Buffettology

Chapter 1:
How to Look at the Stock Market
the Warren Buffett Way
 Buffettology 101
The Wisdom of Warren Buffett

As far as I am concerned,
the stock market doesn’t
exist. It is there only as a
reference to see if anybody
is offering to do anything
foolish.
 Buffettology 101
The Wisdom of Warren Buffett
“Investing is often described as the process of laying
out money now in the expectation of receiving more
money in the future. At Berkshire we take a more
demanding approach, defining investing as the
transfer to others of purchasing power now with the
reasoned expectation of receiving more purchasing
power – after taxes have been paid on nominal gains
– in the future.”
-Warren Buffett (2011 Annual Report)

7/16/2019 Professor Kuhle 6

 Buffettology 101
The Wisdom of Warren Buffett
1. All we want is to be in businesses that we understand, run
by people whom we like, and priced attractively relative to
their future prospects.
2. I buy businesses, not stocks, businesses I would be willing
to own forever.
3. Invest within your circle of competence. It’s not how big the
circle is that counts, it’s how well you define the
parameters.
4. When management with an excellent reputation meets a
business with a poor reputation, it is usually the business’s
reputation that remains intact.

7/16/2019 Professor Kuhle 7

 Understanding the Influence of Ben Graham
on Warren Buffett Through the Story of Mr.
Market
Long ago Ben Graham described the mental attitude toward market
fluctuations that I believe to be most conducive to investment success. He
said that you should imagine market quotations coming from a remarkably
accommodating fellow named Mr. Market who is your partner in a private
business. Without fail, Mr. Market appears daily and names a price at which
he will either buy your interest or sell you his. Even though the business that
the two of you own may have economic characteristics that are stable, Mr.
Market’s quotations will be anything but stable. For, it is sad to say, Mr.
Market is a fellow who has incurable emotional problems. At times he falls
euphoric and can see only the favorable factors effecting the business. When
in that mood, he names a very high buy-sell price because he fears that you
will snap up his interest and rob him of imminent gains. At other times he is
depressed and can see nothing but trouble ahead for both the business and
the world. On these occasions he will name a very low price, since he is
terrified that you will unload your interest on him.
 Ben Graham and Mr. Market Continued:
Mr. Market has another endearing characteristic: He doesn’t
mind being ignored. If his quotation is uninteresting to you today,
he will be back with a new one tomorrow. Transactions are strictly
at your option. Under these conditions, the more manic-depressive
his behavior, the better for you.
But, like Cinderella at the ball, you must heed one warning or
everything will turn into pumpkins and mice: Mr. Market is there to
serve you, not to guide you. It is his pocketbook, not his wisdom,
that you will find useful. If he shows up someday in a particularly
foolish mood, you are free to either ignore him or to take advantage
of him, but it will be disastrous if you fall under his influence.
Indeed, if you aren’t certain that you understand and can value your
business far better than Mr. Market, you don’t belong in the game.
As they say in poker, “If you’ve been in the game 30 minutes and
you don’t know who the patsy is, you’re the patsy.”
7/16/2019 Professor Kuhle 9
 Good News! The Market is
Dropping
 Practice a selective contrarian investment strategy. This is one in
which the investor is motivated to invest by a falling stock price.
Contrarians invest in what the market finds unattractive.
 Recognize that the majority of investors play the short-term investment
game.
 People sell on bad news.
 Companies that have a franchise product and thus a competitive
advantage, have the economic power to weather most bad-news
storms.
 Always invest in companies with a long-term durable competitive
advantage, which we call a franchise product. A product characterized
by few or no substitutes, a product in demand by many, little or no
government regulation.
 Market Volatility – Your Best Friend!

