Warren Buffett Book Report

Compared to Warren Buffett, his mentor Benjamin Graham never looked at owning a position in a company for long periods of time. Graham didn't want to invest in a company unless he could see significant results within a few years. However, despite being one of Graham's best disciples, Buffett chose to explore wealth creation possiblities by investing in companies with long-term advantages. In this book I learned about the different ways in which Warren Buffett analyzes the companies he chooses to invest in.

The purpose of this book is to explore Buffett's two revelations-

1.How do you identify an exceptional company with a durable competitive advantage?

2.How do you value a company with a durable competitive advantage?

- to explainhow his unique strategy works, and how he uses financial statements to put his strategy into practice.

Graham's short-term strategy was value investing, a practice where he focused on finding companies trading at less than what they held in cash. He called it buying a dollar for 50 cents. Buffett realized that many of the companies that Graham sold continued to grow, so he went into the financial statements of these companies to learn what made them wonderful companies. Buffett looks for three basic qualities in a company that is worthy of investment:

1.The company sells either a unique product or unique service.

2.The company is a low cost buyer.

3.The company sells a product that the public consistently needs.

Some examples of companies with these qualities are Coca-Cola, Pepsi, Wrigley, Hershey, Budweiser, and Philip Morris. Buffet thinks of these companies as owning a part of the consumer's mind. When this happens, the company won't feel the need to change it's product, which is a very good thing for companies and their investors. Consistency in the product is key. Costs for research and development become almost nonexistant, and the need for new technology decreases as well. The money that would be spent in these areas reduce debt and interest, allowing the company more opportunities to expand operations or buy back stock to drive the price up. In addition to consistency in the product, Buffett also likes to see consistency in the financial statements of his companies. He looks for consistently high gross margins, consistently operating expenses such as R&D, consistently high earnings, and consistently growing earnings.

In the income statement, Buffett can find profitability, margins, and the consistency and direction of earnings. Two companies that have high gross margins are Coca-Cola and Wrigley, both of which Buffett holds position in. Buffett steers clear of companies with extremely high selling expenses because they limit profit. Buffett believes that high R&D costs are a sign of an inherent flaw of a company which will be reflected in its long-term economics. Buffett also looks at the income statement to make sure that taxes have been paid. According to Buffett, companies that mislead the authorities usually mislead their shareholders as well. High net earnings don't impress Buffett because he cares about consistency and a high ratio of earnings to revenues.

In the balance sheet, he uses ratios as indicators of the balance between assets, debt, and equity. An increase of inventory alongside net earnings signals an increase in sales and profitability. An increase in goodwill means that a company is acquiring other businesses. It is important to have a healthy return on sales, return on assets, and return on equity because they measure how productive your assets are. In terms of long-term debt, Buffett likes companies with little to no long-term debt because they usually have some kind of competitive advantage in their industries. Debt should also not exceed equity, and a debt-equity ratio of less than .8 usually means that the debt is under control.

The last financial statement is the statement of cash flows. The cash flow statement tracks the cash that flows in and out of the business. It is good for seeing how much money is being spent on capital improvement. A durable company gains most of their cash inflow from operations. The cash flow statement also tracks the sales and repurchases of bonds and stock.

Buffett likes to buy in bear markets because the lower the initial investment, the higher the potential rate of return. However, finding a company that is worth buying is still important. An amazing company in a bull market is still not a smart investment. Buffett typically holds onto his stocks for as long as possible, but selling is a good option when there is a better opportunity or when a company might be losing its competitive advantage in the industry.

This book was very informative and relevant to this class. Although some of the content was not new information to me, it strengthened my understanding of investment strategy and accounting principles. Also, since I have read other books about Warren Buffett and his investment strategy, this book gave me a new perspective on how he thinks as an investor and businessman.