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The Conscious Investing Story

Inspired by the world’s greatest investor, Warren Buffett

Warren Buffett

The Conscious Investing story begins with reference to Warren Buffett, whose uncommonly rational approach to stock market investing, provided the original inspiration for the company’s development.

Warren Buffett’s success in the stock market is unmatched. He is the Chairman and CEO of Berkshire Hathaway, a diversified investment company valued at over US$140 billion. Before that Buffett ran private investment partnerships.

Suppose someone had the good sense to invest US$10,000 in one of Buffett’s original partnerships back in 1956 when they first started. And suppose that

when the partnerships terminated in 1969, this person reinvested the proceeds in Berkshire Hathaway. Today that person would be worth over US$280 million—after all taxes and expenses.

An Obsessive Crusade

For more than a decade, Professor John Price has had two goals. The first was to understand how Buffett invests. The second was to develop a system that allows any investor to implement these strategies successfully.

John Price was featured in The Australian's "True Confessions" column.
[Read the article].

John had developed a suite of computer tools for himself to implement Buffett’s methods in a systematic way. He tested them thoroughly with his own investing, through bull and bear markets alike. When John used the tools he found that every time the investment was successful. In contrast, when he used the standard methods, the results were mixed. The worst investments were when he hurriedly followed the advice of people who were acknowledged as “experts”, instead of relying upon his own research and findings.

Of course this process of trial and error itself is often an important part of the process of learning to invest successfully. Buffett has said about his investing before he read Benjamin Graham’s book The Intelligent Investor. “I went the whole gamut,” he explained. “I collected charts and I read all the technical stuff. I listened to tips. And then I picked up Graham’s The Intelligent Investor. That was like seeing the light.”

Later Buffett added, “Prior to that, I had been investing with my glands instead of my head.”

Conscious Investing is laser-focused on what was thought to be an impossible mission … making Warren Buffett's brilliant investing strategies available to ordinary, everyday investors.

Most significantly, however, Conscious Investor overcomes the main objection that most “DIY-Buffetteers” have which is in relation to calculating “what price to pay” for a stock.

Buffett’s Secrecy

One of the problems of trying to unpack Buffett’s methods was his secrecy.

Even though Buffett writes and speaks a great deal about his methods, it is always in general terms. He doesn’t reveal what stocks he is buying or selling unless it is required by SEC legislation. The reason for this is simple. He does not want to give any advantage to other investors. Each year he writes in the Annual Report of Berkshire Hathaway:

“Despite our policy of candor, we will discuss our activities in marketable securities only to the extent legally required. Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisitions are.”

Buffett is also secretive about his investment methods. He often says that he freely discusses them. When you start reading his reports and interviews, it looks like this is the case. (Berkshire Hathaway Annual General Report)

Everything would start well with Buffett giving brilliant descriptions of his general principles. But when you needed something that was detailed enough to apply to the evaluation of a specific company, you would find one of two things. Either there was insufficient information or the information led you in the wrong direction.

Let’s give you two examples: intrinsic value and return on equity.

In the essay An Owner’s Manual for Berkshire Hathaway, Buffett writes, “intrinsic value … is the only logical approach to evaluating the relative attractiveness of investments and businesses.” This is a good start and it gets better. He says that intrinsic value can be defined simply as “the discounted value of the cash that can be taken out of a business during its remaining life.” Now we are getting somewhere.

The next paragraph says that the calculation of intrinsic value is not so simple and different people will arrive at different figures. I can live with that. All I want to know is how W.B. does it. Unfortunately we don’t get this. Nor do we get any further indication of how it is done. He closes the paragraph by saying that “we never give you our estimates of intrinsic value [although] our annual reports do supply the facts that we ourselves use to calculate this value.” This tells us nothing. The annual reports of Berkshire Hathaway are in the same general form as the reports of any other company with the financial sections occupying many pages of dense financial information.

We are left with more questions than we started with. For example, just what is the “cash that can be taken out of a business?” For example, is it earnings, or cash flow, or cash earnings, or free cash flow, or owner earnings, or something else? And how do we estimate its size for future years.

Instead of stumbling around with all the different types of value models, we realized that these difficulties could be bypassed by providing techniques for estimating the actual return you will get with your investments. The idea was that it does not matter what the theoretical value of the stock is. What counts is that you can be confident that it will rise in price so that you can get the return you expect from it within your investment time frame.

This was reinforced by another quote from Buffett stating that he only invests when he is confident of making a return of at least 10 percent after tax. This is why Conscious Investor focuses on the method of calculating the expected return.

Continuing with the problem of insufficient detail, regarding the second example, return on equity, every book and commentator on Buffett’s methods says that he bases his analyses on this figure. We came to the same conclusion. But when we went to apply return on equity in practical situations, sometimes the analyses made sense and sometimes they did not.

So then we went back and re-read everything Buffett had written. Gradually clues began to emerge that he does not use return on equity … he uses return on capital! Suddenly all the pages of analyses and company studies made sense. It became clear in some cases return on equity is better to use, and in other cases return on capital is better. But that wherever possible look at return on capital.

Professor Price's painstaking research, conducted tirelessly over a full decade, has now produced a software system that allows the private and professional to select quality companies. Those rare few businesses with low debt, high return on equity and capital, products and services that stand out from their competitors and that have competent management with a long track record in their industry.


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