Takeaways from the book "Warren Buffet Way"

Recently heard a concise audiobook version of "Warren Buffet Way" - Robert Hangstrom

The author suggests that all of Buffett`s company purchases over time seem to have all or some of the following tenents:

1) Business Tenents:

1. Is the business simple and understandable ? Investment should be based on business fundamentals and not economic forecast or any exterior factors.
2. Does the business have consistent operating history ? Businesses that are turning around or have a new operating strategy increases likelihood of failure.
3. Does the business have favorable long term prospects ? A franchise is much better than a commodity business. A franchise who is not regulated can increase prices without loosing market share or volume.Even if demand is flat the prices can be raised.Conversely a commodity products is indistinguishable from each other. Now banks,insurance etc have become commodity products.Franchises can tolerate mismanagement or mistakes.

2) Management Tenents:

1. Is the management rational i.e. is it a good capital allocator ?
2. Does the management communicate with shareholder candidly without hiding behind GAAP ? Does the management discuss failure openly ?
3. Does management withstand the institutional imperative ? This is the act of imitating other corporate managers no matter how silly the behavior is.You can find that institutional imperative exists when 1) institution resists changes in its current direction 2) just as work expands to fill available time, corporate acquisitions and projects will be started to soak up available funds 3) Any ambitious craving of its leader will be quickly supported by a detailed rate of return and benefit analysis by its troops 4) behavior of peer companies will be mindlessly immitated

3) Financial Tenents:

1. Do not take one year result seriously.......use 4-5 year averages
2. Focus on Return on Equity and not EPS. Since most companies retain earnings from previous year so there is no big deal about increasing EPS. For calculating ROE all marketable securities should be valued at cost. You should exclude all capital gains and extraordinary items. Debt levels should not be too high.
3. Use owner earnings instead of reported earnings. Owner Earnings = Net Income + Depreciation + Depletion + Amortization - Capex - Working Capital. Calculating future capex might just be estimates but guess is better than no guess.
4. Look for companies with high profit margin. High profit margin shows that management is cost sensitive and keeps costs low.
5. For every dollar retained make sure the management has created more than dollar of market value. The stock market tracks the business value over long periods. Hence we can compare the increase in market value with increase in retained earnings to estimate the effective allocation of capital by the management.
6. A value of business is determined by the net cash flow to occur over the life of the business discounted by an appropriate discount rate" . If you are not able to project the future cash flow don't buy the company. Buffet uses discount rate of existing long term government bond.
7. Difference between growth and value is pointless. Value is the discounted value of cash a business would generate over time. Growth is simply the rate at which the free cash flow will increase over time.Using the growth estimate you arrive at the intrinsic value of the company. The decision to buy one company vs other should be purely based on intrinsic value and not the growth rate since intrinsic value already should reflect the growth rate.

4) Market Tenents:

1. Is the intrinsic value greater than the market value ? Always keep a margin of safety between your estimated value and the market value. Because if you made an error in your valuation the discount to intrinsic value might protect you from making a loss on investment.

If we make mistake in investment it can be because of price we paid,management we joined or the future economics of the business. Mistakes in estimating the future economics of businesses is the most common.

Applied Value Investing - Book Author Interview

http://seekingalpha.com/article/177069-joe-calandro-jr-author-of-applied-value-investing-every-investor-should-be-active

Conversely, Graham and Dodd provide a framework to address assumptions up front in every valuation, which is important because, like it or not, when you value a business you are addressing these assumptions, either explicitly or implicitly.

You will make better adjustments if you understand accounting (financial and managerial), strategy, and operations management. There isn’t a silver bullet with this activity, or anything else for that matter. When you read books like “Margin of Safety” by Seth Klarman, “Security Analysis,” “The Intelligent Investor,” and Buffett’s Shareholder letters you see very carefully that they have thought through the assumptions in their valuations very carefully. They aren’t assuming anything away, but rather addressing issues head on, which I think is a key factor of their success.

The need to focus on cross-discipline analysis, which is important for both investors and business people.

When a beginner starts investing, they should do so with a small amount of money because they are going to be wrong (possibly very wrong). Therefore, learning from each failure is critically important; I suggest that every investor conduct a post mortem on each of their investments (both failures and successes) and by so doing they can refine their circle of competence over time. This is important because the circle of competence is essentially what you are offering people as an investor so the sooner you start developing one, the better.