The New Buffettology

Submitted By: Amit Rohit
The New Buffettology Summary

Introduction - How Warren Buffett Turned $105,000 into $30 Billion
 Warren Buffett's “selective contrarian investment strategy” for makes
use of bear markets & down stocks, a strategy that has made him the
second-richest person on earth.
 This book to explain how Buffett became legendary for taking
advantage of bad situations & down markets & how he learned to
achieve unheard-of profits with almost zero risk of losing his capital.
 Warren is only interested in companies that have what he calls a
durable competitive advantage working in their favor.
 This book also answer the question of when and why Warren Buffett
sells a stock
 The foundation of this book is Warren's writings, lectures, interviews,
and conversations.
 Warren's investment methods are fairly simple to grasp, & are easy to
learn, but implementing them can be difficult when the rest of the
world seems to be selling when you are about to buy.2

Chapter 1 - The Answer to Why Warren Doesn't Play the Stock Market
& How Not Doing So Has Made Him America's Number One Investor
 A fool does not see the same tree that a wise man sees — William
Blake
 Warren Buffett got superrich not by playing the stock market but by
playing the people and institutions that play the stock market.
 Most people and financial institutions (like mutual funds) play the stock
market in search of quick profits.
 Warren is able to do this better than anyone else because he has
discovered two things:
 The first is that approximately 95% of the people & investment institutions
are "short-term motivated”. They buy on good news & sell on bad,
regardless of a company's long-term economics.
 Good news phenomenon (Overvalues Stock) – Quarterly increase in earnings or a
quickly rising stock price.
 Bad news phenomenon (Undervalues Stock) – Industry recession to missing a
quarterly earnings projection by a few cents. Momentum investing dictates if a stock
price is falling, the investor should sell. Warren thinks this is madness. On the
other hand, it's the kind of madness that creates the best opportunities.
 The second over time, it is the real long-term economic value of a
business that ultimately levels the playing field & properly values a
company.
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Chapter 2 - How Warren Makes Good Profits Out of Bad News about
Company
 Contrarian Investment Strategy – This strategy focuses on falling
stock prices & pays little mind to the underlying economics of
the companies.
 Selective Contrarian Investment Strategy – Investors buy
shares only when a company has a durable competitive
advantage & only when its stock price has been beaten down by
a shortsighted market.
 The Shortsightedness of the Mutual Fund: -
 Mutual fund managers are under great pressure to produce the highest
yearly results possible (Quick Earn) or people will invest in another
mutual fund that generate more short term results.
 Warren Buffet on Mr. Market: -
 You should be interested only in the price that Mr. Market is quoting
you, not in his thoughts on what the business is worth.
 Listening to his thinking either you will become overly enthusiastic
about the business & pay too much for it, or you become overly
pessimistic & miss taking advantage of Mr. Market's insanely low
selling price.
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Chapter 3 - How Warren Exploits the Market's Shortsightedness
 Warren separates the world of business into two categories: -
 Sickly companies with poor economics. These businesses are in price-competitive industries
that sell commodity type products or services & competes for customers solely on the
basis of price.
 Healthy companies has terrific business economics working in its favor also called companies
with durable competitive advantage. It typically sells a brand-name product or service
that holds a privileged position in market.
 If you want this particular product or service, you have to purchase it from one company
& no one else. This gives the company freedom to raise prices & produce higher earnings. It
faces little or no competition, creating a kind of monopoly. They have fewer ups & downs.
 You have to know what a price-competitive, "sick" commodity-type business looks like &
identify its characteristics or you may end up owning one.
 Warren Got One of His Best Investment Ideas from a Sports Technique Baseball Great
Ted Williams Used To Win Games
 After reading The Science of Hitting book written by baseball superhitter Ted Williams.
Warren carved up his investment strike zone to help him hit investment home runs.
 The way to hit investment home runs is to swing only at healthy companies & only when
they are being oversold by a pessimistic shortsighted stock market.
 Warren also realized that, unlike superhitter Williams, he could never be called out. He
could stand at the home plate all day & let mediocre business after mediocre business fly
by. Warren waits for the perfect pitch, a healthy, oversold company. Then, & only then,
5

