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The Warren Buffett Way
By Robert G. Hagstrom
The Warren Buffett Way by Robert G. Hagstrom provides insight into the investment principles used by America's greatest investor, Warren Buffett.
In 1956, Buffett started his first investment partnership with $100. He cashed out after 13 years with $25 million, achieving a compounded rate of investment return of 29.5% for his investors. Today, Buffett's net worth is about $43 billion.
We learn two different schools of investment thought influenced Buffett. Ben Graham taught Buffett to seek value. Philip Fisher and Buffett's investment partner Charlie Munger taught Buffett to seek quality companies with the potential to grow their earnings.
To determine a stock's value, Buffett examines the business behind the stock and evaluates the company's worth by making an estimate of the future cash flows of the company and then discounting these cash flows back to their present value. Buffett only purchases the company if the purchase price is below its discounted value. This provides Buffett a margin of safety.
Hagstrom explains that Buffett uses a focused approach to investing and often only holds a handful of stocks. And, Buffett invests within his "circle of competence" which usually involves traditional companies Buffett understands. Buffett avoids high-tech investments in companies he doesn't understand. Buffett prefers companies he could hold forever. He avoids businesses without a solid track record or businesses lacking honest and competent management.
The Warren Buffett Way shows how Buffett's investment criteria came into play for several major companies he purchased, including GEICO (Berkshire Hathaway, Buffett's company, owns 100% of GEICO), Clayton Homes (mobile homes), The Pampered Chef (kitchenware sold direct at in-house parties), Gillette, and Coca-Cola. The book's appendix lists Berkshire's major stock holdings each year from 1977 to 2003.
Buffett is most likely to purchase entire companies today. Smaller successful investments do little to grow Berkshire Hathaway.
So, can investors today benefit from Buffett's investment approach? Yes and no, argues Hagstrom. For example, Buffett spends a great deal of time reading annual reports to learn about a company.
Hagstrom writes: "It must be said here, with sadness, that it is possible that the documents you study are filled with inflated numbers, half-truths, and deliberate obfuscations. We all know the names of the companies charged with doing this; they are a rogue's gallery of American businesses, and some of their leaders are finding themselves with lots of time in prison to rethink their actions. Sometimes the manipulations are so skillful that even forensic accountants are fooled; how then can you, an investor without any special knowledge, fully understand what you are seeing? The regrettable answer is, you cannot."
Hagstrom shares a few of Buffett's tips for spotting accounting problems and irregularities in financial documents, such as looking for "unintelligible footnotes."
Also, today, the stock market is composed of many more companies. Hagstrom relates the story of Buffett's interview on the show Money World:
"Appearing on the PBS show Money World in 1993, Buffett was asked what investment advice he would give a money manager just starting out. 'I'd tell him to do exactly what I did 40-odd years ago, which is to learn about every company in the United States that has publicly traded securities.'
Moderator Adam Smith protested, 'But there's 27,000 public companies.'
'Well,' said Buffett, 'start with the A's.'"
Further, Hagstrom argues too many desirable investments are in the field of high technology. To those investors wishing to follow Buffett's approach to investing, Hagstrom suggests: "…expand your circle of competence by studying intently the business models of the companies participating in the New Economy landscape…" Investors who are less willing to spend time understanding business might want to consider indexing their money in a low-cost mutual fund instead.
If you want to understand the investment principles of Warren Buffett, I highly recommend The Warren Buffett Way.