Buffett's philosophy on business investing is a modification of the value investing approach of his mentor Benjamin Graham. Graham bought companies because they were cheap compared to their intrinsic value. He was of the belief that as long as the market undervalued them relative to their intrinsic value he was making a solid investment. He reasoned that the market will eventually realize it has undervalued the company and will correct its course regardless of what type of business the company was in. In addition he believes that the business has to have solid economics behind it.The following are some questions to determine what business to buy, based on the book Buffettology by Mary Buffett:
Is the company in an industry of good economics, i.e., not an industry competing on price points.
Does the company have a consumer monopoly or brand name that commands loyalty?
Can any company with an abundance of resources compete successfully with the company?
Are the earnings on an upward trend with good and consistent margins?
Is the debt-to-equity ratio low or is the earnings-to-debt ratio high, i.e. can the company repay debt even in years when earnings are lower than average?
Is ROE consistent over its history, more than 12%, and high compared to the industry average? Or does the company have high and consistent Return on Total Capital?
Does the company retain earnings for growth?
The business should not have high maintenance cost of operations, low capital expenditure or investment cash outflow. This is not the same as investing to expand capacity.
Does the company reinvest earnings in good business opportunities? Does management have a good track record of profiting from these investments?
Is the company free to adjust prices for inflation?
Buffett's next concern would be when to buy. He does not hurry to invest in businesses with undiscernible value. He will wait for market corrections or downturns to buy solid businesses at reasonable prices, since stock-market downturns present buying opportunities. He is conservative when greed and speculation is rampant in the market and he is greedy and aggressive when others are fearing for their capital. This contrarian strategy is what led Buffett's company through the Internet boom and bust without significant damage, although critics have also noted that it may have led Berkshire to miss out on potential opportunities during the same period.
Then he asks at what price is the business a bargain, and his answer typically is when it provides a higher rate of compounded return relative to other available investment opportunities.
Buffett has coined the term "economic moat,"preferring to acquire companies that possess sustainable competitive advantages over their competitors.
Warren Buffett's letters to shareholders are a very valuable source in understanding his investment style and outlook. Warren Buffett Management Style
Buffett views himself as a capital allocator above anything else. His primary responsibility is to allocate capital to businesses with good economics and keep their existing management to lead the company.
Warren Buffett News Watch
When Buffett acquires a controlling interest in a business, he makes clear to the owner the following:
He will not interfere with the running of the company.
He will make the hiring and compensation a decision of the top executive.
Capital allocated to the business will have a price tag (a hurdle rate) attached. This process is to motivate owners to send excess capital that does not return more than its cost to Berkshire headquarters rather than investing it at low returns. This cash is then free to be invested in opportunities that offer higher returns.
Buffett's hands-off approach has held strong appeal and created room for his managers to perform as owners and ultimate decision makers of their businesses. This acquisition strategy enabled Buffett to buy companies at fair prices because the sellers wanted room to operate independently after selling.
Besides his skills in managing Berkshire's cash flow, Buffett is skilled in managing the company's balance sheet. Since taking over Berkshire Hathaway, Buffett has weighed every decision against its impact on the balance sheet. He has succeeded in building Berkshire into one of the eight companies (as of 005) that are still rated by Moody's as Aaa, the highest credit rating achievable and thus with the lowest cost of debt. Buffett takes comfort in the knowledge that, for the foreseeable future, his company will not be one of those shaken by economic or natural catastrophes. He repeated over the years that his catastrophe insurance operation is the only one he knew that can keep the checks clearing during financial turmoil.
With an estimated fortune of $62 billion, Warren Buffett is the richest man in the entire world. In 1962, when he began buying stock in Berkshire Hathaway, a share cost $7.50. Today, Buffett, 78, is Berkshire's chairman and CEO, and one share of the company's class A stock worth close to $119,000. He credits his astonishing success to several key strategies, which he has shared with writer Alice Schroeder. She spend hundreds of hours interviewing the Sage of Omaha for the new authorized biography. The Snowball. Here are some of Buffett's money-making secrets -- and how they could work for you.
