This post aims to simplify and summarise Buffett’s stock investment strategies based on the book, “The Warren Buffett Stock Portfolio”.
EditI bought this book at a cheap price of SGD 2.50 at a clearance sale. The original price of this book is USD 25!! 😄
Buffett’s stock investment strategy is counter intuitive to the conventional investment theories and strategies.
Basically, Buffett is SELECTIVELY buying in to companies with DURABLE COMPETITVE ADVANTAGES when others are rushing to sell off their stocks. When the market is rising, he is selling off average businesses to gather cash surplus, and holding on to really great businesses with DURABLE COMPETITIVE ADVANTAGES for the long term. The key is to sell off your average stocks before the market crashes, then wait for it to crash. Once the market crashes, you buy companies with LONG TERM COMPETITIVE ADVANTAGES like a sex-starved man in a harem (directly quoted by Buffett) and hold them for the long term.
Now, we’ll be going through the simplified version of Buffett’s method of Stock Analysis to identify companies with DURABLE COMPETITIVE ADVANTAGES.
Read about the background of the company and the company’s product information.
This gives you a brief understanding of how long the company has been in the market (preferably >50 years as Buffett likes old companies) and it’s stock performance.
Also, avoid buying stocks from companies that are constantly investing in Research and Development, such as mobile phone, computer companies. Why? Because the future revenue earned by these companies is less predictable since technology is constantly improving and eventually the company’s technology may become obsolete. Instead, invest in companies that in 15-20 years time, you can still see people consuming. Soft drinks, oreo, chewing gum? That kinda stuff.
Calculate/ Search online for the company’s PSE (Per Share Earnings) Growth.
This gives you a rough estimate of what the PSE will be in a decade from today!
- Across a 10 year period, by how much has the PSE increased? For example, take 10 year PSE growth to be x%.
- Calculate the average compounding rate of PSE by taking: ((PSE10/PSE1)^0.1 – 1) * 100% The rate of average annual PSE growth (across a 10 year period) gives you a good estimate of how fast the company’s earnings are growing on a yearly basis.
- PSE10 and PSE1 denotes PSE at year 10 and year 1 respectively
Calculate the rate of BVPS (Book Value Per Share) Growth.
BVPS can also be termed Equity Val1ue per Outstanding Share. Equity = Assets – Liabilities, and the outstanding shares are basically the total number of shares the company owns.
The rate of growth of BVPS measures the long term economic performance and is a good estimate for the rate of growth of intrinsic value of the company. This is also a measure of DURABLE COMPETITIVE ADVANTAGE.
Furthermore, by comparing BVPS against the company’s stock price, it gives you a good gauge of the extent to which the company is undervalued. (if BVPS > Stock Price, company is undervalued. The greater the difference, the greater the extent it is undervalued!)
- Assume BVPS growth across 10 years is y%.
- Calculate the average compounding rate of BVPS by taking: ((BVPS10/BVPS1)^0.1 – 1)*100%
- BVPS10 and BVPS1 represents BVPS at year 10 and 1 respectively.
Calculate the after corporate tax inital rate of return.
- Initial ROR = Current PSE Value/ Current Company Stock Market Price * 100% = A/B %
After 10 years, there is an assumed x% growth in PSE as mentioned in Step 1. So, the new PSE value 10 years later will simply be
- Final PSE Value = (100+x/100) * Current PSE Value = $C.
Then, calculate the estimated stock price after 10 years as follows
- Estimated Stock Price after 10 years = $C * lowest possible P/E ratio (across the past 10 year period) = $D
Thus, the net gain you will receive per share is estimated to be $(D – B) [Final Stock Market Price – Current Stock Market Price] after 10 years.
You can calculate the total percentage of returns across the 10 year period by taking
- $(D – B)/ B * 100% = e%
Then, calculate the annual rate of return:
- Annual ROR = ((D/B)^0.1 * 100%) = f%
So now the question is… is the Annual ROR of f% attractive enough for you to invest in this company?
Compared with: (2017)
Inflation rate ~2% anually
Current Banks ~1% anually
Random 15YR Endowment Plan ~3% anually
I hope this post has been useful in understanding how Buffett identifies good stocks and why he chooses certain companies over others! If you have any questions, do post them below! 😄😄😉