Tenets of Warren Buffet

1. Tenets of Warren Buffet Business Tenets Management Tenets Financial Tenets Market Tenets

2. Business Tenets Is the business simple and understandable? Does the business have a consistent operating history? Does the business have favorable long-term prospects?

3. Management Tenets Is management rational in allocation capital? Is management candid with with its shareholders? Does management resist the institutional imperative? Does management just do what others are doing or do they think and act independently?

4. Financial Tenets Focus on return on equity, not earnings per share Calculate �owner earnings� including the effects on cash flow of capital expenditures Look for companies with high profit margins For every dollar retained, make sure the company has created at least one dollar of market value

5. Market Tenets INTRINSIC VALUE---What is the value of the business? MARGIN OF SAFETY---Can the business be purchased at a significant discount to its fundamental intrinsic value?

6. �To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these. That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices.�Warren Buffett, BRK Letter to Shareholders, 1996

7. TOP DOWN INVESTING Company analysis is the final step in the top-down approach to investing Macroeconomic analysis identifies industries expected to offer attractive returns in the expected future environment Analysis of firms in selected industries concentrates on a stock�s intrinsic value based on growth and risk

8. Forces Driving Industry Competition Porter�s believes that five competitive forces determine the intensity of competition, and the relative effect of each of these five factors can vary dramatically among industries. As shown in the illustration, these five factors are: Rivalry among existing competitors For each industry analyzed, you must judge if the rivalry among firms is currently intense and growing, or if it is polite and stable. Rivalry increases when many firms of relatively equal size compete in the same industry. Be sure to include foreign competitors in your analysis. Other factors that tend to increase competition include: slow growth, high fixed costs, and exit barriers. Threat of new entrants While an industry may have few firms, you have to determine the likelihood of firms entering the industry and increasing competition. Threat of substitute products Substitute products limit the prices firms in the industry can charge. Bargaining power of buyers Buyers can influence the profitability of an industry because they can bid down prices or demand higher quality or more services by bargaining among competitors. Bargaining power of suppliers Suppliers can alter future industry returns if they increase prices or reduce the quality or services they provide. The fewer suppliers, the more powerful they are. Porter�s believes that five competitive forces determine the intensity of competition, and the relative effect of each of these five factors can vary dramatically among industries. As shown in the illustration, these five factors are: Rivalry among existing competitors For each industry analyzed, you must judge if the rivalry among firms is currently intense and growing, or if it is polite and stable. Rivalry increases when many firms of relatively equal size compete in the same industry. Be sure to include foreign competitors in your analysis. Other factors that tend to increase competition include: slow growth, high fixed costs, and exit barriers. Threat of new entrants While an industry may have few firms, you have to determine the likelihood of firms entering the industry and increasing competition. Threat of substitute products Substitute products limit the prices firms in the industry can charge. Bargaining power of buyers Buyers can influence the profitability of an industry because they can bid down prices or demand higher quality or more services by bargaining among competitors. Bargaining power of suppliers Suppliers can alter future industry returns if they increase prices or reduce the quality or services they provide. The fewer suppliers, the more powerful they are.

9. Porter�s Competitive Strategies Current rivalry Threat of new entrants Potential substitutes Bargaining power of suppliers Bargaining power of buyers

10. Identifying and Selecting Competitive Strategies Five conditions affecting the competitive structure and profits of an industry 1. Current rivalry 2. Threat of new entrants 3. Potential substitutes 4. Bargaining power of suppliers 5. Bargaining power of buyers In describing competition within industries, five conditions have been identified that would affect the competitive structure and profits of an industry. 1. current rivalry 2. threat of new entrants 3. potential substitutes 4. bargaining power of suppliers 5. bargaining power of buyers.In describing competition within industries, five conditions have been identified that would affect the competitive structure and profits of an industry. 1. current rivalry 2. threat of new entrants 3. potential substitutes 4. bargaining power of suppliers 5. bargaining power of buyers.