7/16/2019 Professor Kuhle 11

The driving force of Warren Buffett’s investment
strategy is the rational allocation of capital.
Determining how to allocate a company’s
earnings is the most important decision a
manager will make. Rationality is the quality
Buffett most admires. Buffett’s success has
depended as much on eliminating those things
you can get wrong, which are many (i.e.
predicting markets, economies, and stock
prices), as on getting things right, which are few
and simple (valuing a business). There are two
simple variables Buffett focuses on: the price of
the business and the value of that business.
1. Turn off the stock market. Remember that the
stock market is manic-depressive. Wildly excited
sometimes or unreasonably depressed. This
behavior creates opportunities, but you do not
allow the market to dictate your actions.
2. Don’t worry about the economy. Buy a business
that has the opportunity to profit in any economy.
3. Buy a business, not a stock. Change your
perspective to that of a business owner and learn
as much as possible about the business and
industry.
4. Manage a portfolio of businesses. Don’t diversify
for diversification’s sake.
 Chapter 2:
Concepts Every Investor
Should Know
 Interest Rates
When interest rates rise, business
becomes more difficult and vulnerable.
This is due to the high cost of borrowing
money to invest in the business.
When interest rates decrease, it is easier
to borrow capital and therefore expand
capacity and activity.
Hence, interest rates are the price of
borrowing capital to the business. In
Finance 101 you should have already
covered the before and after-tax cost of
borrowing capital.
The Federal reserve determines interest
rates in three different ways, all of
which you should be familiar with.
The arithmetic makes it plain that inflation is a far
more devastating tax than anything that has been
enacted by our legislature. The inflation tax has a
fantastic ability to simply consume capital. It
makes no difference to a widow with her savings in
a 5% passbook account whether she pays 100%
income tax on her interest income during a period
of zero inflation, or pays no income taxes during
years of 5% inflation. Either way, she is “taxed” in
a manner that leaves her no real income
whatsoever. Any money she spends comes right
out of capital. She would find outrageous a 120%
Common Stock as an Inflation Hedge:

S&P LT Bonds LT Gov’t Bonds T. Bills CPI

Last 10: 13.8% 11.3% 11.9% 5.6% 3.5%

Last 20: 14.6% 10.6% 10.4% 7.3% 5.2%
Last 30: 10.7% 8.2% 7.9% 6.7% 5.4%
Last 40: 10.8% 6.8% 6.4% 5.7% 4.5%
Last 50: 11.9% 5.8% 5.3% 5.7% 4.4%

Source: Ibbotson and Sinquefield, “Stocks, Bonds, Bills and Inflation 2014 yearbook,”
Chicago.
 Bonds
A Bond Example:
Par Value $1,000
Term 30 Years
Coupon Rate 5%
What happens when interest rates change?
Rates go to 3%; What is the value of
the bond?
Rates go to 7%; What is the value of
the bond?
 Chapter Summary
Low Interest High Interest
Rates Rates
Low Inflation Stocks Bonds
High Inflation Stocks Stocks

7/16/2019 Professor Kuhle 19

 Chapter 3:
a Brief Introduction to
Financial Statements
 Income Statement for AAPL
Three Years Ended December 25, 2010
(In Millions, Except Per Share Data) 2012 2013 2014
Net revenue 156,508 170,910 182,795
Cost of sales 87,846 106,606 112,258
Gross margin 68,662 64,304 70,537
Research and development 3,381 4,475 6,041
Selling , general and administrative 10,040 10,830 11,993
Restructuring and asset impairment charges0 0 0
Amortization of acquisition-related intangibles
0 0 0
Operating expenses 13,421 15,305 18,034
Operating income (EBIT) 55,241 48,999 52,503
Other Income 522 1,156 980
Income before taxes 55,763 50,155 53,483
Provision for taxes 14,030 13,118 13,973
Net income 41,733 37,037 39,510

Earnings per common share 6.31 5.66 6.49

 Balance Sheet for AAPL
Three Years Ended September 29, 2014
(In Millions, Except Par Value) 2012 2013 2014
Assets
Current Assets:
Cash and cash equivalents 10,746 19% 14,259 19% 13,844 20%
Short-term marketable securities 18,383 32% 26,287 36% 11,233 16%
Accounts receivable, less allowances 10,930 19% 13,102 18% 17,460 25%
Inventories 791 1% 1,764 2% 2,111 3%
Deferred tax assets 2,583 3% 3,453 3% 4,318 3%
Vendor non trade receivables 7,762 13% 7,539 10% 9,759 14%
Other current assets 6,458 11% 6,882 9% 9,806 14%
Total current assets 57,653 33% 73,286 35% 68,531 30%
Long term marketable securities 92,122 52% 106,215 51% 130,162 56%
Property, plant and equipment, net 15,452 9% 16,597 8% 20,624 9%
Goodwill 1,135 1% 1,577 1% 4,616 2%
Acquired intangible assets, net 4,224 2% 4,179 2% 4,142 2%
Other long-term assets 5,478 3% 5,146 2% 3,764 2%
Total assets 176,064 207,000 231,839

