Investment Strategies of the World's Greatest Investor "Warren Buffet"

WARREN BUFFET was born on 30th august 1930 in Omaha, NEBRASKA. While in his senior year at the University of Nebraska, Buffet read Benjamin Graham's book, The Intelligent Investor. This inspired Buffet that after finishing his degree he left to New York to study with Ben Graham at Columbia graduate business school. There Buffet understood the importance of numbers in investing. He returned back and after the call from graham once again he went back and joined Graham-Newman Company in 1954. In 1956, Graham Newman disbanded. He returned back to Omaha.

With the base of knowledge acquired from Graham he started his investment company when he was twenty-five years old. His family and friends were supported him. In 1961 he bought dempster mill manufacturing company and in 1962 he began purchasing shares in Textile Company called Berkshire Hathaway, which was in miserable condition by that time. Buffet really struggled to turn it into profits. By late 1970s shareholders of Berkshire Hathaway began losing trust. However he didn't lose heart because he believed

• The textile mills were the largest employer in their area.
• The work force was senior people with skills that cannot be transferred.
• High interest from management
• Reasonable union

With all these reasons he believed that profit can be earned from textile business. As Hathaway entered in 1980s Buffet understood the ground realities.

• Textiles Are Commodities and Commodities Can Least Differentiate Themselves from Their Competitors.
• In Order to Stay Competitive Textiles Have to Invest in Capital Improvements.
• Cheap Labor from Foreign Competition was Disturbing Profits.

Then based on these facts Buffet closed his books of textile group, thus ending the business. However in between 1962 and 1980 Buffet has purchased a lot of companies under Berkshire Hathaway, Insurance, Blue Chip Stamps, See's Candy Shops, Buffalo News, Furniture Etc.

Even after closing of textile business he acquired many companies. Based on all his experiences compiled Robert. G.Hagstorm in his book gives four tenets that Warren Buffet adapted as his investment strategy.

1. Business Tenets
   

   a) Is business simple and understandable?
   b) Does the business have a consistent operating history?
   c) Does the business have favorable long -term prospects?

2. Management tenets
   

   a) Is management rational?
   b) Is management candid with the shareholders?
   c) Does the management resist the institutional imperative?

3. Financial tenets
   

   a) Focus on return on equity, not earnings per share.
   b) Calculate" owner earnings" to get a true refection of value
   c) Look for companies with high profit margins
   d) For every dollar retained, make sure the company has created at least one dollar of market value.

4. Market tenets
   

   a) What is the value of business?
   b) Can the business be purchased at a significant discount to its value?

In the upcoming articles I will be explaining each tenet in detail.

SOURCE: THE WARREN BUFFET WAY by ROBERT.G.HAGSTROM

Why to always blame stock experts?

THE VELOCITY OF FAILURE IS GREATER THAN THE SUCCESS

It was in my Diwali vacations. I had a great chance of going back to my native and place myself on the same beach sands, which used to be my good friend throughout my life.

I was able to see three children building sand domes. At first they were building little close to waves. An unexpected big wave came with full of its force and washed it away. Then they moved a little bit away so that it is free from waves reach and constructed the dome with care. By the time they took a break to have some roasted groundnuts a cricket ball from somewhere hit it and the whole set up was spoiled. It sowed the seeds of thought in me. What's wrong with these children? They planned well. Is it there fault which they couldn't even imagine to happen which went beyond all their calculations? I hope for most of it would be no. If we are not to blame the children then how can blaming stock experts can be justified when unexpected events tumble the market.

This is what in management jargon or in stock market parlance we call it as "Black Swan Events". This is what also NASSIM NICHOLAS TALEB, author of the financial book "Fooled by Randomness" points out that the economy is susceptible to black swan events. This is nothing but "No Matter How Many Black Clouds You See You Can Say It May Rain But You Cant Say When It Will Rain". TALEB also says, "These Events Are Neither Repeatable Nor Modelable And They Dominate The Outcome". Is it not a great thing that experts having the knowledge to say that black clouds will cause rain and giving a caution to us is very vital to an investor. I would generally attribute investor's blame on experts to the famous statement "When Success Comes Everyone Shares and When Failure Comes the Leader Is Penalized!"

I was also thinking about the ground realities of forecasting. Forecasting is an equation, which is based on past events to a large extent. If I want to relate it I would say it is the product of past data and safety factor or probability factor. In case of share markets I want to extend this thought by putting investor into the customer basket, shares as a product and experts as a market researcher. Here comes the question of what kind of product are shares? Is it a convenience product or specialty product or unsought product? I would not prefer to put this in any of this category. I would say this investment product where customer (investor) wants to buy this to make this more. As a researcher it is somewhat easy to foretell when a customer will next buy a particular product based on usage rate and lifetime of the product. In case of shares it is the first thing the investor wishes to dispose in case of any emergency to make money. How can an expert predict emergencies of an investor who may suddenly act on his holdings? Though stock market is not driven by single investor we have to agree the fact that it is driven by group of investors.

I also thought it would add sense to bring in the aspect of decision-making. As we all know forecasting is also a decision making process in which we narrow down to certain conclusions. Experts have several variables to take as input in consideration for forecasting. But it is time consuming and they tend to follow what we call "Bounded Rationality" which saves time by limiting to specific predominant variables in decision-making. The point, which is that dominant variable, becomes a foggy concept because markets change much faster than marketing.

We have generally two types of analysts what we call "Fox" type analysts and "Hedgehog" type analysts. In Greek mythology "Fox" knows many things and "Hedgehog" knows one big thing. TETLOCK in his book "Expert Political Judgment" has applied this to stock experts. The fox takes information from many sources including those they disagree with and incorporate their thinking. But hedgehog fits everything into one big idea and that is his final outcome. We should understand the fact that when we are trying to narrow down to one big idea the area of bounded ness becomes very small we are forced to exclude many variables in prediction from consideration set. We are also likely to make more assumptions in predictions. History also reveals that fox like experts predictions are more likely to be true when compared to hedgehog experts.

Then the question arise "Do Always Fox like Experts Succeed in Prediction?" here the principle of "Knowing More" comes into play.

TETLOCK also agrees this "Knowing A Little Might Make Someone More Reliable Forecaster than a Person Who Knows A Lot". He reports, "We Reach the Point of Diminishing Marginal Predictive Returns For Knowledge Disconcerting Very Quickly". Then what is the use of information given by experts? That is what now zooming the size of question mark in our minds now. The answer would be if an investor has a myopic view or if a business has a myopic view and if one expert's advice gives different idea miles away from their rigidity it is thousand million dollars worth in saving the business and investor's wealth.

During Second World War, Nobel winner KENNETH ARROW worked as an army weather forecaster. At one point his colleagues alerted the higher-ups that forecasts didn't work. The reply from him was "We Are Aware That Forecasts Are No Good. But We Need It for Our Planning Purposes!"

Remember though investors cry when they lose based on predictions there are also investors who have made enormous money based on forecasts. But the physics of financial markets states "The velocity of failure is greater than the success".