11. Firm Competitive Strategies Defensive strategy involves positioning firm so that it its capabilities provide the best means to deflect the effect of competitive forces in the industry Offensive strategy involves using the company�s strength to affect the competitive industry forces, thus improving the firm�s relative industry position Porter suggests two major strategies: low-cost leadership and differentiation

12. Porter's Competitive Strategies Low-Cost Strategy The firm seeks to be the low-cost producer, and hence the cost leader in its industry Differentiation Strategy firm positions itself as unique in the industry

13. Buffett�s idea of Economic Moat Buffett looks for �economic castles protected by unbreachable moats.� A Moat stops a rival from eating up excess profits Having a Sustainable Competitive Advantage � key to evaluating a company�s economic moat. Types of Moat>>>

14. Buffett on GEICO�s Moat We expect new competitors to enter the direct-response market, and some of our existing competitors are likely to expand geographically. Nonetheless, the economies of scale we enjoy should allow us to maintain or even widen the protective moat surrounding our economic castle. We do best on costs in geographical areas in which we enjoy high market penetration. As our policy count grows, concurrently delivering gains in penetration, we expect to drive costs materially lower. GEICO's sustainable cost advantage is what attracted me to the company way back in 1951, when the entire business was valued at $7 million. It is also why I felt Berkshire should pay $2.3 billion last year for the 49% of the company that we didn't then own. 1996 Letter to Shareholders.

15. Types of Moat Low-Cost Provider�ex Wal-Mart High switching costs�ex. Stryker The Network Effect�Value increases as more and more people use it. ex. Ebay Intangible Assets�ex. JNJ, Coca-Cola

16. Focusing a Strategy-Porter Select segments in the industry Tailor strategy to serve those specific groups Determine which strategy a firm is pursuing and its success Evaluate the firm�s competitive strategy over time

17. Select one or several segments in the industry to which it tailors its strategy. Firm�s Questions? � Do unique cost or need opportunities exists? � Are they are being served by another firm? � Can they be priced to generate abnormal returns to the firm? Focusing a Strategy Whichever strategy a firm selects, it must determine where it should be focused. A firm must select one or several segments in the industry and tailor its strategy to serve this specific group. For example, a cost focus typically would exploit cost advantages for certain segments of the market. Similarly, a differentiation focus would attempt to serve the special needs of buyers in specific segments. For example, athletic shoe companies have attempted to differentiate based on the type of sport associated with their shoe products. When focusing a strategy a firm must answer several questions. Are there any special costs or need possibilities to serve? If so, are they being served by another firm? And, can this service be priced to generate abnormal returns to the firm? Next the analyst must consider several questions. Which strategy is being pursued? Is the firm successful in pursuit of its strategy? And if the strategies are being sustained? Finally, evaluate a firm�s competitive strategy overtime because strategies need to change as the industry evolves. Different strategies work during different phases of an industry�s life-cycle. Whichever strategy a firm selects, it must determine where it should be focused. A firm must select one or several segments in the industry and tailor its strategy to serve this specific group. For example, a cost focus typically would exploit cost advantages for certain segments of the market. Similarly, a differentiation focus would attempt to serve the special needs of buyers in specific segments. For example, athletic shoe companies have attempted to differentiate based on the type of sport associated with their shoe products. When focusing a strategy a firm must answer several questions. Are there any special costs or need possibilities to serve? If so, are they being served by another firm? And, can this service be priced to generate abnormal returns to the firm? Next the analyst must consider several questions. Which strategy is being pursued? Is the firm successful in pursuit of its strategy? And if the strategies are being sustained? Finally, evaluate a firm�s competitive strategy overtime because strategies need to change as the industry evolves. Different strategies work during different phases of an industry�s life-cycle.

