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  • 8/12/2019 WARREN BUFFET Book Summary.doc

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    THE WARRENBUFFETT

    WAY

    Investment Strategies of the

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    Worlds Greatest Investor

    RBERT G! HAGSTR"MAINIDEA

    Warren B#ffett is one of the most s#$$essf#l sto$% mar%etinvestors of the &ast '( )ears!

    His entire a&&roa$h is to fo$#s on the val#e of the *#siness and its mar%et &ri$e! n$e B#ffettfinds a *#siness he #nderstands and feels $omforta*le +ith, he a$ts li%e a *#siness o+nerrather than a sto$% mar%et s&e$#lator! He st#dies ever)thing &ossi*le a*o#t the *#siness,*e$omes an e-&ert in that field and +or%s +ith the management rather than against them! Infa$t, often his first a$t on *#)ing shares in an) $om&an) is to grant the managers his &ro-)vote for his shares to ass#re them that he has no intention to tr) and move the $om&an) a+a)from its $ore val#es!

    B#ffett $ham&ions the val#e investment strateg), and ts no $reden$e in da) to da)movements in share &ri$es, the im&a$t of the e$onomi$ mood overall or an) other e-ternal

    fa$tors! He maintains a long.term &ers&e$tive at all times, and never loses sight of the#nderl)ing val#e of a *#siness!

    THE BUFFETT APPROACH TOINVESTMENT

    /! Never follo+ the da) to da) fl#$t#ations of the sto$% mar%et!

    The mar%et onl) e-ists to ma%e it easier to *#) and sell, not to set val#es! 0ee& an e)e onthe mar%et onl) for someone +ho is +illing to sell a sto$% at a not.to.*e.missed &ri$e!

    1! 2ont tr) and anal)3e or +orr) a*o#t the general e$onom)!

    If )o# $ant &redi$t +hat the sto$% mar%et +ill do from da) to da), ho+ $an )o# relia*l)&redi$t the fate of the e$onom)4

    '! B#) a *#siness, not its sto$%!

    Treat a sto$% r$hase as if )o# +ere *#)ing the entire *#siness,

    #sing the follo+ing tennets5 B#siness Tennets

    /! Is the *#siness sim&le and #nderstanda*le from )o#r &ers&e$tive as an investor4

    1! 2oes the *#siness have a $onsistent o&erating histor)4

    '! 2oes the *#siness have favo#ra*le long.

    term &ros&e$ts! "anagement Tennets

    /! Is management rational41! Is management $andid +ith its

    shareholders4 Finan$ial Tennets

    /! Fo$#s on ret#rn on e6#it), not earnings &er share!

    1! 7al$#late 8+ner Earnings8!

    '! Sear$h for $om&anies +ith high &rofit margins!

    9! For ever) dollar of retained earnings, has the $om&an) $reated at least one

    dollars e-tra mar%et val#e4 "anagement Tennets

    /! What is the val#e of the *#siness4

    1! 7an the *#siness $#rrentl) *e r$hased at a signifi$ant dis$o#nt to its val#e4

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    9! "anage a &ortfolio of *#sinesses!

    Intelligent investing means having the &riorities of a *#siness o+ner :fo$#sed on long.termval#e; rather than a sto$% trader:fo$#sed on short.term gains and losses;!

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    The Warren Buffett Way - Page4 -

    1. WARRENBUFFETT

    In the /

    t#rnover of=1!( *illion and earned =/? millionafter ta- . a*o#t '.&er$ent of the gor#&so&erating earnings!

    Warren B#ffett and his +ife no+ o+n aro#nd9(.&er$ent of the sto$% of Ber%shire.Hatha+a)He +or%s as 7hief E-e$#tive of the $om&an)for an ann#al salar) of =/((,((( &er )ear"an) of his em&lo)ees +ho manage different&arts of the $om&an) earn m#$h more!

    Ber%shire.Hath+a) had a $or&orate net +orthof =11 million +hen Warren B#ffett ass#med

    $ontrol! Toda), it is +orth more than =/(!1*illion! B#ffetts goal is to in$rease the$om&an)s +orth *) a /.&er$ent $om&o#ndrate ea$h )ear!

