Stock Investing


Buffettology
Previously Unexplained Techniques

One of the characteristics I share with Warren Buffett is a dislike of spending my money unnecessarily.

I like to buy my investing books in thrift stores or charity shops. The result is that I'm sometimes a little behind the times with the latest trading techniques. This doesn't bother me much, because I'm an investor and the best investing strategies are not brand new. They have been developed over a period of years, then nurtured and refined until their advantages and disadvantages have become clear.

Last week I picked up a paperback copy of Buffettology - The Previously Unexplained Techniques That Have Made Warren Buffett The World's Most Successful Investor. The book has 320 pages split into 47 chapters and was written in 1999 by Warren Buffett's former daughter-in-law, Mary Buffett and her co-author, David Clark. The investing techniques it describes are timeless.

Who Should Read Buffettology and What Will They Learn?

Buffettology is aimed at beginning stock investors. If you master all of the techniques described, you could perhaps call yourself an Advanced-Beginner----Theory. (Until you have blooded yourself in the markets for several years you should never describe your investing skills without using the word "beginner" somewhere.)

Buffettology describes Warren Buffett's investing techniques clearly enough for anyone with basic high-school number skills to benefit. It is split into two parts:
  • Part 1 - Basic Buffettology describes Buffett's methods with little emphasis on numbers.
  • Part 2 - Advanced Buffettology uses worked examples to show readers how to calculate the return they might expect from investing in stocks.
For anyone with an interest in fundamental analysis of stocks, the book is well worth reading. It also has a brief history of how Warren Buffett began his investing career and it describes the people and influences that have shaped his investing strategies.

The key elements of Buffett's investing strategies are each given a chapter. For example, Investing from a Business Perspective, Buffett's View of Earnings, Valuing a Business, The Magic of Compounding, The Theory of an Expanding Intrinsic Value, The Equity / Bond with an Expanding Coupon, and What to Look for in an Excellent Business, (to name just a few), have their own dedicated chapters.

Business Perspective Investing

In Part 1 of Buffettology the authors identify the key elements of Warren Buffett's business-perspective investing. These are as follows:
  • Only invest in companies whose future earnings are predictable. (Use past earnings-growth to judge future earnings.)

  • Companies whose earnings are predictable tend to have favorable business economics. Such companies generate cash flows that do not need to be reinvested to keep the company going. They can be used to buy new businesses.

  • Excellent businesses invariably show a high return on shareholders' equity.

  • Excellent businesses often have what Buffett is fond of calling a consumer monopoly - this means the company has developed sufficient strength in its market that its products have become widely available; consumers ask for the products by their brand names. For example Wrigleys enjoys a consumer monopoly in chewing gum and the Washington Post and Newsweek enjoy consumer monopolies in news publishing.

  • Buffett prefers to avoid commodity businesses - these are business with no consumer monopolies. For example, there are no consumer monopolies in coal - nobody who uses coal asks for a particular brand name.

  • The price you pay for a stock is crucial. No matter how good a company is, if you pay too much for it, your investment is doomed to a future of poor returns.

  • List the businesses you would like to become a part-owner of. Buy shares in these businesses only when the price is low enough to ensure that you have a good chance of making a healthy return.
In Part 2 of Buffettology the authors provide plenty of worked examples to enable you to identify companies with the desirable properties identified in Part 1. They also show you how to determine the price you should pay for a stock.

Overall, Buffettology does a good job of providing you with the information you need to invest in stocks from a business perspective. It is an instructive read for anyone interested in applying Warren Buffett's methods to stock investing.