ShareThisWarren Buffett's investing prowess has spawned countless imitators hoping to strike it rich by following the Oracle of Omaha's techniques.
But few are as disciplined as Pavel Begun.
"I've read pretty much every book about Buffett that's out there," says the partner at 3G Capital Management in Toronto. He's also dissected virtually all of Buffett's deals, read through every one of his letters to Berkshire Hathaway shareholders, and put the principles into practice at his own fund.
Berkshire's most recent blockbuster move was the purchase of the Burlington Northern Santa Fe Railway.
So how does Buffett do it?
Begun distilled the billionaire's investing strategy into a few simplified steps.
1. Buy businesses with a sustainable competitive advantage
Buffett is interested in companies whose earnings will grow, and at fairly predictable rates, which is why he favors businesses with a large competitive "moat."
Examples include Coca-Cola Co., whose strong brand name gives it an edge, and Geico insurance, which keeps costs low by selling directly to consumers instead of using agents.
2. Don't buy businesses you don't understand
Buffett didn't get swept up in the tech mania of the late 1990s, and spared his shareholders a lot of pain when the sector collapsed. If you can't understand a business, you can't predict how its earnings will perform.
"He doesn't want to buy something where he doesn't know how the business is going to shake out in 10 to 20 years," Begun says.
3. Look for consistently high return on equity
ROE is a company's annual profit divided by its book value, or assets minus liabilities. In her 1997 book, "Buffettology," Mary Buffett, Buffett's former daughter-in-law, said he demands an ROE of 15 per cent or more -- well above the average of 12 percent for U.S. companies.
4. Beware of debt
Buffett shuns companies carrying a lot of debt, and not just because it restricts their options. A large amount of borrowed money can artificially boost return on equity, and also signals that the business may not be throwing off enough cash internally to grow.
On the other hand, companies with a strong "consumer monopoly" -- that is, they sell a product or service with strong repeat business and brand loyalty -- usually generate so much cash that they don't need to borrow.
5. Avoid commodity businesses
The flipside of a company with a wide competitive "moat" is one that sells a product that's available from countless other sources, the only differentiating factor being price.
6. Look for increasing profit margins
A high profit margin is good. One that's high -- and rising -- is even better. A simple way to calculate profit margin is to divide net income by revenue.
"A high profit margin indicates the company is executing its business well, but increasing margins means management has been extremely efficient and successful at controlling expenses," Investopedia.com says.
7. Think like an owner
Many investors believe the secret to making money is to buy a stock that's shooting up, then sell for a quick profit. Not Buffett. He wants to buy a part-ownership in a business, and considers the company's earnings as his reward.
If you adopt Buffett's philosophy, "you will find yourself waiting for the market to go down instead of up, so that you can buy partial interests in publicly traded companies that you have been wanting to own," Mary Buffett wrote.
If earnings rise, the stock will eventually follow.
8. Buy at a discount
Many of Buffett's greatest investments -- Geico among them -- were made when the company was experiencing a temporary setback that drove the stock down. As he once observed: "A great investment opportunity occurs when a marvelous business encounters a one-time huge, but solvable, problem."
One measure he looks at is the earnings yield -- the per-share profit divided by the share price. This measure -- the reciprocal of the price-to-earnings multiple -- should be well above the yield on long-term government bonds.
Another of his favorite measures is the free cash flow yield, which is the amount of cash per share the business is throwing off as a percentage of the share price. "He normally buys things right around a free cash flow yield of about 10 per cent," Begun says
9. Focus on the long-term
Buffett summarized this principle in his 1996 letter to Berkshire shareholders:
"Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, 10 and 20 years from now ..."
"You must also resist the temptation to stray from your guidelines: If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes."
(Distributed by Scripps Howard News Service, www.scrippsnews.com.)
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