Buffettology
Mary Buffett and David Clark
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After being married into the Buffett family for more than 10 years, her divorce in 1993 permitted her the freedom to speak about Warren Buffett's investment methods that a family member is not permitted.  Buffettology is a primer for investing using Warren Buffett's ideas.  As such it is not very sophisticated, but it does communicate its points rather strongly.

The book first begins by observing that price, a theme to be repeated later, is ultimately what determines the rate of return.  The company will grow however fast it grows, but the cheaper it was purchased, the greater the increase for the investor.  The next point is that Warren Buffet considers that the company's earnings are his (in proportion to his share of ownership).  Thus the company can either give it back to him as a dividend, or invest it for him in the company.  Addressed third is the book's foundation for evaluating the value of a business--its present value, that is, amount necessary to invest today (at a particular rate of return) in order to end up with a certain amount at a set point in the future.

With fundamental ideas address, Mary Buffett begins explaining Warren Buffett's methods.  The key concept is the ownership of businesses with excellent economics, generally companies with effective monopolies, two varieties of which are described.   The first, referred to in the book as "consumer monopolies", are products that have a such a strong brand that consumers are more sensitive to the brand than the price.  Grocery stores pretty much must carry Coca-Cola because of buyer loyalty, giving Coca-Cola a high degree of flexibilty in the price.  The second, "toll-road" companies, control goods that can only be accessed through them.  Cable companies and newspapers that have no competition in a particular region are the examples cited.  Mary Buffett argues that Warren Buffett limits himself to effective monopolies because, empirically, those are the only companies whose earnings can be predicted with a high degree of certainty.  Without certainty the present value calculation is not very useful and thus the business cannot be reliably valued. 

After spending several chapters describing the characteristics of excellent and mediocre businesses, and some methods of finding the former, Mary Buffett describes Warren Buffett's buy timing.  Warren Buffett strongly believes in buying at a good price and will refuse to purchase the excellent companies he has identified until the price is low enough to offer him a good return, which Mary Buffett claims to be a 15% or greater return.  Unlike baseball, you can't get a strike in investing until you swing.  So don't swing until you know that you have a great pitch.

The final principle is when to sell.  Classic Grahamian value investing (Buffett's early strategy) sells as soon as the stock exceeds the value of the company.  Unfortunately, this produces taxes, which lowers the rate of return.  Therefore, if the company still has excellent economics, there is no point to selling, regardless of how the market is currently valuing the company.

Finally, Buffettology discusses some miscellaneous issues (like how share repurchases tends to increase share value by more than the value of the shares purchased) and gives case studies of several companies that Warren Buffett had invested in.  These are straightforward applications of the principles discussed earlier.

Buffettology is a worthwhile book for the beginning investor.  However, it falls short on several accounts.  First, it fails to live up to the claim of its subtitle, "The previously unexplained techniques that have made WARREN BUFFETT the world's most famous investor" (emphasis as taken from the front cover).  The only principle that is not discussed in other value investment books is the effective monopoly, and even this has strong premonitions in Fischer's book and is alluded to frequently in Warren Buffett's Berkshire Hathaway letters, although not nearly as clearly in either case.  Second, while the book makes a good deal of use of the present value calculation, nowhere did they bother to mention that this may be calculated as
present value = future value / ((1 + r) ^ nYears)
and instead direct the reader to press the present value on their calculator.  What happens if you don't happen to have a calculator?  And is the accessibility of the book to "people on the run" going to be reduced by introducing division and exponents, normally taught in elementary school?  Then there is the fact that the present value calculation is only run for an arbitrarily chosen 10 years.  Third, the book spends a fair amount of time convincing the reader that a few percentage points makes a large difference in money over many years.  A valuable point to make, but not three or four times, and not by comparing a thirty year investment at Warren Buffet's unparalleled returns (which the reader is unlikely to get) to a thirty year investment at normal returns (which the read is likely to get) and saying "wow, it's millions of dollars larger".  True statement, but one very, very few people in the world are going to experience.

While the Warren Buffet almost surely uses the principles described in the book, it is questionable whether he does so in the fashions described and for the reasons given.  Unbounded exponential growth is impossible, which makes the present value calculation somewhat unhelpful--when do you stop extrapolating earnings?  It seems likely that Warren Buffett uses a measurement technique whose value does not change depending on the number of years used in the calculation.  There also seems to be the assertion that Buffet likes effective monopolies because the earnings are accurately predicted.  This is quite a bit of wishful thinking:  the example company, Coca-Cola, fell into some earnings problems in and after the Internet Bubble, and the number of excellent companies where a change in management has produced a devaluing is legion.  How do you predict a change in management in your ten year calculations?  It seems more reasonable that Buffet likes effective monopolies because, as the book does point out, he discovered that his investments in mediocre companies often did not rise to their intrinsic value.  Most probably he realizes that it is only effective monopolies that can achieve the maximum return on investment.

In short, Buffettology is clearly a best-seller.  Its easy to read style, its target audience of "people on the run", its clear points, and even the empasis of the name "Warren Buffet" on the cover (as quoted above) all point to this.  Unfortunately it shares all the deficts of a best-seller:  lack of depth, oversimplification, and examples using companies unmarred by imperfections in the time periods used.  Despite that, beginning investors would do well to read it and will enjoy the process.

Review:  8.5

Clearly written and with clearly labelled concepts that even a busy person will have little trouble finding or remembering.  Gives a good background on how Warren Buffett's current thinking evolved but unfortunately abandons the implications in favor of business-school present-value.  Content is good.  However, the book is definitely not an instructive text of any depth and will be obsolete as soon as one is written.

Notes

Copyright © 2004 by Geoffrey Prewett