Even those who are not very familiar with the world of the stock market have probably heard of Warren Buffet. He has been called the most successful investor of all time. He netted over $56 billion personally with an investment partnership he started with only $100.
While he has been sometimes categorized as a ‘value stock investor’ his method was actual a bit different. He focused on the quality of stock as well as the value. Robert Hagstrom, a senior vice president with Legg Mason Capital Management, presented Buffet’s method in the book ‘The Warren Buffet Method’ over 10 years ago. Hagstrom wrote the book because he believed that the average investor could learn from Buffet’s method.
Buffet’s incredible story begins with a small investment partnership established in 1956. In the mid-1960s, this partnership acquired a failing textile company. Buffet was able to bring this company’s net worth from $22 million to $69 billion.
The Buffet method is broken down into 12 tenants that form the basis for evaluating any investment, from stocks to entire companies. One of the key points in the method is that it is necessary to do some hard work (like research and projections) in order to know the investments thoroughly before any money exchanges hands.
The twelve tenets are really questions to ask yourself before making an investment. According to Buffet, the first consideration is “Is this business simple and understandable?” Buffet did not invest in any technology stocks for the simple reason that he did not understand them. If you understand the business you are investing in (or outright purchasing) you will be in position to see the problems and possibilities as they arise. Secondly, ask yourself “Does the company have a consistent operating history?” Viewing the viability of the business in its previous operation can forecast future trends.
The third tenant is “Does the business have favourable long-term prospects?” This question is a gentle reminder that wise investors hold stock in good companies for the long term. Looking to the future of the companies reveals the true value of the investment.
Next, “Is the management rational?” Buffet places a great deal of importance on evaluating the management of the company. He pays attention to how the excess profits of a company are used. Additionally, he asks “Is the management candid with shareholders?” He believes that many company executives hide behind the company and do not fully disclose information to their shareholders. A manager who readily admits any mistakes made is more honourable and trustworthy. Following the theme of management related questions is “Does the management resist the institutional imperative?” Essentially this question evaluates the manager’s ability to act with character rather than cave-in to the peer pressure to do what other managers are doing.
The next question for evaluation is “What is the return on equity?” Buffet focuses on return on equity rather than the more popular ratios. This is because he feels earnings figures can be manipulated. The long term return on equity will have a more powerful effect than simple earnings.
The 8th tenant is “What are the company’s owner earnings?” His calculations of owner’s earnings include estimates of future capital expenditures. The 9th tenant is “What are the profit margins?” If a company makes sales but does not profit, then the company is a failure. Buffet avoids companies with large expenses because in his eyes it reflects a lack of discipline in the management of the company.
The 10th tenant is “Has the company created at least one dollar of market value for every dollar retained?” This is a test of correct capital allocation. If the company is holding onto cash but is not helping its shareholders than something is wrong with the management strategy.
The final two questions are “What is the value of the company?” and “Can it be purchased at a significant discount to its value?” Buffet calculates the value of a company as the total of the net cash flow expected to occur in the life of the business. By buying at discount, an investor will assure that any discrepancies in his calculations will be covered.
8 MONEY SECRETS FROM WARREN BUFFETT
The following are the secrets defined by Warren Buffett:
1. RICH IS A STATE OF MIND
The difference between being poor and being rich is really just a state of mind. Poor people think thoughts of poverty and lack, rich people think thoughts of abundance and prosperity. Your beliefs are going to determine the way you perceive wealth, the decisions you make and the way you act towards it.
2. SUCCESS IS MORE THAN ABOUT YOUR BANK BALANCE
When asked by CNBC what is the secret to success, Buffett replied “If people get to my age and they have the people love them that they want to have love them, they’re successful. It doesn’t make any difference if they’ve got a thousand dollars in the bank or a billion dollars in the bank… Success is really doing what you love and doing it well. It’s as simple as that. I’ve never met anyone doing that who doesn’t feel like a success. And I’ve met plenty of people who have not achieved that and whose lives are miserable.”
3. SPEND LESS THAN YOU EARN
It seems like common sense advice and you’ve no doubt heard financial experts preaching about it for years. You can’t possibly get ahead financially if you’re spending more than your paycheck. Buffett is famous for living a simple and frugal lifestyle. He is the only billionaire that still lives in the same house he bought back in 1958 for $31,500. He drove a 2001 Lincoln Town Car for years which he bought second hand. Buffett has a net worth in excess of $52 billion and yet lives off an annual salary of $100,000. The relative percentage of his spending based on his overall net worth is minuscule.
4. AVOID CONSUMER DEBT
The sooner we realise that consumerism is a social plague that has been propagated by billion dollar marketing machines to keep you shackled to your job, the sooner we can stop spending money on useless stuff. It is a fool’s game to spend today so that you can work tomorrow to pay it off. It is a losing proposition because one day your working days are going to be over but the debt is still going to be hanging over your head. Clever marketing has convinced our society that to be happy you have to have more, be more and do more. Buffett abhors consumer debt instead choosing to use debt wisely by leveraging it in investments.
5. YOU ARE WHO YOU ASSOCIATE WITH
If you want to succeed financially you need to associate with people who are most conducive to encouraging and cheering on your financial journey. If the people you associate with see money as evil, object to capitalism and find wealth a foreign concept then your financial health and well being is going to be influenced by their views. Whether we like it or not we are all influenced to some extent by the people we spend our primary time with. If you aspire to achieve financial security then you need to find a mastermind of people in your life whom you can all encourage and help each other.
6. GAMBLING IS A FOOLS GAME
While we are young and naive we choose to take risks with our money that are dumb and stupid. Trying to hit a home run with your money every time is a losing proposition with long term consequences. To chase investments that offer a high rate of return you must also assume that it also comes with a higher rate of risk. Bill Gates once quipped “Warren’s and my betting has always been confined to $1 bets” when talking about them paying poker together. If two billionaires take risk management this seriously, it’s time we average punters did the same thing.
7. GIVE BACK TO THE COMMUNITY
They say that to have more you need to give more. A contradiction in terms, maybe, but it’s a simple truth that is as enduring as time. As the bible says “It is more blessed to give than to receive.” Buffett has announced in 2006 that he was giving away over $30 billion to the Bill and Melinda Gates Foundation making it at the time of writing the largest charitable donation in history. He also contributes large sums to his children’s charitable foundations.
8. GENEROSITY AND ABUNDANCE GOES HAND IN HAND
A famous bible quote goes—”What benefit will it be to you if you gain the whole world but lose your own soul?” The path to wealth isn’t a solo endeavour. How sad would life be if you come to the end of your life and there is no one to share it with. So as you journey on your path to financial abundance remember that there will be many people who generously helped you on your journey so it is only fitting to pay it forward when the opportunity arises. Generosity with your time, with your money, with your resources are great virtues to have. The greatest ally to building a strong friendship is to help others achieve what they want from life.
