What Warren Buffett Looks for in Company Management

WHAT WARREN BUFFETT LOOKS FOR IN COMPANY MANAGEMENT

Warren Buffett has identified aspects of management that he looks for in companies in which he invests. They include:

• Buy back of shares where the buy back is in the company’s interests, for example where the company has surplus funds and the shares can be bought back at less than intrinsic value

• Capability in allocation of capital

• Managers who stick to doing what the company does best; ‘the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.’

• Ability and readiness to tackle tough problems as they arise

• The use of retained profits to increase company profitability at beyond market rates

• A conservative approach to debt and liquidity

• Demonstrated ability to consistently grow company earnings and rates of return.

WHAT BUFFETT DOES NOT LIKE IN COMPANY MANAGEMENT

Warren Buffett has, throughout his career of public announcements, identified some things that he does not like in company managers:

• Managers who pursue company acquisitions for reasons other than the good of the company – ego trips, the ‘institutional imperative’ of keeping up with other company acquirers, bad judges (they buy a toad and think that it will turn into a princess when they kiss it); as he famously said in 1981, ‘[M]any managerial [princes] remain serenely confident about the future potency of their kisses – even after their corporate backyards are knee-deep in unresponsive toads’.

• Managers who pursue growth for growth’s sake, irrespective of the value of that growth to the company

• Managers who expend too much of the company’s worth by issuing valuable shares to buy overvalued assets or who use debt to do so.

• Managers who enrich themselves at company expense by with extravagant salaries and the abuse of share option arrangements

Sound Management: HOW CAN THE AVERAGE INVESTOR JUDGE MANAGEMENT?

WARREN BUFFETT’S CONTINUING THEME

If there is one theme that continually runs through the public statements of Warren Buffett it is the principle that investor should only consider for investment companies with managers of competence and integrity.

HOW CAN THE AVERAGE INVESTOR JUDGE MANAGEMENT?

The difficulty of course for the average investor is how to determine if a company is soundly managed. Warren Buffett is a rich man and a big investor and, while it is not known if he ever does this, he would be able to question internal company management a lot easier than John Citizen.

The answer for the average investor is to extensively research a company before investing and to ask the kind of questions that it seems Warren Buffett asks before investing in a company.

Have an opinion on future growth - How can the company increase its earnings?

It is only rational to have an opinion on future growth.  Otherwise, how could you ever choose a stock?

When forming that opinion, back up quantitative information with qualitative factors.

For example, ask what management is doing to make a positive impact on earnings.

According to Peter Lynch, there are 5 basic ways a company can increase earnings:

• reduce costs; 
• raise prices; 
• expand into new markets;
• sell more of its products to the old markets; or
• revitalize, close or otherwise dispose of a losing operation.

When management is enacting growth-promoting activities, earnings may be temporarily flat.  They often soon take a giant step up.

Benjamin Graham saw a vulnerability in a high growth rate and in high returns on capital - the two normally go together.

So what's there to worry about in good earnings?  Exceptionally high earnings often attract rough competitors.  

The good part is that high earnings lure enthusiastic new investors, who often bid the share into the stratosphere.


Comment:
Buy good quality growth companies.
Assess the quality of the business and the management.
Then do the valuation.
These are the basics of the QVM or QMV approach to investing.

Price Matters

Price matters in the stock market.

Just like you wouldn't run out and pay $10 a gallon for gasoline, why would you pay 100 times earnings for a company that is growing 15% a year?

Do you think the people who paid $212 for Yahoo YHOO in January 2000 are ever going to get their money back?

Yahoo's a good company, but it may take a very long time for the stock to get back to its old highs.

The same could be said of many other technology stocks and also even those technology companies with moats around them that got clobbered in post 2000.

Remember - the single greatest determinant of a company's return in your portfolio is the price you pay for its shares.

As important as it is to understand the quality of a company - its growth prospects, competitive position, and so forth - it is even more vital that you pay a fair price for the firm's shares.

You'll make a lot more money buying decent firms with low valuations than by paying premium prices for premium companies.  Why?  Because the future is uncertain, and low valuations leave a lot more room for error.

Buying at a Discount to Fair Value

Even though you know about economic moats and have perhaps uncovered a company that has at least one good-sized moat, unfortunately, your work is only half done at this point.  (Quality & Management)

You cannot just go out and pay whatever the market is asking for this stock until you calculate what it's worth (the intrinsic value).  (Valuation)

Otherwise, you might end up having to hold the stock for many, many years to get a decent return on your money.

