Showing posts with label buffett style investing. Show all posts
Showing posts with label buffett style investing. Show all posts

Thursday 3 May 2012

Buffettology: Value Investing Strategy


Buffettology: Warren Buffett Quotes & Value Investment Strategy for Stock Picks


warren buffettWhile it may be tempting to throw yourself into the dramatic highs and lows of investing in the stock market in search of instant gratification, it’s not necessarily the most profitable choice. Warren Buffet has spent his career watching investors pounce on “hot” companies, only to flounder when the market takes a plunge. All the while, he’s been steadily accumulating wealth by taking an entirely different approach.
You may be thinking, “OK, the guy’s successful, why should I care?” Well, in 2008, Warren Buffett was the richest man in the world with an estimated worth of over 62 billion dollars. This kind of wealth is not a result of sheer luck. He’s gained his enormous fortune using a very specific investment strategy, developed on a basis of long term investing. The great news is that, by learning a little about the way Warren Buffett thinks, you too can enjoy greater success in the stock market.
So what exactly is Warren Buffett’s investment strategy and how can you emulate him? Read on and find out.

Secrets to Investing Success

Since Warren Buffett has never personally penned an investment book for the masses, how does one go about learning his secrets? Luckily, many of his letters to shareholders, books that compile such letters, and insights from those close to him are readily available to the public.
There’s a lot to be gained from his quotes alone. Here are a few sayings that have been attributed to him.

Warren Buffett Quotes on Investing

  • “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”
  • “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
  • “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
  • “Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid.”
  • “If a business does well, the stock eventually follows.”
  • “Price is what you pay. Value is what you get.”
  • “Time is the friend of the wonderful company, the enemy of the mediocre.”
Clearly, Warren Buffet is a value investor. He looks for great companies, or “wonderful” ones as he puts it. He is not looking at hot sectors or stocks that may shoot up now, only to cool and fall later. He wants an efficient running business that has favorable long-term prospects.
Additionally, although he wants great stocks, he does not want to pay a premium price. Warren uses a specific calculation to arrive at a fair valuation, then waits until a market correction or crash puts those prices on his doorstep.
Now that you know a little about his basic investing philosophy, let’s take a more in-depth look at how he makes investment choices.

Buffettology and Stock Selection

The book, Buffettology, is a fantastic resource, primarily written by Warren Buffett’s former daughter-in-law, Mary Buffett. The co-author, David Clark, is a long-time friend of the Buffett family. Since these authors probably have some special insight into how Warren Buffet privately analyzes stocks, it’s worth hearing what they have to say. Here are a few of the major points they focus on:

Best Stock Industries

The authors of Buffettology recommend looking for promising companies in 3 broad categories:
1. Consumables
Buffett’s choice businesses include those that make products which are consumed or quickly wear out such as:
  • Snacks
  • Pop
  • Gum
  • Toothpaste
  • Pens
  • Razor blades
Why? Because higher product turnover implies more revenue for the company. If you can also find a leading name brand that people gravitate towards, you have a good starting point.
2. Communications
Another major category of companies that Warren likes is communications. Advertising agencies are a major part of this group as they expand into new platforms like cell phones and tablet computers, in addition to the old standbys of TV, radio, and newspapers.
This is an area where you will need to be careful because what is new today can be discarded as waste tomorrow. Be aware that advertising may go down with the economy as businesses prune costs during tough times. Also, as people turn from print to web, some forms of advertising will increase at the expense of others.
3. Boring Services
The last category is for repetitive and boring services. A few examples of these highly profitable companies doing the same job over and over might be:
  • Lawn care companies
  • Janitorial services
  • Basic tax filing services
“Boring” itself is not enough to warrant an investment. However, if something is both boring and essential, there’s a good chance it’s a stable, efficient, easy-to-operate business that will have a long-lasting life.

