Don't Buy Any Stock in 2025 Unless It Passes This Test

As Warren Buffett, the renowned investor and CEO of Berkshire Hathaway, has been a net seller of stocks for eight consecutive quarters, it's clear that even the "Oracle of Omaha" is being cautious in today's market. Buffett's approach to stock selection is highly selective, and his two-part test can serve as a valuable guide for investors looking to make informed decisions in 2025. In this article, we'll explore Buffett's two-step process and discuss how investors can apply it to their own portfolios.



Buffett's two-step test for stock selection involves first determining whether he can "sensibly estimate an earnings range for five years out or more" for a company. This estimation is crucial because it helps Buffett avoid investing in businesses that might deliver strong earnings growth temporarily, only for that growth to evaporate quickly. In his 2013 shareholder letter, Buffett emphasized the importance of understanding a company's business and industry to make accurate earnings estimates.

The second step in Buffett's test is to buy a stock only if it trades at "a reasonable price" relative to the lower end of his estimated earnings range. This means that Buffett is looking for stocks that are undervalued based on his earnings estimates. By focusing on a company's earnings prospects and its valuation relative to those earnings, Buffett can make more informed decisions about whether a stock is a good investment.



To apply Buffett's two-step test to your own portfolio, follow these steps:

1. Estimate a company's earnings range for five years or more: Begin by thoroughly researching the company's business and industry to make a "sensible" earnings estimate for the next five years or more. Consider both optimistic and pessimistic scenarios, and use a range of possible earnings outcomes to account for uncertainty.
2. Determine if the stock is reasonably valued: Compare the stock's price to the lower end of your estimated earnings range. If the stock is trading at a reasonable price relative to its estimated earnings, it may be a good investment opportunity. Keep in mind that Buffett looks for a margin of safety, which means buying a stock at a price that provides a cushion against potential losses.

By following Buffett's two-step test, investors can make more informed decisions about which stocks to buy in 2025. This approach helps ensure that investors focus on companies with strong earnings prospects and reasonable valuations, reducing the risk of overpaying for a stock.

In conclusion, Warren Buffett's two-step test for stock selection offers a valuable framework for investors looking to make informed decisions in 2025. By estimating a company's earnings range for five years or more and determining if the stock is reasonably valued, investors can identify attractive investment opportunities and build a more resilient portfolio. As Buffett himself has demonstrated, a disciplined and selective approach to stock selection can lead to long-term success in the stock market.