And in some cases, you might never get one.

The Four Filters Invention of Warren Buffett and Charlie Munger

Charlie Munger, the Vice Chairman of Berkshire Hathaway mentions their "4 Investing Filters".

1. Understand the Business
2. Sustainable Competitive Advantages
3. Able and Trustworthy Managers
4. Bargain Price = Margin of Safety


"It is a very simple set of ideas and the reason that our idea has not spread faster is that they are too simple."


The QMV or QVM approach:

Q = Quality
M = Management
V = Valuation

Quality, Value and Management Approach (QVM approach)

http://www.lateef.com/our_process.htm

Long Term Investment Applies to 'Good' 'Business' 'Company'

Over a period of investment, I met with different types of friends. We are all searching for a Low Risk yet High Return investment which is in contrast with the classic 'Modern Portfolio Theory' written by Harry Markowitz.

Some are learning Technical Analysis. A number of theories have been developed in term of the searching of a good stock which has a upward movement or downward movement which they can predict and make use of. However, the cons of this analysis is you are hard to master it and there is still a risk involved which encourage you to 'Cut Lost' if the wind turns another way round.

Some are learning Fundamental Analysis. CFA is a good post graduation course allowing you to learn how to perform fundamental analysis from Global, Sector, and Industry to specific company by annual report. However, there is too many manipulation from the company which hinders you from making a great profit. Instead, some of the companies are trying to cheat the investors by creating a better outlook. So, which one is the best strategy to beat the overall market while enjoying lower risk?

In my previous post Margin of Safety, First thing in Investment, I always emphasize the margin of safety. One of the way we can find out the margin of safety is through searching a good company operates in a good industry and invest it in a good time.

While we try not to time the investment as we can reduce the timing risk by 'Dollar Cost Averaging', I always search for a well managed company in a good industry. ROE (a.k.a Returns On Equity) is the most important key performance indicator which I judge a good company compared against its peers. However, we also must look at its optimal corporate finance structure so that we can know the optimal debt levels it can operates at.

If you want to stay investing in long term, try to find out a good industry too. There is different industry performance in different countries. While Singapore is performing excellently in finance industry, Malaysia is good at the Agriculture & plantation and Islamic Finance. Of course, there are some industries which is less reflect during recession period such consumer industry as well as low cost leadership companies.

If you a serious investor, try to do your homework before invest in any company. Try to make the investment like invest in a business which you think it is the best company you can ever invest in. Of course, some diversification will allow you to sleep well without having worry too much in particular stock.

Long term investment does not necessarily means you have to hold the company for more than 10 years. However, this concept will keep you in mind that while investing a longer period of time in a good business company, you will enjoy a better returns as compared to other lower risk investment such as Fix Deposit, as the more homework and steadiness you performs, the better result you will get. In long run.

http://www.jackphanginvestment.com/2011/05/long-term-investment-applies-to-good.html

Treat your investment as your own business

For those who are in business, they typically know that it is very hard to compete with others with exceptional result by doing a normal job. Their business profits will eventually gone down or up depending on the environment.

Hence, please treat your investment as your own business. Before you make any decision of investing, please ask yourself few questions:

1) Is this a good business? 

2) How reliable of the top management? 

3) Can I hold this investment for long term?

4) Can I buy more if the price goes down further?


If the answers for above questions are positive, what you can do is just wait for the opportunites to invest in to it.

And, please remember to hold it for long term. It is not easy to find a good monopoly business in this world. If you are doing a business, you will understand it.




http://www.jackphanginvestment.com/2011/04/treat-your-investment-as-your-own.html

Why I lost money in some stocks in the stock market?

Why I lost money in some stocks in the stock market?

Buy low, sell high = GAIN
Buy high, sell low = LOSS

Factors to consider:
Price
Company

Price
If you can have the intellect and the emotional control to buy low, you have already WON most of the time, with a high probability. (I often quote, "many a sin is forgiven when you manage to buy at a low price.)

To be able to buy a share at a low price, means you have the ability to value this share. Valuation maybe based on assets, cash flow or multiples of earnings, book etc. Do not over-project growth in your valuation. You can only be approximately right in your valuation. This is alright, as long as you are not absolutely wrong in your valuation. There are also many qualitative factors that cannot be quantified in the valuation.

At a certain price, the stock is undervalued, at another it is fairly priced or overvalued. The ability to value a stock is the most important knowledge of a value investor.