1. Reinvest Your Profits: When you first make money, you may be tempted to spend it. Don't. Instead, reinvest the profits. Buffett learned this early on. In high school, he and a pal bought a pinball machine to pun in a barbershop. With the money they earned, they bought more machines until they had eight in different shops. When the friends sold the venture, Buffett used the proceeds to buy stocks and to start another small business. By age 26, he'd amassed $174,000 -- or $1.4 million in today's money. Even a small sum can turn into great wealth.
2. Be Willing To Be Different: Don't base your decisions upon what everyone is saying or doing. When Buffett began managing money in 1956 with $100,000 cobbled together from a handful of investors, he was dubbed an oddball. He worked in Omaha, not Wall Street, and he refused to tell his parents where he was putting their money. People predicted that he'd fail, but when he closed his partnership 14 years later, it was worth more than $100 million. Instead of following the crowd, he looked for undervalued investments and ended up vastly beating the market average every single year. To Buffett, the average is just that -- what everybody else is doing. to be above average, you need to measure yourself by what he calls the Inner Scorecard, judging yourself by your own standards and not the world's.
3. Never Suck Your Thumb: Gather in advance any information you need to make a decision, and ask a friend or relative to make sure that you stick to a deadline. Buffett prides himself on swiftly making up his mind and acting on it. He calls any unnecessary sitting and thinking "thumb sucking." When people offer him a business or an investment, he says, "I won't talk unless they bring me a price." He gives them an answer on the spot.
4. Spell Out The Deal Before You Start: Your bargaining leverage is always greatest before you begin a job -- that's when you have something to offer that the other party wants. Buffett learned this lesson the hard way as a kid, when his grandfather Ernest hired him and a friend to dig out the family grocery store after a blizzard. The boys spent five hours shoveling until they could barely straighten their frozen hands. Afterward, his grandfather gave the pair less than 90 cents to split. Buffett was horrified that he performed such backbreaking work only to earn pennies an hour. Always nail down the specifics of a deal in advance -- even with your friends and relatives.
5. Watch Small Expenses: Buffett invests in businesses run by managers who obsess over the tiniest costs. He one acquired a company whose owner counted the sheets in rolls of 500-sheet toilet paper to see if he was being cheated (he was). He also admired a friend who painted only on the side of his office building that faced the road. Exercising vigilance over every expense can make your profits -- and your paycheck --go much further.
6. Limit What You Borrow: Living on credit cards and loans won't make you rich. Buffett has never borrowed a significant amount -- not to invest, not for a mortgage. He has gotten many heart-rendering letters from people who thought their borrowing was manageable but became overwhelmed by debt. His advice: Negotiate with creditors to pay what you can. Then, when you're debt-free, work on saving some money that you can use to invest.
7. Be Persistent: With tenacity and ingenuity, you can win against a more established competitor. Buffett acquired the Nebraska Furniture Mart in 1983 because he liked the way its founder, Rose Blumkin, did business. A Russian immigrant, she built the mart from a pawnshop into the largest furniture store in North America. Her strategy was to undersell the big shots, and she was a merciless negotiator. To Buffett, Rose embodied the unwavering courage that makes a winner out of an underdog.
8. Know When To Quit: Once, when Buffett was a teen, he went to the racetrack. He bet on a race and lost. To recoup his funds, he bet on another race. He lost again, leaving him with close to nothing. He felt sick -- he had squandered nearly a week's earnings. Buffett never repeated that mistake. Know when to walk away from a loss, and don't let anxiety fool you into trying again.
9. Assess The Risk: In 1995, the employer of Buffett's son, Howie, was accused by the FBI of price-fixing. Buffett advised Howie to imagine the worst-and-bast-case scenarios if he stayed with the company. His son quickly realized that the risks of staying far outweighed any potential gains, and he quit the next day. Asking yourself "and then what?" can help you see all of the possible consequences when you're struggling to make a decision -- and can guide you to the smartest choice.
10. Know What Success Really Means: Despite his wealth, Buffett does not measure success by dollars. In 2006, he pledged to give away almost his entire fortune to charities, primarily the Bill and Melinda Gates Foundation. He's adamant about not funding monuments to himself -- no Warren Buffett buildings or halls. "I know people who have a lot of money," he says, "and they get testimonial dinners and hospital wings named after them. But the truth is that nobody in the world loves them. When you get to my age, you'll measure your success in life by how many of the people you want to have love you actually do love you. That's the ultimate test of how you've lived your life."