Margaret Baldock, the Co-founder of Conscious Investing
wrote an article for the Australian Women's Money magazine.
Below is a transcript of the part of the article. (Autumn
2004, Page 66-7)
MARGARET BALDOCK looks at the philosophy behind
one of the world's best known investors.
Warren Buffett is undisputedly the world’s
greatest investor. He is the second richest man, behind
Bill Gates' with a personal wealth of US$30 billion
As Chairman and CEO of the diversified investment
company Berkshire Hathaway, Buffett's success in the sharemarket
Suppose someone invested
US $10,000 in one of Buffett's original investment
partnerships back in 1956, then today that person
would have seen a return of over US$280 million after
all taxes and expenses.
What is most fascinating
about Buffett's success is that he created his fortune
entirely through investing, and mostly through investing
in well known listed companies available to any investor.
He simply bought shares
in ordinary businesses, such as Gillette, Walt Disney
and Coca Cola.
Buffett didn't amass
his $30 billion fortune by "hitting the jackpot"
with one or two great picks or by trading in and out
of stocks seeking the maximum, short term returns.
SELECT AND SIT
Buffett selects outstanding companies that he can hold
year in, year out, thereby allowing his returns to compound
over time. Using this simple strategy, Buffett's wealth
has grown at an exponential pace. Isn't this what all
investors aspire to?
Despite Buffett's unmatched and undisputed
track record, almost no investment professionals attempt
to follow his approach. Most investment professionals focus
instead on the futile exercise of predicting general market
In fact, the average managed fund turns over
40 per cent of its entire portfolio each year trying to
emulate movements in the general market, incurring costly
taxes and commissions along the way. This is the key reason
why more than 80 per cent of fund managers consistently
fail to deliver even average returns (as measured by market
indices such as the S&P500 in the United States and
the All Ordinaries Index in Australia).
This obsession with the greatest short term
gains seriously erodes wealth over the long term.
Over a 47 year period, Buffett's investment
company, Berkshire Hathaway has achieved returns of 194,936
per cent versus the Wall Street market index (S&P500)
returns of 4,742 per cent.
There are just three key steps to investing
like Warren Buffett:
STEP 1 - Ignore the "sharemarket":
The first point in understanding Buffett’s investment
methods is to recognize that he does not think about the
After all, the wonderful world of shares really
has nothing to do with "shares". It has to do
with businesses. Every share is tied to a company an actual
enterprise run by managers, employing people and offering
products or services to customers.
"We look at individual businesses,"
Buffett says. "And we don't think of stocks as little
items that wiggle around in the paper. We think of them
as parts of businesses." Buffett's sole focus is on
businesses, not share symbols!
STEP 2 - Don't worry about
the economy: For Buffett, economic conditions are irrelevant.
Instead he seeks good businesses at fair value regardless
of economic conditions. In any case, if economists can't
reliably predict the economy, then what chance do you and
STEP 3 - Buy businesses,
not shares: Buffett is only interested in buying outstanding
or "great" companies, as determined by a set of
rational investment guidelines. These are companies that
have done well in the past and have all the hallmarks of
doing well in the future.
BUFFETT'S CRITERIA FOR SELECTING
"GREAT" COMPANIES ARE:
- Is the business simple and understandable?
Buffett doesn't invest in tech stocks as he says that he
doesn't understand them. Instead he focuses on businesses
within his "circle of competence" which includes
consumer goods, food, newspapers and insurance. Similarly
you should only invest in businesses that you can understand.
- Does it have a consistent operating history?
That is, are its sales and earnings growing consistently
over time? (In the following table we look at Sales Per
Share (SPS) and Earnings Per Share (EPS) to evaluate operating
- Does management have a successful track
record of delivering outstanding returns to shareholders?
If you think of equity as your money, then return on equity
is a measure of how well management is doing with your money.
It is virtually impossible for a medium to long term investment
to be satisfactory if the return on equity (ROE) is low.
Look for companies that have 15 per cent or more return
on equity and return on capital (ROC).
- Does the company have minimal or no debt?
If debt is too high, then the company is vulnerable to credit
squeezes and may have difficulty in raising money for expansion.
- Does the company have favorable long term
characteristics (or what we refer to as an "economic
moat")? An economic moat provides protection against
competitors. This could be geographical (eg Westfield),
patents (eg CSL), brand name (eg RM Williams), entry costs,
and so on.
The following table is a sample of five great
Australian companies that have many of the characteristics
described in steps 1 to 3, that is: high return on equity
and return on capital, low debt, and stable strongly growing
earnings and sales.
These are quality businesses that are potentially
great investments so long as they can be purchased at a
reasonable price. The price that you pay for a quality company
will ultimately determine how profitable your investment
The target price that you establish should
factor in a "margin of safety" that allows you
to protect your capital, in the event that the company's
future performance is not as strong as you would like. In
doing so, you also allow yourself to enjoy unlimited upside
potential on your investments. Buffett has often said that
he is willing to wait indefinitely to buy stock at the right
*Current Price as at 12th December 2003 #
Stock return is based upon buying the stock at the "Current
Price" and holding the stock for 5 years (note: a margin
of safety has been built into these calculations) A The
Target Price is the price that you would need to pay to
achieve your required return (or profitability, given a
reasonable margin of safety). Setting the target price allows
you to protect the downside of your investment while leaving
you with unlimited upside potential.
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