Book Review: The Essential Buffett

The Essential Buffett: Timeless Principles for the New Economy by Robert G. Hagstrom (John Wiley & Sons, 2001)

A great starter for those who are new to Buffett-style investing. Provides all you need to know to kick-start as a value-growth based long-term investor.

This book is an extension of the author's first book on Buffett, The Warren Buffett Way.

While the first book is based on examples from Buffett's stock picking decisions, the sequel focuses more on the ideologies and inspirations of Buffett-style investing. The first two chapters are a recap of his first book. It sets the stage by giving an overview of Buffett-style investing, his thinking and his history, growing up as an investor with an acute interest in crunching numbers and thinking independently.

Influences and Inspirations of Buffett's Investing Approach

Having been influenced by his father, who was a stock broker, and his penchant for numbers Buffett tested the stock market at the age of eleven. He read all the books he could during his teens and when he was ready to go to college he already knew most of the subject matter taught in his undergrad classes. Apart from his readings, there are three important people whose teaching and acquaintance greatly shaped Buffett into what he is today.

They were: Ben Graham, Buffett's mentor, employer and the father of value investing; Charlie Munger, Buffett's partner in business; and Philip Fisher, the pioneer of growth investing. Buffett blended the principles from Ben Graham's value based approach, Philip Fisher's "soundness of business growth prospect" approach and Charlie Munger's "great business does not sell cheap" approach.

Tenets of Buffett-style Investment

The author dissects Buffett's principles into twelve investing tenets categorized as Business Tenets, Management Tenets, Financial Tenets, and Marketing Tenets. These tenets form the foundation of Buffett's blended approach to investing. Just by adhering to these tenets and spending time to research about a company can help an investor do better than the market average.

Focused Investing is the Key to Success

The essence of the book is in the concept of focused investing. Buffett thinks of investing as a punch card which can be used for only 20 punches for the lifetime. An investor should be so diligent that he/she should use those 20 punches wisely. The book provides results of a statistical analysis of the performance of sample stock portfolios with varying numbers of stocks.

The results reveal that the fewer the number of stocks in the portfolio, the greater the return over a long term. Needless to say, these stocks should be carefully selected based on sound research, estimate of intrinsic value, and margin of safety.

Ocean of Opportunity in Technology & Emerging Economies

While Buffett has set his foot into all kinds of traditional businesses from candies to insurance, he has always stayed away from the technology industry. The model of traditional businesses has pretty much remained the same since the dawn of time and they will not change. On the other hand, technology business models are ever-changing, evolving and are more competitive.

This book was published at the peak of the technology bubble and there has been a tremendous change in the information and communication technologies. The value of a technology can be calculated using the financial statements. But predicting the growth of a technology company is relatively very difficult.

The book provides a few factors that can be used to evaluate a technology company. But these factors keep changing according to the technology. This industry is an unexplored frontier for a "value-growth' based investor and the author sees a great opportunity in this. Buffett has not invested a lot in other countries. The author sees a plethora of opportunity in emerging economies as well.

This article was originally published on SeekingAlpha

Book Review: Buffett Beyond Value

"Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing," by Prem C. Jain (Wiley - March 2010)

The most comprehensive, illustrative, elaborate and anecdotal guide to Buffett's value investing principles. A must read for all long-term investors.

This book is written based on extensive research and analysis of decades of Berkshire Hathaway's annual reports, letters to shareholders, academic journal publications and other financial literature. The author himself is a seasoned practitioner of Buffett's contrarian value investing principles. The book contains numerous examples from Buffett's investments and a dissection of the decisions that lead to the investments. The book sets the stage by reasoning why investing in stocks could yield the most return and concretely supporting it with the credible history of Berkshire Hathaway's exorbitant growth.

Value and Growth Constitute Best Investing Strategy

More often, growth investing is associated with speculative upward movement in stock price or the rapid ascent of a high-tech company's stock. Professional investors often view growth investment as the near-term or medium-term speculation based on recent earnings. Most literature on Buffett's investing principles refer to a value investing approach that places emphasis on past performance. This book brings in a fresh new perspective by helping readers see that Buffett's principles are focused not just on intrinsic value but also on the growth potential of the company for many years into the future. It elucidates how to calculate the intrinsic value of a business and to make an investment decision based on it. It also explains how to gauge the future growth potential.