Liabilities and stockholders' equity

Current Liabilities
Accounts payable 21,175 22,367 30,196
Accrued expenses 11,414 13,856 18,453
Deferred revenue 5,953 7,435 8,491
Commercial paper 0 0 6,308
Total current liabilities 38,542 43,658 63,448
Defered revenue- non-current 2,648 2,625 3,031
Long-term debt 0 16,960 28,987
Other non-current liabilities 16,664 20,208 24,826
Total Liabilities 57,854 83,451 120,292
Stockholders' equity:

Common stock and additional paid-in capital 16,422 19,764 23,313

Accumulated other comprehensive income 499 (471) 1,082
Retained earnings 101,289 104,256 87,152
Total stockholders' equity 118,210 123,549 111,547
Total liabilities and stockholders' equity 176,064 207,000 231,839
 AAPL RATIOS

2012 2013 2014

Short term solvency ratios
Current Ratio 1.496 1.679 1.080
Quick Ratio 1.475 1.638 1.047
Cash Ratio 0.865 1.024 0.461
Net Working Capital to Current Liabilities 0.496 0.679 0.080

Asset Utilization or Turnover ratios

Average Collection Period 25.141 27.598 34.386
Inventory Turnover Ratios 197.860 98.888 86.592
Receivable Turnover 14.319 13.045 10.469
Fixed Asset Turnover 10.129 10.298 8.863
Total Asset Turnover 0.889 0.826 0.789

Financial Leverage ratios

Total Debt Ratio (TD/TA) 0.329 0.403 0.519
Debt/Equity 0.489 0.675 1.078
Equity Ratio (TE/TA) 0.671 0.597 0.481
Long-term Debt Ratio (LTD/TA) 0.000 0.082 0.125
Times Interest Earned Ratio (EBIT/TI) there are
0.000
no interest payments0.000 0.000

Profitability ratios
Gross Profit Margin 0.439 0.376 0.386
Net Profit Margin 0.267 0.217 0.216
ROA (NI/TA) 0.237 0.179 0.170
ROE (NI/TE) 0.353 0.300 0.354
ROEWGW (NI/TEWGW): This accounts for Goodwill
0.337 0.288 0.343
Market value ratios
Price/Earnings Ratio 12.000 12.300 13.000
 Basic Report Terminology
• 10K ( Annual Report): These are the annual accounts that
are filed for all major businesses conducted in the last year.
Every corporation must file their annual report within sixty
to 90 days after the fiscal year ends, depending on their
size.
• 10 Q (Quarterly Report): These reports are similar to the
10K but they only cover financial activities for the last
quarter (three months).
• 8Q (Current Report Filing): This report is filed whenever
any major event occurs that could have an effect on the
company’s financial position.
 Keep it
simple

Chapter 4:
Principles
and Rules
of Value
Investing

7/16/2019 Professor Kuhle 27

The basic ideas of investing are to
1) look at stocks as businesses,
2) use market fluctuations to your advantage, and
3) seek a margin of safety.
That’s what Ben Graham taught us. A hundred
years from now they will still be the cornerstones
of investing.
 The Warren Buffett Way - his Tenets
Business Tenets
1. Is the business simple and easy to understand?
2. Does the business have a consistent operating history?
3. Does the business have favorable long-term prospects?
Management Tenets
1. Is management rational?
2. Is management candid with its shareholders?
3. Does management resist the institutional imperative?
Financial Tenets
1. Focus on return on equity, not earnings per share.
2. Calculate shareholders “intrinsic value.”
3. Look for companies with high profit margins.
4. Make sure the “value added” is greater than 1.
Market Tenets