Company
Choosing the right company to invest into is very important for someone who has the buy and hold for the long term philosophy. Choose the company in a business with durable competitive advantage. Its business moat is so huge and deep, that competitors find hard to erode their growth and profits over the long haul. Therefore, looking at the quality of the company's business and the management (integrity, intelligence and hard working) are important here.

Even the best company can fail. Look at the Dow Jones Index of 30 companies over the century. The index is made up of the best companies of each period. Many have faded or disappeared into oblivion. Of the 30 original companies at the start of the last century, only 1 or 2 of these are still in the Dow Jones index.

So, you may lose money when your high quality company with good management that you bought at undervalued price deteriorated in its business fundamentals permanently. In this situation, you will need to sell urgently to minimise your loss.


Conclusion
If you have done the hard work in selecting good quality company and valuing this company, the chances of losing money are few. From the above discussion, essentially, these are: (1) buying a poor quality company with no durable competitive advantage, and (2) paying a high price for your purchase.

This approach essentially means focusing on valuation and the company, and is not influenced by the market or herd mentality. The market is there to be taken advantage of, when the prices are right to buy or to sell, and otherwise for most of the time, can be ignored.

Nine reasons Warren Buffett loves Lubrizol (QVM approach)

MARCH 18, 2011, 10:25 A.M. ET

Why Warren Buffett Just Spent $10 Billion

By BRETT ARENDS

In other news on the markets this week, Warren Buffett quietly made an acquisition.

A big one. Even by his standards.

The 80-year old investor put down $9.7 billion, or about a quarter of Berkshire Hathaway's entire cash pile, to buy Lubrizol Corporation, a specialty chemicals company based in Wickliffe, Ohio.

What does this mean for you? Warren Buffett's investment moves are usually worth a closer look, even if you're not one of his stockholders. After all, he's one of the most successful stock pickers ever. And it's never too late to practice your swing, even if your own stock portfolio is closer to $20,000 than, say, $20 billion.

A look through the company's financials reveals nine reasons Warren Buffett loves Lubrizol.


QUALITY (Q) 

1. It has a lucrative niche.

Lubrizol's main business is making additives for fuel, which make engines run better and last longer. They are a small part of the cost of the fuel, but they are valuable to the end users and they are lucrative. Lubrizol's gross margins last year were a thumping 33%, up from 25% five years ago. The company's return on equity is 34%.

2. It has a wide moat.

Lubrizol has little trouble defending its business from competition. It has been around for 82 years – even longer than Mr. Buffett – and has built up a strong franchise. It is the market leader in the industry. And the fuel additives industry is technically advanced. Lubrizol owns a remarkable 1,600 patents and has 6,900 employees worldwide.

3. It's in a dull industry.

Nobody goes into the fuel additives business for the glamour. Venture capitalists are not throwing money after new fuel additives start-ups. Companies in the sector do not typically give away their products for free to gain market share, "eyeballs," "mind share" or the like. Indeed some of the existing players have been getting out – making life better for those who are left.

4. It has pricing power.

Mr. Buffett recently said "the single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business." At a time of rising raw material costs, that's especially important. Lubrizol fits the bill. The company's own raw materials jumped 10% last year, but it was able to pass those costs on to its customers.

5. It's stable.

Sales fell 9% in 2009, but gross profits actually rose, from $1.1 billion to $1.5 billion. And the company says less than half of its revenues rely on boom-and-bust cyclical industries, such as construction and industrial production. Lubrizol had $2.7 billion in total liabilities at the end of last year – and $2.5 billion in cash and other current assets. Dividends have risen steadily, from $1.04 per share five years ago to $1.39 last year.

6. It benefits from overseas growth.

Two-thirds of last year's revenues came from outside the U.S.A. The company has 40% of its plant and equipment overseas. And that's rising. Last fall Lubrizol broke ground on a new factory in southern China, that will begin production in 2013. The company is a big beneficiary from economic growth in emerging markets. In countries like China, India and Brazil, hundreds of millions of people are moving into the middle class, buying cars, and driving them more. Every drive needs fuel, and every gallon of gas needs additives.

7. It has low unionization.

Just 4% of Lubrizol's U.S. employees are members of a union (although some overseas workers are also members of collective bargaining agreements). That's good for profits. Mr. Buffett may be a Democrat at nights and on weekends, but when he's at the office he's all business.


VALUATION (V)

8. The stock was reasonably priced.

Even a great company can be a bad investment if you pay too much for it. In the case of Lubrizol, Mr. Buffett is paying $135 a share. That's less than 13 times last year's earnings, and 12 times forecasts for 2011. If you find a good company at a good price, who cares what "the market" is doing?