    Ber%shire &a)s no dividends *#t reinvests almone) earnt! Therefore, shareholders loo% toa $a&ital gain in the val#e of their sto$%! Sin$e/

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    The Warren Buffett Way - Page5 -

    2. TWO MENTORS

    "ainIdea

    Warren B#ffets investment methodolog) is ah)*rid mi- of the strategies t for+ard *) t+o/

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    '! "argin of Safet)A&&roa$hInvest onl) in $om&anies +hi$h have a largemargin *et+een earnings and fi-ed $osts! Ina do+nt#rn, that $om&an) is most li%el) toride o#t a re$ession +ell! A&&l)ing this$on$e&t to a sto$%, *#) shares onl) in a

    $om&an) for +hi$h the share &ri$e is *elo+its intrinsi$ val#e as determined *) assets,earnings, dividends and f#t#re &ros&e$ts!

    Graham strongl) advo$ated the margin ofsafet) a&&roa$h +ith investment in $ommonsto$% of gro+th $om&anies! His a&&roa$h toinvestment +as to r$hase gro+th$om&an) shares +hen the overall mar%et istrading at a lo+ &ri$e or +hen gro+th$om&an) shares are trading *elo+ theirintrinsi$ val#e! Ho+ever, sin$e *#)ing at

    mar%et lo+s is ever)ones o*@e$tive, there isno $om&etitive advantage in that a&&roa$h!Therefore, Graham s#ggested thatidentif)ing #nderval#ed sto$%s, regardlessof mar%et sentiment, +as the %e) to sto$%mar%et investment s#$$ess!

    Intrinsi$ val#e is $losel) lin%ed to a$om&an)s f#t#re earning &o+er and fi-ed$osts! It is hard or real assets &l#s the f#t#reval#e of the earnings those assets +ill

    &rod#$e!Graham advo$ated t+o a&&roa$hes to*#)ing shares5/! B#) for less than t+o.thirds a $om&an)snet asset val#e!1! Fo$#s onl) on lo+ &ri$e.to.earningsratio sto$%s!

    These sto$%s +ill generall) *e o#t of favo#r+ith mar%et sentiment! The mar%etineffi$ien$), $reated *) emotions, generatesval#a*le o&&ort#nities for the rationalinvestor!

    1! Chili& Fisher

    A#thor of "ommon Stoc#s And $ncommon%rofits, Fisher +as a sto$%*ro%er +ho set #&in *#siness @#st after the /

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    al+a)s tried to garner an a$$#rate &i$t#re ofrelative strengths and +ea%nesses *) hisresear$h!

    Fisher s#ggested it +as *etter to holdsto$% in a fe+ o#tstanding $om&aniesthan a large n#m*er of average $om&anies!He al+a)s invested +ithin his o+n $ir$le of$om&eten$e . that is, +ith $om&anies he

    #nderstood and felt $omforta*le +ith!

    3. FOUNDATIONS OF THE BUFFETTAPPROACH

    "ainIdea

    Warren B#ffett lets $om&anies inform him *)their o&erating res#lts, not *) short.term sto$%mar%et fl#$t#ations! His is a ver) &atientinvestment strateg) *ased on the val#e of the

    *#siness! B#ffetts +hole a&&roa$h is to loo% ata share r$hase from the &ers&e$tive of a*#siness o+ner rather than as a sto$% mar%etda**ler!

    S#&&ortingIdeas

    /! There is a large differen$e *et+eeninvesting in a &arti$#lar sto$% and tr)ing to&redi$t the dire$tion of the general mar%et!

    In s&ite of te$hnolog), it is still &eo&le that

    ma%e mar%ets! Investor sentiment has thelargest infl#en$e over short.term mar%etdire$tion and sta*ilit)! Ho+ever, the long.term val#e of a sto$% is #ltimatel)determined *) the e$onomi$ &rogress of the*#siness, not the da).to.da) mar%etfl#$t#ations!

    1! The "r! "ar%etAllegor)!

    Imagine )o# are the o+ner of a small

    *#siness in &artnershi& +ith "r! "ar%et!Ever) da), "r! "ar%et 6#otes )o# a &ri$e at+hi$h he is +illing to *#) )o#r half of the*#siness or sell )o# his half! While the

    *#siness is so#nd and ma%es good&rogress, "r! "ar%ets 6#otes var) +idel)a$$ording to the mood he is in!

    When he is in an #&*eat mood, his &ri$e ise-$e&tionall) high! 7onversel), stri%e him ona *ad da) and he is ver) &essimisti$ and6#otes an #n#s#all) lo+ &ri$e!

    If )o# +ere in *#siness +ith "r! "ar%et and

    )o# tried to ta%e advantage of his +isdom,)o# +o#ld *e on an emotional roller $oasterride! Rather, it is "r! "ar%ets &o$%et*oo%)o# sho#ld ta%e advantage of, not his+isdom! It is disastro#s if )o# fall #nder hisinfl#en$e!