What Characteristics in a Company to Look For

Once you know where to look, it’s important to know who you should turn your attention to. The book cites the following factors for determining which companies to watch closely.
1. Existence and Value
Warren Buffett analyzes considerable historical financial data on a stock. In general, this would exclude new companies where only a few years of financial data exist. He picks stocks based on their intrinsic value and the ability of the company to continually increase that value, often wanting a minimum of 15% annually over many years. This kind of regular increase can be considered a High Annual Rate of Return.
2. Market EdgeThis includes companies that have a monopoly, where no other alternative exists. Think of a toll-bridge as one example. Other market edges could include companies that sell a unique product. Buffett is not as keen on commodity-based companies where the price is set by the market, competition is stiff, and the company has no ability to freely adjust for inflation.
3. Finances
Warren looks for these financial traits in companies:
  • Increasing Earnings. It is especially important that a large amount of this money is being retained and used for further growth. Sitting on a big pile of cash, or giving earnings back as dividends, is not viewed as desirable since extra tax may need to be paid on dividends, and the burden of re-investing is placed on the shareholder.
  • Reasonable Financing. The financing for the company should be reasonable, without a high debt-load.
  • Simple Business Model. The company model should be simple with few moving parts, and not a lot of money needed to maintain the business model. It should be a lean, mean, and profitable operation.
But when you find such a wonderful company, how will you know if it is a good buy? For that we need to learn how to value a stock the Buffett way.

Valuing a Company Buffett-style

Buffettology also outlines a few different methods to determine the value of a stock and whether or not it is a good buy. Two of the most popular methods revolve around “Earnings Yield” and “Future Price Based on Past Growth.”

1. Earnings Yield

The concept behind this is elementary and rooted firmly in the price-to-earnings ratio, or more correctly, the opposite, which is called the earnings yield. When you divide the annual earnings by the current share price, you find your rate of return. Therefore, the lower the stock price is in relation to its earnings, the higher the earnings yield. Here are three examples for comparison:
  • Aeropostale Inc. (NYSE: ARO) has a share price of around $25 and an annual earnings of $2.59. If you divide $2.59 by $25 you get the earnings yield of 10.36%.
  • Hansen Natural Corporation (NASDAQ:HANS) has a share price of $56 and an annual earnings per share of $2.39 and only 4.2% of the share price is annual earnings.
  • McDonald’s is trading at a $75 with annual earnings of  $4.62 per share, which gives us an earnings yield 6.2%.
Warren would use this formula to compare similar stocks with steady earnings to see which would provide a higher earnings yield based on share price. Based on these examples, Aeropostale has the most attractive earnings yield.
Keep in mind, this is only to be used as a very quick and crude method of comparing similar stocks, or to compare yields to bond rates. As you will see in the next two valuation methods, the earnings yield is far from accurate in giving us a long-term growth rate.

2. Future Price Based on Past Growth

For this, Buffett would analyze the long-term growth trend to determine how it might perform over the next 10 years. Depending on the company and the industry, it may make sense to use any of a variety of metrics, including both the PE ratio and the Enterprise Value/Revenue multiple.
Let’s use the PE ratio to illustrate how this strategy works. To guess what growth might be like over the next 10 years, you first need to determine what the average earnings growth rate has been on the stock over the past 5 to 10 years.
I will use McDonald’s as an example. They are a big name brand, they aggressively opened up in new markets, and McDonald’s provides a consumable product that has a loyal following. Let’s say the EPS growth over the past 5 years averages 17.6%. Using an EPS of$4.62 EPS in year 0, and a growth rate of 17.6% per year, will yield the following 10-year forecast:
  • Year 0, EPS: 4.62
  • Year 1, EPS: 5.43
  • Year 2, EPS: 6.39
  • Year 3, EPS: 7.51
  • Year 4, EPS: 8.84
  • Year 5, EPS: 10.39
  • Year 6, EPS: 12.22
  • Year 7, EPS: 14.37
  • Year 8, EPS: 16.90
  • Year 9, EPS: 19.88
  • Year 10, EPS: 23.37
Now you have an estimated total earnings per share by the end of year 10. Today, the EPS is $4.62 and in a decade that should appreciate to $23.37.
Now, you must determine what this means for the share price. To do this, you simply look to a long-term average of P/E, or the price-to-earnings ratio. The 5 year P/E average in this example is 17.7. Multiply this by the future expected earnings rate of $23.37, and you get an estimated price of $413.65.
If the price right now is $75, what is the rate of return over the next 10 years?
You can simply use an online rate-of-return calculator to calculate annual profits of 18.62%. Remember, this is a basic estimate that doesn’t include dividends, which can boost your yield by 3% every year, or almost 22% when using capital gains and dividend yield together. Moreover, it is based on the assumption that the PE ratio will remain constant, which is unlikely, but still serves as a good example
For those of you who find all of this a little overwhelming, that doesn’t mean that Buffett-style investing isn’t for you. There is a simpler option.

