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.