The Previously Unexplained Techniques That Have Made Warren Buffett The Worlds Most Famous Investor
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David Clark and Mary Buffett
Notes
His preference is to acquire 100% ownership of an enterprise that has excellent business economics and management. When he is unable to do that, his next choice is to make a long-term minority investment in the common stock of a company that also has excellent business economics and management.
Warren will make long-term investments only in businesses whose future earnings are predictable to a high degree of certainty…strength and predictability of earnings are an important consideration.
…his real trick is getting a high annual compounding rate of return that is not subject to personal income taxes.
A survey of a company’s per share earnings for the last seven to ten years will usually show any boom-or-bust patterns, which are endemic to the commodity-type business.
Companies that benefit from consumer monopolies, because of their large cash flows, are often nearly debt free…When looking for an excellent business, look for companies that possess a consumer monopoly and are conservatively financed. If the company with a consumer monopoly is using large amounts of long-term debt, it should be only to acquire another company with a consumer monopoly.
What Warren wants is a business that seldom requires replacement of plant and equipment and doesn’t require ongoing expensive research and development.
There are three types of toll bridge businesses that produce excellent results:
- Businesses that make products that wear out fast or are used up quickly, that have brandname appeal, and that merchants have to carry to stay in business.
- Communications businesses that provide a repetitive service manufacturers must use to persuade the public to buy their products.
- Businesses that provide repetitive consumer services that people and business are consistently in need of.
What he is interested in is what the company will be earning in ten years. While Wall Street is focusing on next year, Warren realizes that to let compounding work its wonders he has to focus on predicting the future. That is why companies that have consumer monopolies and are earning high rates of return on shareholder equity are so very important to him.
As a rule, a portion of the profit must be used to replenish capital equipment of the core business that produced the profit. Warren considers these earnings to be restricted earnings.