Berkshire Hathaway

If you want to utilize his strategies without actually having to learn them, you can buy shares in Warren Buffett’s company. He is the Chairman and CEO of the publicly owned investment managing company, Berkshire Hathaway. Take advantage of his success by choosing from the following:
  • Class A Shares with a current sticker price of $127,630 each.
  • Class B Shares which currently sell for $85.04 each.
As you can probably tell from the price discrepancy, it takes 1,500 Class B shares to have equivalent ownership of one Class A share. They are similar except that Class A shares have proportionally more voting rights per dollar of worth.
How have the shares of Berkshire Hathaway performed over the past 46 years? The cumulative gain is 490,409% which works out to an average of 20.2% per year. This is an average annual 10.8% excess of the market as tracked by the S&P 500 index (including dividends). If in 1965, you invested a whopping $1,900 with Warren Buffett, this would be worth $9,545,300 by the end of 2010.

Effects Of Success

With those numbers, you may be wondering why anyone would choose to attempt Warren’s strategy on their own. Unfortunately, this kind of incredible growth is becoming harder for Berkshire Hathaway to attain. When a company has hundreds of billions of dollars in revenue, achieving significant growth is far more difficult.
Buying up smaller companies did not impact Warren Buffett’s Berkshire’s financials as much as when his company was smaller. He has become an elephant stomping around the market in search of increasingly elusive good buys.

Final Word

The simplest way to invest Warren Buffet style is to buy shares of Berkshire Hathaway and forget about them for the next 10 or 20 years. But, as his company has reached astronomical heights, this strategy has become less and less valuable.
Thus, many people who love the “Warren Buffett investing style” choose to invest on their own. If you are excited by due diligence, scanning thousands of stocks for that highly profitable (and oftentimes mundane) business, forecasting company earnings, and monitoring the company’s progress, then the “Warren Buffett investment method” may be a perfect fit for you. Remember, perhaps above all else, to have guts of steel when the market drops so that you can buy undervalued and profitable stocks.
What are your thoughts on Warren Buffett and his investing style? Do you try to replicate his strategies and success? Share your experiences in the comments below.


http://www.moneycrashers.com/buffettology-warren-buffet-quotes-investment-strategy-stock-picks/

Thursday 1 March 2012

Interesting to Note that this is a development that hurts Berkshire Hathaway during 2011


-  Three large and very attractive fixed-income investments were called away from us by their issuers in 2011. Swiss Re, Goldman Sachs and General Electric paid us an aggregate of $12.8 billion to redeem securities that were producing about $1.2 billion of pre-tax earnings for Berkshire. That’s a lot of income to replace, though our Lubrizol purchase did offset most of it.

http://www.berkshirehathaway.com/letters/2011ltr.pdf


Comment:  Buffett emphasizes increasing the aggregate pre-tax earnings and incomes.  He reinvests into or replaces companies, to achieve growth in aggregate pre-tax earnings and incomes.   This is very sound strategy to follow.

Saturday 25 February 2012

WARREN BUFFETT'S INVESTMENT PRINCIPLES

Warren Buffett does not readily disclose the investments he makes on behalf of himself or Berkshire Hathaway. He does, every year, report on the substantial holdings of his company in other corporations. These provide only tiny clues however to why, when and where he invests.


