For twelve years, Mary Buffett was part of the Buffett inner circle. He owes his success to hard work, integrity, and that most elusive commodity of all, common sense. The quotes are culled from a variety of sources, including personal conversations, corporate reports, profiles, and interviews. We just try to buy businesses with good-to-superb underlying economics run by honest and able people and buy them at sensible prices. This irresistibly browsable and entertaining book is destined to become a classic. Warren Buffett has always believed that the time to buy stocks is when nobody else wants them.
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By Nick Kraakman There are dozens of books written on the topic of value investing , and many even claim to reveal the secrets that made superinvestor Warren Buffett billions of dollars.
As a value investor, you should always try to buy companies below their intrinsic value , right? Not anymore. Graham aimed to purchase companies for less than they were worth. He called this discount to intrinsic value his margin of safety. Graham versus Buffett Graham was an absolute pioneer in the field of value investing, and Warren Buffett soaked up all of his knowledge and started applying this strategy himself.
His ideas of how to value companies were all shaped by how the Great Crash and the Depression almost destroyed him, and he was always a little afraid of what the market can do.
It left him with an aftermath of fear for the rest of his life, and all his methods were designed to keep that at bay. Buying those cheap, cigar-butt stocks [companies with limited potential growth selling at a fraction of what they would be worth in a takeover or liquidation] was a snare and a delusion, and it would never work with the kinds of sums of money we have. But he was a very good writer and a very good teacher and a brilliant man, one of the only intellectuals — probably the only intellectual — in the investing business at the time.
The key realization was that if you only focus on getting something for the cheapest possible price, you will end up with crappy companies in your portfolio which never realize their value, or even worse, see their value decline over time, because many of these cheap companies are cheap for a good reason! If, on the other hand, you purchase a great company with a durable competitive advantage, what Buffett calls a consumer monopoly, and which is able to consistently compound its returns at above average rates, the price you pay becomes less of an issue, because such a company will see its value steadily increase over time.
So what is the main characteristic of a wonderful business? The book says they are like toll bridges: you have to cross them and it costs you a fee each time. Some examples are credit card companies, Google AdWords, and brand name consumer products shops have to carry, like Coca-Cola.
This sounds more difficult than it really is. All this rate tells you is how much you can expect to earn each year by purchasing stocks of a certain company at a certain price. This Inflation and Taxes Besides the profitability and value of a business, Buffettology reveals that inflation and taxes are also two things Buffett takes very seriously.
This way he is essentially able to let his tax money work for him by letting it compound until he finally decides to sell his stocks. This brilliant maneuver has allowed Buffett to maximize his returns by minimizing the amount of taxes he has to pay.
The book also mentions another very interesting idea: inflation can actually benefit shareholders of companies that have a consumer monopoly working in their favor. Well, a company with a consumer monopoly generally produces high rates of return on a small net tangible asset base which it almost never has to replace. In order to earn serious money on the stock market, you need a serious sum of money to start with.
Warren Buffett did not have such a sum of money himself, so he decided to use the money of others instead! The initial way he approached this was to start his own investment partnership.
So why exactly was this so brilliant? Well, because an insurance company receives monthly payments from the people it ensures, but only has to pay this money out sporadically.
In other words, insurance companies are sitting on a pile of idle cash, waiting to be paid out if necessary. Buffett used this float to massively increase the amount of money available for investments, which drastically increased his absolute returns. Retained Earnings and Return on Equity Buffett believes all earnings are his, either through dividend payments or retained earnings, since he is part owner of the companies he invests in.
According to the authors, Buffett places a tremendous importance on retained earnings, which is the net income which remains after dividends have been paid out, and return on equity ROE. It is not difficult to see why, because retained earnings is the money that a company can reinvest into the company for future growth, and the return on equity determines to a large extend the extra income that will be generated from these investments. So the higher the retained earnings and the higher the return on equity, the faster the intrinsic value of a company will grow over time.
After taxes this works out to a This is because dividends lower retained earnings and therefore limit future growth. A company should only pay a dividend, according to the authors, if it has no better way of allocating the money, for example if a company has grown to the size of Apple AAPL and therefore has limited room for growth left. The price you pay determines your rate of return. To be able to determine your rate of return, earnings and profitability should not only be above-average, but also predictable.
Warren Buffett does not calculate the intrinsic value and then buys at half that price. Instead, he calculates the Expected Annual Compounding Rate of Return, compares it with other available investments, and buys the best one.
So limit your number of transactions. This could mean you have to hold on to stocks which are trading above their intrinsic value. Consumer monopolies, or sustainable competitive advantages , are the key to long-term, consistent, above-average returns on the stock market. Test: "If you had access to billions of dollars and the five best managers in the world, could you launch a company to compete with the business in question?
Dividends only make sense if the company has low returns on equity or only minor growth prospects. Share buybacks only make sense if they happen at prices lower than intrinsic value. Acquisitions only make sense if the acquired company is also an excellent business. The books states that "in order to become a billionaire you have to get other people to give you their money to invest. I hope to see you on the inside!
Lessons from Buffettology (Summary)