Chapter 4 - How Companies make Investors Rich: The Interplay
between Profit Margins & Inventory Turnover & How Warren Uses It
 Comparing Businesses on Making Earnings: - You should not view Sales &
PAT Margin but view how much return we are making on our equity(ROE).
 Businesses make money in two ways: -
 1st by having the highest profit margins possible &/or
 2nd by having the highest inventory turnover possible
 Example: - You have a lemonade stand in the desert
 If you want to get rich selling lemonade, one of two things must happen:
 1st either your profit margins will have to increase &/or
 2nd your inventory turnover will have to increase
 You are the only lemonade seller in town: -
 1st Case High Profit Margin & Low Inventory Turnover:
 With a monopoly like that, you can sell at million dollars a glass cost you only $2 to make, then
you really only need to sell one glass to get rich.
 You may have the highest profit margins in the world, but you won't get rich if you don't sell
any lemonade.
 2nd Case High Inventory Turnover & Low Profit Margin:
 Stick with your $3 price tag & $1 profit margin, but sell a million glasses a year. You won't make
a fortune on each glass sold, but you can make a fortune if you sell a lot of glasses.
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PAT Margin 20% 15%
Asset Turnover 2 4
Leverage 1 1
ROE 40% 60%

Chapter 4 - How Companies make Investors Rich: The Interplay
between Profit Margins & Inventory Turnover & How Warren Uses It
 Two desert towns in which you might open up a lemonade stand: -
 1st Town (Price-competitive business, which Warren wants no part of): -
 It has 100000 thirsty tourists going through it a year, but it also has 50 lemonade stands & you
are going to face a lot of competition, which means that you can't charge high prices for your
lemonade.
 This means that your profit margins are going to be low. The high level of competition will also
keep your inventory turnover low.
 If you lower your prices to attract more business, your competitors will probably do the same
thing. That's not good for business & it's no way to get you rich.
 2nd Town (A local monopoly): -
 It has 100000 tourists go through it a year & not a single lemonade stand except yours., so you
can charge high prices.
 You are also going to have high inventory turnover because you are selling a lot of lemonade.
 Individually, both of these things are great for profits; combined, they can make you rich.
 Back to 1st Town (with Competitive Advantage which gives consumer monopoly): -
 You decide to make a special effort to use only the finest ingredients in your lemonade & call
your product by the brand-name Jack's lemonade.
 With Brand name & selling a much better product than first town's lemonade stands, you might
be able to open a lemonade stand in the first town & maintain your high profit margins.
 Your inventory turnover in the first town may not be as great as in the second, but it is still a
very profitable business.
 Once we identify company with a durable competitive advantage, we need
only wait until the shortsighted market has oversold makes its shares
(Undervalued). This type of businesses that can will survive any bad-news
situation.
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Chapter 5 - The Hidden Danger: The Type of Business Warren Fears &
Avoids
 Warren does not want to invest in a price-competitive, "sick,"
commodity-type business also called mediocre & lack a durable
competitive advantage.
 They are really popular in traditional contrarian investors due to
lots of ups & down (Can make high profit in short term).
 Identifying the Price-Competitive, "Sick" Business: -
 In Price competitive business Price is the single most important
motivating factor in the consumer's decision to buy (Consumers
buy it because it’s cheap compare to others)
 Low-cost provider wins: -
 In most cases the low-cost producer must constantly make manufacturing
improvements to keep the business competitive (which require high Capex).
 Price-competitive business is entirely dependent upon the quality &
intelligence of management to create a profitable enterprise.
 “If the choice the consumer makes is motivated by price alone, the company
that is the low-cost producer will be the winner & the others will end up
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Chapter 6 - The Kind of Business Warren Loves: How He Identifies &
Isolates the Best Companies to Invest In
 Two types of businesses possess competitive advantage: -
 Producing Unique Product
 Providing Unique Service
 The Durable Competitive Advantage: -
 Having competitive advantage is not enough, it should be durable, without having
to expend great sums of capital to maintain it.
 Making the same product or providing the same service (over the years) with no
R&D cost at all because some company’s competitive advantage (moat) is
dependent on management's ability to create new & innovative products to
beat the competition.
 Low-cost durable competitive advantage is important for two reasons:
 1st the predictability of the business's earning & thus is more likely to recover from any short-
term bad-news event
 2nd it enhances shareholders' fortunes as opposed to simply maintaining them
 Predictable product = Predictable profits, which gives certainty we needs to
bet big when the market's shortsightedness overreacts to bad news & kills the
stock price of one of these companies.
 When you think of a durable competitive advantage, think durable product
or service.
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Chapter 7 - Using Warren's Investment Methods to Avoid the Next
High-Tech Massacre
 Many investors get caught up in the visions of new industries promise to reshape &
transform society.
 All optimistic investors' dreams of immediate wealth, so many investors invest a lot of
money into them which cause upward trend in share price.
 Many people see others getting rich & they too join the game, which sends stock prices
soaring even higher.
 This process often continues until economic reality is left far behind. But it can't go on
forever, for economic reality is like gravity. At some point the bubble bursts & stock prices
fall.
 Transforming Industries = Intense Competition = Lower Profits = Lack of Durable
Competitive Advantage = No History of Product Durability
 High selling prices that don't make business sense given the economic reality of the
business.
 Buying 1 share = Buying whole company: -
 Company - A, Selling at Market Cap = Rs 1000 Cr & If I paid Rs 1000 Cr for the company,
what rate of return will I get after buying whole company?
 Compare that return with other investment returns like Bonds or FD.
 Suppose company earning Rs 10 Cr annually (1%) & we are getting Rs 70 Cr in FD (7%) then
buying company is not a good idea at this selling price. (P.S. Effect of Inventory Turnover, ROE,
Retain earnings & Compound growth is not considered).
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PATM 1% 7%
Asset Turnover 10 1
Leverage 1 1
ROE 10% 7%