He is prepared, however, and does so regularly, to outline general principles of sound investment. These have a consistent theme and can be summed up like this.


Stock investments should be looked at in the same way as buying a business. The stock investor is really buying a tiny share or partnership and should apply the same principles that they would in buying a business – the Benjamin Graham approach:


1. The company should be soundly managed. Tests of good management include:
2. The company has demonstrated earning capacity with a likelihood that this will continue. Tests of earning capacity include:
3. The company should have consistently high returns. Warren Buffett would look at both:
4. The company should have a prudent approach to debt.

5. The businesses of the company should be simple and the investor should have an understanding of the company.  See case studies

6. Assuming that all these thresholds are satisfied, the investment should only be made at areasonable price, with a margin of safety. This is always a matter for independent judgment by the investor but it is relevant to consider:
7. Investors need to take a long term approach.


Wednesday 23 November 2011

Ignore shares and get poorer.

Diary of a private investor: ignore shares and get poorer
Our private investor is back - and he says that savers who are prepared to take some risk will prosper.


BP sign
Despite the Gulf of Mexico oil spill last year, BP shares are doing well Photo: PA
After the glorious year of 2010 - for the stock market anyway - this year has, so far, been a damp squib. First it was up, then it relapsed, then it rose once more before retreating again. As I write, it is within 2pc of where it started.
As Lady Bracknell said in The Importance of Being Earnest, "this shilly-shallying is absurd". Which is it to be? Will shares finally rise or fall?
On the bearish side, I'm told, by people who ought to know, that Greece is bust, whatever the politicians say. Another well-placed individual has the same opinion about Ireland.
If either is right, shares could fall heavily on the day the default is announced. Some people say "it is already in the price", but I doubt it.
On the other hand, shares still look good value. I own some in BP which, at 458p, stands at a mere 6.8 times forecast earnings for 2011.
Its adventures in Russia do worry me a bit and, of course, the shadow of the disaster in the Gulf of Mexico still hangs over it. But rarely in its history have the shares been treated with such disdain.
Professional and lifelong investors are now generally back in the stock market. But many private individuals are still holding back.
Over the past few years, I've talked to quite a few people about their investments and found they can be divided into four sorts.
The first thinks shares are too risky. They remain almost entirely in cash. In some cases they have good reason. Some have a limited amount of money and a very specific thing - such as school fees - which they want to be sure they can pay.
Others argue that shares are unpredictable and they don't know anything about them. Better to keep the money safe in the bank. These people have their reasons. But over the long term, I've seen so many of this sort, who were once well off, become very gradually much less so. I knew the daughter of a Seventies multi-millionaire who inherited her fair share. She kept the money in a building society and is now, frankly, just getting by. It's frustrating. She could have stayed rich.
The second group consists of those who have made quite a bit of money but have not had much time or interest in managing it. They were then persuaded by persistent, charming salesmen to invest in certain funds. For these salesmen, nothing was too much trouble. They visited them in their homes. They brought wonderful, sophisticated brochures and "personalised" recommendations.
The untold story which the salesmen never quite got around to explaining in detail was the full extent of the commissions and expenses involved. The people in this group have generally had a pretty thin time of it over the past dozen years.
The FTSE 100 is still rather lower than it was in January 2000, and all those commissions have eaten a substantial hole in the dividend income.
The third sort are thrill-seekers. To be honest, I know only one person in this group. There was a time when he got very excited about shares and was dealing on an hourly basis, following recommendations from a broker. After initial success, he lost a bundle and decided to give it all up.
Long-term, persistent portfolio investors are the fourth group. They have built up experience and understanding. They tend to have done best.
But where does that leave the sort of person who has other things to do and does not want to spend time building up experience in shares?
My flippant answer would be "poorer". You make your choices and live with the consequences. Trying to be more helpful, let me suggest this: how about putting, say, 15pc of free cash in a selection of lowest-possible-cost tracker funds? And then increasing the amount each year up to a level with which you are comfortable?
This way, you will not give away a fortune in commission. You will keep most of the dividends. You will not have to worry about selecting individual shares. And you are likely - though not guaranteed - to be richer in 10 years than otherwise. You could go for a mixture of, say, half of the invested amount in a FTSE 250 shares fund, a fifth in a Far East fund, another fifth in a US fund and a 10th in an emerging markets fund.


