The Warren Buffett Way: Principals for Successful Investment
In his book "The Warren Buffett Way", Robert Hagstrom outlines 12 principles Warren Buffett follows in his investment decision making. This article illustrates these tenets implemented by Buffett when selecting stocks or companies.
Principle 1: Simplicity and Understandability of the Business
Warren Buffett avoided the investment in a business he had no understanding of. This is the reason for which he did not undertake investments on technology stocks. He claimed that understanding a business facilitated the spotting of problems and opportunities.
Principle 2: Reliable Operating History
Buffet studied the history record of a target company. He is well aware of the fact that a past performance is not a guarantee for future success, but he used it to see whether the particular business was able to endure the different market conditions.
Principle 3: Positive Long-Term Prospects
Warren Buffet investing philosophy included the holding of a company over the long-term. Therefore, a clear future was of importance to him. He disregarded the profitability of companies that were about to fall out of taste tomorrow, such as technology stocks or companies that were susceptible to trend conditions.
Principle 4: Rational Management
Buffet placed extreme importance on the management team of the company. He paid attention on the way the management operated with the excess cash generated. In order to construct a shareholder value, the cash that is generated above the average returns should be reinvested. If the reinvestment is not possible the excess cash should be returned to the shareholders in a dividend form or whatever other form the management considers appropriate. Rationality is what should stand behind every decision.
Principal 5: Open Management-Shareholder Relationships
Buffet put a great importance on the open relationships between shareholders and management. This means that the latter should provide information on the activities of the company and be able to admit its mistakes when committed and take its responsibilities in fixing them.
Principal 6: Institutional Imperative Resistance by Management Teams
Buffet is against the acting as the rest of the companies in the industry no matter that sometimes this may mean undertaking out-of-the-ordinary actions.
Principal 7: Return on Equity Importance
Return on equity is one of the basic criteria against which Buffett evaluated a target company. He regards earnings as of less importance. The significance of return on equity is dictated by its defined effect on the wealth of the company over the long run.
Principal 8: Owner Earnings Importance
When evaluating a company Warren Buffet makes estimations that disregard cash flow, but instead focus on future capital expenditures. As a result he gets a more clear view on the value of the company.
Principal 9: Profit Margins Importance
Buffett places importance on the ability of a company to transform sales into profits. A failure on the part of the company to do so discouraged Buffett to invest in it. Additionally, if the expenses of a company are inflated, Buffett considered this as a lack of discipline no matter the level of profitability of the company. Control over the expenditures of the company is what matters.
Principal 10: The Creation of a Dollar Market Value for Every Obtained and Retained Dollar
If the company has failed to do so, then this is an indication of incorrect capital allocation. Thus, the company has failed to create both shareholder and market value. The holding of cash is regarded as pointless by Buffett.
Principal 11: Company Value Importance
Again the long-term focus is present in this tenet. This is so since Buffett uses total net cash flow that is projected to occur over the lifespan of the target company to determine its value. This may seem impossible since it requires you to be able to predict the performance of the company over a too long time period. However, Buffett claims that if all other tenets can be found in the company, this prediction will be of no difficulty.
Principal 12: Company Availability at a Discount
The discounted price of the stock will compensate for the potential downs in the value. This is one of the main tactics of Buffet that provides him with a level of safety.
Finally, we highly recommend the reading of "The Warren Buffett Way", but be aware that the duplication of Buffett's success through the repeating of his actions is of very small likelihood.
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