Chapter 8 - Interest Rates & Stock Prices— How Warren Capitalizes on
What Others Miss
 Investment returns ultimately compete with each other like FD Returns with stock returns.
 If you pay $1500 for business that earns = $100 per year: -
 Rate of return of Business = Earning / Payment = $100 / $1500 = 6.67%
 Rate of return of Bond = Earning / Payment = $150 / $1500 = 10%
 Bonds were earning 10% would create downward pressure on the selling price of the
business (limited pool of money in market).
 RBI is not interested in whether stock prices go up or down. It is only interested in
growing the economy through sound fiscal policy.
 Low Interest Rate (cause Inflation): - Cheaper money (things become expensive), which
means that business can easily take a loan for their growth, which creates a more active
economy.
 High Interest Rate (cause Recession): - Expensive money , which means that business
can't take a loan for their growth, which creates recession in economy.
 This type of interest-rate engineering works because businesses & individuals borrow
money to finance purchases.
 Example: - You will buy new car when interest rates have fallen. Assuming you are
borrowing money to finance purchases.
 Higher Interest Rate = Business Earnings worth less to an investors = Will drive stock
price down
 Low Interest Rate = Business Earnings worth more to an investors = Will drive stock price
up
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Chapter 9 - Solving the Puzzle of the Bear/Bull Market Cycle & How
Warren Uses It to His Advantage
 Warren's selective contrarian investment strategy: -
 1st identifying a company with a durable competitive advantage
 2nd identifying a buying opportunity
 Certain repetitive types of market, industry & business conditions provide him
best opportunity to invest into companies with durable competitive advantage.
 Bear/Bull market cycle
 Industry recessions
 Individual calamities
 Structural changes
 Bear Markets: -
 True bear markets destroy stock prices across the board
 They are rarest but the easiest to spot (media announce to the world that we are
in a bear market).
 Bear market usually appear after long bull market after bursting of bubble (high
stock prices with no support of economical fundamentals).
 Transformation of Bear Market into Bull Market: -
 During a bear market you will find companies with durable advantage having P/E
ratios lower (Contrast that situation with a bull market)
 RBI repeatedly dropped interest rates to help stimulate the economy, & making
stocks more attractive. (Low Banks rates, so investors will invest into stock market
to get high return)
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 Bull Market (Bull market can run for years): -
1. Lowering of interest rates -> Increase in stock prices -> Start of a bull market ->
Attracts more investors -> Seeing the spectacular results (quick result) -> Other
Investors taking their money out of low-interest investments & start buying stocks
2. Stock Market Corrections & Panic Selling During Bull Market: -
 People sell during bull market in fear of bubble burst (i.e. prices will go down after bull market)
so they start to sell & if that fear combined with any bad news about company then they will sell
even more (great opportunity to buy).
 It offer the safest investment opportunities because they don't change the earnings of the
underlying businesses. There is no real business problem nor real problem with the economy.
3. Top of the Bull Market: -
 In Panic Selling Momentum fund managers oversell stocks -> Fall below intrinsic value of
business -> Value oriented fund managers start to buy -> to take advantages of this buy (up
prices) momentum investors jump back (to make quick money)
 During this mass re-evaluation (PE single digit 9 to PE 50+), some value-oriented mutual fund
managers begin to change their valuation criteria (If Stock P/E < Market's average P/E = Buy
Stock) & since market (as a whole) heading upward, their investment choices are usually verified
right buy.
 Creation of Bubble (Bull market is in its final phase): -
 However, after stocks begin to trade at P/Es of 50+ or better, a funny thing happens: The
investment community announces that earnings no longer matter (valuations are based
on total sales & not on profit). Hence business that don’t have earnings see their share price
increase.
 During this time momentum investors earn really high returns, so value investors either
have to leave game or accept momentum investing. (In long run momentum investors loose,
they can’t win year after year)
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4. When Value Investors Leave the Game: -
 Value-oriented investors quit the game -> Sign that the bull market has
bubbled & it's time to get out -> It also tells him that some great buys are
