Wednesday, December 27, 2006

Buffettology by Mary Buffett

Buffettology was among the first investing books that I read way back when I was a 19 year old college senior, and it remains one of the foundations of my investment philosophy.

Mary Buffett was Warren Buffett's daughter-in-law for 12 years and wrote this book following her 1993 divorce from Warren's son Peter (for the sake of clarity, I will refer to Ms. Buffett as "Mary" and Warren as "Buffett" from here out). It gives her "insider" perspective on on Buffett's investing style and offers a fairly in-depth look at how she thinks he makes his decisions.

The book is broken into two main parts- "The Art of Basic Buffettology" and "Advanced Buffettology."

If you think the stock market is about ticker symbols, three week moving averages, relative strength, reading analyst reports, buying, selling, and momentum, then anything you hear from or about Buffett will seem counterintuitive.

Mary lays this out right at the beginning of the book "Warren had little use for typical Wall Street banter. He didn't seem to care which way the Dow Jones Industrial Average went, and he certainly had no use for all the soothsayers and their predictions. In fact, he acted as if the entire stock market didn't exist. He never looked at a chart, and if anyone tried to give him a stock tip, he would usually shut him or her off... He seemed to care only about the individual businesses he was interested in owning."

From the book you will quickly learn that Buffett takes a business perspective to investing. He doesn't think of buying stocks like the way many people think about buying them. He understands that they represent an ownership interest in a business, and evaluates whether or not he wants to own a piece of that business.

Of particular interest in the first half of the book is Mary's treatment of the general kinds of businesses Buffett likes to invest in. According to Mary, Buffett divided businesses into two basic categories - commodity type businesses and excellent businesses.

The commodity-type businesses "offer the least for future growth of shareholder value," and they share some or all of the following characteristics: low profit margins, low returns on equity, absence of brand-name loyalty, the presence of multiple producers, the existence of substantial excess production capacity in the industry, erratic profits, and profitability almost entirely dependent upon management's abilities to efficiently utilize tangible assets. Buffett stays away from these kinds of businesses, she says, because price competition generally reduces profits, and in the event that the business does earn some profits, "the capital is usually spent upgrading plant and equipment to keep abreast of the competition."

The excellent businesses, on the other hand, have something called a "consumer monopoly" going for them. When a company produces products with "some distinctive attributes that are particularly attractive to buyers, who then form an attachment to a company and the products it sells," that company has a consumer monopoly.

Mary lists nine questions to help determine if a business is an excellent one:

"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 shareholders' 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 company free to reinvest retained earnings in new business opportunities, expansion of operations, or share repurchases? How good a job does the managment do at this?
8) Is the company free to adjust prices to inflation?
9) Will the value added by retained earnings increase the market value of the company?"

The second half of the book is called "Advanced Buffettology" and takes a more quantitative look at some of the Buffett tools such as projecting rates of return, forecasting future earnings, and playing the short term arbitrage game. To wrap it up, Mary presents a few case studies of stocks that Buffett has actually purchased, and walks through his most likely rationale for making the investments that he did.

Coupled with a reading of Buffett's shareholder letters, this book makes an excellent introduction to the investing style of Warren Buffett. Mary lays it all out in short, distinct modules that make it very easy to pick up the book, spend 10-20 minutes reading, then put it down to come back to at another time.

Since Buffett has never written a book himself, we may never get a perfect insight into how he selects and values stocks. However, I think it is an extremely worthwhile exercise to try to figure it out using the materials available to us. If you are interested, I would recommend picking up a copy of this book and adding to your knowledge of The Oracle of Omaha.

4 comments:

Anonymous said...

David Clark, Omaha lawyer specializing in auto accident cases wrote the book "Buffetology". Clark, whose brother Sam Clark is also an Omaha attorney, has never run any Buffett family funds, or any funds whatsoever, and has completely fabricated his C.V. in writing this series of books. The "Buffetology" series is a scam to make money off the Buffett name,done by lawyers in Omaha from the same Clark family.

Anonymous said...

Buffettolgy is a good book to read especially if you have stocks investment. If you dont have any stocks investment better shut up.It is also recommend to read Benjamin Graham's Intelligent Investor.

Mr D

Richard said...

I have now read all of Mary Buffets books. If you really want to understand Warren Biffets methods in simple easy to understand language these are the books for you. I have literally read hundreds of books on the topic of investment and finance and consider Mary Buffets books to be the best you can buy on the subject. Start with Buffetology and then work your way through all of them. You will be glad that you did.

Anonymous said...

The book has a flaw, you have to spend money to make money. Don't knock technicals till you have enough experience to knock it. I studied Richard Whyckoff back in the day. My objective was to learn how to follow the large investors. The fundamentals you speak of shows itself in how price behaves over time through a process of development. If retail traders think sell then you think buy, if they are chasing higher prices, you chase lower prices. Internet has been down & depress since golly 2009 & wallstreet is going to keep you eyes on whats moving higher as cash gets rotated. In 2012, internet such as Yahoo & Facebook popped up while the the market was questioned by many & held up waiting for unattractive stocks invested over years to catch up. This alone should tell you the future of the market in 2013. Reality is now what wallstreet wants you to look at, reality is what is going on inside the index. If price is at holding at the highs, either stocks are being rotated down or up.. either way, a waiting period to complete the objective. A bottom is just the start of all good things, the rotation will take a good 6-12 months for enough stocks to catch up, you need at least 50% of all stocks in one direction or another to show a willing. If the fundamentals describe quality of a investment then it's the technicals that describe leadership & when you combine both, you have a future. Development which lasts 1 year, would allow price to rise for one year. shares are placed at the highs pushing price down while professionals pick up the shares, push price lower & pick up more & it's your ability as a investor trader to determine what the professionals are doing & what there longer objectives are. The market does not run on fundamentals in todays world, they run on technicals while investors have changed in activity otherwise they lose control over there investments. A good company may have the best fundamentals but that does not mean, it would attract a flock of investors & without the right kind of investing, there's no future for such fundamentals. Do you actually think you can forecast the future ? If thats the case then when will the bear market start ? Companies do not have the life span as they once did, investors have less faith in markets & to think that a company would last 20 years if wishful thinking.