Wednesday 26 October 2011

Are you Mr. Market or Mr. Buffett? Rewire yourself to Invest like Mr. Buffett.


Warren Buffett's Investment Advice: Why It's So Hard to Follow

by Carlos Portocarrero on 18 March 2010


A year ago, I wrote a piece called Cash is King: Now What Should I do With It? 
After going through all the responsible options of what I could do with our pile of cash, I added one last one: what if I just threw it in the stock market and tried to double it?
Obviously, the fear of getting stabbed and divorced by my wife told me that this wasn't worth it—the risk was too high.
But you always wonder...what if...?
Chart of the S&P 500
You'll see that the market had just bottomed out and was on a path to a steady recovery. Maybe it wasn't such a crazy idea to invest that pile of cash after all.

What Would've Happened

The day I published the story, the S&P 500 was at around 814. If I would've invested $10,000 in the S&P, I would've bought just over 12 "shares." Today, those "shares" would be worth $14,238. That's a 42% return in just under a year—an outstanding return.

What this Has to do With Warren Buffett

I've said this before many times: I'm a huge fan of Warren Buffett. I think his mix of intelligence, patience, and quirkiness is admirable. And one of his most famous sayings applies to my whole dilemma of investing (or not investing) my pile of money a year ago:
Be greedy when others are fearful and fearful when others are greedy
Back in March 2009, everyone was scared. From mutual fund managers to your average mom and pop store—we were all scared. No one knew what was going to happen to the economy and the stock market had just annihilated millions of dollars of people's money. It was the perfect time to put Warren Buffett's axiom to the test.
But that's where the problem lies: I was one of the people that was scared. There was no way I was putting all my hard-earned money into a machine that so many were saying was broken and had already cost so many people their life's savings.
And this is why Warren Buffett commands so much respect: he not only talks the talk, he walks the walk. He reacts differently than the rest of us to these situations: he trusts his instincts and doesn't get caught up in the panic that most of us do. And believe me, back then there was quite a bit of panic.
This is why we can't simply "invest like Warren Buffett." You have to have the cash, the brains, and the ability to overcome panic and fear. Forget about picking the right stocks—that's the least of it—the hardest part is not falling for all the hysteria and panic in the air.
The opposite is also true: the next time you see people acting greedy and feeling a little too comfortable with themselves and how much money they're making in the stock market—watch out. Something bad is about to happen.


http://www.wisebread.com/warren-buffetts-investment-advice-why-its-so-hard-to-follow

Friday 14 October 2011

How to Never Lose Money in the Stock Market



Now that’s a pretty controversial heading, isn’t it?  It reminds you of Will Rogers’ line:  “I’m more interested in the return of my money than the return on my money.”

Losing money seems to be as big of a part of stock market investing as wealth building.  Losses and their devastating results certainly draw more attention.  In fact, the U.S. Securities and Exchange Commission, as well as other stock market watchdog agencies, require a warning to investors that losses are possible.

So how can I get away with that heading?  Simple:  Because it’s true!  A man named Benjamin Graham first wrote about the system in the ‘50s.  Warren Buffett and his Berkshire Hathaway company followed these rules and became the most successful stock market investor of all times.  These are their rules, and their system.  And here it’s presented in easy-to-follow terminology.

