Saturday, July 4, 2009

Buffett's Filter

According to Buffet the following are some questions to determine what business to buy,

  • Is the company in an industry of good economics, i.e., not an industry competing on price points.
  • Does the company have a consumer monopoly or brand name that commands loyalty?
  • Can any company with an abundance of resources compete successfully with the company?
  • Are the Owner Earnings on an upward trend with good and consistent margins?
  • Is the debt-to-equity ratio low or is the earnings-to-debt ratio high, i.e. can the company repay debt even in years when earnings are lower than average?
  • Does the company have high and consistent Returns on Invested Capital (his version differs from the popular definition)?
  • Does the company retain earnings for growth?
  • The business should not have high maintenance cost of operations, low capital expenditure or investment cash outflow. This is not the same as investing to expand capacity.
  • Does the company reinvest earnings in good business opportunities?
  • Does management have a good track record of profiting from these investments?
  • Is the company free to adjust prices for inflation?
  • Buffett's next concern was when to buy. He does not hurry to invest in value. He will wait for market corrections or downturns to buy solid businesses at reasonable prices, since stock-market downturns present buying opportunities.
  • Buffett's is known for being conservative when speculation is rampant in the market and being aggressive when others fear for their capital. This contrarian strategy is what led Buffett's company through the Internet boom and bust without significant damage, where many companies’ stock prices crashed or vanished.
  • Then he asks at what price is the business a bargain, and his answer typically is when it provides a higher rate of compounded return relative to other available investment opportunities.