    A s#$$essf#l sto$% mar%et investor sho#ldt aside the emotional +hirl+ind "r!"ar%et #nleashes on the general mar%etever) da) and e-er$ise so#nd *#siness

    @#dgement!'! Investors m#st *e finan$iall) and

    &s)$hologi$all) &re&ared to deal +ith theever)da) mar%et fl#$t#ations! Unless )o#$an +at$h the val#e of )o#r sto$% holdingsde$line *) (.&er$ent or more +itho#t*e$oming &ani$ stri%en, )o# +ill nevers#$$eed!

    9! Cri$e de$lines are a +el$ome +a) to addmore shares to )o#r &ortfolio at a lo+er&ri$e! As long as )o#r are investing in aso#ndl) r#n *#siness +ith goodf#ndamentals, management and &ri$es, themar%et +ill event#all) a$%no+ledges#$$ess!

    ! The a*ilit) to sa) DDno #nless all the fa$tsare in )o#r favo#r is a signifi$ant advantagefor an) sto$% mar%et investor! Rather than$onstantl) *#)ing and selling shares inmedio$re *#sinesses on the strength of ar#mo#r, B#ffett *#)s and holds shares

    &ermanentl) in @#st a fe+ o#tstanding,+ell.managed *#sinesses! His a&&roa$h isal+a)s to +ait &atientl) #ntil a tr#l) greatinvestment o&&ort#nit) s#rfa$es and then goto it!

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    ?! Investment s#$$ess is not the same asinfalli*ilit)! Instead, s#$$ess $omes a*o#t *)doing more things right than +rong! To dothat, red#$e the n#m*er of things )o# $anget +rong and fo$#s on the things )o#e-&e$t to get right!

    ! The "ar%et R#mo#r

    Cara*leAn oil &ros&e$tor +as met at the gates ofheaven *) St! Ceter +ho told him there +asno room for him to $ome in! The &ros&e$toras%ed if he might sa) @#st fo#r +ords to theoil &ros&e$tors &resent! He )elled, DDildis$overed in Hell With that, all the oil menmar$hed o#t of heaven headed for hell! St!Ceter +as im&ressed and invited the man inno+ there +as &lent) of room! DDNo than%s,

    said the ne+$omer! DDI thin% Ill @#st go along+ith the rest of the *o)s! There @#st might *esome tr#th to that r#mo#r after all!

    2es&ite all the e-&erien$e and ed#$ational6#alifi$ations fo#nd in sto$% mar%etinvestors :in$l#ding instit#tions;, it still a$tsirrationall) and +ith a DDfollo+ the mo*mentalit)! B#ffett ta%es no $omfort fromhaving DDim&ortant &eo&le agree +ith him,and does not lose $onfiden$e +hen the)disagree!

    >! An investor and a *#siness&erson sho#ldloo% at a $om&an) in the same +a)! The*#siness&erson +ants to *#) the entire$om&an) +hile an investor +ants a &art!

    The first 6#estion an) *#siness&erson +illas% is, DDWhat is the $ash generating&otential of this $om&an)4 ver time, there+ill al+a)s *e a dire$t $orrelation *et+eenthe val#e of a $om&an) and its $ashgenerating $a&a$it)! The investor +o#ld

    *enefit *) #sing the same *#sinessr$hase $rieria as the *#siness&erson!

    7hange )o#r thin%ing from *#)ing andselling shares in a $om&an) to *#)ing andselling a *#siness )o# +ant to o+n and)o#ll have a m#$h im&roved &ers&e$tive!

    >! Short term &ri$e fl#$t#ations are an #n+ise$riteria *) +hi$h to @#dge a $om&an)ss#$$ess! Instead, loo% at5.. Ret#rn on *eginning

    shareholders e6#it)!

    .. &erating margin$hanges!.. 2e*t level$hanges!.. The $om&an)s $ashgenerating a*ilit)!

    That is, #se e$onomi$ $riteria rather than

    &ri$e $hanges!

    With this a&&roa$h, investors a$t li%eo+ners of the $om&anies the) o+n sharesin! The) &rovide &atient $a&ital allo+ingmanagement to rs#e long.term gro+tho&&ort#nities! Sto$% is held long.term andinvestors +or% +ith management to im&rove$or&orate &erforman$e!

    /(! Warren B#ffett #s#all) assigns voting rights

    for shares he r$hases to the managementof the $om&an)! That sends the $lear signathat he is not see%ing $hanges! He avoids$om&anies in need of ma@or overha#lsHe also avoids $onfronting management toim&rove shareholder ret#rns! B#ffett sim&l)+ill not invest in an) $om&an) +hi$h he$onsiders re6#ires a $hange in offi$ers*efore tr#e val#e $an *e reali3ed! Hedoes not loo% for a $om&an) +hi$h is#ndergoing a t#rnaro#nd or restr#$t#ring

    e-er$ise, as this $reates a sit#ation in +hi$hthere are too man) varia*les!

