Wednesday, October 11, 2006

NRao on Buffett's Investment Methods - I

These days I am spending my time going through the various investment texts and my posts reflect it.

I have to give a presentation on Warren Buffett's integration of Graham's ideas and Phil Fisher's ideas. In this connection I am going through the books, Buffetology Work Book and Permanent Value.

The last time I read the book Permanent Value, I did not appreciate the content. But in this reading, I appreciate the contribution made by the author in explaining Buffett's investment methodology and practice.

This remark on Freddie Mac in page 457, brings out clearly the power of relative value analysis.

"If you were to take Freddie Mac and look at the simple numbers-it's selling at 12 times earnings versus 18 to 20 times earnings for the S&P. It probably has a double-digit earnings growth rate versus an average growth rate over nine years of7% or even less for the S&P. Its return on equity is 20% or better against an average return of 12.5% to 13% for the S&P. So by any simple statistical measure, it's very attractive stock."

Buffett used exactly the investment operations in running his partnerships that Graham employed in his investment practice

Page 81

1. "Generals" - Undervalued stocks generally to be held for a long time.
2. "Workouts"- Securities with a timetable, arbitrage situations arising form sell-outs, mergers, reorganizations and the like.
3. "Control"- owning such a sizeable block that the partnership gains control of the business.

The similarity with Phil Fisher is Buffett also has quality criteria which are different from the quantitative numbers. Important among them is that Buffett liked consumer monopoly companies. In this respect Buffett is following the principle of selection among the companies that satisfy the quantitative criteria. Graham used to buy or recommend buying of all the companies that satisfy the criteria.

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