All posts by Buffettpedia

Buying a stock: do your homework

“One person’s hot growth stock is another’s disaster waiting to happen,” said Pat Dorsey, author of “The Five Rules For Successful Stock Investing: Morningstar’s Guide to Building Wealth and Winning in the Market”.

“For one thing, you’re putting your money at risk, so you should know what you’re buying,” Pat Dorsey said. His advice? “…you can’t just take some one’s word that a company is an attractive investment.”

In other words, you must “Do Your Homework”. This is Pat Dorsey’s first recommended rule. This means, according to Pat Dorsey, “sitting down and reading the annual report cover to cover, checking out industry competitors and going through past financial statements.”

Pat Dorsey’s other recommended rules are: find economic moats, have a margin of safety, hold for the long haul, and know when to sell.

Recommended reading:

The Five Rules for Successful Stock Investing: Morningstar’s Guide to Building Wealth and Winning in the Market

Why Warren Buffett won’t sell coke stock

Published on Jul 23, 2013
“The Oracle of Omaha” and Coca-Cola board member, Warren Buffett sits down with Coke CEO Muhtar Kent to share his history, affection and enthusiasm for the company, KO stock and explains why he’ll never sell a share. Article link.

In 1937, a seven-year-old entrepreneur in Omaha, Nebraska had the bright idea to buy six-packs of Coca-Cola from his grandfather’s store for a quarter and sell the bottles to his thirsty neighbors for a nickel apiece.

He couldn’t keep them in stock, especially during the sweltering summer months.

“I had no inventory or receivables… it was the best business I ever had,” said Warren Buffett, now 82. “But I made one mistake. I didn’t put the money I made into Coca-Cola stock.”

He rectified that mistake several years later. Buffett’s company, Berkshire Hathaway, is now the largest Coca-Cola shareowner. He has never sold a share of Coke stock, and says he never will.

During a 20-minute conversation with Coca-Cola chairman and CEO Muhtar Kent today at the company’s annual general meeting in Atlanta, “The Oracle of Omaha” explained why KO will always have a “Buy” rating in his book.

“I’m the kind of guy who likes to bet on sure things,” said Buffett, who served on Coke’s board of directors for 17 years. “No business has ever failed with happy customers… and you’re selling happiness.”

“I like wonderful brands,” he added. “If you take care of a great brand, it’s forever.”

Calling complacency the fatal flaw of many businesses, Buffett credited Coke with resisting temptation to rest on its laurels. “You want a restlessness… a feeling that someone is always after you, but that you’re going to stay ahead of them,” he said. “That restlessness – that tomorrow is more exciting than today – you have to have it permeate the organization.”

Buffett shared his thoughts on why America’s best days are still ahead, calling a baby born in the U.S. today the luckiest person in the world.

“Just think – in 1790, we had 4 million people here, and there were hundreds of millions of people in the world,” he said. “We weren’t smarter and we didn’t even work harder than people elsewhere, necessarily. But we had a system that unleashed human potential. And that system – quality of opportunity, a rule of law, a market system – has produced an abundance. It has improved the standard of living in my lifetime six to one.”

He concluded, “We’ve got the formula. We’ll always have problems… but the world does not belong to the pessimist, believe me.”

Article link.

Who is Benjamin Graham?

Benjamin Graham. Source: Wikipedia

Benjamin Graham (May 8, 1894 – September 21, 1976) is the father of value investing, an investment approach that he began teaching at Columbia Business School in 1928. The British-born American professional investor was well-known for his book Security Analysis which was published in 1934. Together with co-author David Dodd, he refined his investment approach through various editions of the book. Since its publication, the book has been widely treated as an investment bible in the investment community. He had many disciples in his lifetime, among which is Warren Buffett of Berkshire Hathaway. Warren Buffett, hailed widely as the Wizard of Omaha, the Oracle of Omaha or the Sage of Omaha, described Benjamin Graham as the second most influential person in his life after his own father. Warren Buffett said Security Analysis is an investment road map that he has been following. Another of Benjamin Graham’s famous books is Intelligent Investor, described by Warren Buffett as “the best book about investing ever written”. Benjamin Graham’s other well-known disciples include William J. Ruane, Irving Kahn and Walter J. Schloss.

Recommended reading:

(1) The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

(2) Security Analysis: Sixth Edition, Foreword by Warren Buffett (Security Analysis Prior Editions)

Measuring profit performance

dollarsignIn his 1977 letter to Berkshire Hathaway shareholders, Warren Buffett said that “most companies define ‘record’ earnings as a new high in earnings per share”.
This measure is not appropriate in Mr Buffett’s views. “Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5% increase in earnings per share. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding.”
What then is a more appropriate measure of managerial economic performance?
In the same 1977 letter, Mr Warren Buffett said: “Except for special cases (for example, companies with unusual debt-equity ratios or those with important assets carried at unrealistic balance sheet values), we believe a more appropriate measure of managerial economic performance to be return on equity capital.”
Giving an example, Mr Buffett said: “In 1977 our operating earnings on beginning equity capital amounted to 19%, slightly better than last year and above both our own long-term average and that of American industry in aggregate. But, while our operating earnings per share were up 37% from the year before, our beginning capital was up 24%, making the gain in earnings per share considerably less impressive than it might appear at first
This view on the measurement of managerial economic performance was seen again in Warren Buffett’s letter to shareholders in 1979, when he said: “Measuring such results against shareholders’ equity with securities valued at market could significantly distort the operating performance percentage because of wide year-to-year
market value changes in the net worth figure that serves as the denominator. For example, a large decline in securities values could result in a very low ‘market value’ net worth that, in turn, could cause mediocre operating earnings to look unrealistically good. Alternatively, the more successful that equity investments have been, the larger the net worth base becomes and the poorer the operating performance figure appears. Therefore, we will continue to report operating performance measured against beginning net worth, with securities valued at
“…The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the achievement of consistent gains in earnings per share. In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place
upon earnings per share, and upon yearly changes in that figure.”

Recommended reading:
Berkshire Hathaway Letters to Shareholders, 1965-2013

How Warren Buffett picks marketable securities

wallstreetfreeWarren Buffett said in his letter to shareholders in the 1977 annual report that Berkshire Hathaway selected marketable equity securities in much the same
way it would evaluate a business for acquisition in its entirety.
Warren Buffett said then: “We want the business to be (1) one that we can understand, (2)
with favorable long-term prospects
, (3) operated by honest and
competent people
, and (4) available at a very attractive price.”
The fourth point, “available at a very attractive price”, was changed to “available at an attractive price” in his letter to shareholders in the 1992 annual report.
“We have seen cause to make only one change in this creed: Because of both
market conditions and our size, we now substitute an attractive
price’ for ‘a very attractive price’,” Warren Buffett said in the 1992 annual report.
The consistency of Berkshire Hathaway’s investment creed can be seen in Warren Buffett’s letter to shareholders in the 2007 annual report.
Warren Buffett said then: “Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag. We like to buy the whole business or, if management is our partner, at least 80%. When control-type purchases of quality aren’t available, though, we are also happy to simply buy small portions of great businesses by way of stockmarket purchases. It’s better to have a part interest in the Hope Diamond than to own all of a rhinestone.” “Charlie” refers to Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway.

Recommended reading:
Berkshire Hathaway Letters to Shareholders, 1965-2013