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THE WARREN BUFFET WAY- Investment Strategies of the World’s Greatest Investor

  1. 1. 1 THE WARREN BUFFET WAY Investment Strategies of the World’s Greatest Investor By Robert G Hagstrom Roziana Mohammad
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  3. 3.  86 years old  An investment guru  No. 4 richest man in 2014 one of the richest  Most successful stock market investors for the past 30 years  CEO of Berkshire Hathaway – investing in stocks and buying companies  Mentor : Benjamin Graham (Father of value investing and Dean Wall Street  Theory : “Mr Market” and “Margin of Safety”  A mix approach investment from Ben Graham and Philip Fisher Source : Forbes 2014 WARREN BUFFET – “THE ORACLE OF OMAHA” 3
  4. 4. • Only buy stocks at a price that is well below an intrinsic value of the business – determined by assets, earnings, dividends and future values • Provides high-return opportunities but also gives some protection on the downside if things don't work out as planned Principle No. 1: Always Invest With a Margin of Safety Principle No. 2: Mr MARKET – Expect Volatily and Profit from It Mr Market as a business partner who offers to buy or sell you his interest daily. Price could be high or could below and an investor you are free to buy his interest, sell out to him or ignore if you don’t like the price. He will always come back tomorrow with a different offer. Have freedom to say no and think rationally. BENJAMIN GRAHAM – FATHER OF VALUE INVESTING 4
  5. 5. Type of Investors Defensive Aggressive/Enterprise Investors Based on willingness and ability to bear on the task • Eg. Doctor – not able to spend too much time to the process • Focus on shares of companies that have strong financial background and long term profitable companies • Eg. a sharp young executive interested in finance) • Expand their universe substantially, but purchases should be attractively priced as established by intelligent analysis Understanding the business and economic conditions Portfolio diversification • Highly believer in defensive investing and protecting a portfolio against errors in judgment • Recommends purchase of a minimum of 10 different issues and a maximum of 30. – Low risk, good return, buy and hold for long term • Stock holdings should be reviewed at least annually, focus on dividend returns and the operating results of the company, and ignore share price fluctuations • Take advantage on the market fluctuation on the upside – stocks overvalued • Have some understanding of business and economic conditions and will form some opinion concerning the prospects of a firm or industry • Use Historical data – historical rates provide a starting point, not representing future but it gives some indicatives of future rates • Use the proper historical rate requires considerable investment judgment • Make decision based on quantitative than qualitative factors BENJAMIN GRAHAM INVESTMENT PRINCIPLES 5
  6. 6. “I am 85% of Benjamin Graham” “Risk comes from not knowing what you're doing” -Warren Buffet- Combo investment approach of Ben Graham and Philip Fisher Rule No. 1: Never Lose Money, Rule No. 2 : Never Forget Rule No. 1 Be a sensible investor.. Don’t be frivolous Don’t gamble Don’t go into an investment with a cavalier attitude Be informed on the companies’ operating results not by the short term fluctuations Be patient and go for the value of business Do your homework – if you know more about a company, why give more attention on what market says? Buy shares because you believe in the company – intend owning it for number of years NEVER FOLLOW THE DAY TO DAY FLUCTUATIONS OF THE STOCK MARKET ONLY check the market for anyone who sells a good business at a GREAT PRICE!
  7. 7. Don’t try and analyse or worry about the general economy If the business does well, the stock eventually follows…. Impossible to predict the stock on daily basis Impossible to forecast what the economy will do in the next 5 years Don’t assume that that the direction comes from the economy predicted Find a business that exhibit favourable for LONG TERM prospects – more VALUABLE Does the company :-  Have a CONSISTENT operating profit?  Have a DOMINANT franchise?  Is the business generating HIGH and SUSTAINABLE profit margins? A business that has ability to PROFIT in ANY economic environment is very VALUABLE! 7
  8. 8. It is better to buy a wonderful company at a fair price than a fair company at a wonderful price Buy a business NOT a stock Buy QUALITY stocks and look for a company with..  Business operations that are UNDERSTOOD  FAVOURABLE long term business prospects  Operated by HONEST and COMPETENT people  Available at an ATTRACTIVE price Assess companies based on :- Business tenets – Simple and understandable business? Operating History? Profitable/Good Prospects? Management tenets – Rational management? Honest with its shareholders? Financial tenets – Return on equity not EPS, calculate owner earnings, search companies with high profit margins, for every $1 of retained earnings, has the company created at least $1 worth of extra value? Market tenets – Value of business? Right company at the right price – with MoS against unknown risk? 8
  9. 9. Act like a owner of the business and NOT the owner of a piece of paper Manage a portfolio of businesses UNDERSTAND the company’s operating fundamentals DIVERSIFICATION only required when the investor does not know what they are doing. NOT MANY business owners are COMFORTABLE AND EXPERIENCED to operate a number of companies portfolio at the same time. Only BUY shares at the companies which are thoroughly UNDERSTOOD “ Perfect timing is where, we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”
  10. 10. In the nutshell.. Buffet’s investment strategy is to locate wonderful companies with long term value and fairly priced stock. He understands the business that he is comfortable with, and acts like a business owner rather that a stock market speculator. He champions the value investment strategy, maintains a longer perspective at all times, and never loses sight of the underlying value of a business. 10
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Notes de l'éditeur

