The author of this book is Robert G. Hagstrom. He is a fan of Warren Buffett and has been studying the great investor for some time. This book is written with the aim to provide lessons that help to improve the readers’ investment results. The target audience is US readers, thus there are some issues that may be irelevant in Malaysia such as the capital gain tax.
Layout of The Warren Buffett Way
This book is the third edition and has eight chapters with three forewords (each for a different edition from different people), an introduction and a preface.
Chapter 1 and 2 are about the growth and development of Warren Buffett.
Chapter 3 talks about the 12 investment tenets while chapter 4 gives us some case studies.
Chapter 5 is about focus investing.
Chapter 6 and 7 discuss the role of psychology in investment.
The final chapter tells us Buffett’s personal life and the author gives his final advice here too.
Highlights
There are 12 investment tenets mentioned in the book and they are divided into four categories, namely business, management, financial and market. In this review, I will share the financial and market tenets. There are four principles in the financial tenets and these are: 1) Focus on return on equity, not earnings per share, 2) Calculate “owner earnings” to get a true reflection of value, 3) Look for companies with high profit margin, and 4) For every dollar retained, make sure the company has created at least one dollar of market value. Market tenets have only two factors: 1) What is the value of the business? and 2) Can the business be purchased at a significant discount to its value? By applying the tenets, it is possible to buy a great business at a significant discount.
The author also provides the formula to estimate the value of a stock. The formula is owner earnings divided by the risk-free rate. The owner’s earnings is net income plus depreciation and amortization minus capital expenditures. We can use the future owner earnings (based on our estimation) too. The risk-free rate that Buffett uses is the long-term US government bond but we can use our preferred rate of return as a substitute. Nonetheless, if we use a higher rate, there will be a larger margin of safety in the valuation.
Normally, when we talk about risk in investment, it is related to the price volatility. Nonetheless, in Buffett’s mind, risk has nothing to do with price volatility but whether the stock will produce a profit. Thus, it is important to only invest in high quality companies. As for diversification, Buffett believes that wide diversification is required for investors who do not know what they are doing. Thus, he practises focus investing where he only invests in a handful of stocks. Nonetheless, mistakes are unavoidable and the author advises us to sell the losers so that we can deploy the capital to better candidates.
Rationality and patience are important in achieving investment success. The abilities to see past the present and analyse several possible scenarios and wait patiently for the stock price to catch up with its intrinsic value are not so common among investors. Lastly, investment success comes from doing more things right than wrong, so do not be afraid to make mistakes but make sure to learn from the missteps.
Conclusion
I learned a lot from this book. This book makes me rethink my investing strategy. I am guilty of taking action even though there is no great opportunity. Thus, I have to be more patient now and wait for the right time to strike. I believe this is a great book for value investors. If you are interested in Warren Buffett’s way of investing, The Warren Buffett Way is the book that you should read.
As usual, before I end, I will share some quotes from the book.
“Both active and index funds do offer diversification, but, in general, neither strategy will give you exceptional returns.”
“It appears to me that the most sensible way to approach horse racing, or the stock market, is to wait until the good horse comes to the post with inviting odds.”
“Given enough time, the price of a business will align with the company’s economics.”
“In the short run, investor sentiment – human emotion – has a more pronounced impact on stock prices than a company’s fundamentals.”
“One thing we can say with certainty is that knowledge works to increase our investment return and reduces overall risk. I believe we can also make the case that knowledge is what defines the difference between investment and speculation.”
Recommended book
If you are interested in The Warren Buffett Way, you may get the book from Kinokuniya Malaysia through the link below*.
*Disclosure: The above link is Involve Asia affiliate link. Thus, I may earn a small commission when you purchase the book through this link.