Putting Other People's Money to Work

The book provides classic examples of how Buffett uses other people's money from his insurance and re-insurance businesses to buy more companies that will keep minting money for eternity. The best period to hold stocks is forever. Higher the portfolio turnover the more money paid in taxes. Holding a stock for a long time is akin to getting a loan from the IRS at zero interest, while the net worth keeps increasing year-over-year even with modest price appreciation.

Learn to Reduce Downside Risk - Above Market Returns Will Be Evident

Of all the ways that money can be used to make more money, investing in stocks is the one that has the potential to give the most return. And at the same time, this could let one down the most. In the long run the returns outweigh the risks. But by how much is the question that makes a big difference. While the upside potential is essentially unlimited, the downside is not loosing more that what was invested, at its worst. Anyone can get a return matching at least the market rate by investing in index stocks. But by how much more return can one get above the market is all that makes the difference. This book will definitely provide one with motivation, methods and means to get jump started as a Buffett-type investor.

Numbers Are What Everyone Sees, Quality of Management is What Only a Few See

The book stresses the idea that, while it is important to understand the financial measures of a company, it is as important to understand management and corporate governance. Buffett invests a great deal of time in learning a company's management personnel, style and the decisions made on capital allocation. The author mentions this philosophy in numerous instances throughout the book as well as explains in detail in the final part.

Knowledge, Discipline, Commitment, Patience: Ingredients For Success

The last four parts of the book focus on market efficiency, ability to interpret financial statements, expending quality time and effort, and developing the right mind-set. One can save a lot of time by not looking at the stock price everyday and giving less attention to raining opinions of media. Rather, use that time to study a company and its management more closely. With knowledge comes the confidence and the mid-set to buy stocks in lots when the market is ridden with fear. It is also important to accept mistakes and learn from them. The author highlights Buffett's mistakes as well as acknowledging his own. He recommends keeping an investment journal of self-learning.

Comprehensive Coverage, Lucid Explanations, Truly Motivating

Although the author is highly educated in finance and accounting, he hasn't used any technical jargon in this book. The book is divided into nine parts that flow in a sequence. Each part contains bite-sized chapters. The chapters are filled with solid investment examples and analysis of those examples. Each chapter is concluded with a gist of the entire chapter that helps to recollect and keep track of what was learned from that chapter. The book is studded with numbers and analysis and does not carry any fluff.

This article was originally published on SeekingAlpha

Book Review: "The New Buffettology"

The New Buffettology - The Proven Techniques for Investing Successfully in Changing Markets, by Mary Buffet & David Clark (Rawson Associates Scribner, 2002).

This investor's manual for value investing provides step-by-step techniques used by the super-rich investment guru Warren Buffett to pick value stocks.

The term "Buffettology" may not have secured a place in the Webster dictionary yet, but it sure is the magic word in the dictionary of investing. There have been so much coverage of his decades old wisdom in numerous books, magazines, and all channels of media. His investment principles are as simple as using common sense and understanding the power of compound interest. Yet, many turn a blind eye to them in search of quick profits. Just following the steps that this book teaches could earn a return, better than the market average.

How to Pick Companies to Buy, Rather Than Stocks to Trade

In the first few chapters, the book explains how Warren Buffett stands to differ from the crowd in picking stocks to buy. Most of the investors buy on good news and sell on bad news. Buffett buys on bad news. People are skeptical of a stock when it is beaten up to its lows. But this is when Buffett sees the opportunity of a lifetime. He starts looking deep into the company fundamentals to see if the underlying business model is sound and that the negative even is just a one-time occurrence. Once he is confident in the business he goes and buys with all the cash he can use. He does not believe in buying a little to avoid downside risk. When in doubt he moves on. The author defines this approach as contrarian investment strategy. What Buffett practices is the selective contrarian strategy, where he buys a part or whole of a company which has a competitive durable advantage and its stock price is beaten up due to bad news or recession.

Buy Only Companies With Competitive Durable Advantage

Buffet classifies companies into two types. One is price-competitive-commodity business and the other is competitive-durable-advantage business. Buffet avoids the first type of business, as there are several companies offering the same product or service and the profit margins are narrow due to price competition. Second type of business is the one who has less competition, or has a strong brand name, or has a high inventory turnover to compensate for the low prices. Competitive durable advantage is the strategy that this book emphasizes all over. A company with durable competitive advantage should have earned a consistent return on equity (ROE) of over 12% for at least in the past 10 years. Should have a positive trend in the earnings.

