POST OF THE DAY
Berkshire Hathaway
Re: HDI a Buffettt pick?

Format for Printing

Format for printing

Request Reprints

Reuse/Reprint

By DeliLama
December 27, 2004

Posts selected for this feature rarely stand alone. They are usually a part of an ongoing thread, and are out of context when presented here. The material should be read in that light. How are these posts selected? Click here to find out and nominate a post yourself!

Buffett has never publicly disclosed his strategy (other than some references to it in his famous annual reports), but investors can gain a great deal on insight into his approach to investing using the book "Buffettology" written by his daughter-in-law Mary Buffett. This is the book I have used to develop my strategy based on Buffett.

I'm going to explain Warren Buffett's methodology right here and now. This information can make you very wealthy over a long period of time. Amazingly enough, most people stumble into it, refuse to believe it's that simple, and continue looking for it somewhere else. They want those magic beans.

1) Buy things when you can pay much less than they're worth in situations where you have very high confidence that the value is "much" greater than the price. How "much" greater depends on just how exact is your knowledge of what it's worth and how likely the thing is to remain worth that much or more. NOTE: There will be lots of situations where you have some confidence, but not very high confidence. Avoid buying in those situations.

2) Only do this when the thing you're buying can be sold at some distant future date for full value. In other words, this rules out things that are short lived such as pumpkin futures in early October. It also rules out things that are unlikely to ever have a market value.

3) In terms of market value, the only measure of the value of something is equal to the time discounted value of free cash that it produces (look up discounted cash flow, it's a very standard financial analysis method, but be honest with yourself by choosing a realistic risk-free interest rate that you can expect to receive from risk-free investments in the long term future). For stocks, imagine you owned the whole business but without being able to control the management. If you owned a lumber mill, the only thing you'd probably care about is how much money you could siphon out of it and when. If it produces lots of cash, but management grabs it all, the business ain't worth squat. And earnings aren't worth a damn. Free cash that isn't needed by the business over the long term is what counts. The business may choose to re-invest cash, but it should only do so when it's extremely likely to create additional value.

4) Despite what Buffett says, what Buffett does is usually sell things when someone offers full price for it. This is especially true if you don't need to keep a reputation of not selling businesses.

5) Never stray into investments where you can't figure out a minimum value of free cash flow, no matter how glamorous it is or emotionally attached you may be. If you find yourself owning such a thing, sell it ASAP.

6) Spend a lot more time thinking than doing. An investment decision should be a deliberate action, which could very well last a decade or more. Don't own something for 5 minutes that you wouldn't want to own for 10 years because that's how long you might be owning it if you apply the above principles.


ADVANCED BUFFETT PRINCIPLES

7) Never make an action which would degrade your reputation. Spend your life building a good, honest reputation on treating people the way you'd want to be treated if your roles had a 50/50 chance of being reversed.

8) Don't work with people you don't like if at all possible, even if it means passing up opportunity. You probably won't regret it and life is too short for that, anyway.

9) Seek out people you admire and ask them lots of questions. Be perpetually curious and inquisitive about investment.

10) Look for certain types of successful business people who enjoy being competent and very good at what they do.

11) Cultivate rationality. Anticipate cause-and-effect. Form bad eating habits and don't take yourself too seriously.

That's my take on The Warren Buffett Methodology.

DeliLama


Become a Complete Fool
Join the best community on the web! Becoming a full member of the Fool Community is easy, takes just a minute, and is very inexpensive.