right around the corner & he'd better have lots of cash to take advantage of
them.
 In bull market
 More & more money gets pumped into the stock market as more & more
people have greed to easy riches, jump into the game
 Mass Speculation send Share prices really high
 Making public feel rich
 A public that feels rich acts like it, spending money like crazy
 which heats up the economy (inflation)
 If RBI raises rates enough, it will eventually burst the bubble (this will won’t
happen overnight)
 Initially the market will ignore the RBI's interest rate hikes (Momentum
investors don't care about earnings, nor interest rates hikes)
 As interest rates begin to rise, certain industries (like insurance industry)
will see their stock prices collapse as momentum investors sell out to
generate more cash to throw at the hotter stocks (high-tech industry)
 Hot segment's bubble is about to burst
 When you see this splitting of the market, you should begin to look at
investing in stocks that are being rejected by momentum investors
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5. Popping of the Bubble: -
 RBI rising interest rates to control inflation, Momentum investors shift valuations
from earnings to revenue
 Value-oriented fund managers getting out of game
 Momentum investors take money (limited pool of money) out of certain industries
to popular industry which bifurcated market
 If you are in hot segment sell the stock & buy unpopular segment
 When the bubble pops, it will destroy stock prices in the hot segment & send
unpopular stocks suddenly upward
 As the unpopular segments pick up a little steam, momentum investors will jump
in to send them even higher
6. Beware buying stock in Bull Market Bubble: -
 Durable Competitive Advantage: If you buy at PE 50 & then fall to PE 9, it may
take years to fully recover.
 Price Competitive Business: If you buy at PE 50 & then fall to PE 9, then you
might suffer real & permanent losses of capital.
7. After The Bubble Bursts: -
 You will see reports of falling corporate profits because people can’t borrow
money to support their purchase (high interest rates).
 RBI will actively drop interest rates, which will re-spark the economy & if this
don’t revive economy then country will slip into depression & stock price at bottom
(Best opportunity to buy)
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Chapter 10 - How Warren Discerns Buying Opportunities Others Miss
1. Industry Recessions: -
 Entire industry suffers a financial setback.
 It can lead to serious losses or nothing more than mild reduction in EPS.
 Recovery time generally one to four years (Excellent buying opportunities).
 In extreme cases, a business may even end up in bankruptcy.
 Stay with one that was very profitable before the recession.
 In an industry recession, everyone gets hurt. The strong survive while the
weak are removed from the economic landscape.
2. Individual Calamity (Disaster): -
 Sometimes brilliant companies do stupid things, & when they do, they lose some
big money.
 You have to figure out whether this situation is a passing calamity (temporary)
or irreversibly damaging (permanent).
 Company that has the financial power of a durable competitive advantage
behind, has the strength to survive almost any calamity.
 Stupid things like bad acquisitions (that convert good business to loss making)
or management change made change in business model or some silly costly
mistakes.
3. Structural Changes: -
 Mergers, restructuring, reorganizing costs, spinning-off of business
 It can have a very negative or positive impact on net earnings, which
translates into lower or higher share price
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Chapter 11 - Where Warren Discovers Companies with Hidden Wealth
 Durable competitive advantage is a kind of hidden wealth that a
company can develop through pure competitive struggle.
 Regional Monopoly can be acquire in Price competitive industry by
low cost producers or sole provider.
1) Businesses that Fulfill a Repetitive Need with a Consumer Product
with Brand-Name Appeal: -
I. Brand-Name Fast-Food Restaurants: -
 Like McDonald's, Burger King, Taco Bell, KFC, & Pizza Hut have taken generic
food— such as the hamburger, pizza, taco, chicken— & branded it.
 Consumer associates the taste pleasure of these foods with companies' brand
names as result many repeat customer visits.
 Buying Opportunity: Bear market (Recession Proof), Panic sell-off during a bull
market, Individual Calamity (single tainted hamburger or pizza)
II. Patented Prescription Drugs: -
 Products that people desperately need, & they are protected by patents.
 Buying Opportunity: Bear market (Recession Proof), Panic sell-off during a bull
market, Individual Calamity (Government Intervention)
III. Brand-Name Beverages: -
 Buying Opportunity: Bear market (Recession Proof) & Panic sell-off during a
bull market17