    //! B#ffett is 6#ite $ontent to hold an) se$#rit)indefinitel), so long as the &ros&e$tiveret#rns on e6#it) $a&ital of the *#siness

    is satisfa$tor), managemenisshareholder.oriented and $om&etent andthe mar%et does not overval#e the *#sinessGenerall) s&ea%ing, B#ffett sells onl) +henthe sto$% &ri$e sho+s the mar%et isa&&re$ia*l) overval#ing the *#siness *) hisre$%oning!

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    0e)Tho#ghts

    The farther one gets from &all Street, the

    more s#epticism one will find as to the

    pretensions of stoc#'mar#et forecasting or

    timing.!!

    .. BenGraham

    I have long felt that the only value of stoc#forecasters is to ma#e fortune tellers loo#good.!!

    .. WarrenB#ffett

    The most common cause of low prices is

    pessimism ' sometimes pervasive,

    sometimes specific to a company or industry.

    &e want to do business in such an

    environment, not because we li#e pessimism

    but because we li#e the prices itproduces. It!soptimism that is the enemy of rational buyers.!!

    .. WarrenB#ffett

    An investor should act as though he had a

    lifetime decision card with (ust twenty punches

    in it. &ith every investment decision his card is

    punched, and he has one fewer for the rest of

    his life.!!

    .. Warren

    B#ffett

    As time goes on, I get more and more

    convinced that the right method in investments

    is to put fairly large sums into enterprises

    which one thin#s one #nows something about

    and in management of which one thoroughly

    believes. It is a mista#e to thin# that one

    limits one!s ris#s by spreading too much

    between enterprises about which one #nows

    little and has no special reason for special

    confidence. One!s #nowledge and e)perienceis definitely limited and there are seldom more

    than two or three enterprises at any given time

    which I personally feel myself entitled to put full

    confidence.!!

    .. ohn "a)nard0e)nes

    The reasonable man adapts himself to the

    world. The unreasonable one persists in trying

    to adapt the world to himself. Therefore all

    progress depends on the unreasonable man.!!

    .. George Bernard

    Sha+

    "an you really e)plain to a fish what it!s li#e to

    wal# on land* One day on land is worth a

    thousand years of tal#ing about it and one day

    running a business has e)actly the same #ind

    of value.!!

    .. WarrenB#ffett

    Invest within your circle of competence. It!s

    not how big the circle is that counts, it!s how

    well you define theparameters.!!.. Warren

    B#ffett

    +ationality is the uality that uffett thin#s

    distinguishes his style with which he runs

    er#shire ' and the uality he often finds

    lac#ing in other corporations.!!

    .. 7arol oomis, Fortune-againe

    eware of past performance proofs in

    finance. If history boo#s were the #ey to

    riches, the Forbes /00 would consist of

    librarians.!!

    .. WarrenB#ffett

    After we buy a stoc#, conseuently, we would

    not be distrurbed if mar#ets closed for a year

    or two. &e don!t need a daily uote on our 100

    percent position in See!s or 2.2. rown to

    validate our well being. &hy, then, should we

    need a uote on our 3 percent interest in"o#e*!!

    .. WarrenB#ffett

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    "ain Idea

    4. THE WARRENBUFFETT WAY

    /! B#siness Tennets

    Business Tennet 1.

    Is the business simple andunderstandable from the

    Rational allo$ation of $a&ital is the %e) to an)investment s#$$ess!

    The B#ffett a&&roa$h to investment is5

    /! Never follo+ the da) to da) fl#$t#ations ofthe sto$% mar%et!

    1! 2ont tr) and anal)3e or +orr) a*o#t thegeneral e$onom)!

    '! B#) a *#siness, not its sto$%!

    9! "anage a &ortfolio of *#sinesses )o#

    +ant to o+n! S#&&orting Ideas

    /! Never follo !"e #$% !o #$% fl&'!&$!(o)*of !"e *!o'+

    ,$r+e!.

    In essen$e, a sto$% mar%et e-ists sim&l) tofa$ilitate the *#)ing and selling of shares!

    An)time an investor tries to t#rn the mar%etinto a &redi$tor of f#t#re &ri$es, the) r#n into&ro*lems!

