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  Warren Buffet’s Style of Management

Abstract

Warren Buffet is considered as the most successful investor of the current era. At present, hi net worth is estimated to be around 50 million dollars. He began his investment career by investing $10,000 in the Berkshire Hathaway during the mid of the 1960s and gradually succeeded in becoming the second richest man in the world. His popularity as a smart and most successful investor has reached to its peak during the past several years. His views and opinions are considered so important that an incredible number of stockholders gather in his annual stockholder meeting. During this meeting the various business issues and company policies of Berkshire Hathaway are discussed. The company has an impressive record of maintaining an extremely stable financial position and therefore its stocks have remained stable in the market (Buffet, David, 2001). Buffet’s career is marked with his successes and smart decisions for buying and holding stocks.

Personal Influences and Difficulties

Born in 1930, Buffet belongs to the town of Omaha. His father, Howard Buffet, was also an investor and a congressman. Warren has been quite interested in numbers since his childhood, which was evident from his impressive memorizing abilities. He used to amaze his peers by memorizing the population of different cities in the United States. Being interested in stock brokerage business, he began to participate in his father’s business affairs in his brokerage house at a very early age. He bought his first stock at the age of 11. He bought the preferred stock of Cities Service and sold them in a later period at a higher price. However, he missed an instant boost of these stocks. His first investment decision taught him the lesson to be patient in the business. He started to act as a true entrepreneur from a very young age (Buffet, Benjamin, 1985). However, his actual professional development as an investor began during his studies at the University of Nebraska. During his tenure at the university, he had the opportunity to read several articles, journals and books on the issue of investment decisions. He was really impressed with the work of Benjamin Graham, “The Intelligent Investor”, which exposed him to a new strategy of investment. This work of Graham has been considered as a bible of value investors and is popular among investors. Graham advises the investors to overlook the stock market trends and urges them to search for those stocks which are traded at a considerably lower price than their actual value. However, Warren soon discovered that it was not that easy to identify such stocks as identifying these companies a close watch of the market, patience and a skillful analysis of the balance sheets. This challenging aspect of this business created further interest for Buffet, as he was excellent in terms of his mathematical skills.

Warren Buffet’s Style

For years, Buffet has adopted the strategy of “Buy and Hold”. This strategy of investing and then holding up the stocks for a long time is a notion, which has been traditionally discouraged by the Wall Street experts. Analysts believe that Buffet’s strategy in fact has been to “Buy and Watch”. He keeps the stocks until and unless there is a business potential and then sells it out as soon as it looses its worth (Buffet, Lawrence, 2001). In response to this argument, Buffet comments that although he has sold stocks at some instances but he do not purchases businesses with the intention of selling them out. He claims that despite of the fact that he has sold several stocks in the last several years, he has never purchased a stock with an idea of reselling it. (Lowenstein, 1996) The objective behind a stock purchase is to hold it back and to profit from the business’s growth. At present, the company owns a number of investment instruments including stocks, equity bonds and arbitrage despite of the fact that some of these instruments do not tend to yield a permanent return on investments. He considers these instruments as one of the many means to increase wealth in the short term. However, with a long-term perspective, he believes that he should invest in those businesses, which present a healthy picture of the organization in terms of its overall management practices and business potential (Buffet, David, 2002). He comments that he purchases only those businesses about which he is sure enough that it is going to yield rewards in the long run. Once a business is purchased, it is intended to be kept in forever. He wants the same sort of commitment from his Berkshire stockholders that they should keep the company’s stocks forever. Those investors, who once make an investment with Buffet, usually prefer to remain stuck with him because of the huge business potential they have by doing business with him. For instance, the majority of the investors who financed Buffet in the beginning are still with him apart from the famous wife and husband who left their 750 million dollar wealth to the charities. There are a number of investors who currently have their wealth in millions. Majority of these investors had started their investments in terms of thousands of dollars. (Vick, 2003)            

Warren Buffets strategy is to pick stocks whose   fundamentals, based on these criteria, are good. And rather than set a price level, he advocates holding onto a stock so long as the business continues to look good. Buffet evaluates businesses as if he was buying the whole thing - after all in buying a share you are effectively buying into the business. He's looking for a business he can understand, with favorable long-term prospects, managed by honorable, competent people, and available at an attractive price. His strategy mixes analysis with subjectivity, hard-nosed numbers with an assessment of the business's markets, prospects and management.

The 'good numbers' revolve around calculating what Buffet terms "owner earnings” (a somewhat detailed calculation arrived at by adding depreciation, amortization and other non-

cash charges to the reported earnings and then deducting the average annual amount of capitalized expenditure for plant, equipment etc required to maintain the business's long term competitive position and production volumes) and then applying a growth rate to arrive at an estimate of future cash flows. These cash flows are then discounted back to arrive at a measure of the current value of the business. The result is used to determine whether or not the current price of a stock is "attractive". Buffet also took great stock of the ‘return on equity capital employed’, being somewhat wary of returns built on excessive borrowings.