MANAGEMENT (M)


9. He likes the management.

Lubrizol chief executive James Hambrick has been with the company since 1973, when he started there as a co-operative education student. He's been CEO for seven years. "Lubrizol is exactly the sort of company with which we love to partner – the global leader in several market applications run by a talented CEO, James Hambrick," Mr. Buffett said when he announced the deal. "Our only instruction to James – just keep doing for us what you have done so successfully for your shareholders."

http://online.wsj.com/article/SB10001424052748703328404576207040639038696.html

Philip Fisher: Quality first, Price second

Fisher formulated a clear and sensible investing strategy (which I'll get to in a second), wrote one of the best investment books of all time, Common Stocks and Uncommon Profits, and made a good deal of money for himself and his clients.


His son wrote that Phil's best advice was 

• to "always think long term," 
• to "buy what you understand," and 
• to own "not too many stocks." 

Charles Munger, who is Buffett's partner, praised Fisher at the 1993 annual meeting of their company, Berkshire Hathaway Inc. (BRK/A): "Phil Fisher believed in concentrating in about 10 good investments and was happy with a limited number.  That is very much in our playbook. And he believed in knowing a lot about the things he did invest in. And that's in our playbook, too. And the reason why it's in our playbook is that to some extent, we learned it from him."


In addition to the warning against over-diversification — or what Peter Lynch, the great Fidelity Magellan fund manager, calls "de-worse-ification" — the book makes three important points:


(1)  First, don't worry too much about price.  (Quality first, Price second)

• "Even in these earlier times [he's talking here about 1913], finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colorful practice of trying to buy them cheap and sell them dear."

• In fretting about whether a stock is cheap or expensive, many investors miss out on owning great companies. My own rule is: quality first, price second.

(2)  Second, Fisher says that investors must ask, "Does the company have a management of unquestionable integrity?" 

(3)  Finally, Fisher offered the best advice ever on selling stocks. "It is only occasionally," he wrote, "that there is any reason for selling at all."


Yes, but what are those occasions? They come down to this: Sell if a company has deteriorated in some important way. And I don't mean price! 


Fisher's view, instead, is to look to the business — the company itself, not the stock. 


"When companies deteriorate, they usually do so for one of two reasons: 

• Either there has been a deterioration of management, or 
• the company no longer has the prospect of increasing the markets for its product in the way it formerly did."

A stock-price decline can be a key signal: "Pay attention! Something may be wrong!" But the decline alone would not prompt me to sell. Nor would a rise in price. 


Time to sell? If you did, you missed another doubling.


"How long should you hold a stock? As long as the good things that attracted you to the company are still there."


http://myinvestingnotes.blogspot.com/2010/09/learning-from-long-men-late-phil-carret.html

Why do you Sell and When?

Taking profit

Profit should be realised from sales of stocks in the following situations:
(I) when the stock is obviously overpriced, or
(II) when the sale of the stock frees the capital to be reinvested into another stock with potentially better return.

Not taking profit in the above situations can harm your portfolio and compromise its returns. In other circumstances, let the winners run.

Underperforming stocks should also be sold early. Hanging onto underperforming stocks is costly too. There is the opportunity cost that the capital can be better employed for higher return. Also, hanging onto these lack-lustre stocks reduces the overall return of your portfolio.


Reducing serious loss

When the fundamentals of a stock have deteriorated, sell to protect your portfolio. This decision should be make quickly based on the facts and situations, in order to keep your losses small.

Quality Investing

Quality investing
From Wikipedia, the free encyclopedia

Quality investing is an investment strategy based on clearly defined fundamental factors that seeks to identify companies with outstanding quality characteristics. The quality assessment is made based on soft (e.g. management credibility) and hard criteria (e.g. balance sheet stability). Quality Investing supports best overall rather than best-in-class approach as the specific industry’s or country’s quality is evaluated as well.

Contents  [hide] 1 History 2 Identification of Corporate quality 3 Comparison to other investment models 4 References 5 See also

[edit]History

The idea for quality Investing originated in the bond and real estate investing, where both the quality and price of potential investments are determined by ratings and expert attestations. Later the concept was applied to enterprises in equity markets.

