The Warren Buffett Way

Robert Hagstrom

📚 GENRE: Business & Finance

📃 PAGES: 320

✅ COMPLETED: March 24, 2020

🧐 RATING: ⭐⭐⭐⭐⭐

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Short Summary

Robert Hagstrom reveals the strategies and investing fundamentals that have helped Warren Buffett achieve spectacular success in the market. Hagstom gives readers an in-depth look at the men who shaped Buffett’s outlook and how he’s modified his approach over time.

Key Takeaways

1️⃣ Look for A Durable Competitive Advantage — Companies that have a durable competitive advantage are ones you want to invest in. Look for companies that are easy to understand and have some kind of unique feature that gives them a leg up. 

2️⃣ Management Is Key — The leaders of the company are just as important as any financial number. You want to invest in companies that are led by people who make good decisions and have a strong set of core values. The CEO is like a quarterback — he/she has a huge impact on the success of the firm.

3️⃣ Buy At Reasonable Prices — Once you’ve determined that a company is worth investing in, make sure you’re not overpaying for it. Watch the P/E Ratio and be strategic about when you buy shares. 

Favorite Quote

"Time is the friend of the wonderful business and the enemy of the mediocre."

Book Notes 📑

Foreword

  • Warren Buffett – Runs Berkshire Hathaway, and investment company that is now worth over $2 billion.
    • Buffett is the world’s second wealthiest man.
  • Buffett is a value investor who buys and holds. His emphasis is on buying great companies at fair prices, then holding for a long time.
    • He’s been great at buying companies at the right time, especially when they are experiencing a rare unfortunate period.
  • By holding for a long time, you get to sell at the capital gains tax rate (15% if you hold a stock for over 1 year) instead of your normal tax bracket rate, and you allow your money to compound over the years.
  • Buffet is big about diversification in the portfolio.
  • Buffet’s annual Berkshire Hathaway report is designed to help investors learn and make good investment choices.
    • Read it!

Introduction

  • Quote: “There is an incredible resistance to thinking, learning, and changing.” — Warren Buffett 
    • Always learn and develop yourself. Not too many people are focused on these things. 
  • This book is designed to give you tips on investing that you can use to your benefit. They come from Buffett’s principles of investing.

Chapter 1

  • Buffett has said that he is planning to give away 99% of his money to charity when he passes.

Chapter 1.1

  • 1930 — Buffett was born in 1930 in Omaha, Nebraska.
  • The Great Depression had a big impact on Buffett’s family and inspired him to become great at managing money.
  • City Service Preferred was Buffett’s first stock purchase at age 11.
    • He ended up selling it too early and didn’t maximize his gain. This was the start of him learning about patience in the stock market.
  • 1950 — Graduated from the University of Nebraska at age 19.
  • The Intelligent Investor by Benjamin Graham had a huge influence on Buffett.
    • This book is all about value investing and how to measure the intrinsic value of companies.
    • Buffet later took Graham‘s class at Columbia University.
    • Buffett later worked for Graham briefly at his firm.

Chapter 1.2

  • Buffet Partnership Limited — An investing company that Buffet started.
    • Started with seven members and started with $105,000 of initial capital.
    • The firm was beating the Dow Jones average by a lot.
    • The company invested $13 million into American Express when AE was down big-time. 
      • American Express was very undervalued at the time.
    • Buffett later invested in Berkshire Hathaway and controlled the company by 1965.
    • 1969 — Buffett ended Buffett Partnership Limited to focus on Berkshire Hathaway. 

Chapter 1.3

  • Berkshire Hathaway — Formed as merger between a cotton and textile mill company in 1955.
    • The company struggled a lot in the decades following the merger.
    • 1985 — Buffett closed the textile part of the company.

Chapter 1.4

  • 1967 — Berkshire purchased two insurance companies. This was the start of the company’s big success.
    • Berkshire later bought Geico out at a really nice price.

Chapter 1.5

  • Today, Berkshire Hathaway is divided into three business components:
    1. Insurance Operations
    2. Regulated Capital Businesses
    3. Manufacturing, Retail, Service Operations
      • Includes anything from lollipops to jets.

Chapter 2

  • Benjamin Graham, Philip Fisher, Charlie Munger… these were Buffett‘s greatest teachers.

Chapter 2.1

  • Benjamin Graham — Considered the godfather of security analysis and value investing.
    • Taught Buffett and worked with him for a while.
    • Graham’s emphasis was on safety and avoiding speculation.
    • Graham created the idea of the “Margin of Safety.”
    • Graham was one of the first to emphasize buying stocks when the market is down and selling stocks when the market is on a high.

Chapter 2.2

  • Philip Fisher — Started an investment counseling firm in the 1930s after the Great Depression.
    • Fisher believed that superior returns could be had by:
      1. Investing in companies with above average potential
      2. Investing in companies with great management
    • Fisher’s emphasis was on buying companies that had sales and profits growing at rates greater than the industry average.
    • High profit margins and low debt were two things Fischer looked at very closely.

Chapter 2.3

  • Charlie Munger — Buffett’s main partner at Berkshire Hathaway.
    • Buffet and Munger have very similar approaches to investing.

