In May 2019, I listened to 5 audiobooks: The Warren Buffett Way, The Warren Buffett Portfolio, Stress Test: Reflections on Financial Crises, The Culture Code: The Secrets of Highly Successful Groups, and Sway: The Irresistible Pull of Irrational Behavior. All these 5 books were interesting and unique in their own ways. However, in this week’s blog post, I will review The Warren Buffett Way by Robert G. Hagstrom, Jr. The reason I chose to review this book is because it is a great introductory book to value investing. The Warren Buffett Way analyzes the investing method and rationale used by one of the greatest value investors of all time, Warren Buffett. The book gives readers an idea of the mentality of value investors.
This book is primarily focused around Warren Buffett’s 4 principles: Business, Management, Financial, and Value tenets. In this blog post, I will go over these 4 tenets, and the questions that Buffett addresses within each tenet.
- Business Tenets – The idea is to stay focused on the companies that are relatively predictable i.e. stick to businesses with consistent operating history and favorable prospects. Here are the 3 questions that Buffett addresses within this category:
- Is the business simple and understandable?
- Does the business have a consistent operating history?
- Does the business have favorable long term prospects?
- Management Tenets – The idea is to stay focused on companies that are well run. Buffett believes that excellent managers can make all the difference in the company’s future success. According to Buffett, Business and Management tenets will give a good sense of company’s future earnings potential. Here are 3 important questions that address the qualities management must display:
- Is management rational?
- Is management candid with its shareholders?
- Does management resist the institutional narrative?
- Financial Tenets – Financial Tenets provide/reveal the numbers needed to determine the company’s real value. There are 4 critical financial decisions a company must maintain, and here are those questions that address those decisions:
- What is the return on equity?
- What are the company’s owner earnings?
- What are the profit margin?
- Has the company created at least $1 market value for every dollar retained?
- Value Tenets – Value Tenets take you through the mathematics necessary to get you to the final answer i.e. based on everything, is this a good buy? The 2 interrelated guidelines about purchase price are addressed through these questions:
- What is the value of company?
- Can it be purchased at a significant discount to its value?
The author exemplifies these tenets by giving examples of various investments that Buffett made throughout Buffett’s career. The example that I found the most interesting was how Warren Buffett calculated the value of The Washington Post. Buffett coined the term “Owner’s Earnings”, which is calculated by adding Net Income + Depreciation/Amortization – Capital Expenditure. To get the true value of The Washington Post business, Buffett simply divided Owner’s Earnings number by the long term bond yield. In the book, the author also discusses 3 things that create a moat: First, the product is needed or desired; Second, there is no close substitute to that product; Third, the product is not regulated. Towards the end of the book, the author talks about focus investment strategy, which is when you bet on a few stocks, but you bet big on them. This “Focus Investment” topic was a great lead into Robert Hagstrom’s second book: The Warren Buffett Portfolio. I would definitely recommend The Warren Buffett Way to anyone interested in value investing. This book gives you an idea of how great investors like Warren Buffett make their investment decisions.
Hope you learned a little and found this blog post helpful. We reviewed the Warren Buffett Way, and talked about 12 questions that Warren Buffett addresses through his 4 principles. The 4 principles were: Business Tenet, Management Tenet, Financial Tenet, and Value Tenet. As always, you can sign up for our mailing list here. Like us on our Facebook page here. Thank you!
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Superior North LLC’s content is for educational purposes only. The calculators, videos, recommendations, and general investment ideas are not to be actioned with real money. Vyom Joshi is not a professional money manager or a financial advisor. Contact a professional and certified financial advisor before making any financial decisions.