What Is the Warren Buffett Way

What Is the Warren Buffett Way

How the world’s champion stockpicker makes his picks

Robert G. Hagstrom Jr., in his bestseller The Warren Buffett Way (John Wiley & Sons, 1994), synthesizes the formula that made Warren Buffett the world’s greatest investor. We asked Hagstrom, who manages the Focus Trust in Philadelphia, to explain how Buffett does it.

Turn off the stock market: Warren Buffett doesn’t; have a stock quote machine in his office and he seems to get by fine without it. If you plan on owing shares in an outstanding business for a number of years, what happens in the market on a day-to-day basis is inconsequential.

Don’t worry about the economy: If you find yourself discussing and debating whether the economy is poised for growth or tilting toward a recession, stop! Except for his preconceived notions that the economy inherently has an inflation bias, Buffett dedicates no time or energy to analyzing the economy.

Buy a business, not a stock: Consider first if the business is easy to understand. Then determine if the business has a consistent operation history and favorable long-term prospects. What about its management? Is it rational, candid with shareholders, and able to avoid the herd mentality? Look at the financials, focusing on return, on equity, not earnings per share. Buffett seeks out companies that generate cash in excess of their needs and companies with high profit margins, which reflect not only a strong business but a management with a tenacious spirit for controlling costs. Other financials to look at: retained earnings, estimated cash flows, and the value of a business. Once you have determined the value of a business, the next step is to look at the stock price. Buffett’s rule is to buy the business only when the stock price is at a significant discount to its value. Note that only at this final step does Buffett look at the stock market price.

Manage a portfolio of businesses. Buffett does not believe that wide diversification is required, so long as you understand business economics and can find 5 to 10 sensible priced companies that have long-term competitive potential. In Buffett’s mind, it is too difficult to make hundreds of smart decisions in a lifetime. He would rather position his portfolio so he only has to make a few smart decisions.

Can you buy a building investing in a good stock? Photo by Elena