    The essential 6#estion is +hether )o#vedone )o#r home+or% or not! If )o# %no+more a*o#t a $om&an) than the mar%etdoes, then +h) give an) attention to +hatthe mar%et sa)s4

    Se$ondl), if )o# *#) a share *e$a#se )o#*elieve a $om&an) has so#nd finan$ial&ros&e$ts and )o# intend o+ning it for an#m*er of )ears, +hat ha&&ens in themar%et on a da) to da) *asis is totall)in$onse6#ential!

    An investor does not need the mar%etsvalidation for an) share r$hase the) have$om&leted!

    The onl) #se for a reg#lar glan$e at themar%et is to $he$% +hether an)one is foolisheno#gh to sell a good *#siness at a great&ri$e!

    1! Do)-! !r% $)# $)$l%e or orr% $/o&!!"e 0e)er$l e'o)o,%.

    If it is im&ossi*le to &redi$t +hat the sto$%mar%et +ill do from da) to da), ho+ $an it *eeven remotel) a$hievea*le to fore$ast +hatthe e$onom) as a +hole +ill do in the ne-t

    fe+ )ears4

    The &ro*lem is some investors *egin +ithan e$onomi$ ass#m&tion a*o#t thedire$tion of the e$onom) and sele$t onl)

    sto$%s +hi$h fit their model! In this +a)the &redi$tions *e$ome *oth self.f#lfillingand limiting!

    A s#&erior a&&roa$h is to *#) a *#siness+hi$h has a realisti$ o&&ort#nit) to&rogress regardless of +hether theoverall e$onom) is e-&anding or$ontra$ting! A *#siness +hi$h has thea*ilit) to &rofit in an) e$onomi$environment is ver) val#a*le!

    '! B&% $ /&*()e** )o! (!* *!o'+.An investor sho#ld onl) *#) shares in a$om&an) +hi$h he +o#ld *e +illing tor$hase o#tright if he had s#ffi$ien$a&ital! From this &ers&e$tive, an investosho#ld loo% for a $om&an) +ith *#sinesso&erations that are #nderstood, hasfavo#ra*le long.term &ros&e$ts, iso&erated *) honest and $om&eten&eo&le and is availa*le at an attra$tive&ri$e!

    The de$ision to *#) a*#siness is *ased on5.. B#sinesstennets.."anagementtennets.. Finan$ialtennets.. "ar%et

    tennets

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    perspective of theinvestor?

    2o )o# #nderstand ho+ the $om&an)generates sales, in$#rs e-&enses and&rod#$es &rofits4

    That means )o# need to #nderstand reven#es,e-&enses, $ash flo+, la*o#r relations, &ri$ing,fle-i*ilit) and $a&ital re6#irements . ane-$e&tionall) high level of %no+ledge! It meansthat investors sho#ld *#) shares onl) in$om&anies +ithin their o+n $ir$le of finan$ialand intelle$t#al #nderstanding!

    An investor need to *e realisti$ a*o#t +hatthe) do not %no+! A*ove average res#lts aremost often a$hieved *) doing ordinar) thingse-$e&tionall) +ell!

    Business Tennet2.

    oes the business have a consistent

    operating history?

    In general, the *est level of &rofits over thelong.term are a$hieved *) $om&anies thathave *een &rod#$ing the same &rod#$t orservi$e for a n#m*er of )ears! ne.off+indfalls generated *) #n#s#al events are @#sttoo hard to reasona*l) &redi$t!

    An investor sho#ld never ignore a $#rrent*#siness realit) *e$a#se of some vision off#t#re s#$$ess! oo% to *#) a *#siness +hi$h

    has sho+n it $an reasona*l) +eather differente$onomi$ $)$les and $om&etitive for$es!

    The *est time to *#) an) *#siness is +hen&rofita*ilit) has *een interr#&ted for somee-ternal short.term reason! This $an $reate arare one.time o&&ort#nit) to r$hase a so#nd*#siness at an #n#s#all) lo+ &ri$e!

    Business Tenent

    !.

    oes the business have favourable long-

    termprospects?

    The e$onomi$ +orld is divided into a largegro#& of $ommodit) $om&anies and a smallgro#& of $om&anies that o+n the fran$hisefor their &rod#$t or servi$e!

    7ommodit) $om&anies $om&ete solel) on

    &ri$e, +ith no differentiation *et+eens#&&liers! As +ell as the traditional oil andgas $om&anies, the $ommodities gro#& no+in$l#des $omters, a#tomo*iles andairlines!

    B) $ontrast, $om&anies +hi$h o+n thefran$hise have a &rod#$t or servi$e +hi$h isneeded, has no $lose s#*stit#tes and for+hi$h an #nreg#lated mar%et e-ists!

