.

Then, a low debt level…

Debt can be a double-edged sword. While it can amplify returns during good times, it can also cripple a business during downturns.

Buffett prefers companies with manageable debt levels, ensuring they have the flexibility to navigate economic storms. This doesn’t mean he avoids companies with debt altogether; rather, he looks for firms where the debt serves a productive purpose, such as funding strategic acquisitions or expanding a competitive advantage.

Take Johnson & Johnson, whose balance sheet is a model of financial prudence. Despite its size and global reach, J&J maintains a conservative debt-to-equity ratio, ensuring it can weather crises without jeopardizing shareholder value.

During the 2020 pandemic, when many companies struggled to manage their obligations, J&J continued to invest in R&D and expand its MedTech segment—all while maintaining its growing dividend (see graph below). This kind of financial stability is a hallmark of the businesses Buffett loves!

…and profit margins which are stable.

Profit margins offer a window into a company’s ability to control costs and maintain pricing power. Consistent or growing margins suggest that a business isn’t under pressure to slash prices or cut corners to stay competitive. For Buffett, stable margins are a sign that a company has a strong competitive position—what he calls a “moat.”

Coca-Cola exemplifies this perfectly. As a global beverage giant, it benefits from economies of scale and unparalleled brand loyalty. Its margins have remained stable over decades, even as it faced competition and changing consumer preferences (see graph below; gross profit margins of Coca-Cola, Pepsi & Monster Beverage).

This consistency reassures investors that the company can sustain profitability, regardless of market conditions.

The Daily Newsletter for Intellectually Curious Readers

If you're frustrated by one-sided reporting, our 5-minute newsletter is the missing piece. We sift through 100+ sources to bring you comprehensive, unbiased news—free from political agendas. Stay informed with factual coverage on the topics that matter.

Join for free today!

What About Free Cash Flow?

If earnings are the heart of a business, free cash flow is its lifeblood.

FCF represents the cash a company has left after covering operating expenses and capital expenditures. Unlike accounting profits, which can be influenced by non-cash items like depreciation, FCF shows how much real cash a business generates. Buffett loves companies with robust FCF because it gives them the flexibility to reinvest in growth, pay dividends, or buy back shares.

Johnson & Johnson, for instance, consistently generates strong FCF. This allows it to fund groundbreaking R&D initiatives in pharmaceuticals and MedTech while rewarding shareholders with growing dividends. Similarly, Coca-Cola uses its FCF to invest in marketing and innovation, ensuring its brand remains relevant across generations.

For Buffett, a healthy FCF isn’t just a financial metric—it’s a sign that the business is built on a solid foundation.

Case Studies: Icons of Predictability

As we said, few companies exemplify Buffett’s investment philosophy as well as Coca-Cola and Johnson & Johnson. These two giants operate in vastly different industries—beverages and healthcare—but they share key traits that make them perfect long-term holdings: resilience, predictable earnings, and the ability to weather economic storms.

Coca-Cola has been a staple of Buffett’s portfolio for decades. When he first invested in the company, he wasn’t just buying a stock; he was buying into a brand that resonates with billions of people worldwide. Coca-Cola’s business model is remarkably straightforward: it sells beverages that people consume daily, ensuring steady demand. This inelasticity means that even during economic downturns, Coca-Cola’s revenues remain resilient. For Buffett, Coca-Cola is a timeless business that delivers value year after year.

Johnson & Johnson, on the other hand, represents the power of diversification. With its pharmaceuticals, medical devices, and consumer health segments, J&J benefits from multiple revenue streams that offset each other during market volatility. For example, during the COVID-19 pandemic, its pharmaceutical division thrived, while its consumer health products ensured steady cash flow.

J&J’s ability to innovate is another reason it aligns with Buffett’s principles. Recent breakthroughs in oncology treatments and MedTech innovations have driven growth, even as the company faced challenges like litigation costs. For Buffett, J&J exemplifies the kind of business that can adapt to challenges while maintaining its long-term earning power. Together, Coca-Cola and Johnson & Johnson show that investing in predictable, resilient businesses is the key to navigating any market condition.

 Don’t Fear the Storm

Buffett’s patience is legendary. He doesn’t panic when the market drops; he sees it as a chance to buy more of the businesses he loves. His Washington Post investment in the 1970s is a classic example. Despite the stock’s high beta and negative sentiment, Buffett focused on the company’s earning power and made a fortune.

Key takeaway? If you’ve done your homework and invested in solid businesses, there’s no need to react to every dip in the market. Sit tight, and let time do its thing. Buffett’s philosophy rests on the idea that short-term price movements are meaningless for those who focus on the long-term potential of their investments.

Conclusion: Predictability Trumps Excitement

At the heart of Buffett’s philosophy is the idea that slow and steady wins the race. Flashy stocks might offer quick thrills, but companies with reliable earnings deliver lasting wealth. Coca-Cola and Johnson & Johnson aren’t the trendiest picks, but their track records make them investor favorites.

Buffett summed it up best: “Our favorite holding period is forever.” And forever looks pretty good when you’re collecting dividends from businesses with rock-solid foundations.

By focusing on predictable earnings and ignoring volatility, you can invest with the confidence of knowing your portfolio is built to last. Because in Buffett’s world, the only risk is not knowing what you’re doing.

Subscribe for FREE to the Raising InvestorIQ YouTube Channel for more leading Investing info, insight, and analysis.

Do you want to invest on your own (but don’t know where to start)? Tykr gives beginners the power to manage their own investments with confidence.

14-Day FREE trial when you sign-up!!

Disclosure/Disclaimer

As a Tykr affiliate, Raising InvestorIQ earns from qualifying purchases. As a Seeking Alpha affiliate, Raising InvestorIQ earns from qualifying purchases.

Information provided on this site is based on my own personal experience, research, and analysis, and it is not to be construed as professional advice. Please conduct your own research before making any investment decisions.  I am not a professional financial advisor, stockbroker, or planner, nor am I a CPA or a CFP.

The contents of this site and the resources provided are for informational and entertainment purposes only and do not constitute financial, accounting, or legal advice. The author is not liable for any losses or damages related to actions or failure to act related to the content on this website.