  • Buffett is Chairman of Berkshire Hathaway (BRK.A) a holding company for a diverse set of businesses, which he developed from an unprofitable textile manufacturing operation. Berkshire Hathaway makes most of its profits from buying and owning entire companies. Buffett does hold these businesses indefinitely and makes very long-term plans for those companies that may encompass planning ahead 50 years or even more

    Value investing is an approach that is widely used today by individual investors and portfolio managers

    Intrinsic value is justified by a firm’s assets, earnings, dividends, and financial strength. Focusing on this value, he felt, would prevent an investor from being misled by the misjudgments often made by the market during periods of deep pessimism or euphoria

    Philip Fisher investment approach is focused more on qualitative metrics – on companies with the ability to grow sales and profits over the years at rates greater than the industry average.
  • Intrinsic value- The actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value.

    Concept of MoS is important - as value investing can provide substantial profits once the market inevitably re-evaluates the stock and raises its price to fair value. It also provides protection on the downside if things don’t work out as planned and the business falters. Graham believes that that identifying undervalued stocks, regardless of market sentiments was the key to stock market investment success.
    2 Key approaches in buying shares:-
    1.Buy for less than 2 thirds a company’s net asset value
    2. Focus only on low price to earning ratio stocks

    In other words, volatility refers to the amount of uncertainty or risk about the size of changes in a security's value. A higher volatility means that a security's value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security's value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.

    One measure of the relative volatility of a particular stock to the market is its beta. A beta approximates the overall volatility of a security's returns against the returns of a relevant benchmark

    Mr Market
    Mr. Market,” the imaginary business partner of each and every investor. Mr. Market offers investors a daily price quote at which he would either buy an investor out or sell his share of the business. ​Sometimes, he will be excited about the prospects for the business and quote a high price. Other times, he will be depressed about the business’s prospects and will quote a low price.
    Because the stock market has these same emotions, the lesson here is that you shouldn’t let Mr. Market’s views dictate your own emotions or, worse, lead you in your investment decisions. Instead, you should form your own estimates of the business’s value based on a sound and rational examination of the facts. Furthermore, you should only buy when the price offered makes sense and sell when the price becomes too high. Put another way, the marketwill fluctuate–sometimes wildly–but rather than fearing volatility, use it to your advantage to get bargains in the market or to sell out when your holdings become way overvalued.
  • Type of Investors
    Long term profitable companies here means –substantial size with a leading position in industry, which could be a company who holds a large pie or 2nd large pie in the market share of the industry.

    Key rules for defensive investors:-
    Adequate size: Exclude small companies with less than $100 million of annual sales for industrial companies and $50 million of total sales for public utilities. – with 5% annual growth rate i.e. public utility companies
    • Strong financial condition: For industrial companies, current assets (cash, accounts receivable and inventory) should be at least twice current liabilities (short-term debt), and long-term debt should not exceed the net current assets (working capital, or current assets less current liabilities); for public utilities the debt should not exceed twice the stockholders’ equity (total assets less total liabilities).
    • Earnings stability: Positive earnings for at least the last five years.
    • Strong dividend record: Uninterrupted dividend payments for at least the past 20 years.
    • Earnings growth: Minimum increase of at least one-third in earnings per share in the past 10 years (a 2.9% average annual growth rate over 10 years).
    • Moderate price-to-earnings ratio: The current price should not be more than 15 times average earnings for the past three years.
    • Moderate price-to-book-value ratio: The current price should not be more than 1½ times the last reported book value

    Enterprise Investors
    No restrictions; stocks of unpopular large companies and secondary companies (ones that are not leaders in a fairly important industry) considered particularly promising.