    Ideall), a *#siness r$haser +ill +ant to

    *#) a fran$hise t)&e of $om&an)! These$om&anies have an a&&re$ia*le margin ofsafet) +here*) &ri$es $an *e raised tooffset management mista%es!

    The onl) &ro*lem is a strong fran$hiseholder soon attra$ts $om&etitors ands#*stit#te &rod#$ts, +hi$h in t#rn leads tothe $reation of a $ommodit) mar%et aro#ndthat &rod#$t or servi$e! Whenever thatha&&ens, the val#e of the management*e$omes even more $riti$al to the e$onomi$

    &erforman$e of the $om&an)!

    If it is not &ossi*le to r$hase a fran$hise$om&an), the ne-t *est o&tion is to *#) thelo+est $ost s#&&lier in a $ommodit) mar%et!ver the long.term, the lo+est $ost s#&&lieral+a)s $omes to dominate a $ommodit)mar%et!

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    1! "anagementTennets

    "anagementTennet 1.

    Is managementrational?

    2oes the management a$t and thin% li%e an

    o+ner of the $om&an) #nfailingl)4 In&arti$#lar, ho+ is $a&ital allo$atted *) the$om&an)4 Rational managers +ill investan) e-$ess $ash generated *) the $om&an)in &ro@e$ts that &rod#$e earnings at rateshigher than the $ost of $a&ital! ver thelong.term, allo$ation of $a&ital determinesthe val#e of the $om&an)!

    All $om&anies move thro#gh an e$onomi$life $)$le! In the develo&ment stage, the

    $om&an) loses mone) +hile esta*lishingmar%ets and im&roving its &rod#$ts! 2#ringthe ne-t stage of ra&id gro+th, the $om&an)re6#ires $ash to gro+ and retains earningsand *orro+s or iss#es more e6#it)! In thethird stage :mat#rit);, the $om&an)generates more $ash than it needs as salese-&and! In the last stage, e-$ess $ashta&ers off as sales de$line!

    The %e) 6#estion is +hat managers do +iththe e-$ess $ash in the mat#rit) and de$line

    stages! A rational management +ill investthis $ash in &ro@e$ts that earn a higher rateof ret#rn than the $ost of $a&ital on the o&enmar%et . other+ise the f#nds sho#ld *eret#rned to shareholders as dividends or *)*#)ing *a$% the $om&an)s o+n shares!

    B) $ontrast, irrational managers are oftenover$ome *) their o+n &ro+ess and$ontin#e to reinvest in &ro@e$ts +ithdiminishing ret#rns!

    "anagementTennet 2.

    Is management candid #ith itsshareholders?

    The ideal *#siness manager re&ortsfinan$ial &erforman$e o&enl) and gen#inel),+ith an a*ilit) to admit mista%es and re&ortthe &rogress of all as&e$ts of the $om&an)!The management sho#ld also *e a*le toreaffirm that the $om&an)s &rime o*@e$tiveis to ma-imi3e the ret#rn on shareholders

    investment! This $on$e&t sho#ld $olo#r

    ever) a$tion ta%en!

    The tenden$) to in$l#de ever) &ie$e ofinformation that o+ners +o#ld deemval#a*le +hen @#dging the $om&an)se$onomi$ &erforman$e is a $hara$teristi$of a strong management team!

    "anagement

    Tennet !.oes management resist theinstitutional imperative?

    The instit#tional im&erative is thetenden$) of $or&orate managers to mimi$the a$tions of other $om&anies, even+hen those a$tions are destr#$tive oirrational! "ost managers are soinfl#en$ed *) +hat other $om&anies aredoing that the) are #n+illing to do

    an)thing +hi$h res#lts in short.term &ainin e-$hange for long.term &rofit!

    A meas#re of an) $om&an)smanagement s%ill is ho+ effe$tivel) the)thin% for themselves rather than settle fomindless imitation of +hat ever)one elseis doing! In essen$e, s#$$essf#$om&anies have managers +ho ref#se tofollo+ the herd into medio$rit)!

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    '! Finan$ialTennets

    $inancial Tennet1.

    $ocus on return on e%uity& not earningsper share.

    7om&anies are $ontin#all) adding to their$a&ital *ase *) retained earnings in &arti$#lar!

    Therefore, )o# e-&e$t earnings &er share toin$rease )ear *) )ear!

    A *etter meas#re of a $om&an)s &erforman$eis ret#rn on e6#it) . the ratio of o&eratingearnings to shareholder e6#it)! This meas#resthe managements a*ilit) to generate a ret#rnon the o&erations of the *#siness given the$a&ital em&lo)ed!

