Monday, September 27, 2010

Investing in Equities -part 1

In this session, I would like to share with you the basic strategies that Warren Buffet has followed over the past five decades.
Warren started out early in life - as a school kid, he made money selling lemonades and having a news paper route. At the age of 14, with his earnings, he bought 40 acres of land and rented it out. In college, he studied Value investing under Benjamin Graham –the father of value investing. Value investing denotes an approach where investors pick up stocks at rock bottom prices.  He went into stock broking after college and by the age of thirty, he was a millionaire. He started Buffet associates in 1962 - over time bought a dying textile mill called Berkshire Hathaway. Using the cash generated from the mill, he slowly invested in other companies – overtime these investments overshadowed the textile operation and in 1985, he shut down the textile business altogether. His investments have given a CAGR of 20% plus between 1964 and 2009 and today, he is the third richest person in the 2010 Forbes list with a net worth of USD 47 Billion.
The basic investment philosophy of Warren can be described in the following Buffet quotes:
·         Rule No.1: Never lose money.   Rule No.2: Never forget rule No.1.

·         You don't need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.

·         All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies.

·         If a business does well, the stock eventually follows.

·         The best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.

·         Time is the friend of the wonderful company, the enemy of the mediocre.

·         Never invest in a business you cannot understand.

·         Risk comes from not knowing what you're doing.

·         Wide diversification is only required when investors do not understand what they are doing.

·         Diversification may preserve wealth, but concentration builds wealth.

·         What we learn from history is that people don't learn from history.

Warren believes that any equity investor should view the company in the same way as any business person buying up the whole company –focussing on its cash generating potential in the future   – overtime the company that has a superior cash generating potential would give a good value appreciation of the stock.
Warren identifies excellent businesses and then sets out to acquire the shares of the business if the price is right.  Once invested, he holds the investment for long term until the business loses its attractiveness or until a more attractive alternative investment becomes available.
In this session, I describe 14 questions that one must ask before investing in any company. I also take an example of CRISIL to explain these questions – at the end of these 14 questions, we will arrive at two ways of projecting the stock price of CRISIL in 2020 – and this would then give us the 10 year CAGR if you invested in CRISIL today – I also share results of the same calculation on CRISIL done in 2003 and see what the results looked like today.
For details of these 14 questions, you will need to wait for a few more days. Patience is one of the halmark of good investors :-)