The New Buffettology

 

  1. Warren Buffet separates the World of Business into two categories:
    1. 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:

                                                               i.      Internet portal companies

                                                             ii.      Internet Service provider

                                                            iii.      Memory-chip manufacturers

                                                           iv.      Airlines

                                                             v.      Producers of raw foodstuffs such as corn and rice.

                                                           vi.      Steel producers

                                                          vii.      Gas and Oil companies

                                                        viii.      The lumber industry

                                                           ix.      Paper manufacturers

                                                             x.      Automobile manufacturers

    1. 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.

                                                               i.      Companies that have competitive advantage have either a unique product or a unique service.

                                                             ii.      Low-cost durability, i.e. maintain profit margin and production without too much investment in infrastructure. E.g. is Hershey Chocolate, KFC, Coca Cola, Taco Bell.

  1. Companies make money in two ways: by having the highest profit margins and/or by having the highest inventory turnover.
  2. Warren 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.
  3. Higher Interest Rates make business earnings worth less to an investor and will drive stock prices down.
  4. Lower Interest Rates make business earnings worth more to an investor and will drive stock prices up.
  5. 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)
  6. 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.
  7. 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)
  8. Net income / Total shares = XX.  Is XX more than market share price in bad times. (Pg 86 Wells Fargo)
  9. 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.
  10. FIVE MAJOR TYPES OF BAD NEWS Situations that give rise to prospective investment (buying) situations:
    1.  A stock market Correction or Panic (E.g Dot.Com bubble burst)
    2. An Industry Recession (e.g. Real estate market down or Airline industry down due to war situation)
    3. Individual Calamity which affects its current earnings(e.g. American Express $60 Million law suit pg 88)
    4. Structural Changes (e.g. Mergers, re-organization, etc.)
    5. War (e.g. 9/11 hurt entire travel, hotel, airline industry)
  11. Companies with a durable competitive advantage are:
    1. 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.

                                                               i.      Brand Name Fast Food: These companies are essentially recession-proof, which means that the best buying opportunities are a bear market or a panic.

                                                             ii.      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, etc.

                                                            iii.      Brand Name Food and Beverages: They manufacture that own a piece of consumer mind. E.g. Nestle, Pepsi, Coca Cola, Kraft.

                                                           iv.      Brand Name Toiletries / House Products: Everyday we use toothpaste, shampoo, soap, detergent, etc. E.g. Gillette, Colgate-Palmolive, Procter & Gamble.

    1. The advertising business, which provides a service that manufacturer, must continuously use to persuade the public to buy.

                                                               i.      Advertising Agencies, Television, Newspapers, Magazines, etc.

    1. 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 pest control.
    2. 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.
  1. Warren’s Checklist includes ten points as follows:
    1. The rate of Return on Shareholder’s Equity (ROE)
    2. The right Rate of Return on Total Capital (ROA)
    3. The Right Historical Earnings
    4. A company that is relatively Debt free.
    5. The Right kind of Competitive Product or Service.
    6. No Labor Unions.
    7. The product or service should be inflation proof, i.e. it is free to increase the prices of its products.
    8. 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.
    9. Can and Does the company repurchase shares to the investor’s advantage.
    10. Does the value added by the Retained Earnings increase the market value of the company.
  2. 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).
  3. Never 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.
    1. 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.
    2. Warren 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.
  4. STOCK ARBITRAGE – Investing in corporate sellouts, reorganizations, mergers, spin-off, and hostile takeovers – is one of Warren’s greatest secrets for making millions.
    1. 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.
    2. 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.
    3. 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).
    4. ALWAYS invest after the investing situation has been announced, and not on humors.
    5. 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.
    6. 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.
  5. WHAT YOU BUY AND THE PRICE YOU PAY WILL DETERMINE HOW MUCH MONEY YOU MAKE. (Pay more earn less. Pay less earn more)
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