1. What is the “intrinsic value” of the business?

2. Can the business be purchased at a discount to it’s market value?
 The Warren Buffett
Way:
 Business Tenets
 Is the business simple and understandable?
 Does the business have a consistent operating history?
 Does the business have favorable long-term prospects?
 Is the business simple and understandable. Does the
company have an identifiable durable competitive
advantage?
 Does the business have an identifiable consumer
monopoly or franchise product? What is the chance the
product will become obsolete in the next 20 years?
 The Warren Buffett
Way:
 Business Tenets
 Is the business simple and understandable? What does this
mean? Does the business make a product(s) that is simple or
complex for the average investor to understand? An example
would be See’s Candy. Everyone can relate to See’s Candy,
especially on special occasions. It doesn’t take a lot of new
technology to continue to make the product and it is relatively
insulated from increasing prices. Compare this to an Intel,
whose products may lead the market but it does take a lot of re-
investment of capital to maintain a competitive edge.
 The Warren Buffett Way:
 Business Tenets
 Does the business have a consistent operating history?
Apple Inc
Value Line Data
Symbol: AAPL Beta: 0.85 Price: $125.86

2009 2010 2011 2012 2013 2014

ACRR
Sales per share 40.0% $5.80 $10.17 $16.64 $23.81 $27.15 $31.16
Cash flow per share 51.3% $1.02 $2.35 $4.26 $6.85 $6.96 $8.09
Earnings per share 48.3% $0.90 $2.16 $3.95 $6.31 $5.66 $6.45
Dividends per share 36.6% $0.00 $0.00 $0.00 $0.38 $1.63 $1.81
Capital Spending per share 55.4% $0.18 $0.31 $0.65 $1.26 $1.30 $1.63
Book value per share 33.9% $4.42 $7.45 $11.78 $17.98 $19.63 $19.02
Common Shares Outstanding (Mill) 6298.6 6411.8 6504.9 6574.5 6294.5 5866.0
Average annual P/E ratio 19.2 15.2 12.4 12.0 12.3 13.0
Average price to earnings ratio 14.0
Average annual dividend yield 0.0% 0.0% 0.0% 0.5% 2.3% 2.2%
Sales ($mill) 38.0% $36,537 $65,225 $108,249 $156,508 $170,910 $182,795
Operating margin 7.6% 22.9% 29.8% 32.9% 37.4% 32.6% 33.1%
Depreciation ($Mill) $703.0 $1,027.0 $1,814.0 $3,277.0 $6,757.0 $7,946.0
Net profit ($Mill) 47.3% $5,704.0 $14,013.0 $25,922.0 $41,733.0 $37,037.0 $39,510.0
Income tax rate (%) 28.6% 24.4% 24.2% 25.2% 26.2% 26.1%
Net profit margin (%) 0.1% 21.5% 22.5% 23.9% 26.7% 21.7% 21.6%
Working Capital ($Mill) $16,983.0 $20,956.0 $17,018.0 $19,111.0 $29,628.0 $5,083.0
Long-term Debt ($Mill) $0.0 $0.0 $0.0 $0.0 $16,960.0 $28,987.0
Shareholder equity ($Mill) 32.0% $27,832.0 $47,791.0 $76,615.0 $118,210.0 $123,549.0 $111,547.0
Return on equity 20.49% 29.32% 33.83% 35.30% 29.98% 35.42%
Average return on equity 30.73%
ACRR = AVERAGE Compounded Rate of Return
Dividend payout ratio 0% 0% 0% 6% 29% 28%
Minimum P/E Ratio 12.0
Maximum P/E Ratio 19.2

Calculations
2009 2010 2011 2012 2013 2014
ACGR
Price per share $17.28 $32.83 $48.98 $75.72 $69.62 $83.85
Owners cash flow 48.4% $5,273.24 $13,052.35 $23,507.79 $36,726.18 $35,611.16 $37,894.42
Annual cash flow growth rate 147.52% 80.10% 56.23% -3.04% 6.41%
5 year average cash flow growth 57.4%
Annual sales growth 78.49% 66.00% 44.62% 9.17% 6.96%
5 year average sales growth 41.0%
VALUE ADDED $7.26 $4.17 $4.29 ($1.61) $1.36
Average value added $3.09
Owners cash flow per share $0.84 $2.04 $3.61 $5.59 $5.66 $6.46
SHARE PRICE/BOOK VALUE 3.91 4.41 4.16 4.21 3.55 4.41
 The Warren Buffett Way:
 An investor needs to do very few
things right as long as he or she
avoids big mistakes.
 We like stocks that generate high
returns on invested capital where
there is a strong likelihood that it
will continue to do so. I look at
long-term competitive advantage and
whether that’s something that’s
enduring.
 The Warren Buffett
Way:
 Management Tenets
 Is management rational?
 Is management candid with its

