Saturday, September 27, 2008
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What is Warren Buffet's Investing Strategy?
Even those who are not very familiar with the world of the stock market have probably heard of Warren Buffet. He has been called the most successful investor of all time. He netted over $42 billion personally with an investment partnership he started with only $100.
While he has been sometimes categorized as a “value stock investor” his method was actual a bit different. He focused on the quality of stock as well as the value. Robert Hagstrom, a senior vice president with Legg Mason Capital Management, presented Buffet’s method in the book “The Warren Buffet Method” over 10 years ago. Hagstrom wrote the book because he believed that the average investor could learn from Buffet’s method.
Buffet’s incredible story begins with a small investment partnership established in 1956. In the mid-1960s, this partnership acquired a failing textile company. Buffet was able to bring this company’s net worth from $22 million to $69 billion.
The Buffet method is broken down into 12 tenants that form the basis for evaluating any investment, from stocks to entire companies. One of the key points in the method is that it is necessary to do some hard work (like research and projections) in order to know the investments thoroughly before any money exchanges hands.
The twelve tenets are really questions to ask yourself before making an investment. According to Buffet via Hagstrom, the first consideration is “Is this business simple and understandable?” Buffet did not invest in any technology stocks for the simple reason that he did not understand them. If you understand the business you are investing in (or outright purchasing) you will be in position to see the problems and possibilities as they arise. Secondly, ask yourself “Does the company have a consistent operating history?” Viewing the viability of the business in its previous operation can forecast future trends.
The third tenant is “Does the business have favorable long-term prospects?” This question is a gentle reminder that wise investors hold stock in good companies for the long term. Looking to the future of the companies reveals the true value of the investment.
Next, “Is the management rational?” Buffet places a great deal of importance on evaluating the management of the company. He pays attention to how the excess profits of a company are used. Additionally, he asks “Is the management candid with shareholders?” He believes that many company executives hide behind the company and do not fully disclose information to their shareholders. A manager who readily admits any mistakes made is more honorable and trustworthy. Following the theme of management related questions is “Does the management resist the institutional imperative?” Essentially this question evaluates the manager’s ability to act with character rather than cave-in to the peer pressure to do what other managers are doing.
The next question for evaluation is “What is the return on equity?” Buffet focuses on return on equity rather than the more popular ratios. This is because he feels earnings figures can be manipulated. The long term return on equity will have a more powerful effect than simple earnings.
The 8th tenant is “What are the company’s owner earnings?” His calculations of owner’s earnings include estimates of future capital expenditures. The 9th tenant is “What are the profit margins?” If a company makes sales but does not profit, then the company is a failure. Buffet avoids companies with large expenses because in his eyes it reflects a lack of discipline in the management of the company.
The 10th tenant is “Has the company created at least one dollar of market value for every dollar retained?” This is a test of correct capital allocation. If the company is holding onto cash but is not helping its shareholders than something is wrong with the management strategy.
The final two questions are “What is the value of the company?” and “Can it be purchased at a significant discount to its value?” Buffet calculates the value of a company as the total of the net cash flow expected to occur in the life of the business. By buying at discount, an investor will assure that any discrepancies in his calculations will be covered.
While he has been sometimes categorized as a “value stock investor” his method was actual a bit different. He focused on the quality of stock as well as the value. Robert Hagstrom, a senior vice president with Legg Mason Capital Management, presented Buffet’s method in the book “The Warren Buffet Method” over 10 years ago. Hagstrom wrote the book because he believed that the average investor could learn from Buffet’s method.
Buffet’s incredible story begins with a small investment partnership established in 1956. In the mid-1960s, this partnership acquired a failing textile company. Buffet was able to bring this company’s net worth from $22 million to $69 billion.
The Buffet method is broken down into 12 tenants that form the basis for evaluating any investment, from stocks to entire companies. One of the key points in the method is that it is necessary to do some hard work (like research and projections) in order to know the investments thoroughly before any money exchanges hands.
The twelve tenets are really questions to ask yourself before making an investment. According to Buffet via Hagstrom, the first consideration is “Is this business simple and understandable?” Buffet did not invest in any technology stocks for the simple reason that he did not understand them. If you understand the business you are investing in (or outright purchasing) you will be in position to see the problems and possibilities as they arise. Secondly, ask yourself “Does the company have a consistent operating history?” Viewing the viability of the business in its previous operation can forecast future trends.
The third tenant is “Does the business have favorable long-term prospects?” This question is a gentle reminder that wise investors hold stock in good companies for the long term. Looking to the future of the companies reveals the true value of the investment.
Next, “Is the management rational?” Buffet places a great deal of importance on evaluating the management of the company. He pays attention to how the excess profits of a company are used. Additionally, he asks “Is the management candid with shareholders?” He believes that many company executives hide behind the company and do not fully disclose information to their shareholders. A manager who readily admits any mistakes made is more honorable and trustworthy. Following the theme of management related questions is “Does the management resist the institutional imperative?” Essentially this question evaluates the manager’s ability to act with character rather than cave-in to the peer pressure to do what other managers are doing.
The next question for evaluation is “What is the return on equity?” Buffet focuses on return on equity rather than the more popular ratios. This is because he feels earnings figures can be manipulated. The long term return on equity will have a more powerful effect than simple earnings.
The 8th tenant is “What are the company’s owner earnings?” His calculations of owner’s earnings include estimates of future capital expenditures. The 9th tenant is “What are the profit margins?” If a company makes sales but does not profit, then the company is a failure. Buffet avoids companies with large expenses because in his eyes it reflects a lack of discipline in the management of the company.
