Investment Analysis Strategies Given By Warren Buffett Management Essay

Warren Edward Buffett was born on 30th August, 1930 is one of the most successful investors of America, rather most successful investors of the world. He was also a business man and humanitarian. He is a primary shareholder and along with that he is CEO of Berkshire Hathaway. Warren Buffet is known as “Oracle of Omaha” for his observance to the value of investment philosophy. In this investment analysis, we are going to highlight his strategy of investment in the shares.

If you want to follow the classical way of investment, then Warren Buffet’s investment strategies will prove to be great role model for you. In this article, we will describe various investment strategies given by Warren Buffett and their impact on the regular market. We will also encounter the reason that why Warren Buffett’s investment strategies are not successful among the small investors and the initial investors.

Body

Warren Buffett’s investment style comes from his research for various questions which arose in his mind few years back which he stated to be most important questions before investment in any company. These questions are as follows:

  • Does the company have good economic status in the industry?
  • Does the company have brand name associated with it or monopoly of the consumers?
  • Is the company loyal to the investors?
  • Is the profit margin associated with the company’s earnings to the shareholder good?
  • Does the company provide decent returns on investment to the shareholders?
  • Does the company possess high earning growth?
  • Is the debt to equity of debt ratio of the company low?
  • Is the earning to debt ratio of the company high? (Green, 2008)
  • Does the company or the business incur high cost of maintenance or high cost of operations? If such is the case, then investing in such company is not good
  • Does reinvestment of earnings is done in prolific business opportunities?
  • At the time of inflation, can the company handle the adjustment of price?
  • Does the company hold a decent track record by its management in the past?

Hence, according to Warren, company should satisfy all the above mentioned questions before company in the portfolio, he had maintained.

Concentrated Purchase

Concentrated purchases were made by Buffett in his investment strategy. Warren Buffet has very few stocks in his portfolio but at the time of economic downturn in the industry, he buys lots of shares of good companies at lower price. His company, Berkshire Hathaway is considered to be one of the major players of soft drinks, insurance, shoes, steel, jewelries, energy, chocolates, etc. Berkshire Hathaway owns a huge share of small dividend paying stocks, for example,

  • Procter and Gamble
  • Coca Cola
  • Wells Fargo
  • Conoco Phillips
  • Kraft Foods

According to his strategies, long term returns available with equity shares can not beaten by any other alternative. However, there are some options in which one can invest, like real estate companies and investment in bond which provide around five percent dividends. One can also invest money in the money market which gives two percent return. (Harper)

According to him, an investor should hold a concentrated stock portfolio. According to this concentrated stock portfolio, he means that investor should own small number of stocks but investor should know all information about these stocks. Hence, in a lifetime of investment, an investor should buy and sell stocks for not more than twenty times. Buffett suggested that an investor should act in a way that he has a lifetime investment card with him in which there are just twenty buttons to punch. One should think that one investment decision makes him one step fewer towards the rest of the life of investment. This will result in some very fantastic consequences of investment. For example:

  • Twenty stocks are purchased and none sold, or
  • Tens stocks are purchased and ten sold
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Warren said that patience is something very important for any investor. He said he read the financial report of Anheuser Busch Inc. twenty five years before he bought their stocks.

Warren Buffett about Value Investment

Buffett also interpreted properly the concept of value investment. He said that value investment is an important tool because it is mainly concerned with the buying of stock at a lesser price than its intrinsic value. Warren Buffett worked on the further Approach in Value Investment Strategies given by Benjamin Graham who mainly focused on discount rate of the security and thus the decision about the investment is made but Warren Buffett mainly focused upon the investment at a further level and target specific companies at rather price. He was not concerned with targeting general companies at discounted price.

Buffett investment strategies mainly focused upon return on equity rather than focus on earning per share. He understood that Return on equity can be affected by leverage which is debt to equity ratio and hence instead on evaluating leverage, he preferred companies with low leverage and having high profit margin. Buffett had twelve tenets or key considerations for investing in any company. (Warren Buffett investment strategy, 2009)

According to him, investment is not something that you know but it tells about how realistic you are in defining what you do not know. This is the prerequisite for evaluating performance of future business any company. Business tenet of Warren Buffett talked about objective of producing robust projection. It is important to analyze the business first, then economy, industry or market.

There were three investment tenets of Buffett related to the management quality of any company. According to him, evaluating the management quality of any company is the most difficult task for any investor.

Warren Buffett was mainly interested in estimating the intrinsic value of a company. He is also known as bond math. He at first forecasts the earning of the present and then calculates the present value of this forecast by discounting it to present. He forecasts future earning by historic earnings of the company. In his forecasts, he defined a term moat, according to which a company having wide economic moat should be favored. According to him, a clear advantage should be given to these companies over the other companies and protect them against raid from competition. Project earning of the company should be discounted at a risk free rate in order to have virtual elimination of risk.

Problems with Buffett Investment Strategies

There are various problems with Buffett investments strategies. Most of the problems are associated with the small investors or begging investors.

Mostly, small investors fail to implement his strategies successfully. Main reason behind this was they do not have enough access to the management quality. Buffett, from the early times was at a privileged position but most of the investors are not that big.

Buffett also focused upon learning investment through trial and error which was not acceptable in the real investing situations. (The Trouble With Warren Buffett’s Investment Strategy, 2005)

Buffett investment strategies fail for the beginning investors. Following his strategies, they usually fail because they do not have access to the information whereas Buffett had superior access to the information.