shareholders?
 Does management resist the institutional

imperative?
 The Warren Buffett Way:
 When you have able managers of high character running
businesses about which they are passionate, you can
have a dozen or more reporting to you and still have time
for an afternoon nap.
 In evaluating people, you look for three qualities:
integrity, intelligence, and energy. If they don’t have
the first, the other two will kill you.
 In the long run, of course, trouble awaits managements
that paper over operating problems with accounting
maneuvers.
7/16/2019 Professor Kuhle 35
 The Warren Buffett Way:
 The Institutional Imperative
This is defined as the “lemming like” tendency of corporate management to imitate
the behavior of other managers, no matter how silly or irrational that behavior may
be. The institutional Imperative is responsible for several serious conditions:
1. the organization resists any change in its current direction
2. just as work expands to fill available time, corporate projects or
acquisitions will materialize to soak up available funds.
3. any business craving of the leader, however foolish, will quickly be
supported by detailed rate-of-return and strategic studies prepared
by his troops.
4. the behavior of peer companies, whether they are expanding,
acquiring, setting executive compensation or whatever, will be
mindlessly imitated.

7/16/2019 Professor Kuhle 36

 The Warren Buffett
Way:
 Financial Tenets
 What is the return on equity?
 What are the company’s “owner cash flows”
 What are the profit margins?
 Has the company created at least one dollar of
market value for every dollar retained (value
added)?
 Does the Company have less than 30% debt?
 Apple Inc
Value Line Data
Symbol: AAPL Beta: 0.85 Price: $125.86

2009 2010 2011 2012 2013 2014

ACRR
Sales per share 40.0% $5.80 $10.17 $16.64 $23.81 $27.15 $31.16
Cash flow per share 51.3% $1.02 $2.35 $4.26 $6.85 $6.96 $8.09
Earnings per share 48.3% $0.90 $2.16 $3.95 $6.31 $5.66 $6.45
Dividends per share 36.6% $0.00 $0.00 $0.00 $0.38 $1.63 $1.81
Capital Spending per share 55.4% $0.18 $0.31 $0.65 $1.26 $1.30 $1.63
Book value per share 33.9% $4.42 $7.45 $11.78 $17.98 $19.63 $19.02
Common Shares Outstanding (Mill) 6298.6 6411.8 6504.9 6574.5 6294.5 5866.0
Average annual P/E ratio 19.2 15.2 12.4 12.0 12.3 13.0
Average price to earnings ratio 14.0
Average annual dividend yield 0.0% 0.0% 0.0% 0.5% 2.3% 2.2%
Sales ($mill) 38.0% $36,537 $65,225 $108,249 $156,508 $170,910 $182,795
Operating margin 7.6% 22.9% 29.8% 32.9% 37.4% 32.6% 33.1%
Depreciation ($Mill) $703.0 $1,027.0 $1,814.0 $3,277.0 $6,757.0 $7,946.0
Net profit ($Mill) 47.3% $5,704.0 $14,013.0 $25,922.0 $41,733.0 $37,037.0 $39,510.0
Income tax rate (%) 28.6% 24.4% 24.2% 25.2% 26.2% 26.1%
Net profit margin (%) 0.1% 21.5% 22.5% 23.9% 26.7% 21.7% 21.6%
Working Capital ($Mill) $16,983.0 $20,956.0 $17,018.0 $19,111.0 $29,628.0 $5,083.0
Long-term Debt ($Mill) $0.0 $0.0 $0.0 $0.0 $16,960.0 $28,987.0
Shareholder equity ($Mill) 32.0% $27,832.0 $47,791.0 $76,615.0 $118,210.0 $123,549.0 $111,547.0
Return on equity 20.49% 29.32% 33.83% 35.30% 29.98% 35.42%
Average return on equity 30.73%
ACRR = AVERAGE Compounded Rate of Return
Dividend payout ratio 0% 0% 0% 6% 29% 28%
Minimum P/E Ratio 12.0
Maximum P/E Ratio 19.2