    When $al$#lating ret#rn on e6#it), val#emar%eta*le se$#rities at $ost . not mar%et

    val#e :as mar%et val#e is *e)ondmanagements $ontrol;! E-$l#de all non.re$#rring e-traordinar) items +hi$h are#nrelated to the *#siness!

    A good management team +ill $onsistentl)a$hieve good ret#rns on e6#it) +hileem&lo)ing little or no de*t, or at leastem&lo)ing a managa*le de*t level for thenat#re of the *#siness!

    $inancial Tennet2.

    'alculate (()#ner*arnings.++

    The #ltimate val#e of an) $om&an) is its a*ilit)to generate a s#r&l#s of $ash! Ho+ever, a$om&an) +ith a high fi-ed asset to &rofit ratio+ill re6#ire a larger share of retained earningsto sta) &rofita*le than a $om&an) +ith a lo+fi-ed assets to &rofit ratio!

    DD+ner earnings is $al$#lated *) addingde&re$iation, de&letion and amorti3ation

    $harges to net in$ome and s#*tra$ting the$a&ital e-&endit#re re6#ired to maintaine$onomi$ &osition and #nit vol#me!

    DD+ner earnings refle$ts the tr#e $ash flo+&osition of a $om&an)! Some enter&rises:li%e a real estate develo&ment for e-amre6#ire heav) e-&endit#re at the start andver) little later on! thers, li%eman#fa$t#ring, re6#ire reg#lar e-&endit#reon &lant #&grades or the *#siness sli&s!DD+ner earnings is an attem&t to &rovide a

    $ross ind#str) anal)sis meas#re!$inancialTennet !.

    ,earch for companies #ith highprofit margins.

    Carado-i$all), managers of high.$ost$om&anies tend to find +a)s to $ontin#all)add to their overheads +hereas themanagers of lo+.$ost o&erations ta%e &ridein lo+ering their e-&enses!

    An) mone) s&ent on #nne$essar) $ostsde&rives shareholders of e-tra &rofits! The$#lling of #nne$essar) e-&enses is a$onsistent theme of effe$tive managers!

    $inancialTennet .$or every dollar of retained earnings&

    has the company created at least one

    dollar+s #orth of e.tra mar/et value?

    ver the longer term, sto$% mar%et val#e+ill a$$#ratel) refle$t the e$onomi$ val#e of

    the $om&an)! The same is tr#e forin$reased mar%et val#e $reated *) retainedearnings!A +ell managed $om&an) +ill addat least one dollar of mar%et val#e for ever)dollar of retained earnings!

    To estimate this fa$tor, s#*tra$t all dividendsfrom a $om&an)s net in$ome over the lastten )ears! This is the total retained earnings!

    Add that fig#re to the $om&an)s mar%etval#e at the *eginning of the ten )ear &eriod

    to get TotalA! If the $om&an) has em&lo)edretained earnings effe$tivel), the mar%etval#e at the end of the ten )ear &eriod +ille-$eed Total A! If it doesnt, *e+are!

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    9! "ar%etTennets

    "ar/etTennet 1.

    What is the value of thebusiness?

    B#ffett $al$#lates the val#e of a *#siness as

    the net $ash flo+s e-&e$ted to o$$#r overthe life of the *#siness dis$o#nted at ana&&ro&riate interest rate! Net $ash flo+s arethe $om&an)s o+ner earnings over a long&eriod! Something li%e the thirt).)ear U!S!treas#r) *ond rate $an *e #sed as ameas#re of the interest rate for this$al$#lation!

    B) $al$#lating the *#siness val#e this +a),vastl) different *#siness enter&rises $an

    realisti$all) *e $om&ared! If the *#siness isgro+ing ra&idl) *#t has #n&redi$ta*le f#t#rereven#es, then the $om&an) is not $lassifiedas sim&le and #nderstanda*le and thisform#la $annot *e a&&lied! The dis$o#nted$ash.flo+ a&&roa$h des$ri*ed is ver)$onservative as long as an a&&ro&riatedis$o#nt rate is a&&lied!

    In our view, what ma#es sense in business

    also ma#es sense in stoc#s. An investor

    should ordinarily hold a small piece of an

    outstanding business with the same tenacity

    that anowner would e)hibit if he owned all the

    business.!!

    .. WarrenB#ffett

    "ar/etTennet 2.

    'an the business currently be

    purchased at a significant discount to its

    value?

