Basics of stock investing: The Warren Buffett Strategy by mutiso

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									Basics of Stock investing:
Warren Buffett strategy

        By: Franco Martin Mutiso

One of the World’s richest men, Warren Buffett has had an incredible long-term track record of
investment success since he began investing in 1956. Referred to as the Oracle of Omaha and a
Superman of Investors, Buffett reads and interprets corporate reports at high speeds, has an
uncanny memory for numbers, and makes crucial investment decisions during jittery, jarring
markets, with nerves of steel; his personality is also mild mannered.

Many of Buffett's lessons directly contradict what has been taught in business and law schools
during the past thirty years, and what has been practiced on Wall Street and throughout corporate
world during that time.

Many people speculate on what Berkshire and Buffett are doing or plan to do. Their speculation
is sometimes right and sometimes wrong, but always foolish. People would be far better off not
attempting to ferret out what specific investments are being made at Berkshire, but thinking
about how to make sound investment selections based on Berkshire's teaching. That means they
should think about Buffett's writings and learn from them, rather than try to emulate Berkshire's

If you want to understand literature, you study the great authors; music, the great composers.
Why, then, do most investment courses ignore the great investors and instead preach the efficient
market theory, which tells us no one can beat the market and ignore those who do? You’ll find
more practical advice in this one publication than in a dozen academic investment texts. You will
also learn about the biggest mistakes almost every investor makes in selecting and selling stocks.

Warren Edward Buffett was born on August 30,1930 to his father Howard, a stockbroker-turned-
Congressman. The only boy, he was the second of three children, and displayed an amazing
aptitude for both money and business at a very early age. Acquaintances recount his uncanny
ability to calculate columns of numbers off the top of his head - a feat Warren still amazes
business colleagues with today. At only six years old,Buffett purchased 6-packs of Coca Cola
from his grandfathers grocery store for twenty five cents and resold each of the bottles for a
nickel, pocketing a five cent profit. While other children his age were playing hopscotch and
jacks, Warren was making money. Five years later, Buffett took his step into the world of high
finance. At eleven years old, he purchased three shares of Cities Service Preferred at $38 per
share for both himself and his older sister, Doris. Shortly after buying the stock, it fell to just
over $27 per share. A frightened but resilient Warren held his shares until they rebounded to $40.
He promptly sold them - a mistake he would soon come to regret. Cities Service shot up to $200.
The experience taught him one of the basic lessons of investing: patience is a virtue.

Warren Buffett’s holding company Berkshire Hathaway (NYSE: BRK.B) has been the single
greatest investment of our lifetimes.

How has Warren Buffett’s investment strategy been so successful? He takes a disciplined value
approach to investing. And he sticks with it.

Warren Buffett’s Investing Questions

Before Warren Buffett invests a dime, he asks:

       Is the company in an industry with good economics? That is, is it not in an industry
        competing on price?
       Does the company have a consumer monopoly or brand name that commands loyalty?
       Can anyone with an abundance of resources compete successfully with the company?
       Are the earnings on an upward trend with good and consistent profit margins?
       Is the debt-to-equity ratio low, or is the earnings-to-debt ratio high? Can the company
        repay debt even in years when earnings are lower than average?
       Does the company have high and consistent returns on invested capital?
       Does the company retain earnings for growth?
       Does the business have high maintenance cost of operations, high capital expenditure or
        investment cash outflow? (if so, that’s not good.)
       Does the company reinvest earnings in good business opportunities? Does management
        have a good track record of profiting from these investments?
       Is the company free to adjust prices for inflation?

In short, he makes companies jump through a lot of hoops before he considers putting them in
his portfolio.

Buffett’s Investment Strategy

Concentrated Purchases

Buffett also makes concentrated purchases within his investment strategy. For its size, Buffett’s
portfolio has few stocks. But once a downturn comes, he buys millions of shares of solid
businesses at reasonable prices.

Berkshire is a major player in the markets for insurance, soft drinks, chocolates, shoes, jewelry,
publishing, furniture, steel, energy, homebuilding and private jets.

Berkshire owns significant portions in well-known, cheap, dividend paying stocks like:

      Coca-Cola (NYSE:KO)
      Wells Fargo (NYSE:WFC), one of the few U.S. banks in good standing.
      Procter & Gamble (NYSE:PG)
      Anheuser Busch (NYSE:BUD), which has seen a major boost in its share price thanks to
       the takeover bid from InBev.
      Conoco Phillips (NYSE:COP)
      Kraft Foods (NYSE:KFT) and others.

Warren Buffett’s Investment Strategy & The Economic Downturn

Why is Buffett buying companies if by his own admission, the economic downturn, is likely to
be deeper and longer lasting than generally expected?

      First off, because he knows that nobody can accurately or consistently predict something
       as big, diverse and dynamic as the global economy.

      Secondly, he knows that even if you somehow knew what was going to happen in the
       economy, you still wouldn’t necessarily know what is about to happen in the stock
       market. Perversely, stocks sometimes fall during good times. They often rally during bad
      Thirdly, Buffett knows that the stock market is a discounting mechanism. It takes the
       news and reflects it into stock prices immediately. Who in their right mind
       would sell their stocks today because he realizes the economy is slowing down? We’ve
       known that for months now.

To guide him in his decisions, Buffett uses twelve investing tenets, or key considerations, which
are categorized in the areas of business, management, financial measures and value


Buffett adamantly restricts himself to his “circle of competence” - businesses he can understand
and analyze. As Hagstrom writes, investment success is not a matter of how much you know but
rather how realistically you define what you don’t know. Buffett considers this deep
understanding of the operating business to be a prerequisite for a viable forecast of future
business performance. After all, if you don’t understand the business, how can you project
performance? Buffett’s business tenets each support the goal of producing a robust projection.
First, analyze the business, not the market or the economy or investor sentiment. Next, look for a
consistent operating history. Finally, use that data to ascertain whether the business has favorable
long-term prospects.


BuffetCs three management tenets help evaluate management quality. This is perhaps the most
difficult analytical task for an investor. Buffett asks, “Is management rational?” Specifically, is
management wise when it comes to reinvesting (retaining) earnings or ret
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