Calculations
2009 2010 2011 2012 2013 2014
ACGR
Price per share $17.28 $32.83 $48.98 $75.72 $69.62 $83.85
Owners cash flow 48.4% $5,273.24 $13,052.35 $23,507.79 $36,726.18 $35,611.16 $37,894.42
Annual cash flow growth rate 147.52% 80.10% 56.23% -3.04% 6.41%
5 year average cash flow growth 57.4%
Annual sales growth 78.49% 66.00% 44.62% 9.17% 6.96%
5 year average sales growth 41.0%
VALUE ADDED $7.26 $4.17 $4.29 ($1.61) $1.36
Average value added $3.09
Owners cash flow per share $0.84 $2.04 $3.61 $5.59 $5.66 $6.46
SHARE PRICE/BOOK VALUE 3.91 4.41 4.16 4.21 3.55 4.41
The Warren Buffett
Way:
 Value Tenets
 What is the business value of the
company – that is the “intrinsic” value?
 Can the shares be purchased at a

significant discount (roughly 50%) to its

current trading price?

Professor Kuhle 39
 Value Tenets
INTRINSIC VALUATION MODEL - TWO-STAGE EARNINGS GROWTH PROJECTIONS

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

Prior year cash flows (mil) 37,894 47,368 59,210 74,013 92,516 115,645 144,556 180,695 225,868 282,335
10-year growth rate (.00) 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00% 25.00%
Cash flow 47,368 59,210 74,013 92,516 115,645 144,556 180,695 225,868 282,335 352,919
Discount Rate (.00) 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15
Discount Factor (mult.) 0.869565 0.756144 0.657516 0.571753 0.497177 0.432328 0.375937 0.326902 0.284262 0.247185
Discounted value per annum 41,190 44,771 48,664 52,896 57,496 62,495 67,930 73,837 80,257 87,236
Sum of present value of cash flows $616,773

Residual value
Cash flow in year 10 $352,919
Growth rate (.00) (g) 0.04
Cash flow in year 11 $367,036
Capitalization rate (k-g) 0.11
Value at end of year 10 $3,336,691
Discount factor year 10 0.24718

Present value of residual $824,779

Total Intrinsic Value (mil) $1,441,552
Number of shares (mil) 5,866
Intrinsic value per share 245.75
Intrinsic / Market 1.95

Input discount & growth rates

First 10 year growth rate 25.00%

Growth Rate Year 11 in perpetuity 0.04
Discount rate 0.15
Owners cash flow (mil) $37,894.42

This page is all pre-determined by the information from the Value Line page. The only thing you may have to change is the growth rate for the three different scenarios.
 Buffett’s Four
Principles of Investing
1. The company must have
capable and vigilant
leaders.
2. The company must have
long-term prospects .
3. Is the stock stable and
understandable?
4. A company must be
undervalued so you can
make a “good buy.”
Principle 1 – Vigilant Leaders
1. Rule 1 – Low debt. A D/E < .5 and a D/TA < .3
2. Rule 2 – High Current Ratio. CR > 1.5
3. Rule 3 – Strong and consistent ROE. Buffett
requires 8% average over a 10 year period. Kuhle
likes to see an average of 15%.
4. Appropriate management incentives.
 AAPL RATIOS

2012 2013 2014

Short term solvency ratios
Current Ratio 1.496 1.679 1.080
Quick Ratio 1.475 1.638 1.047
Cash Ratio 0.865 1.024 0.461
Net Working Capital to Current Liabilities 0.496 0.679 0.080

Asset Utilization or Turnover ratios

Average Collection Period 25.141 27.598 34.386
Inventory Turnover Ratios 197.860 98.888 86.592
Receivable Turnover 14.319 13.045 10.469
Fixed Asset Turnover 10.129 10.298 8.863
Total Asset Turnover 0.889 0.826 0.789

Financial Leverage ratios

Total Debt Ratio (TD/TA) 0.329 0.403 0.519
Debt/Equity 0.489 0.675 1.078
Equity Ratio (TE/TA) 0.671 0.597 0.481
Long-term Debt Ratio (LTD/TA) 0.000 0.082 0.125
Times Interest Earned Ratio (EBIT/TI) there are
0.000
no interest payments0.000 0.000