You must have a hook, and the acronym I use for this system is this: D.A.B.L.  (Don’t dabble in the markets, DABL instead). Each letter of the acronym stands for a part of investing; a rule if you will.  Follow these four rules and you will never lose money in the market.  Break even once, and you’re gambling.  There’s an old time Brooklyn comedian, named Myron Cohen, who said this about gambling:

“Here’s how you come out ahead in Las Vegas:  When you get off the plane, walk into the propeller!” So don’t walk into the propeller, follow the D.A.B.L. and build your wealth as sure as sunrise.

“D” Stands for Diversification.  To be properly diversified you need thousands of stocks encompassing all descriptions.  Large Caps, Mid-Caps, Small Caps, International, Growth, Value, Growth and Income, etc.  When you have a widely diversified portfolio, individual stock losses are swallowed by individual gains.  The “Enrons” will be offset by the “Microsofts” and “Exxons.”  In our practice, we use 54 mutual funds to achieve this.  Each fund owns hundreds and thousands of stocks.  Diversification upon diversification.  Now you might ask, “But what if I’d bought Microsoft and Exxon 20 years ago? Wouldn’t I have made much more?”  Yes you would have.  But what if you’d bought Enron?  Before it crashed and burned, Wall Street analysts wouldn’t shut up about what a great buy Enron was. You’d have lost everything, and it wouldn’t have recovered the same as the rest of the market when times got better.   In short, diversification removes the gambling aspect of stock market investing.

“A” Stands for Asset Allocation.  This goes hand in hand with diversification.  This is simply allocating investments in varied sectors of the economy to minimize market downturns and profit on the inevitable upswings.  Here’s a conservative asset allocation for all seasons:

Small Cap Growth funds               5%
Mid Cap Growth funds                 5%
Large Cap Growth funds               5%
Small Cap Value funds                 10%
Mid Cap Value funds                   10%
Large Cap Value funds                 10%
Value Blend funds                        10%
Aggressive Growth funds             10%
High Yield Bonds fund                   5%
Investment Grade Bonds                5%
International Global Bonds             5%
Global Emerging Markets               5%
International Growth                       5%
International Value                        10%

The word “cap” refers to Capitalization – the size of the stocks the fund purchases.  “Blend” means the fund invests across all styles and sizes in its area.  International usually means outside the U.S., while global includes U.S. investments.  This allocation uses strictly mutual funds.  Software like Morningstar places each fund in the “style boxes” described in this allocation.  If you don’t have enough assets to buy all those funds, start with “value” and “growth,” and leave “aggressive” and “emerging” markets for last.  If you’re investing in your 401(k) and don’t have all those options, do the best you can to duplicate this allocation with emphasis on “value.”

“B” Stands for Buy and Hold.  Buy and hold works, as proven repeatedly by the likes of Benjamin Graham and Warren Buffett.  Buying and selling securities results in losses or minimum gains for most investors.  It does generate lots of commissions, which is why the brokerage industry hates that one fact.  However they’re coming around with fee-wrapped account, tacitly encouraging buy-and-hold.

“L” Stands for Long Term Goals.  The minimum holding period is five to seven years.  Diversified buy-and-hold investments have achieved this goal in every seven-year period since 1969.  Stock market investments should always be held for the long term.  Anything else is gambling.

Now here’s a question that always comes up:  “I will be retiring next year.  Shouldn’t I be invested mostly in safe investments like treasury bonds and CDs?”

Well that depends on how much money you have for retirement.  The D.A.B.L. system is strictly to make money grow – make the pie bigger.  Most retirees have enough funds to leave a certain amount alone for seven years.  That’s the amount that should be invested for growth.  It’s going to vary for everyone.  There’s no pat answer – you’ve got to analyze your own situation.  Remember, this system is for growth, and every retirement portfolio needs growth – a certain amount of money targeted to get much larger in a given number of years to offset the ravages of inflation.

So go ahead, D.A.B.L – just don’t dabble.



By Patrick Astre

http://www.myarticlearchive.com/articles/8/224.htm



Message:  If you do not diversify, do not asset allocate, do not buy and hold, and do not keep your stocks for 5 to 7 years ... you are NOT investing but gambling.