Buffett Stock Strategy from Jae – my action: do it now for my positions
Really need to digest of this
http://www.oldschoolvalue.com/blog/investing-strategy/warren-buffett-stock-strategy/
Buffett took 5 minutes, not because he is a super accountant. It took him a mere 5 minutes because he already had built up his internal database and understanding of the industry and economics of the business.
Road to Uncommon Profits
I have a question that I ask people regularly.
- Are you overwhelmed with information and opinions?
Everybody says yes and it goes to show how hard it is to focus on the right thing.
Buffett tells you straight up – to exponentially improve your stock picking skills, study the industries and economics of the business.
If you know the industry and business well, the numbers are easy to interpret.
If you know a lot about retail, you’ll easily compare things like cash conversion cycle, inventory turnover and margins to figure out which company is the best.
However, if you have no idea about how retailers work and try to make sense of the numbers, it’s tough.
One of my hobbies involves photography but I find it amazing how pros can take magnificent photos with cheap disposable cameras.
What most people don’t understand is that these pros understand what type of light, angle and composition makes the scene majestic.
This is the qualitative stuff that pros understand.
On the other hand, there are many people who solely focus on the specs of a camera and want the latest equipment without fully understanding the bigger goal of taking good photos.
He bought net nets, took activist roles, invested in special situations and was quite active.
To try and summarize one way of investing like Buffett, here’s an the-warren-buffett-way-investing-from-a-business-perspective that goes into great detail of the types of companies that Buffett likes to invest in.
Aside from the obvious Buffett mantra of investing in businesses, it discusses in good detail, the selection criteria for Buffett type stocks which you can apply yourself to find, analyze and value.
Keep in mind that this is just one practical approach to consider.
The Practical Warren Buffett Approach to Stock Picking
Buffett’s Philosophy and style
Investment in stocks based on their intrinsic value, where value is measured by the ability to generate earnings and dividends over the years.
Buffett targets successful businesses—those with expanding intrinsic values, which he seeks to buy at a price that makes economic sense, defined as earning an annual rate of return of at least 15% for at least five or 10 years.
Universe of Stocks
No limitation on stock size, but analysis requires that the company have been in existence for a considerable period of time.
Criteria for Initial Consideration
Consumer monopolies, selling products in which there is no effective competitor, either due to a patent or brand name or similar intangible that makes the product unique.
In addition, he prefers companies that are in businesses that are relatively easy to understand and analyze, and that have the ability to adjust their prices for inflation.
Other Factors
- A strong upward trend in earnings
- Conservative financing
- A consistently high return on shareholder’s equity
- A high level of retained earnings
- Low level of spending needed to maintain current operations
- Profitable use of retained earnings
Valuing a Stock
Buffett uses several approaches, including:
- Determining the firm’s initial rate of return and its value relative to government bonds: Earnings per share for the year divided by the long-term government bond interest rate. The resulting figure is the relative value—the price that would result in an initial return equal to the return paid on government bonds.
- Projecting an annual compounding rate of return based on historical earnings per share increases: Current earnings per share figure and the average growth in earnings per share over the past 10 years are used to determine the earnings per share in year 10; this figure is then multiplied by the average high and low price-earnings ratios for the stock over the past 10 years to provide an estimated price range in year 10. If dividends are paid, an estimate of the amount of dividends paid over the 10-year period should also be added to the year 10 prices.
How Buffett Analyzes Financial Statements
Combine the methods from above with how Warren Buffett analyzes and interprets financial statements and you have a powerful “Buffett toolset”.
A Buffett Screen?
If you are itching to take it one step further, how about applying this Buffett screen I found in a Seeking Alpha article.
- ROE: 5-year Avg. >= 17%
- Return on Invested Capital: 5-year Avg. >= 17%
- Pre-tax profit Margin: 5-year Avg. >= 1.2* Industry Avg. Pretax Margin: 5-year Avg.
- Price/cash flow ratio <= 0.8* Industry Average price/cash flow ratio
- Price/cash flow ratio >=0.1
- Debt to Equity Ratio <= 0.8*Industry Average Debt to Equity Ratio
- Income per employee >= 1.1* Industry Average Income per employee