1) Businesses that Fulfill a Repetitive Need with a Consumer
Product with Brand-Name Appeal: -
IV. Brand-Name Foods: -
 Cereal, chocolate, chewing gum, Packaged Processing Food
 Products that own a piece of the consumer's mind (competitive advantage)
 Buying Opportunity: Bear market (Recession Proof), Panic sell-off during
a bull market, Individual Calamity
 These are also the kinds of stocks that get hit in a bifurcated market (During
bull market investors sell unpopular stock to buy popular stocks).
V. Brand-Name Toiletries/House Products: -
 Toothpaste, soap, shampoo, detergent, tampons, & razor blades
 They make slight modifications – mint flavor in the toothpaste, new design
on the razor – but in truth they're still selling the same products they did
twenty-five years ago. They'll probably keep peddling them for another fifty.
 Buying Opportunity: Bear market, Panic sell-off during a bull market,
Individual Calamity
VI. Brand-Name Clothing Business: -
 Fashion is where the money is
 People are willing to pay a lot of money for an fashionable item of clothing
made for just a few dollars (by contract manufacturing from others)
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2) The Advertising Business Provides a Service that Manufacturers must
Continuously use to Convince the Public to Buy their Products: -
I. Advertising: -
 Advertising is battleground on which manufacturers compete with one another.
 Once businesses begin to advertise, it is almost impossible for them to stop. Competition
creates repetitive need. If a company stops advertising, its competitors will step in & fill the
void.
 Advertising creates a conceptual toll bridge between the potential consumer & the
manufacturer.
 Toll bridge Owned by the agencies, radio stations, television networks, newspapers,
billboards, direct-mail, e-mail companies & magazines.
II. Advertising Agencies: -
 They develop entire ad campaigns that companies use to sell their products to the masses.
III. Television: -
 It have the power to reach millions of potential customers but it also cost a lot during IPL.
IV. Newspapers: -
 In a good-size town a one newspaper can make excellent returns, but two or more
competitors & neither will do very well.
V. Magazines: -
 Established magazines have grip on certain segments of the market , which allow them to
earn high.
VI. Direct-Mail & Billboard Companies
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3) Businesses that Provide Repetitive Consumer Services that People &
Businesses are consistently in Need of: -
I. Pest & termite control service, home-security business, filling tax forms,
credit card companies.
II. They provide necessary services but require little in the way of capital
expenditures
4) Low-Cost Producers & Sellers of Common Products that Most People Have
to Buy At Some Time in their Life: -
I. Purchase large quantities of inventory deeply discounted from
manufacturers. This is known as monopoly buying power.
II. This allows it to sell product for less than the competition can (pass discount
to customers).
III. Large retailers earn quasi-monopoly profits by selling cheap & moving a lot
of inventory (High Inventory Turnover)
IV. These merchants, as a rule, own their stores & the property they sit on.
V. These companies create barrier to entry by being the low-cost operator & own
their large retail space.
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Chapter 12 - Financial Information: Warren's Secrets for Using the
Internet to Beat Wall Street
 Circle of Confidence: -
 To determine durability of a company's competitive advantage you have
to understand nature of the business, products that it makes & needs
it fulfills.
 Determining whether it will be around 10 years from now (future) is far
more difficult.
 Certain fields of business like technological industry are evolving so
fast that, it is impossible to make any sort of determination of future
product durability.
 If we can't evaluate it, we should not invest in it.
 But if you understand business & its future durability then next step is
scuttlebutt
 Scuttlebutt: -
 Process of investigation in which the future investor calls the
competition & customers of a business & asks what it thinks of a
particular company.
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Chapter 13 - Warren's Checklist for Potential Investments: His Ten
Points of Light
 Before searching for great companies to invest in, you'll need a working
knowledge of several hundred companies that have a durable
competitive advantage.
1) The Right Rate of Return on Shareholders' Equity: -
 Consistent (durable competitive advantage) high rate of return on
shareholders' equity, typically above 12%.
 Price-competitive commodity-type businesses historically have low
returns on shareholders' equity— typically below 12%.
 Due either to industry recession or onetime problem, the ROE will drop
substantially (Create Buying Opportunity).
2) The Safety Net: The Right Rate of Return on Total Capital (ROCE): -
 When business purposely reduce their equity (with dividend payment or
buyback shares) to increase ROE, then you should check ROCE to
measure profitability of business
 Consistently (durable competitive advantage) earn both a high ROE & a
high ROCE
 Example: Company – A: Equity = 150, Debt = 0 & Total Assets = 150
 Taken debt 200
 Equity 150 + Liability 200 = Total Assets 350
 Buyback share of 150
 Equity 0 + Liability 200 = Total Assets 200
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Points of Light
3) The Right Historical Earnings (EPS): -
 Individual calamity that causes a reduction in EPS must be thoroughly
understood before an investment is made.
 Buying Opportunity: Company suffers a onetime solvable problem to
which the stock market has overreacted.
4) When Debt Makes Buffett Nervous: -
 Companies that have durable competitive advantage makes them
financially powerful enough to survive bad news.
 Debt-to-equity ratio for the financial strength of a company to be a poor
measure, selling assets (except inventory) are never a source of funds
unless the company is in bankruptcy.
 Most of equipment is so unique to the business that, in truth, it is
worthless to others.
 The wealth of a company is in its ability to earn a profit, not what it
could sell its assets for.
 Debt Burden = Total Debt / PAT
 Debt Burden = Total Debt / Free Cash Flow (less than 5 times)
 Long-Term Debt Used to acquire another Business: -
 If company with durable competitive advantage acquire another company (with
durable advantage) then they can pay high debt also. But paying too much that
don’t make business sense is bad idea.
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Points of Light
5) The Right Kind of Competitive Product or Service: -
 You're looking for a product that consumers are continuously in need of, not
one they buy once in their lifetime
 This repetitive buying makes a competitive advantage profitable
 Keep producing & selling the same product, with little modification
 Just because business has brand-name product or service does not mean that
it is an excellent business. Management can fail in dozens of ways.
6) How Organized Labor Can Hurt Your Investment: -
 Auto Manufacturers: Show increase in profits, labor unions start demanding
higher salaries for their workers.
 If management refuses to meet union demands, its members cripple the
company by going on strike
 Fat profits can become fat losses overnight
7) Figuring Out Whether the Product or Service Can Be Priced To Keep equal
Of Inflation: -
 Company with the durable competitive advantage can increase its product
value with inflation.
8) Understand the Right Operational Costs: -
 The more durable competitive advantage, the less business has to spend to
maintain it.
 Use retain earnings either to expand, buyback, invest in new business, or Paying
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Points of Light
8) Understand the Right Operational Costs: -
 Calculating return on Retain Earnings
 2009 EPS = $1.16
 Retain Earnings 2010 to 2020 = Total EPS 2010 to 2020 – Paid Dividend 2010
to 2020
 Retain Earnings = $17.14 – $9.34 = $7.80
 2020 EPS = $2.56
 Earnings due to retain = EPS $2.56 – EPS $1.16 = $1.40
 Thus $7.80 produced $1.40 additional income
 Return on Retained Earnings = (2020 EPS – 2009 EPS) / Retain Earnings
 Return on Retained Earnings = (EPS $2.56 – EPS $1.16) / $7.80 = 17.9%
 If we getting return of < 7% then better to retain money in bank FD
account rather than business.
 This test is not perfect (it’s useful only when EPS rises).
 Fast method of determining whether its management utilize retained
earnings to increase shareholders' riches.
25