    Armed +ith an a$$#rate $al$#lation of theval#e of the *#siness, )o# sho#ld no+ loo%at the as%ing &ri$e! The r#le for mar%ets#$$ess is r$hase onl) +hen the $#rrentmar%et &ri$e is at a signifi$ant dis$o#nt toval#e!

    The intention of an) investor is to earna*ove.average ret#rns! The differen$e*et+een *#siness val#e and &ri$e is theinvestors margin of safet)! "ost investors

    set their o+n margin of safet)! B#ffet

    generall) aims for a 1.&er$ent dis$o#nt ashis margin of safet)!

    Additionall), a +ell $hosen sto$% +ill haveso#nd f#ndamentals, +hi$h over the longeterm +ill lead to an a*ove average gro+th inthe $om&an)s share &ri$e! This, in effe$t*e$omes an additional re+ard for the

    intelligentinvestor +ho r$hases at a dis$o#nt!

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    4. M$)$0e $ or!fol(o of/&*()e**e*.

    The $on$e&t of intelligent investing is that *)*#)ing shares in a $om&an), )o# sho#ld a$tli%e the o+ner of the *#siness, not theo+ner of a &ie$e of &a&er! That means )o#need to #nderstand the $om&an)so&erating f#ndamentals!

    2iversifi$ation is onl) re6#ired +hen aninvestor does not %no+ +hat the) are doing!er) fe+ *#siness o+ners are $omforta*leand e-&erien$ed eno#gh to o&erate an#m*er of $om&anies at the same time! Sotoo, an investor sho#ld a$t li%e an o+nerand *#) shares onl) in $om&anies +hi$h arethoro#ghl) #nderstood!

    0e)Tho#ghts

    I would rather be vaguely right thanprecisely wrong.!!

    ..0e)nes

    The mar#et, li#e the 4ord, helps those who

    help themselves. ut unli#e the 4ord, the

    mar#et does not forgive those who #now not

    what they do.!!

    .. WarrenB#ffett

    Investing is most intelligent when it ismost businessli#e.!!

    .. Ben@aminGraham

    I put a heavy weight on certainty. If you do

    that, the whole idea of a ris# factor doesn!t

    ma#e any sense to me. +is# comes from not

    #nowing what you!re doing.!!

    .. WarrenB#ffett

    5ou are neither right nor wrong because the

    crowd disagrees with you. 5ou are right

    because your data and reasoning are right.!!

    .. Ben@aminGraham

    It is not good enough to have goodintelligence. The principle thing is to apply itwell.!!

    ..2es$artes

    As far as I am concerned, the stoc# mar#et

    doesn!t e)ist. It is there only as a reference to

    see if anybody is offering to do anything

    foolish.!!.. Warren B#ffett

    -ost managers have very little incentive to

    ma#e the intelligent'but'with'some'chance'of'

    loo#ing'li#e'an'idiot decision. Their personal

    gain6loss ratio is all to obvious7 if an

    unconventional decision wor#s out well, they

    get a pat on the bac#, and if it wor#s out

    poorly, they get a pin# slip. Failing

    conventionally is the route to go7 as a group,

    lemmings may have a rotten image, but no

    individual lemming has ever received bad

    press.!!.. Warren B#ffett

    It has been helpful to me to have tens of

    thousands students turned out of business

    schools taught that it didn!t do any good to

    thin#. &hat we do is not beyond anybody

    else!s competence. It is (ust not necessary to

    do e)traordinary things to get e)traordinary

    results.!!

    .. Warren B#ffett

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    SAMPECACUATION

    CACUATIN THE VAUE OFA BUSINESS

    Ass#m&tions5

    /! The $om&an)s $ash flo+ +ill gro+ at a $om&o#nd rate of / &er )ear $onsistentl) for the ne-t/( )ears!

    1! A dis$o#nt rate of

    '! Ass#me in )ear // that the $om&an)s $ash flo+ +ill again in$rease *) !

    9! All dollar amo#nts are in millions!

    CRESENT AUE F FUTURE 7ASH FWS

    Ye$r 1 2 3 4 5 6 7 8 9 TOT

    Crior Year 7ash =1 =' ='? =9/ =9> = =? =' => = = =? = =>9 =< =/,/

    2is$o#nt ! ! ! ! ! ! ! ! ! !

    2is$o#nted al#e Cer =1< =' ='1 ='9 =' =' =' =91 =9 =9 =',

    7A7UATIN F RESI2UA AUE

    7ash Flo+ in Year /( =/,/

    Gro+th Rate

    7ash Flo+ in Year // =/,/

    7a&itali3ation Rate

    al#e at End of Year /( =1