Billionaire investor Warren Buffett has a tremendous track record of buying undervalued shares of high-quality companies. His investment strategy has shifted slightly over time. However, his approach of putting value at the forefront has led to his Berkshire Hathaway portfolio generating an average 19.8% annualised return since 1965. 

Even after an impressive double-digit rally over the last 12 months, there remains plenty of underappreciated businesses in the stock market both in the UK and abroad. And by adopting Buffett’s investing strategy, investors could position their portfolios to reap significantly higher returns in the coming years.

Focusing on quality at a reasonable price

Early on in Buffett’s investing journey, he was primarily focused on finding the biggest and best bargain stocks money could buy. This included mediocre businesses that were doomed for bankruptcy but whose liquidation value was still greater than their market price.

However, his strategy has since evolved. And today, his focus is on investing in high quality companies trading at a fair price. That still predominantly results in undervalued shares being added to the Berkshire Hathaway portfolio.

But it’s also opened the door to some of his more recent success stories, such as the addition of Apple (NASDAQ:AAPL) in 2016, which has gone on to generate an 800% return.

The importance of competitive advantages

Business quality comes in many forms, from financial strength to market dominance. And finding quality companies today isn’t all that difficult since they’re usually the ones with the largest market-caps. However, with so much growth already achieved, the opportunity to earn triple- or even quadruple-digit returns has likely already largely passed.

The challenging part is identifying top-notch enterprises before they’ve made it to the top. And on this front, Buffett’s always focused on a firm’s competitive moat. Let’s take another look at Apple. A big contributor to the group’s long-term success undeniably stems from the pricing power that emerged from a cult-like following from customers.

When shoppers are willing to queue outside an Apple store overnight to get the latest iPhone, that’s a clear signal a business is doing something right. And even today, in a world with intensifying competition, Apple customers are still sticking with an iPhone despite far cheaper equivalents in the Android market.

Balancing risk with reward

A core philosophy of Buffett’s strategy is to never invest in something that’s too difficult to understand. Investors who don’t know the inner workings of a business or its industry are unlikely to be able to spot weaknesses and risks before it’s too late. And even the biggest companies in the world today have their weak spots.

Looking again at Apple, despite all its pricing power, it seems demand for its latest iPhone 16 has been fairly subdued comparing the early launch sales versus previous editions.

Apple pundits claim this is largely due to adverse economic conditions within the global consumer electronics industry rather than a lack of interest from customers. And to be fair, the economic slowdown in electronics has hit many other businesses, lending credence to this theory.

But even if that’s true, it reveals that even one of the largest businesses in the world is susceptible to cyclical downturns – a threat that investors must consider before allocating capital.