The New Buffettology
The New Buffettology

The New Buffettology

He doesn’t “play” the stock market—at least not in the conventional sense of the word. He is not interested in current investment trends, and he avoids the popular investments of the day. (Location 224)

Here is the big secret: Warren Buffett got superrich not by playing the stock market but by playing the people and institutions who play the stock market. (Location 231)

The first is that approximately 95% of the people and investment institutions that make up the stock market are what he calls “short-term motivated.” This means that these investors respond to short-term stimuli. (Location 238)

Warren has discovered that in both situations the underlying long-term economics of the company’s business is often totally ignored. The short-term mentality of the stock market sometimes grossly overvalues a company, just as it sometimes grossly undervalues a company. (Location 253)

The second foundation of Warren’s success lies in his understanding that, over time, it is the real long-term economic value of a business that ultimately levels the playing field and properly values a company. (Location 256)

Warren came to realize that undervalued businesses with strong long-term economics are eventually revalued upward, making their shareholders richer. (Location 260)

What has made Warren superrich is his genius for seeing that the short-term market mentality that dominates the stock market periodically grossly undervalues great businesses. (Location 265)

The first, the sickly, are the companies with poor economics. These businesses are in what he calls price-competitive industries that sell commodity type products or services. A price-competitive type of business manufactures or sells a product or service that many other businesses sell and competes for customers solely on the basis of price. (Location 421)

durable competitive advantage. A company with a durable competitive advantage typically sells a brand-name product or service that holds a privileged position in the stream of commerce that allows it to price its product or service as if it faces little or no competition, creating a kind of monopoly. (Location 425)

These companies also have the greatest potential for long-term economic growth. They have fewer ups and downs and they possess the wherewithal to weather the storms that a shortsighted stock market will overreact to. (Location 429)

Businesses make money in two ways: by having the highest profit margins possible and/or by having the highest inventory turnover possible. (Location 458)

Warren wants to own businesses with high profit margins and high inventory turnover. If he can’t get one of these superbusinesses, he will settle for one with low profit margins and really high inventory turnover or one with high profit margins and low inventory turnover. These are the kinds of businesses that he can be certain will survive any bad-news situation that creates a buying opportunity and will go on to earn him a bundle over the long term. (Location 494)

durable long-term competitive advantage. (Location 513)

knowing what not to invest in is just as important as knowing what to invest in. (Location 548)

The selective contrarian investment philosophy that Warren practices dictates that he give the price-competitive business a pass regardless of how great the buying opportunity looks. (Location 556)

All of these companies sell a product or service for which there is considerable competition in the marketplace. (Location 567)

In a price-competitive business the low-cost provider wins. This is because the low-cost provider has greater freedom to set prices. (Location 589)

the kind with a durable competitive advantage. The company with a durable competitive advantage has the ability to increase prices along with an increase in demand. The lack of competition means that these types of companies don’t have to compete on price. (Location 601)

Price-competitive businesses sometimes try to create product distinction by bombarding the buyer with advertising to create a brand name. (Location 637)

The problem is that no matter what is done to a commodity product or service, if the choice the consumer makes is motivated by price alone, the company that is the low-cost producer will be the winner and the others will end up struggling. (Location 639)

It’s the industry that is the problem. Poor economics, which go hand in hand with excess competition, resulted in a substantial production overcapacity for the entire textile industry. (Location 648)

Two types of businesses possess competitive advantage in the business world: those that produce a unique product and those that provide a unique service. (Location 671)

Warren likes to use the castle-and-moat analogy. Pretend that the business in question is a castle and surrounding the castle is a protective moat we’ll call its competitive advantage. (Location 680)

The same can be said of a large town with only one newspaper. (Location 687)

These companies have a competitive advantage—a brand name or regional monopoly—that enables the business producing the product or service to earn monopolylike profits. (Location 688)

What he means by durable is that the business must be able to keep its competitive advantage well into the future without having to expend great sums of capital to maintain it. (Location 693)

Having a low-cost durable competitive advantage is important to Warren for two reasons. The first is the predictability of the business’s earning power. (Location 696)

To him, consistent products equate to consistent profits. (Location 699)

The key for Warren is that the product or service has durability. (Location 713)

Intel’s competitive advantage is dependent on management’s ability to create new and innovative products to beat the competition. (Location 722)

When stock market analysts and media pundits proclaim that earnings are no longer important in valuation, the bull market is in its final phase. This is where it begins to bubble. (Location 970)

Certain areas of commerce have a greater propensity to spawn companies with a durable competitive advantage. For instance: (Location 1162)

Businesses that fulfill a repetitive consumer need (Location 1163)

The advertising business, which provides a service that manufacturers must continuously (Location 1165)

Businesses that provide repetitive consumer services that people and businesses are consistently in need of. (Location 1167)

Low-cost producers and sellers of common products (Location 1169)

Return on total capital is defined as the net earnings of the business divided by the total capital in the business. (Location 1549)

Warren is looking for a consistent return on total capital of 12% or better. (Location 1571)

Companies with a durable competitive advantage have strong enough earnings that they can easily pay off their long-term debt within just a few years. (Location 1658)

Companies with a durable competitive advantage typically have long-term debt burdens of fewer than five times current net earnings. (Location 1671)

For Warren, a business with a durable competitive advantage is free to increase the prices of its products right along with inflation, without experiencing a decline in demand. That way its profits remain fat, no matter how inflated the economy gets. (Location 1794)

In essence this calculation takes the amount of earnings retained by a business for a certain period and measures its effect on the earning capacity of the company. (Location 1830)

Be careful that the per share earnings figures you employ for this test are not aberrations, but rather are indicative of the company’s earning power. The advantage to this test is that it gives you, the investor, a fast method of determining whether it is a durable-competitive-advantage business that lets its management utilize retained earnings to increase shareholders’ riches or whether it’s a price-competitive business that is stuck allocating its retained earnings to maintain its current business. (Location 1882)

This meant that he could often purchase them for a mere four to six times pretax earnings, which would give him an immediate 16% to 25% pretax return on his investment. (Location 2003)

These businesses are all firmly entrenched and have long, successful business histories. The companies that manufacture brand-name (Location 2005)

The store’s pretax net earnings of $14.5 million, against the selling price of $60 million, equates to an initial pretax return of 24% ($14.5 million ÷ $60 million = .24). (Location 2022)

You should understand that Warren is not calculating a specific value for the stock, as many who watch and write about Warren believe. Nor is Warren saying that Gannett is worth X per share and I can buy it for half of X, as Graham used to do. Warren is instead asking, if I pay X per share for Gannett stock, given the economic realities for the company, what is my expected annual compounding rate of return going to be at the end of ten years? After determining the expected annual compounding rate of return, Warren then compares it to other investments and the annual compounding rate of return that he needs to stay ahead of inflation. (Location 2878)

Point:Warren knows a secret: Excellent businesses that benefit from a durable competitive advantage and can consistently earn high rates of return on retained earnings (shareholders’ equity) are often bargain buys at what seem to be high price-to-earnings ratios. (Location 2983)