Points of Light
9) Can The Company Repurchase Shares To The Investors'
Advantage?: -
 Buyback effect on company’s share: -
 Company – A
 No. of shares = 100 million
 CMP = $10
 Market Cap = 100 million x $10 = $1 Billion
 Net Income = $50 million
 EPS = Net Income / No. of share = $50 million / 100 million = $0.50
 PE = CMP / EPS = $10 / $0.50 = 20
 Buyback 10 million shares @ $10 (Usually buy in Premium)
 No. of shares = 100 million – 10 million = 90 million
 EPS = Net Income / No. of shares = $50 million / 90 million = $0.56 (Increased 12%)
 If P/E Ratio is remain same
 CMP = PE x EPS = 20 x $0.56 = $11.2 (Increased 12%)
 Of course none of this would be possible if Company - A didn't have a durable competitive
advantage creating an abundance of excess cash.
 Buybacks increase inventor’s ownership as well as saves from taxes that investor’s will have to
pay after receiving dividend.
26

Chapter 14 - How to Determine When a Privately Held Business Can Be
a Prosperity
 Some privately owned companies had established a
durable competitive advantage by developing a regional
monopoly, brand-name product or low cost producer
making their owners rich.
 Tax Aspects: -
 Buy 10% ownership
 Buy $10 per share & sold at $25
 Tax will be on = $25 – $10 = $15 (taxable)
 Buy 100% business
 Buy $10 & retained (invested again) $8 = Total buying value
$18 & Sold at $25
 Tax will be on = $25 – $18 = $7 (taxable)
 Sometimes it's better to eat the whole cake rather than take a27