    Be willing to buy something no one else wants, cheaply. Key rules when investing:-
    Size: Select from a wider universe of stocks. • Financial condition: Current assets should be at least 1½ times current liabilities, and debt should not be more than 110% of net current assets. • Dividend record: Some level of dividend payments. • Price-to-book-value ratio: The price should be less than 120% of net tangible assets

    Graham thought enterprising investors could also find success investing in secondary companies if purchased as bargains. A secondary company is defined by Graham as one that is a smaller concern in an important industry, or a top firm in an unimportant industry; many mid-sized listed companies. In general, Graham felt the stock market tends to undervalue these firms. At the same time, he believed these firms were large enough to sustain themselves through various economic environments, with the ability to earn a fair return on invested capital; investors would thus profit both from earnings paid in dividends and those that were reinvested. And in bull markets, he noted, the price of these firms often advances to full valuation.

    Portfolio diversification
    investors should take advantage of market fluctuations on the upside, when a stock becomes overvalued (or fairly valued for stocks that were purchased at below their intrinsic value); at these times, investors should sell and replace their holding with one that is more fairly valued or undervalued.
    Price declines are a welcome way to add more shares to your portfolio. As long as you are investing in a soundly run business with good fundamentals, management and prices it will give good return
  • Philip Fisher use a qualitative metrics thru interviewing customers, competitors and consultants. He will always look for companies
    That are dedicated to maintaining their competitive advantage and strengthening their market position.
    That could grow without requiring additional equity financing. If a company expanded on the strength of its products and services rather than by
    expanding its capital base, Fisher thought that predicted well for the future.
    That have a great Mgt capabilities – good working relationships in a company

    He believed in holding stock in a few outstanding companies than a large number of average companies.

    Like fisher, Buffet is willing to invest in a small number of good companies, rather than diversify across a large no. of companies that he doesn’t understand as well.
  • Buffett looks not at the performance of a given stock, but at the performance of the underlying business. This is critical, because a strong underlying business means that an investment will almost always payoff, at least sooner or later.

    The reason why most investors fail to follow Buffett’s advice in this regard is because it requires a lot more work. You actually have to research the individual companies, and have a keen understanding of their business and how well they are faring against the competition. Market sentiment of the company’s stock has little to do with it.

    One of Buffett’s hallmark investment strategies is a investing in quality.
    This means that he invests in companies that have well-known, well-regarded products that add value to the consumer and the economy. The companies he inverts money in are usually household names, which is to say that they have both strong market penetration and brand recognition.

    Many less successful investors are drawn to companies and industries that they know little or nothing about. They assume that the less they know, the more likely it is that the investment will be a success, as though it will succeed based on some unexplained mystery factor. Quality – not mystery – makes a company a long-term winning investment.

    He does this by buying companies that are selling at a discount to their real value. This strategy is more commonly referred to as value investing, which is the practice of buying stock in companies that are undervalued compared to other companies in their industry, as well as to the general market.

    While many investment analysts tend to focus on a company’s numbers, market position, specific assets, and even public sentiment, Buffett looks more closely at management. Every one of those tangible metrics can change in the future, substantially weakening a company. But the caliber of management represents the future of the business. With the right people at the helm, the business will grow and prosper no matter what challenges it may face.

    Buffet has this down to a science. He looks at the fundamentals of a company – it’s earnings, revenue, price-earnings ratio, return on equity and dividend yield, among other metrics – then he compares them to the same metrics in competing companies. If the company is generally strong compared to the competition, but the stock price is well below them, it becomes an investment candidate.

  • Be in the game for the Long Haul
    When you look at the companies that Buffett either owns individually, or through Berkshire Hathaway, they’re all long-term investments. Buffett will buy stocks and hold onto them – not for years – but for decades. As long as the business is strong, the investment will payoff. Buffett’s track record, and the size of his portfolios, are testaments to the success of this strategy.