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What
is Warren Buffet's Investing Strategy?
Even those who are not very familiar with
the world of the stock market have probably heard of Warren
Buffet. He has been called the most successful investor
of all time. He netted over $42 billion personally with an investment
partnership he started with only $100.
While he has been sometimes categorized as a “value stock
investor” his method was actual a bit different. He focused
on the quality of stock as well as the value. Robert Hagstrom,
a senior vice president with Legg Mason Capital Management,
presented Buffet’s method in the book “The Warren Buffet Method”
over 10 years ago. Hagstrom wrote the book because he believed
that the average investor could learn from Buffet’s method.
Buffet’s incredible story begins with a small investment partnership
established in 1956. In the mid-1960s, this partnership acquired
a failing textile company. Buffet was able to bring this company’s
net worth from $22 million to $69 billion.
The
Buffet method is broken down into 12 tenants that form
the basis for evaluating any investment, from stocks to entire
companies. One of the key points in the method is that it is
necessary to do some hard work (like research and projections)
in order to know the investments thoroughly before any money
exchanges hands.
The twelve tenets are really questions
to ask yourself before
making an investment. According to Buffet via Hagstrom, the
first consideration is “Is this business simple and understandable?”
Buffet did not invest in any technology stocks for the simple
reason that he did not understand them. If you understand the
business you are investing in (or outright purchasing) you
will be in position to see the problems and possibilities as
they arise. Secondly, ask yourself “Does the company have a
consistent operating history?” Viewing the viability of the
business in its previous operation can forecast future trends.
The third tenant is “Does the business have favorable long-term
prospects?” This question is a gentle reminder that wise investors
hold stock in good companies for the long term. Looking to
the future of the companies reveals the true value of the investment.
Next, “Is the management rational?” Buffet places a great
deal of importance on evaluating the management of the company.
He pays attention to how the excess profits of a company are
used. Additionally, he asks “Is the management candid with
shareholders?” He believes that many company executives hide
behind the company and do not fully disclose information to
their shareholders. A manager who readily admits any mistakes
made is more honorable and trustworthy. Following the theme
of management related questions is “Does the management resist
the institutional imperative?” Essentially this question evaluates
the manager’s ability to act with character rather than cave-in
to the peer pressure to do what other managers are doing.
The next question for evaluation is “What is the return on
equity?” Buffet focuses on return on equity rather than the
more popular ratios. This is because he feels earnings figures
can be manipulated. The long term return on equity will have
a more powerful effect than simple earnings.
The 8th tenant is “What are the company’s owner earnings?”
His calculations of owner’s earnings include estimates of future
capital expenditures. The 9th tenant is “What are the profit
margins?” If a company makes sales but does not profit, then
the company is a failure. Buffet avoids companies with large
expenses because in his eyes it reflects a lack of discipline
in the management of the company.
The 10th tenant is “Has the company created at least one dollar
of market value for every dollar retained?” This is a test
of correct capital allocation. If the company is holding onto
cash but is not helping its shareholders than something is
wrong with the management strategy.
The final two questions are “What is the value of the company?”
and “Can it be purchased at a significant discount to its value?”
Buffet calculates the value of a company as the total of the
net cash flow expected to occur in the life of the business.
By buying at discount, an investor will assure that any discrepancies
in his calculations will be covered. # # # # # SolveYourProblem.com : 2007
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