The 10th tenant is “Has the company created at least one dollar of market value for every dollar retained?” This is a test of correct capital allocation. If the company is holding onto cash but is not helping its shareholders than something is wrong with the management strategy.
The final two questions are “What is the value of the company?” and “Can it be purchased at a significant discount to its value?” Buffet calculates the value of a company as the total of the net cash flow expected to occur in the life of the business. By buying at discount, an investor will assure that any discrepancies in his calculations will be covered.
Aware of U S Financial institutions.What made Wrong?
IT all began with the sub-prime crisis.
If you lost your money in the market crash of January 2008, here's the route to your loss, in chronological order.
2001-2005: House prices in the US begin to rise rapidly. Banks lend aggressively and create a sub prime industry.
Sub-prime lending refers to lending (at slightly higher interest rates) to people who may not be eligible for a loan under normal circumstances. Maybe they don’t have a regular job or income, or have defaulted in the past.
Banks traditionally did not lend to such people due to high risk of default. But since these loans were mortgaged against property and property prices were rising continuously, banks started doing so. If customers defaulted, they could sell the mortgaged property.
2005: The booming housing market halted abruptly in many parts of the US.
2006: Prices are flat, home sales fall.
February 2007: Sub-prime industry collapses in the US; more than 25 sub-prime lenders declare bankruptcy, announce significant losses, or put themselves up for sale.
While they were lending, banks did not factor in the possibility of a fall in property prices. When the Federal Bank (the US equivalent of RBI) started increasing interest rates, the sub-prime borrowers started defaulting and banks started selling off the mortgaged properties. As more and more properties came into the market for selling, the property prices fell.
August 2007: Many leading mortgage lenders in the US filed for bankruptcy
March 2008: Bear Sterns falls.
September 2008: Lehman Brothers file for bankruptcy. Merrill Lynch sells off to Bank of America.
Between 2001 and 2006, the US financial markets had developed a new product – a bond securitised against the mortgages.
In simple terms it means that the mortgage banks borrowed money against the mortgages on the condition that they would repay to lenders as soon as they recovered their mortgages. The lenders in this case were financial institutions (like Bear Sterns, Lehman and Merril Lynch) who in turn sold retail bonds to individuals.
If you lost your money in the market crash of January 2008, here's the route to your loss, in chronological order.
2001-2005: House prices in the US begin to rise rapidly. Banks lend aggressively and create a sub prime industry.
Sub-prime lending refers to lending (at slightly higher interest rates) to people who may not be eligible for a loan under normal circumstances. Maybe they don’t have a regular job or income, or have defaulted in the past.
Banks traditionally did not lend to such people due to high risk of default. But since these loans were mortgaged against property and property prices were rising continuously, banks started doing so. If customers defaulted, they could sell the mortgaged property.
2005: The booming housing market halted abruptly in many parts of the US.
2006: Prices are flat, home sales fall.
February 2007: Sub-prime industry collapses in the US; more than 25 sub-prime lenders declare bankruptcy, announce significant losses, or put themselves up for sale.
While they were lending, banks did not factor in the possibility of a fall in property prices. When the Federal Bank (the US equivalent of RBI) started increasing interest rates, the sub-prime borrowers started defaulting and banks started selling off the mortgaged properties. As more and more properties came into the market for selling, the property prices fell.
August 2007: Many leading mortgage lenders in the US filed for bankruptcy
March 2008: Bear Sterns falls.
September 2008: Lehman Brothers file for bankruptcy. Merrill Lynch sells off to Bank of America.
Between 2001 and 2006, the US financial markets had developed a new product – a bond securitised against the mortgages.
In simple terms it means that the mortgage banks borrowed money against the mortgages on the condition that they would repay to lenders as soon as they recovered their mortgages. The lenders in this case were financial institutions (like Bear Sterns, Lehman and Merril Lynch) who in turn sold retail bonds to individuals.
Sadly, the repayment never happened. And Institutions like Bear Sterns, Lehman, Merrill Lynch and AIG were the casualties. Since the mortgages were not honoured, the banks could not repay these financial institutions who in turn could not repay retail investors.
Sources: Moneycontrol
Inflation remains unchanged at 12.14%:
Inflation for the week ended September 13, 2008 remain unchanged at 12.14%.
The prices of primary articles increased to 11.56% for week ended September 13, 2008 as compared to 11.27% for the preceding week.
The prices of fuel items also remain unchanged at 16.66% for the week.
The inflation for manufactured products continued to decline for third consecutive week to 10.61% during the week, as compare to 10.78% for the preceding week.
The manufacturing inflation fell by 10bps week on week, maximum since, December 2008.
Amongst the manufactured articles, the prices of metal products, food products, Beverages tobacco & tobacco products and woods products rose the most, by 21.44% yoy, 13.92% yoy, 10.79% yoy and 9.77% yoy respectively.
However, on week on week basis, prices of most of the manufacturing articles remained stable or declined.
Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
The prices of primary articles increased to 11.56% for week ended September 13, 2008 as compared to 11.27% for the preceding week.
The prices of fuel items also remain unchanged at 16.66% for the week.
The inflation for manufactured products continued to decline for third consecutive week to 10.61% during the week, as compare to 10.78% for the preceding week.
The manufacturing inflation fell by 10bps week on week, maximum since, December 2008.
Amongst the manufactured articles, the prices of metal products, food products, Beverages tobacco & tobacco products and woods products rose the most, by 21.44% yoy, 13.92% yoy, 10.79% yoy and 9.77% yoy respectively.
However, on week on week basis, prices of most of the manufacturing articles remained stable or declined.
Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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