Benjamin Graham, the founding father of value investing, was the first to recognize the quality problem among equities back in the 1930s. Graham classified stocks as either quality or Low quality. He also observed that the greatest losses result not from buying quality at an excessively high price, but from buying Low quality at a price that seems good value.^[1]

The quality issue in a corporate context attracted particular attention in the management economics literature following the development of the BCG matrix in 1970. Using the two specific dimensions of life cycle and the experience curve concept, the matrix allocates a company's products – and even companies themselves – to one of two quality classes (Cash Cows and Stars) or two Non-quality classes (question Marks and Dogs). Other important works on quality of corporate business can be found primarily among the US management literature. These include, for example, "In Search of Excellence" by Thomas Peters and Robert Waterman^[2], "Built to Last" by Jim Collins and Jerry Porras^[3], and "Good to Great" by Jim Collins^[4].

Quality Investing gained credence in particular after the burst of Dot-com bubble in 2001 when investors learned of the spectacular failures of companies such as Enron and Worldcom. These corporate collapses focused investors’ awareness of quality from stock to stock. Investors started to pay more attention to quality of balance sheet, earnings quality , information transparency, corporate governance quality.

[edit]Identification of Corporate quality

As a rule, systematic quality investors identify quality stocks using a defined schedule of criteria that they have generally developed themselves and revise continually. Selection criteria that demonstrably influence and/or explain a company's business success or otherwise can be broken down into five categories:^[5]

1. Market Positioning: quality company possesses an economic moat, which distinguishes it from peers and allows to conquer leading market position. The company operates in the industry which offers certain growth potential and has global trends (e.g. ageing population for pharmaceuticals industry) as tailwinds.

2. Business model: According to the BCG matrix, the business model of a quality company is usually classified as star (growing business model, large capex) or cash cow (established business model, ample cash flows, attractive dividend yield). Having a competitive advantage, quality company offers good product portfolio, well-established value chain and wide geographical span.

3. Corporate Governance: Evaluation of corporate management execution is mainly based on soft-criteria assessment. Quality company has professional management, which is limited in headcount (6-8 members in top management) and has a low turnover rate. Its corporate governance structure is transparent, plausible and accordingly organized.

4. Financial Strength: Solid balance sheet, high capital and sales profitability , ability to generate ample cash flows are key attributes of quality company. Quality company tends to demonstrate positive financial momentum for several years in a row. Earnings are of high quality, with operating cash flows exceeding net income, inventories and accounts receivables not growing faster than sales etc.

5. Attractive valuation: Valuation ultimately is related to quality, which is similar to investments in real estate. Attractive valuation, which is defined by high discounted cash flow (DCF), low P/E ratio and P/B ratio, becomes an important factor in quality investing process.

According to a number of studies the company can sustain its quality for about 11 months in average, which means that quantitative and qualitative monitoring of the company is done systematically.

[edit]Comparison to other investment models

Quality investing is an investment style that can be viewed independent of value investing and growth Investing. A quality portfolio may therefore also contain stocks with Growth and Value attributes.

Nowadays, Value Investing is based first and foremost on stock valuation. Certain valuation coefficients, such as the price/earnings and price/book ratios, are key elements here. Value is defined either by valuation level relative to the overall market or to the sector, or as the opposite of Growth. An analysis of the company's fundamentals is therefore secondary. Consequently, a Value investor will buy a company's stock because he believes that it is undervalued and that the company is a good one. A quality investor, meanwhile, will buy a company's stock because it is an excellent company that is also attractively valued.

Modern Growth Investing centers primarily on Growth stocks. The investor's decision rests equally on experts' profit forecasts and the company's earnings per share. Only stocks that are believed to generate high future profits and a strong growth in earnings per share are admitted to a Growth investor's portfolio. The share price at which these anticipated profits are bought, and the fundamental basis for growth, are secondary considerations. Growth investors thus focus on stocks exhibiting strong earnings expansion and high profit expectations, regardless of their valuation. Quality investors, meanwhile, favor stocks whose high earnings growth is rooted in a sound fundamental basis and whose price is justified. (QVM approach)

References

1. ^ Benjamin Graham (1949). The Intelligent Investor , New York: Collins. ISBN 0-06-055566-1.
2. ^ Thomas Peters and Robert Waterman (1982). In Search of Excellence. ISBN 0-06-015042-4
3. ^ Jim Collins and Jerry Porras (1994). Built to Last. ISBN 978-0887307393
4. ^ Jim Collins (2001). Good to Great . ISBN 978-0-06-662099-2
5. ^ Weckherlin, P. / Hepp, M. (2006). Systematische Investments in Corporate Excellence, Verlag Neue Zürcher Zeitung. ISBN 3-03823-278-5.

[edit]See also

• Value investing
• Growth investing

http://en.wikipedia.org/wiki/Quality_investing