I’ve had this copy of Buffettology by Mary Buffett and David Clark for what must have been 5 years. Its one of those books that you tell yourself that its a good book to read someday but never ever got around to reading it. I had been thinking about the problem of stock picking for some time, from learning about DCF, all the ratios, and finally getting down to picking some stocks. It was at that time that I felt it was opportune to finally start reading Buffettology.
And I must say, its been an excellent journey. Many of the conclusions that I had arrived to literally mirror what was written in the book, and the best thing is, the book went further and developed a whole neat model of how to pick stock based on the underlying principles. Many of what was presented in the book is so logically and beautifully thought-out, I am sure that Warren Buffett did originate them.
- To convert from earnings to price, initially it was suggested using earnings/risk-free rate. Later it was suggested to use the average historical P/E ratio. I’m thinking that that some adjustments need to be made: 1) adjustment for the stock risk taken (total risk, not just systematic), 2) adjustment to include all future earnings not just one year of earnings. This would include projection of growth of earnings. 1) will reduce the price. 2) will increase the price.
- What kind of earnings should be used? FCFF? FCFE? NI? CF? should depreciation be included? I am inclined more and more towards using real cash flow available to stockholders. Amortization will not be done, so that the initial spending will make a larger dent. Also, is there some kind of reconciliation that can be done with our original method of estimating FCFF (estimating 3 params on working capital rate, dep rate, etc.)
- With respect to the kind of companies to invest in, I agree wholeheartedly with the commodity vs consumer monopoly (toll bridge) analogy. However, with all the outsourcing in recent times, things may not be as clear cut. Many things being sold now are produced in China/India. That brings about volatility. The Chinese production facilities can easily defect to other companies. There would also be manageability problems. Hence even current “consumer monopoly” companies might not be that “safe”. What then is the solution? The obvious solution is to choose consumer monopolies that thrive on intangibles – intellectual capital, intellectual property etc. Not drug companies though, too risky with the drug approval process. Apart from firms such as market research and consulting firms, software firms deserve more attention.
- The book gives the impression that Buffett does long term investing and only participates in short-term investing when there’s no better opportunities around. More on that later
- When calculating ROE, should we use Avg Equity (beg eq + end eq / 2) as the denominator? it complicates calculations as we would need to use the solver, but it seems to reflect the reality more accurately.
[Note: There is a good summary here.]
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