Warren Buffett through the Berkshire Hathaway Group has been consistently one of the best investors in the stock market for many years. With success comes opportunity to learn from him and duplicate the success for you. In the stock market there are multiple methods to come to decision to buy and sell stock and when you find the correct formula for you then it likely will be a combination of more than one investor. A number of years ago, Mary Buffett wrote a book called Buffettology published by Rawson Associates, NY, 1997 in which she outlines the process or techniques which Mr. Buffett uses.

6. Determining What Kind of Business You Want to Earn

What are the characteristics of the businesses that you would want to own? Everyone has a different idea and that is what makes the economy, this is good. If you go into a store for a bargain, is everything on sale or is  a bargain to you? Hopefully you said no, maybe many things but not everything. The next decision is when do you sell? How do you know you bought a company that will not work on for you, even though the price is good for? Warren’s answer is the theory of an expanding intrinsic value. The theory is over the long term, if a company has an expanding value – higher earnings every year, profitable, can reinvest in the company, the price of the stock will go higher and you will get the return you are expecting. Time is the friend of a great business and a curse to the mediocre. A mediocre business rarely will be anything besides a mediocre business. A great business only gets better over time.

7. How to determine what is mediocre and what is a great business.

In Warren’s investing, there are two types of businesses – commodity type or consumer monopoly. A commodity business is a business where price is the single most important motivation factor for the consumer’s buy decision. In a commodity type business, the low cost provider win. The lower the costs to produce, the higher the profit margins, but profit margins will fall when someone can produce for less.

Identifying a Commodity type business

low profit margins – competition will mean prices are set lower.

low returns on equity – in 1997 the average return of equity was 12%, if it is less, then it is a

absence of any brand name loyalty

presence of multiple producers

existence of substantial excess production capacity in the industry  – think base metals

erratic profits

profitability almost entirely dependent upon management’s abilities to efficiently utilize tangible assets

8. How to Identify the Excellent Business

1. Does the business have an identifiable consumer monopoly?
2. Are the earnings of the company strong and showing an upward trend?
3. Is the company conservatively financed?
4. Does the business consistently earn a high rate of return on shareholders’ equity?
5. Does the business get to retain its earnings?
6. How much does the business have to spend on maintaining current operations?
7. Is the company free to reinvest retained earnings in new business opportunities, expansion of operations, or share repurchases?
8. Is the company fee to adjust prices to inflation
9. Will the value added by retained earnings increase the market value of the company?

Linking to dividend paying stocks, one of the keys to excellent businesses is the moat and the ability to raise prices for inflation. The classic example is electric utilities and the regulatory body, 99% of the time they allow for increases. After identifying the industry the challenge is to pick the best alternative in the industry.

There are more questions than answers, till the next time – to raising questions.