The New Buffettology
- Warren Buffet separates the World of Business into
- Companies with poor economics. These are companies
that are in price competitive industries that
sell commodity type products or services. A price-competitive type of business
manufactures or sells a product or service that many other businesses sell and competes for
customers solely on the basis of price. The intense level of price
competition leads to low profit margins and offers little growth to shareholders value. These
type of business include the following:
Internet portal companies
Internet Service provider
Producers of raw foodstuffs such as corn and rice.
Gas and Oil companies
The lumber industry
- The second type are the
healthy type of companies that have a durable competitive
advantage. A company with durable competitive advantage
usually sells a brand name, product or service that holds a privileged
position in the stream of commerce. It faces little or no competition, creating a type
of monopoly. If
you want a particular type of product or service, you have to purchase it
from one company and no one else. This gives the company the
freedom to raise prices and produce higher earnings. They have fewer ups
and downs and they possess the ability to weather the storms that a
shortsighted stock market will overreact to.
Companies that have competitive advantage have either a unique product or
a unique service.
durability, i.e. maintain profit margin and production without too much
investment in infrastructure. E.g. is Hershey Chocolate, KFC, Coca Cola, Taco Bell.
- Companies make money in two ways: by having the highest profit margins
and/or by having the highest inventory turnover.
likes to play a little game and pretend that he is going to buy the whole
business by calculating the market capitalization. (E.g. Company X has 100
million shares @ $50/- per share. That equals $ 5 billion. Now if I had $
5 billion in my account, would I buy the whole company??). He believes that if the
entire company isn’t worth purchasing at the current stock market price,
he should not buy even one share.
Interest Rates make
business earnings worth less to an investor and will drive stock prices
Interest Rates make
business earnings worth more to an investor and will drive stock prices
- During a Bear market it is nothing to find a stock
like Coca Cola, GE, etc, trading at P/E Ratio in the single digits or low
teens. (contrast that situation with a bull market P/E of 30 or better for
those same companies)
- In a Bull market more and more money gets pumped into the stock market
as more and more people, enticed to easy riches, jump into the game. This
mass speculation sends stocks prices up across the board, making the
public feel rich and prosperous. A public that feels rich acts like it, spending money like crazy, which
heats up the economy. A heated economy means Inflation.
- Remember that in an industry wide recession (e.g.
banking, or IT) everyone gets hurt. The strong survive while the weak are
removed from the economic landscape)
- Net income / Total shares = XX. Is XX more than market share price in
bad times. (Pg 86 Wells Fargo)
- Individual Calamity:
Sometimes brilliant companies do stupid mistakes and loose big money. The
stock market, upon seeing this, will slam the stock price. Your job is to figure out
if the situation is a passing calamity or irreversibly damaging.
- FIVE MAJOR TYPES OF BAD NEWS Situations that give rise to
prospective investment (buying) situations:
- A stock
market Correction or Panic (E.g Dot.Com bubble
- An Industry Recession (e.g. Real estate market down
or Airline industry down due to war situation)
- Individual Calamity which affects its current
earnings(e.g. American Express $60 Million law suit pg 88)
- Structural Changes (e.g. Mergers, re-organization,
- War (e.g. 9/11 hurt entire travel, hotel, airline
- Companies with
a durable competitive
- Businesses that fulfill a repetitive consumer
need with products that wear out fast or are used up quickly. This
includes everything from cookies to panty hose.
Brand Name Fast Food: These
companies are essentially recession-proof, which means that the best buying
opportunities are a bear market or a panic.
Patented Prescription Drugs: If you
want to get well you have to pay the toll to the gate keeper who is the doctor.
E.g. Hamdard, Glaxo Smith,
Brand Name Food and Beverages: They
manufacture that own a piece of consumer mind. E.g. Nestle, Pepsi, Coca Cola, Kraft.
Brand Name Toiletries / House Products:
Everyday we use toothpaste, shampoo, soap, detergent, etc. E.g. Gillette,
Colgate-Palmolive, Procter & Gamble.
- The advertising business, which provides a service
that manufacturer, must continuously use to persuade the public to buy.
Advertising Agencies, Television, Newspapers,
- Businesses that provide repetitive consumer
services that people and businesses are consistently in need of. This
is the world of tax preparers, cleaning services, security services, and
- Low-cost producers and sellers of common products
that most people have to buy at some time in their life. This includes
from furniture to jewelry to carpet to insurance.
- Warren’s Checklist includes ten points as
- The rate of Return on Shareholder’s Equity (ROE)
- The right Rate of Return on Total Capital (ROA)
- The Right Historical Earnings
- A company that is relatively Debt free.
- The Right kind of Competitive Product or Service.
- No Labor Unions.
- The product or service should be inflation proof,
i.e. it is free to increase the prices of its products.
- Companies that have the right operational cost.
They usually do not have to spend a high percentage of their Retained
Earnings to maintain their operations.
- Can and Does the company repurchase shares to the
- Does the value added by the Retained Earnings
increase the market value of the company.
- The Big Money has always come from buying
companies with a durable competitive advantage and holding them over a
long term (In some cases 20 – 30 years).
make a mistake of selling flowers to buy weeds. If you are lucky
enough to get into a company that has a strong durable competitive
advantage and management that knows how to maximize profits, then hold it
until you are offered an insanely high price.
- BUT, you have to keep your eye on the horizon to
make sure that a change in the business or its environment doesn’t change
a durable competitive advantage company into a price-competitive
business, or worst, render it completely obsolete.
says that it is almost impossible to see a disaster in the making with financial institutions because of their
ability to hide problems until they become disasters.
- STOCK ARBITRAGE – Investing in corporate sellouts,
reorganizations, mergers, spin-off, and hostile takeovers – is one of Warren’s greatest
secrets for making millions.
- Once an opportunity is seen, Warren would carefully track it to make
sure that nothing went wrong – such as the buyer backing out of the deal.
- An investment opportunity arises for the
arbitrageur when a price spread develops between the announced sale or
liquidation price and the market price for the company’s stock before the
sale or liquidation.
- Time is of great essence here, as the longer the
time from the date the transaction closes, the smaller your annual rate
of return (ROR).
- ALWAYS invest after the investing situation has
been announced, and not on humors.
- When the market starts to sink, opportunities in
the field of arbitrage start to rise. This is because the stock price of
a company goes down and the company management and share holders are more
willing to liquidate or merge.
- Try to figure out the per share buyout figure, when
is the transaction expected to close, and the current trading price for
the company’s share.
- WHAT YOU BUY AND THE PRICE
YOU PAY WILL DETERMINE HOW MUCH MONEY YOU MAKE. (Pay more earn less. Pay less earn more)