Although, the recent decline in economy because of the events of September 11 has affected Buffets investment plans and have brought him losses in some of his investment ventures, he is still positive about the long term and have some smart plans to meet the challenges of weakening markets of corporate America, threat of terrorism at domestic level and slowdown in the economy. (Buffet, Clark, 1999)  

In his recent announcement, Buffet has declared that he will still keep the stocks of companies like Coca Cola, The Washington Post and Gillette, despite of the fact that they have these stocks have recently experienced a decline. He believes that the long-term profitability of these companies is expected to be higher as compared to the newly emerging high technology companies. In addition to this, he believes that the growth potential in these industries is easier to define and their market growth rate is stable, which is not the case for high technology companies where growth is uncertain and unstable. His primary objective in fact is to invest in stocks where income potential is certain and risk of failure is minimal. Despite of his high level of confidence on his analytical abilities and excellent judgment for the stock markets, he is unwilling to invest in high technology companies, even not in stable and highly successful companies like IBM and Microsoft. As far as the issue of investing in the startups and Internet firms is concerned, he totally refuses to show any interest in such ventures. He believes that these companies do not have a long-term growth strategy and that he is unable to forecast their income potential in the long term. His overemphasis on the long term issues are viewed with suspicion as in the current business climate, stocks are held for only days or even hours. In case of any other organization, such strategic posture might not be acceptable to the company executives but Buffet’s reputation of outpacing the Dow Jones’s average for years brings him in a stronger position to argue on his point. (Buffet, Clark, 2000)

Buffet’s investment decisions to buy and keep stocks of companies like Coca Cola, Gillette, The Washington Post and Dairy Queen are usually viewed with suspicion. However, these investment moves can be helpful in gaining a deeper understanding of Buffet’s investment strategies. The first lesson that one can learn from these investment initiatives is that Buffet only invests in those business ventures, which he clearly understands and can certainly forecast their future growth. He conducts extensive research on his potential business ventures before giving them a serious consideration. In fact, if Berkshire’s business strategies would be closely monitored, it will be found that a reasonably knowledgeable investor can easily understand the motivation behind the investments and the growth potentials of businesses in which investment is made. Buffet’s primary focus is not only on the financials of the organization under consideration but also on its business practices, its attitude towards the customers, its current market standing, its competitive edge over other players in the market and its potential to expand its business in the years to come. These are issues which an investment can easily consider and evaluate an organization’s future growth potential on the basis of these aspects. It is also interesting to note that although Buffet has been continuously focusing on the domestic market, he has intentions to enter the international business arena in the years to come. At present, he thinks that he do not have enough exposure to the different international markets, which he might consider enough to make an investment move. However, he expects to receive a positive response from the international market and is willing to make investments in the foreign markets (Buffet, David, 1999). It should also be noted that not all investment decisions made by Buffet are in fact truly understood by him. There are some investment moves about which Buffet himself wonders as to how he has been able to benefit from it. For instance, during the recent economic recession, the housing sector has remained considerably strong, which was a surprising issue for the majority of the people. Buffet believes that his forecast about the housing sector a few years ago was totally different as compared to the current market situation. However, Buffet still have strong reasons to believe that the current growth in the housing sector is primarily due to a stable condition of other supporting industries such as paints and bricks. It should here be noted that the one of the biggest beneficiary from the boost of housing industry is the Berkshire Hathaway as it holds the second largest real estate holding company in the United States. Because of this boom, the company is expected to experience high growth in sales. (Buffet, Clark, 2001)  

Buffet argues that whenever he makes the decision to purchase the stock, the first issue of concern for him is that whether he will be satisfied enough to keep the stock for coming few years. If he feels that owing a particular stock is a good opportunity for business, he makes the decision for purchase of that particular business. The main issue of concern for him, in purchasing a particular stock is the potential of that particular business to grow in the years to come. He does not believe on betting on the price movements of the stock as he considers that this strategy is not going to payback in the long run. Although, Buffet’s investment strategies appear to be very hard to understand but still his investment moves sound to be pretty uncomplicated. Buffet’s own philosophy in this regard is that the investment decisions made by him are simple but are not very easy to make. He believes that a usual investor normally learns from experience. Every investment decision that he makes exposes him to some new level of understanding and enables him to judge the market moves in a more effective manner.

Buffet’s investment decisions to buy and keep stocks of companies like Coca Cola, Gillette, The Washington Post and Dairy Queen are usually viewed with suspicion. However, these investment moves can be helpful in gaining a deeper understanding of Buffet’s investment strategies. The first lesson that one can learn from these investment initiatives is that Buffet only invests in those business ventures, which he clearly understands and can certainly forecast their future growth. He conducts extensive research on his potential business ventures before giving them a serious consideration. In fact, if Berkshire’s business strategies would be closely monitored, it will be found that a reasonably knowledgeable investor can easily understand the motivation behind the investments and the growth potentials of businesses in which investment is made.

Conclusion

Despite of the recent decline in the economy, Buffet is still positive about some of his businesses. As he has investments in a wide range of businesses, he has different opinions about the prospects of different industries (Buffet, David, 2002). For instance, he believes that despite of a weak economy, the consumer products industry is expected to remain strong including several sectors like household appliances and furniture. However, he is hopeful about the long-term growth of the market. Despite of the fact that the market is currently going through a period of troubles, he is hopeful about the future market trends as the economic indicators in some cases are showing a quite positive picture.

 References

Buffet, Mary & David Clark (1999) Buffettology: The Previously Unexplained Techniques That Have Made Warren Buffett The Worlds: Fireside

Buffet, Mary & David Clark (2001) The Buffetology Workbook: Value Investing: The Warren Buffet Way: Fireside

Buffet, Mary & David Clark (2002) The New Buffettology: The Proven Techniques for Investing Successfully in Changing Markets That Have Made Warren Buffett the World's Most Famous Investor: Scribner

Buffet, Warren & Benjamin Graham (1985) The Intelligent Investor: Harper Collins

Buffet, Warren E. & Lawrence Cunningham (2001) The Essays of Warren Buffet: Lessons for Corporate America: The Cunningham Group

Lowenstein, Roger (1996) Buffett: The Making of an American Capitalist: Doubleday

Vick, Timothy P. (2003) How to Pick Stocks like Warren Buffet: Profiting from the Bargain Hunting Strategies of the World's Greatest Value Investor: McGraw Hill