Choosing the Right Opportunity to Buy a Stock

The book gives some great practical tips on when to buy a stock once a company is determined to have competitive durable advantage. It does not mention about looking into a stock chart anywhere. It teaches you how to estimate the underlying book value of a company. And if the stock price is below that at any point of time, it is a great buying opportunity. The market is fearful. That's when Buffett buys them in huge numbers. He lets go if the price is not right. Because according to his principle, the price one pays for a stock determines ones' rate of return. Such buying opportunities come during a bear market, a recession, a calamity, or bad news about a company.

How to Interpret the Financials, Using a Check List, Getting Into And Getting Out of the Game

The book teaches when financial information to look for in a company like Return of Equity, Return of Total Capital, Earnings per Share. It also provides the sources that Buffett uses for his research. It gives a 10 point check list to use before picking a company to buy. The last chapter provides a wonderful template of questions about a company. Answering all the questions will help one decide whether to buy a stock or not. The book also lists all the companies that Buffett had or has invested in in the past few decades and also the rationale behind them. Even he has made his share of mistakes. But was very smart to learn from them.

This book should be in the desktop of all those who seek to invest in the stock market. One additional attribute that the book needs from the reader is patience. This book doesn't speak of a short-term quick buck, but rather long-term, solid wealth creation.

This article was originally published on SeekingAlpha

Book Review: Interpretation of Financial Statements

Whether one is investing, managing a business, or beginning to learn finance, this book is the 101 rapid course in Financial Statements. A must read, have.

Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage by Mary Buffet & David Clark (Scribner; 1st edition, 2008)

The author has written this book with the objective of making Financial Statements understandable to almost anyone. Every component of Balance Sheet, Income Statement, & Cash Flow Statement is dismantled and explained in simple language without any financial jargon. Anybody, who would, in some way, be starting to learn finance or accounting, should read this book first.

Importance of Financial Statements in Investing

The author sets the stage for delving into all the elements of financial statements. She starts by explaining the types of businesses that Buffett would buy in part or a whole. She explains how Buffett took the value investing philosophy advocated by Benjamin Graham and augmented it with his philosophy of durable competitive business advantage. Graham believed in buying interest in business whose stocks are undervalued and selling it when the price is escalated, with less regard to the type of business. Whereas, Buffett looks at businesses that always have, what he calls, a durable competitive advantage.
How does he unearth the hidden treasures? Only with the help of financial statements. Beginners and novice investors or traders just look into the metrics on the quote snapshots, which does not tell much about the financial strength or the competitiveness of a business. Financial Statements are what he turns to to discover the gems. These don’t require reading between the lines, but just understanding the lines.

Income Statement – Where to Get the Bottom-line Measure

The book first elucidates the metrics in the income statement, which is the most important of all the financial statements. It contains the bottom-line metrics, the net income, and all the components that equate to the net income. It is not enough to just look at the most recent statement. Buffett's uses 10 years’ worth of bottom-line numbers to predict the durability of a company for at least the next 10 years.

How to Determine the Strength, Size, Sustainability, and Solvency

The next section details the components of a balance sheet. This provides a different view of a company. It tells about the size of a company, the liabilities, the magnitude of debt it carries, and the shareholder equity.
The third section details the importance of cash flow statement. It explains what to look for in a cash flow statement. It is necessary to look into actual cash coming in and going out as the net income may not be actual income earned, it is just the sales recorded and it may have been sold on credit to the customers.

One Financial Statements Pocket Guide to Definitely Carry for Quick Reference

The last section illustrates how Buffett makes his buy decision, once he has determined that the fundamentals are strong based on financial statements. The price paid for a stock determines the return. Even if the company is a good investment, if the price is not right, Buffett lets it go or awaits an opportunity. He also compares the return on treasury bonds to estimate the right price to pay.
Every term on a financial statement is crisply explained in one or a few pages. This is a great book for those who are averse to reading pages of fluff. If this book is published with small text, it could be the bestselling pocket reference to interpreting financial statements.