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Buffett for every market condition

Buffett for every market condition

Jayant R. Pai, vice-president, Institutional Equity Sales, Parag Parikh Financial Advisory Services, takes a look into a Buffett book, co-authored by his estranged daughter-in-law, that provides an insight on how the master investor selects his stocks.



      Almost 10 years ago in 1997 “Buffettology” first appeared on the scene, in the midst of a long bull market phase. The scenario was different in 2002, when The New Buffettology was published; it was a bear phase and the stock markets had dipped. In that sense, this book is a classic since it has traversed both the ups and downs of the market. Having seen the price peaks turning to troughs, worried investors have wondered if there are any constants at all in a volatile market. The answer is yes: Warren Buffett’s value investing strategies make money. And, as The New Buffettology demonstrates, there is no better time to acquire than the bear market.

        What the book offers
The kind of companies that   capture Buffett’s interest
Mathematical equations that assist Buffett to make investments
Buffett’s secrets that have proved successful consistently
In a way, this book is the first guide to Warren Buffett’s strategy for exploiting down stocks— a strategy that has made him the world’s second richest person. However, when I started reading this book I was hoping to learn the methods that Buffett implements to buy a company’s shares. However, this book emphasises too much on Buffett’s buying history from the late 1960s to the late 1990s, something that is well chronicled in The Warren Buffett Way (reviewed in MONEY TODAY, 14 December 2006).

 9 QUESTIONS TO HELP YOU DETERMINE IF A BUSINESS IS GOOD
1. Does the business have an identifiable consumer monopoly?
2. Are the earnings of the company strong and showing an upward trend?
3. Is the company conservatively financed?
4. Does the business consistently earn a high rate of return on shareholder’s equity?
5. Does the business get to retain its earnings?
6. How much does the business have to spend on maintaining current operations?
7. Is the firm free to reinvest retained earnings in new businesses, expansions or share repurchases?
8. Is the company free to adjust price to inflation?
9. Will the value added by retained earnings increase the market value of the company?
There is a step-by-step methodology for readers to follow on how to pick a valued company but too many things confuse the issue, though this book can polish up your math skills.

The book discusses contrarian investing, which is how Buffett exploits a bear market. Which companies to buy in a down market, how to identify them and how to choose the right company to gain the kind of profit that one wants, are all comprehensively outlined in this book. The underlying fact is that the way to crack the stock market under any phase is to be fearful when others are greedy and greedy when others are fearful.

It is a book of examples and I think that’s what I like most about it. It explains clearly the importance of a company having a durable competitive advantage, honest and able management, staying within a circle of competence, ensuring a margin of safety exists, how interest rates affect stock prices, and more. That’s great, but the rubber hits the road with the numerous case studies of actual Buffett investments and how he applied the above concepts to help him decide to invest in Coca-Cola, Gillette, the Washington Post and Geico, to name a few. One may argue that there is little in way of examples for people outside the US. However, the examples are so well illustrated that you can always relate them to companies in India.

Along with the case studies come the formulas; lots and lots of formulas. Does the company have strong earnings with an upward trend? Plug 10 years worth of earnings into your spreadsheet and calculate the annual earnings growth rate. Does the company return an above average returnon- equity? What’s the stock’s value relative to a Treasury bond? The book will tell you how to calculate the answers here. The exercise goes on case study after case study.

Nothing is more boring than long windy theories with no meat to back them up. Mary Buffett and David Clark serve up the meat in large sized portions. Where does one go for 10 years of financial information? Where do you find the current government bond rate? What’s important in an annual report? What habits should you develop? Many of the answers may surprise you. The book doesn’t just talk about financial analysis; it shows you how to do it.

The only drawback of this book is its over-simplification of value-investing methods. To identify value stocks is not easy when one looks at real data. Still, The New Buffettology gives many examples to walk the reader through the methodology.

Though there is no statistical result to demonstrate that the value-investing method indeed beats the market. You have to take it on faith that this methodology is used by Buffett, that it is what produced his great success, and that it can be replicated in today’s market.

It is a great book and I recommend it to investors and to businessmen who need to understand more about durable competitive advantage and the kinds of businesses they should be creating. An excellent, easy to read guide on how and when Buffett selects stocks that have made him wealthy.

The book is great at telling you how to determine the long-term economic value of a company and whether its shares have been oversold by the big hedge funds. This is not a book for quick ins and outs—it is a book for the longterm investors just like all the Buffett books are.