Chapter 15 - Warren's Secret Formula for Getting Out at the Market Top
 Warren has bought & sold hundreds of securities over his lifetime, but his
big money has always come from buying companies with a durable
competitive advantage & holding them over the long term, in some cases for
30 or more years.
1) Warren's Formula for Selling Out at the Top: -
 When stocks that have historically traded at between 10 – 25 earnings begin
trading at 40+ earnings, for no other reason then the market is going through a
period of mass speculation, it's time to get out.
 At the top of a bull market, durable-competitive-advantage businesses can
reach prices at which it makes business sense to sell.
2) Better Opportunity Presents Itself: -
 Sell out of an investment when the underlying business hasn't performed well
in order to take advantage of a new opportunity.
 But don't make the mistake of selling flowers to buy weeds.
3) When the Business or Environment Changes: -
 When change in the business model or its environment change durable-
competitive-advantage company into price-competitive business.
4) Target Price for the Security Has Been Met: -
 Reaching a stock's target price can dictate a sale28

Chapter 16 - Where Warren Buffett Is Investing Now!
 Simply because companies meet selective criteria
don’t mean you have to buy them today, bought when
the price is right.
 You want to identify the company with a durable
competitive advantage & then let the price of its
shares determine when you pull the trigger.
 The right price may come tomorrow or it may be after
five years.
29

Chapter 17 - Stock Arbitrage: Warren's Best-Kept Secret for Building
Wealth
 Stock Arbitrage: -
 Corporate Sellouts
 Reorganizations
 Mergers
 Demerger
 Acquisition
 Spin-offs
 Takeovers
 It can take long time than we expected & if these
stock arbitrage failed to occur after announcement
then stock price will drop back to previous price or
lower.
 Better to buy shares on the bases of announcement30