18. Analyst�s Questions? � Which strategy is being pursued? � Is the firm successful? � Are strategies are being sustained? � Does strategy need to be changed? Focusing a Strategy Whichever strategy a firm selects, it must determine where it should be focused. A firm must select one or several segments in the industry and tailor its strategy to serve this specific group. For example, a cost focus typically would exploit cost advantages for certain segments of the market. Similarly, a differentiation focus would attempt to serve the special needs of buyers in specific segments. For example, athletic shoe companies have attempted to differentiate based on the type of sport associated with their shoe products. When focusing a strategy a firm must answer several questions. Are there any special costs or need possibilities to serve? If so, are they being served by another firm? And, can this service be priced to generate abnormal returns to the firm? Next the analyst must consider several questions. Which strategy is being pursued? Is the firm successful in pursuit of its strategy? And if the strategies are being sustained? Finally, evaluate a firm�s competitive strategy overtime because strategies need to change as the industry evolves. Different strategies work during different phases of an industry�s life-cycle. Whichever strategy a firm selects, it must determine where it should be focused. A firm must select one or several segments in the industry and tailor its strategy to serve this specific group. For example, a cost focus typically would exploit cost advantages for certain segments of the market. Similarly, a differentiation focus would attempt to serve the special needs of buyers in specific segments. For example, athletic shoe companies have attempted to differentiate based on the type of sport associated with their shoe products. When focusing a strategy a firm must answer several questions. Are there any special costs or need possibilities to serve? If so, are they being served by another firm? And, can this service be priced to generate abnormal returns to the firm? Next the analyst must consider several questions. Which strategy is being pursued? Is the firm successful in pursuit of its strategy? And if the strategies are being sustained? Finally, evaluate a firm�s competitive strategy overtime because strategies need to change as the industry evolves. Different strategies work during different phases of an industry�s life-cycle.

19. Lynch-Favorable Attributes of Firms 1. Firm�s product is not faddish 2. Company has competitive advantage over rivals 3. Industry or product has potential for market stability 4. Firm can benefit from cost reductions 5. Firm is buying back its own shares or managers (insiders) are buying

20. Some Lessons from Peter Lynch Favorable Attributes of Firms 1. Firm�s product should not be faddish 2. Firm should have some long-run comparative advantage over its rivals 3. Firm�s industry or product has market stability 4. Firm can benefit from cost reductions 5. Firms that buy back shares show there are putting money into the firm

21. Categorizing Companies-Lynch 1. Slow growers 2. Stalwart 3. Fast growers 4. Cyclicals 5. Turnarounds 6. Asset plays

22. Peter Lynch�s Stock Types 1. Slow grower grows with GDP- Dividend yield, not PE 2. Stalwarts- they grow faster (10-12%) than a slow grower, but not fast- PE ratio important 3. Fast grower, 20-25% growth --Lynch ratio=g/PE>1.0 Must understand the product. 4. Turnaround-battered, depressed, HIGH RISK 5. Asset Plays-value that Wall Street does not recognize 6. Cyclical-�timing is everything� two decision stock, buy high PE and sell low PE

25. Site Visits and the Art of the Interview Focus on management�s plans, strategies, and concerns Restrictions on nonpublic information �What if� questions can help gauge sensitivity of revenues, costs, and earnings Management may indicate appropriateness of earnings estimates Discuss the industry�s major issues Review the planning process Talk to more than just the top managers

26. Influences on Analysts Investment bankers may push for favorable evaluations Corporate officers may try to convince analysts Analyst must maintain independence and have confidence in his or her analysis

27. When to Sell Holding a stock too long may lead to lower returns than expected If stocks decline right after purchase, is that a further buying opportunity or an indication of incorrect analysis? Continuously monitor key assumptions Evaluate closely when market value approaches estimated intrinsic value Know why you bought it and watch for that to change

28. Efficient Markets Opportunities are mostly among less well-known companies To outperform the market you must find disparities between stock values and market prices - and you must be correct Concentrate on identifying what is wrong with the market consensus and what earning surprises may exist