Warren Buffett - The Investment Prodigy Y ou may have heard very little about a company called Berkshire Hathaway or its chairman, Warren Edward Buffett, who is the second richest man in America. Warren Buffett, the ‘Oracle of Omaha', is generally considered to be the world’s most successful investor with a net worth around U.S. Dollars 40 Billion. His investment vehicle, Berkshire Hathaway, is legendary with an astounding share price that has rooted up to as much as $84,000! The company has major investments in some of the top companies such as Coca- Cola Co., Gillette Co., Washington Post, Salomon Bros and McDonalds and quite a few subsidiaries such as General Re Corp., GEICO Corp., an auto insurance company, and Executive Jet Aviation- a company that owns business jets. Buffett did not inherit this colossal wealth from his family but built up his empire through careful and skilful investments that earned him a name as the greatest value investor of all times. Warren Buffett was born in 1930 in Omaha, Nebraska, U.S.A. and his father was a stockbroker turned Congressman. As a youngster, Buffett had an amazing aptitude for business and an affinity for numbers with an ability to calculate columns of numbers off the top of his head - a feat he still amazes business colleagues with today. At eleven years old, he purchased three shares of Cities Service at $38 per share for both himself and his older sister. 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. After graduating from high school at the age of seventeen, Buffett attended the Wharton Business School at the University of Pennsylvania for two years before transferring to University of Nebraska-Lincoln where he graduated. One thing he always complained was that he knew more than his professors. He was finally persuaded to apply to Harvard Business School, which, in the worst admission decision in history, rejected him as "too young". Slighted and completely surprised, Warren applied to Columbia University and completed a Masters in Economics. This is where famed investors Benjamin Graham and David Dodd taught - an experience that would forever change his life. Benjamin Graham was the author of “Security Analysis", one of the greatest works ever penned on the stock market and subsequently "The Intelligent Investor" which Warren celebrates as the greatest book on investing ever written. Warren has described himself as 85% Benjamin Graham and 15% Phil Fisher, both notable portfolio investors. Initially, Graham used ratios such as inventory to sales, debt to equity etc to determine the quality of a company. Overtime, Graham developed even simpler criteria for guiding purchases of shares in a company. The simplest criterion was that it is safe to buy shares if the price is less than 2/3 of Net Quick Assets, i.e. Current Assets less Current Liabilities. A second Graham criterion is to buy a share if the earnings yield is not less than double the interest on AAA rated bonds. For example, if the government bonds are trading at 6% yield, the earnings sought on shares should be at least 12% which means a Price/Earning Ratio (P.E.Ratio) of about 8 or less. An addition to this criterion is that the total debt of the company should not exceed its tangible net worth. A third criterion refers to a dividend yield of at least 2/3 the yield on AAA bonds. Warren treated Graham as his mentor and idol and wanted to work for him which he eventually did a few years after graduation. Buffett spent his days analysing S&P reports, searching for investment opportunities. It was during this time that the difference between the Graham and Buffett philosophies began to emerge. Warren became interested in how a company worked - what made it superior to every other in its field. Graham simply wanted numbers whereas Warren was/is predominately interested in a company's management as a major factor when deciding to invest, Graham looked at the balance sheet only and could care less about corporate leadership. Warren insists, 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. In 1956, Warren Buffet started a limited partnership in Omaha, using capital contributed by family and friends. The partnership was a great success and Buffett is said to have averaged an annual rate of return for the partnership in excess of 23 per cent, far in excess of the market. Buffett, after several years, decided to wind up the partnership, returning the lucky investors their capital and their share of the profits, and bought an interest in Berkshire Hathaway, a textile company, giving his original investors the chance to invest. The smart ones did so. Buffett’s early days at Berkshire Hathaway were not great. The company, being in an industry facing real challenges from exports and high manufacturing costs, was in trouble. Warren Buffett had not, however, forgotten what he had learned under Graham, and arranged for the company to buy out two insurance companies. This was the start of Buffett’s interest in insurance and the rise to financial fame of both himself and Berkshire Hathaway. The insurance game is a hard one but under Buffett, the company has become, not only a successful share investor, but also a leading provider of insurance. Sooner, he owned 49% of Berkshire and became the Chairman of the company and since then Berkshire Hathaway has become an investment giant that wholly owns a number of successful companies. What is the Buffett Investing Philosophy? Warren Buffett does not give stock tips. He does however, from time to time, sound out investment principles in his annual letters to Berkshire Hathaway stockholders, in reports to annual meetings and, from time to time, in the media. His approach is simple, even a bit odd. Ignoring both macroeconomic trends and Wall Street fashions, he looks for undervalued companies with low overhead costs, high growth potential, strong market share and low Price/Earning ratios, and then waits for the rest of the world to catch up. Buffett's investment strategy, known as value investing, has been one of the most successful ever. Value investing looks for stocks whose prices are low for their companies' supposed intrinsic worth, which is determined by an analysis of certain characteristics and fundamentals of companies. Mirroring the mentality and shopping style of a bargain hunter, value investors look for products that are beneficial and high quality but cheap in price. In other words, the value investor searches for stocks that he or she believes are undervalued by the market. Like the bargain hunter, the value investor tries to find those items that are valuable but not quite recognized as such by the majority of other buyers. Buffett looks for companies which have sustainable competitive advantage without tying up much capital. He will not invest in a business unless he feels reasonably certain how much it will earn over the next 20 to 25 years. In Buffett's view, the quality of a company's management is integral to its value as a business. And when acquiring companies, Buffett is as concerned with the motives of the selling CEOs as he is with their abilities. ''What I must understand is why someone will continue to get out of bed in the morning once they have all the money they could want,'' Buffett says. ''Do they love the business, or do they love the money?''. Amazingly, the world's savviest investor has sat out the entire stampede over technology stocks, backing away even from proven players like Microsoft or Hewlett- Packard. As for Internet stocks, Buffett says he won't invest in a company unless he can "see" it, unless he can imagine what its balance sheet might look like in a decade or two - a shockingly long view, especially at a time when many investors hold stocks for just days, or even minutes, at a time. Even though, Buffett’s investing principles have been regarded high in the corporate world, he has quite a few critics too. One common argument is that in the current scenario, it will be impossible to “buy and hold” shares for a longer period. Another point is that Buffett uses his money to acquire companies and then uses the funds flow from those companies to buy more. In our Sri Lankan context, it could be a little bit difficult to apply Buffett’s principles due to various reasons. Most of the local companies do not pay substantial amounts of dividends to lure investors to hold on to the shares for good 10-15 years. Changing economic and corporate environments that arise from changes in governments posses a question as to whether is it possible to arrive at a reasonable forecast for a company for the next decade or so. By B Asanga Cooray.