Investing like Warren

Buffett

Dilip Gala, CFA

Portfolio Manager,
Nipra Financial Services Pvt
Ltd
Who is Warren Buffett ?
• Warren Buffett is the world’s greatest living
investor and surely one of the greatest
that’s ever lived, having compounded his
money at an average of approximately
28% per year since 1950.
• He is the second richest man in the world.
• He is the Chairman of Berkshire Hathaway,
Inc.
Who is Warren Buffett ?

• His company, Berkshire Hathaway’s

Per-Share Book Value has grown by
CAGR 21.4% from 1965-2006 as
compared to 10.4% growth in S & P
500 Index.
• That means Overall Gain of
3,61,156% as compared to 6,479%
of S & P 500 Index.
Investing like Warren
Buffett
• According to Warren Buffett, there is no
fundamental difference between buying
a business outright and buying shares
in a business.
• He looks for companies he understands,
with favorable long-term prospects that
are operated by honest and competent
people and, importantly, are available
at attractive prices.
Investing like Warren
Buffett
• When he evaluates a potential
acquisition or stock purchase, Buffett
works first and foremost from the
perspective of a businessperson. He
looks at the business holistically,
examining all quantitative and
qualitative aspects of its management,
its financial position, and its purchase
price.
Investing like Warren
Buffett
• Step 1: Turn off the stock market.
• Step 2: Don’t worry about the
economy.
• Step 3: Buy a business, not a stock.
• Step 4: Manage a portfolio of
businesses.
Step 1: Turn Off the Stock
Market
• Don’t allow the market to dictate your actions.
• The market exists merely to assist you with the
mechanics of buying or selling shares of stock.
• If you believe that the stock market is smarter than
you are, give it your money by investing in index
funds.
• But if you have done your homework and
understand your business and are confident that you
know more about your business than the stock
market does, turn off the market.
Step 2: Don’t Worry About the
Economy

• No one has economic predictive powers

any more than they have stock market
predictive powers.
• If you select stocks that will benefit by a
particular economic environment, you
inevitably invite turnover and
speculation.
• Prefer to buy a business that has the
opportunity to profit regardless of the
economy.
Step 3: Buy a Business, Not a
Stock
• Imagine you have to make a very important
decision. Tomorrow you will be given an
opportunity to pick one business in which to
invest. Also once you have made your
decision, it can not be changed and,
furthermore, you have to hold the investment
for 10 years. What would you do?
• If Warren Buffett were given the same test, he
would methodically begin with the following
principles, or tenets.
Business Tenets

• Is the business simple and

understandable?
• Does it have a consistent operating
history?
• Does it have favorable long-term
prospects?
Simple and Understandable
• You cannot make an intelligent guess about the
future of your business unless you understand
how it makes money.
• Too often individuals invest in stocks without a
clue as to how a company generates sales,
incurs expenses and produces profits.
• If you can understand this economic process,
you have the ability to intelligently proceed in
your investigation.
Consistent Operating
History
• If you are going to invest your
family’s future in a company, you will
need to know whether the company
has stood the test of time.
• You should be assured that your
company has been in business long
enough to demonstrate an ability,
over time, to earn significant profits.
Favorable Long-Term
Prospects
• The best business to own, the one with
the best long-term prospects, is a
franchise. A franchise is a business that
sells a product or service that is needed or
desired, that has no close substitute, and
whose profits are not regulated.
• The worst business to own is a commodity
business.
Management Tenets

• Is management rational?
• Is management candid with the
shareholders?
• Does management resist the
institutional imperative?
Rationality
• Watch your company’s cash. How the
management reinvests cash earnings will
determine whether you will achieve adequate
return on your investment.
• A rational manager will only invest excess
cash in projects that produce earnings at rates
higher than the cost of capital. If those rates
are not available, the rational manager will
return the money to shareholders.
Candor (Openness)
• Does your manager report the progress
of your business in such a way that you
understand how each operating division
is performing?
• Does management confess its failures as
openly as it trumpets its success?
• Is the company’s prime objective to
maximize the total return of their
shareholders’ investment?
The Institutional Imperative

• Is your manager doing mindless,

lemming like imitation of other
managers, no matter how irrational
their actions may be.
• One measure of managers’
competence is how well they are
able to think for themselves and
avoid the herd mentality.
Financial Tenets
• Focus on return on equity, not
earnings per share.
• Calculate “owner earnings” to get a
true reflection of value.
• Look for companies with high profit
margins.
• For every rupee retained, make sure
the company has created at least
one rupee of market value.
Return on Equity

• Since companies continually add to

their capital base by retaining a
portion of their previous year’s
earnings, growth in earnings per
share is really meaningless.
• A true measure is return on equity,
because it takes into consideration
the ever growing capital base.
“Owner Earnings”
• Buffett seeks out companies that generate cash
in excess of their needs as opposed to
companies that consume cash.
• Accounting earnings need to be adjusted to
reflect the cash-generating ability.
• To determine owner earnings, add depreciation
and amortization charges to net profit and then
subtract the capital expenditures needed to
maintain company’s economic position.
Profit Margins

• High profit margins reflect not only a

strong business but management’s
determined spirit for controlling
costs.
• Also high margins are cushion in bad
times.
The One-Rupee Premise
• Add the company’s retained earnings over
a ten-year period. Next, find the difference
between the company’s current market
value and its market value ten years ago.
• If your business has been able to earn
above-average returns on retained capital,
the gain in market value of the business
should exceed the sum of the company’s
retained earnings.
Market Tenets

• What is the value of the business?

• Can the business be purchased at a
significant discount to its value?
Determine the Value

• The value of a business is

determined by the estimated cash
flows expected to occur over the life
of the business, discounted at an
appropriate interest rate.
• The cash flows of a business are the
company’s owner earnings.
Buy at Attractive Prices
• Once you have determined the value
of a business, the next step is to look
at the price.
• Buffett’s rule is, purchase the
business only when its price is at a
significant discount to its value.
• Only at this final step does Buffett
look at the stock market price.
Step 4: Manage a Portfolio of
Businesses

• Now that you are a business owner as opposed to

a renter of stocks, the composition of your
portfolio will change.
• As a manager of a portfolio of businesses, you
must resist the temptation to purchase a
marginal company just because you have cash
reserves. If the company does not pass your
tenet screen, do not purchase it.
• Be patient and wait for the right business. It is
wrong to assume that if you are not buying and
selling, you are not making progress.
Thank You