Chapter 2.4

  • Buffet eventually realized he had to make some modifications to Graham’s strict value investing strategy.
  • Quote: “Time is the friend of the wonderful business and the enemy of the mediocre.” — Warren Buffett
    • Same with personal habits and disciplines. When you’re performing great daily habits and disciplines, time is to your benefit. You will grow over time. When you have bad habits, time is not on your side; eventually you will run into problems. 
  • Greed and optimism typically drive the market up. Fear and panic drive it down.
  • Buffet’s philosophy is kind of a blend of Graham and Fisher‘s approaches.
    • Graham — Focus on buying cheap stocks and finding intrinsic value by looking at financial statements.
    • Fisher — Focus on studying the actual business and its quality of management. Focus on buying stocks at fair, not necessarily cheap, prices. Focus on companies that are steadily and consistently growing.

Chapter 3

  • Buffet looks for companies he understands with favorable long-term prospects that are operated by good people and are available at good and fair prices.
  • There are 12 tenets that make up Buffett’s approach to buying a stock or company. These are grouped in four areas:
    1. Business Tenets
    2. Management Tenets
    3. Financial Tenets
    4. Market Tenets

Chapter 3.1

  • Business Tenets — Buffett makes decisions on how a business operates and its financial fundamentals. He tries to learn all he can about the business. He looks at three things here:
    1. The business must be simple and understandable
    2. The business must have consistent operating history
    3. The business must have favorable long-term prospects
  • Buffet does not buy companies that are constantly changing directions or products.
    • He instead buys companies that have produced the same products successfully year after year
      • Ex. Coca-Cola
  • Look for companies that have a durable competitive advantage.
    • Don’t go for commodities like computers, cars, airline service, banking. Commodities can’t differentiate their products from competitors.
      • This means they can only compete by lowering price.

Chapter 3.2

  • Management Tenets — Look for good, quality, trustworthy managers. There are three things to look for here:
    1. Is management rational?
    2. Is management candid with shareholders?
    3. Does management resist the institutional imperative?
  • Look for a management team that acts like shareholder and are always trying to increase shareholders’ wealth. 
    • Specifically, look for what managers do with additional money. Returning money to investors is what companies should do.
      1. Dividend raising
      2. Share buybacks

Chapter 3.3

  • Financial Tenets — Looking at the financial statements of a company.
    • Don’t take one-year numbers too seriously. Look at the last 5-10 years. You’re looking for trends. Things to look for here:
      1. Focus on Return on Equity over Earnings Per Share (EPS)
      2. Calculate owner earnings
      3. Look for companies with high profit margins
      4. For every dollar retained, make sure the company has created one dollar of market value
  • Good companies will use very low or no debt.
  • Gross profit margin is also key. Companies should try to keep costs as low as possible. This helps the gross profit margin. 

Chapter 3.4

  • Market Tenets — Price and value are different.
    • Price = Market Price
    • Value = What you think the price should be after studying the company
      • If the market price is below the per share value that you assign, buy.
  • Determining Value — Buffet looks at net cash flow expected over the life of the business discounted at an appropriate interest rate.

Chapter 3.5

  • You need to know a company‘s products and services, fundamentals, and management if you’re going to buy stock. 

Chapter 5

  • Focus Investing — Choose a couple of stocks likely to produce above average returns over the long-haul and concentrate the bulk of your investments in those stocks. Stick with them.
  • Buffet suggest focusing your investments on 5-10 stocks. 
    • You don’t want be too diversified because it’s hard to keep an eye on all of the companies and follow their story. 
    • You’re also more likely to buy something that’s not good when you invest in a lot of companies.
  • Your best companies should get the majority of your portfolio money because they have a higher probability of turning in good and steady returns.

Chapter 5.2

  • Steps to determining whether a stock should be bought:
    • Determine the long-term economics of each business
    • Assess the quality of people running the business
    • Buy at a fair price
  • Study the annual reports and financial statements of the companies you own stock in. Quarterly calls are also a great resource.

Chapter 6

  • Fear and greed are big contributors to a stock’s movement.
    • It’s important to act rationally and not get caught up in these emotions.
    • Social proof causes people to follow market trends. Try not to follow the herd.
      • Ex. Coronavirus — People get scared and sell their stocks. The market falls. Everybody sees this and also sells, driving the market every further down. 

Chapter 7

  • Since 1970, people are holding their stocks for less time than ever.
  • Studies have shown that the greatest returns come after at least three years. 
    • Most people do not hold for that long.
  • Try to find the company’s intrinsic value before investing.
  • Be patient. Hold your stocks for the long haul. Don’t lose your nerve when prices go down. 

Chapter 8

  • From 1965-1969, Buffett earned an average return of 29.5% for his partnership. 
    • This was 22% better than the Dow Jones Index.
  • Berkshire Hathaway has outperformed the Dow and S&P 500 by a lot since 1965.
  • Efficient Market Theory — Claims that the stock price reflects the company’s value because all available news is already “priced in.” 
    • There is therefore no need to do research. 
      • This theory is incorrect. 
  • Buffet handles the capital allocation of Berkshire Hathaway as well as the investing.
  • Berkshire is decentralized, meaning its 80 or so subsidiaries and companies are managed and run by talented managers.
  • Retained Earnings — What is left over after net income has been calculated and any portion of it has been distributed to shareholders.
    • This is an accumulating number that increases every year. 
  • The “margin of safety” between market price and you’re determined intrinsic value of the company protects you against possible declines in market price. It’s a buffer.