Profitability ratios
Gross Profit Margin 0.439 0.376 0.386
Net Profit Margin 0.267 0.217 0.216
ROA (NI/TA) 0.237 0.179 0.170
ROE (NI/TE) 0.353 0.300 0.354
ROEWGW (NI/TEWGW): This accounts for Goodwill
0.337 0.288 0.343
Market value ratios
Price/Earnings Ratio 12.000 12.300 13.000
 Vigilant Leaders
 When you have able managers of
high character running businesses
about which they are passionate,
you can have a dozen or more
reporting to you and still have time
for an afternoon nap.
 In evaluating people, you look for
three qualities: integrity,
intelligence, and energy. If you
don’t have the first, the other two
will kill you.
 In the long run, of course, trouble
awaits managements that paper
over operating problems with
accounting maneuvers.
Principle 2 – Long term
Prospects
Rule #1 – Persistent or Durable Product(s)
The kind of business to invest in is one which is
Durable (franchise product) meaning that the
business must be able to keep its
advantage well into the future without having to
expend great sums of capital to maintain it. A
low-cost competitive advantage is important for
two reasons: First, is the predictability of the future
earning power. Second, it improves the chances
the business can expand shareholders’ fortunes
rather than having to expend capital.
 The Franchise Product has (is):
1. A Durable Product with a Competitive
Advantage that is sustainable over the long-run
(5-10 years).
2. In high demand by a large segment of the
market.
3. Little or no close substitutes.
4. Little or no Government regulation.
 Franchise Product
The example used in the book is a good one. While
Apple is a consistently high performer, they must stay
ahead of the curve by investing in R&D and coming out
with new products that may replace major products already
in the market. This doesn’t mean that Apple won’t be
profitable in the future, it means that there will always be
more uncertainty attached to their products.
Graham always told us that speculation on the future
was no way to invest. A steady-eddy like Coke already has
a record for a solid long-term success with it’s current
franchise products.
 Franchise Product
When considering a new investment
you should aim to determine whether changing
technology will have a significant effect on the
demand for that product in the future, this is
what establishes a long-term competitive
advantage. You must be able to ascertain the
feasibility of a franchise product at least 10
years into the future.
When Buffett says he “doesn’t
understand” a business he means he knows how
it works but doesn’t know what their future
looks like.
Again, it comes down to the
simplicity of the business and the investing
story. Mr. Buffett says that “the chance of being
way wrong about Coke (where he does own
shares) are probably less than being way wrong
in Apple or Google.” Ultimately, he says, “I just
don’t know how to value them.”
vs. $336,375

vs. $42,956
 According to Buffett, what causes
Risk?

1. Excessive Debt: Buffett never considers a company that

has a Debt/Total Asset ratio greater than 30%.
2. Overpaying for an investment. The price you pay for a
stock should have a potential of at least a 50%
premium. That is for every dollar you spend for an
asset, you should get at least $1.50 in intrinsic value.
3. Not knowing what you are doing. That is, not knowing
the company and what they do.

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 Sayings of Warren Buffett

1. I’ve never swung at a ball while it’s still in the pitcher’s glove.
2. Never ask the barber if you need a haircut.
3. Wall Street is the only place that people ride to in a Rolls Royce to get
advice from those who take the subway.
4. When you combine ignorance and borrowed money, the consequences
can get interesting.
5. Most of our shareholders have to pay their bills in U.S. dollars.
6. When I was 20, I invested well over half of my net worth in GEICO.
7. Do a lot of reading.
8. If you have to go through too much investigation, something is wrong.

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 Sayings of Warren Buffett

9. I can’t be involved in 50 or 75 things. That’s a Noah’s Ark way of investing-you end

up with a portfolio that resembles a zoo.
10. We’re looking for 747’s, not model airplanes.
11. Read Ben Graham and Phil Fisher, real annual reports, but don’t do equations with
Greek letters in them.
12. In reference to quantitative analysis: Every priesthood does it. How could you be
on top if no one is on the bottom?
13. The funny thing is, better shows don’t cost that much more than lousy shows.
14. Anything that can’t go on forever will end.
15. It’s an old principle. You don’t have to make it back the way you lost it.

