Buffet Approach of Valuing Stock

In: Business and Management

Submitted By frank983
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The Buffett Approach to Valuing Stocks
Focusing on return on capital may be the key to investment success.
By Steven R. Ferraro, CFA, PhD
2009 Volume 12 Issue 3
Much has been written about famed U.S. investor and Berkshire Hathaway CEO Warren Buffett’s investment style and successes. Preeminent among these writings are the oft-cited Berkshire Hathaway shareholder letters, written by the “Oracle of Omaha” himself. These informative letters have been the basis for a multitude of books. But even with an abundance of available information on “how to invest like Warren Buffett,” it is apparent that something is lacking, how does Buffett determine an acceptable price for companies of interest? This article provides an example of the process Buffett is reported to go though to determine the intrinsic value of a publicly traded company.

Photo: Bogdan Radenkovic

Starting at the Beginning
Before we get our hands dirty with the valuation aspects of the investment decision, let us review a brief outline of the qualitative and quantitative aspects of Buffett’s decision process as observed by Robert G. Hagstrom.[1] This map helps us navigate the turbulent waters of Wall Street and is comprised of business, management, financial, and market tenets.
Investment Tenets
Business
• Is the business simple and understandable?
• Does the business have a consistent operating history?
• Does the business have favorable long-term prospects?
Management
• Is management rational?
• Is management candid with the shareholders?
• Does management resist the institutional imperative?
Financial
• What is the return on equity (ROE)? [Do not just focus on earnings per share (EPS).]
• How high are the firm’s profit margins?
• Does the firm create one dollar in market value for every dollar retained?
Market
• What is the value of the business?
• Can the…...

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