Conclusion

From the above paragraphs, it is clear that Buffet’s strategies have been very effective in the equity market. His own company Berkshire Hathaway, of which he is the CEO, has been very successful financially and has shown that under his leadership and guidance, investment can be as effective and empirical as science, rather than just a bundle of statistical estimates, which often fail in the real world. He has proved to be a king in the art of classical investment strategies, and has from time to time shown his mettle, i.e., his expertise in the field of investment into financial instruments.

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As mentioned earlier, the strategies and methods introduced by Buffet in the field of investment are relatively uncomplicated yet effective. He forms a set of questions, which were listed earlier, which act as an excellent starting point for the evaluation of a company and a rough evaluation of probable returns that may be obtained through the purchase of equity shares of that company.

Buffet uses a concept of Concentrated Purchase in which he buys only a limited number of equity shares should be purchased by an investor, but this purchase must be backed with substantial knowledge of the companies to which these shares belong. This alone, he says, is the most profitable portfolio management technique, since he asserts strongly that long term equity price changes can’t be beaten by any other alternative like dividends from a large number of companies. While having said this, he does not completely discard the practice of purchasing bonds and investment in assets that take long time periods to mature to reach a certain level of profitability, since he agrees that a small amount of investment into these can provide a good stability in terms of income to an investor’s portfolio. He also mentions the advantages of purchasing a large number of shares during the economic downturn in the financial markets, since this requires very little investment owing to low prices of shares, and the fact that the equity share prices rise to very profitable values in no time, one the economic downturn gets over. 

Buffet also stresses on the advantages of the concept of value Investment. He worked further into the existing concept and modified it to use it to even greater advantage. Basically, he talks about buying shares of companies at the instant when the price reaches below the intrinsic value of the share. However, he mentions that not any company can be selected to use this strategy on. He gives a set of guidelines on the selection of a company. Along with this, the modification of the strategy from the then existing concept made by Buffet was that he focused on return on equity rather than on earning per share of a company. This means that one does not need to bother about the exact performance of a company in terms of its total profits, rather on the possible changes that the company is likely to undergo in terms of performance from its existing performance, which would determine the long term price change that would occur in the equity share of that company.

Along with the aforementioned, he mentions that the most important criterion for the evaluation of a company is the quality of management present therein, and that a thorough analysis of the management quality must be made before investment into the equity shares of the company. He also introduces a concept of moat in his analysis of economic forecasting, in which he says that companies with wide economic moat should be given higher preference over others.

Having mentioned the strategies of Warren Buffet along with the effectiveness of these, it has to be remembered that for most investors, which includes investment firms, the total available resources for investment are not large, so the option of implementing the method of trial and error in the investment into various companies is not possible. Thus it is not perfectly justified to say that the Buffet’s strategies could have been prepared and implemented by anyone with a small fund backup. Also, due to the position that Buffet held, he had excellent access to information about the management quality of various companies and other similar information, which small investors cannot have. Therefore, it is not always possible in the real world situation for small scale investors to successfully implement Buffet’s investment strategies.

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LesSon learnt

Having mentioned the pros and cons of Buffet’s investment strategies along with a thorough evaluation of the applicability of the same in the real world situation for all kinds of investors, it can be understood that Buffet’s strategies are excellent on a stand-alone basis, which is proved by the fact they have put his firm on an excellent standing. However, if one wants to use his strategies, they must be modified appropriately by considering one’s own particular situation, both with respect to availability of information and more importantly, financial standing. For example, for a small investor, it would be more profitable to invest a higher portion of the total funds into bonds and other income generating financial instruments, so that a continuous return is obtained, so that there is always a certain amount of risk elimination and fund backup. Thus, the total earning would become lower on a long term basis since there would be a lower possession of number of shares, but the risk of the complete portfolio going flat would be, to a certain extent, eliminated.

Of course, the guidelines and pointers provided by Buffet related to the evaluation of a company are extremely effective for all kinds of investors, and there exists no doubt in the fact that these would work in all situations. Also, the analysis tools provided by Buffet, including both modified existing strategies and novel techniques related to forecasting etc, are excellent for any investor and can be used for investing successfully.

Recommendation

It is essential to absorb the good points introduced by Buffet, while making sure that his strategies are not followed blindly, and are appropriately modified before investing. For small scale investors, it is more advisable to use the analytical tools introduced by buffet for the analysis of various companies and financial instruments rather than follow the exact investment pattern used by him in his own situation. This is because, as mentioned earlier, Buffet was always in a very superior position with respect to finances and availability of information with respect to small investors. For large investors, Buffet’s successful strategies should be used so as to obtain satisfactory returns on various investment portfolios. Of course, the tools for analysis of the market can be used by such investors also. However, with the global market evolving perpetually and markets fluctuating at unpredictable rates, it has to be remembered that there is no guarantee of all strategies that have been successful in the past to perform in the exact manner in the future. Thus, even though Buffet has proved to be an iconic figure in the field of investment, a thorough analysis of the tools and strategies introduced and used by him in the past must be performed so that all possible fallacies that may have arisen within them due to the contingencies of time may be properly understood, which would alone allow various investors to implement them successfully in their own particular situation.

References

* Green, Alexander. (2008). Warren Buffett’s Investment Strategy: Time to Buy the Ultimate No-Brainer. Retrieved on March 23, 2010 from

* Harper, David. (n.d.). What Is Warren Buffett’s Investing Style? Retrieved on March 23, 2010 from

* (2009). Retrieved on March 23, 2010 from

* (2005). Retrieved on March 23, 2010 from

This statement means whether company will be able to repay the debt to the lenders even in the situation when company’s earning are lower than its standard earnings?

 


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