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 Sayings of Warren Buffett
16. You need a moat in business to protect you from the guy who is going to come
along and offer it (your product) for a penny cheaper.
17. Owning Snow White (the movie) is like owning an oil field. You pump it out and
sell it and then it seeps back in again.
18. It’s far better to own a portion of the Hope diamond than 100 percent of a
rhinestone.
19. Diversification is a protection against ignorance. It makes very little sense for
those who know what they’re doing.
20. Buffett says he’s a Rip Van Winkle investor. What does he mean and why?
21. I don’t try to jump over 7-foot bars: I look around for 1-foot bars that I can step
over.

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 Sayings of Warren Buffett

22. Like Wayne Gretzky says, go where the puck is going, not where it is.
23. To swim a fast 100 meters, it’s better to swim with the tide than to work on
your stroke.
24. I’d be a bum on the street with a tin cup if the markets were always efficient.
25. You can’t get rich with a weather vane.
26. I like to buy stocks when the bears are giving them away.
27. Berkshire buys when the lemmings are heading the other way.
28. Happily, there’s more than one way to get to financial heaven.
29. I call it the cigar-butt theory of investing. You find these well-smoked, down-
to-the-nub cigars, but they’re free. You pick them up and get one free puff
out of them.

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 Sayings of Warren Buffett
30. Good jockeys will do well on good horses, but not on broken-down nags.
31. We don’t tell 400 hitters how to hit.
32. Of Wall Street maxims the most foolish may be “you can’t go broke taking a
profit.”
33. If you expect to be a net investor for the next five years, should you hope for
a higher or lower stock market during the period? Explain.
34. Grahamites should probably endow chairs to ensure the perpetual teaching
of EMT.
35. In their hunger for a single statistic to measure risk, academics forget a
fundamental principle: it is better to be approximately right than precisely
wrong.

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36. We think that the very term “value investing” is redundant.
37. Business growth, per se, tells us little about value.
38. An intelligent investor in common stocks will do better in the secondary market
than he will do buying new issues.
39. Why does Berkshire prefer to use cash vs. Berkshire stock to buy companies?
40. Bull markets can obscure mathematical laws, but they can’t repeal them.
41. Charlie and I have found that making silk purses out of silk is the best that we can
do; with sow’s ears, we fail.
42. There seems to be some perverse human characteristic that likes to make easy
things difficult.

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43. With enough inside information and a million dollars, you can go broke in a year.
44. If the true value of a company doesn’t just scream at you, it’s too close.
45. In investments, there’s no such thing as a called strike.
46. I never attempt to make money on the stock market. I buy on the assumption that
they could close the market the next day and not reopen it for five years.
47. There seems to be some perverse human characteristic that likes to make easy
things difficult.
48. “In the business world, the rearview mirror is always clearer than the windshield.”

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49. “Only when the tide goes out do you discover who's been swimming naked”
50. “If past history was all there was to the game, the richest people would be
librarians”
51. “When a management team with a reputation for brilliance tackles a business
with a reputation for bad economics, it is the reputation of the business that
remains intact.”
52. “Only buy something that you'd be perfectly happy to hold if the market shut
down for 10 years.”
53. “Time is the friend of the wonderful company, the enemy of the mediocre.”
54. “We simply attempt to be fearful when others are greedy and to be greedy only
when others are fearful.”

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55. The Golden Rule works in business too.
56. Healthy cultures create wealth; toxic cultures destroy it.
57. To create long-lasting wealth, don’t lose money.
58. Aiding investors’ analysis builds investor trust.
59. Failed discipline will lead to a poorhouse, not an economic
powerhouse.
60. A conclusion about the economy does not tell us if the stock
market will rise or fall.
61. Great CEO’s need to be disciplined capital allocators.
62. Price is what you pay; value is what you get.
63. A chain of folly will always end badly.
64. What looks safe may be unsafe; challenge assumptions and be
open to new facts.
65. Remember that large, unfathomable derivatives are still
financial weapons of mass destruction.
66. Indecipherable disclosures tell us which emperors are naked.

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67. Live beneath your means.
68. Betting on tortoises can create long-lasting wealth.
69. Invest with CEO’S who explain important risks.
70. Recovery depends on choosing to restore our social compact and
to reset our moral compasses.

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 It’s been a
Wonderful life

End of
Buffettology
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