Chapter 18 - For the Hard-Core Buffettologist: Warren Buffett's
Mathematical Equations for Uncovering Great Businesses
 Finding a company with durable competitive advantage then waiting
for a buying opportunity to deliver a stock price that makes
business sense.
 Financial Equation #1 – Predicting Earnings at a Glance: -
 Company III & IV – Probable Durable Competitive Advantage,
investigate why EPS decreased, is it due to one time solvable problem
or permanent damage.
31
Company I Company II Company III Company IV
Durable Competitive
Advantage
Business
Commodity
Business
Probable Durable
Competitive
Advantage
Business
Probable Durable
Competitive
Advantage
Business
Year EPS EPS EPS EPS
2011 ₹ 1.07 ₹ 1.57 ₹ 1.07 ₹ 1.07
2012 ₹ 1.16 ₹ 0.16 ₹ 1.16 ₹ 1.16
2013 ₹ 1.28 -₹ 1.28 ₹ 1.28 ₹ 1.28
2014 ₹ 1.42 ₹ 0.42 ₹ 1.42 ₹ 1.42
2015 ₹ 1.64 -₹ 0.23 ₹ 1.64 ₹ 1.64
2016 ₹ 1.60 ₹ 0.60 ₹ 1.60 ₹ 1.60
2017 ₹ 1.90 ₹ 1.90 ₹ 1.90 ₹ 1.90
2018 ₹ 2.39 ₹ 2.39 ₹ 2.39 ₹ 2.39
2019 ₹ 2.43 -₹ 0.43 ₹ 2.43 ₹ 2.43
2020 ₹ 2.69 ₹ 0.69 ₹ 0.48 -₹ 1.69

 Financial Equation #2 – Test to Determine your Initial Rate of
Return: -
 Think from "business perspective". If company earns $5 EPS &
we owns 100 shares of the company, we should think has just
earned $500 ($5 x 100).
 Other people don’t consider business earnings as their own
earnings they just consider dividend income as their own income.
 Initial Rate of Return (Earning Yield) = Business earnings / Business
price = EPS / CMP
 Financial Equation #3 – Test to Determine the Per Share
Growth Rate: -
 Growth in EPS = Growth in Share Price = Growth in Shareholders
Wealth
 To get EPS to grow, the company must employ its retained
earnings in a manner that will generate more earnings per share.
 CAGR = ((Ending Value / Starting Value) ^ (1 / Years) – 1) * 100
 EPS growing then it could have following reason:
 Buyback of shares
 Increase Earnings with Increase Revenue
 Business economics that caused this change
 Retain Earnings
32

 Financial Equation #4 – Stock's Value Relative to Treasury Bonds: -
 All investments compete with one another & that the return on treasury
bonds is the benchmark that all investments must ultimately compete.
 Stock’s Value Relative to Bond = EPS / Rate of Return on Bond
 EPS = $2.77 & Bond’s Rate of Return = 6%
 Stock’s Value Relative to Bond = $46.17. To earn more than bond we have to
buy stock at lower price.
 Financial Equation #5 – Using the EPS Annual Growth Rate to Project
Future Stock Value: -
 To Project Future EPS For 2020 (Based on Past EPS Growth): -
 EPS CAGR From 2010–2020 = (($1.18/$0.47) ^ (1/10) – 1) = 9.6%
 Same growth rate Possible if company has a durable competitive advantage
 Future Value EPS 2030 = EPS 2020 EPS * (1 + 9.6%) ^ 10 = $1.18 * (1 + 9.6) ^ 10 = $2.95
 To Project the Market Price Stock for 2030 (Based on Past EPS Growth &
PE): -
 PE traded From 2010–2020 2010 = Low 11.5 to High PE 23 & average PE is 17.5
 Projected Stock Price for 2030 = PE * EPS = 17.5 * $2.95 = $51.62
 Calculate Annual Compound Rate of Return If we buy stock at current price:
-
 Buy stock at $14.80 today & Projected Stock Price = $51.62
 CAGR Rate of Return = (($51.62 / $14.80) ^ (1/10) – 1) * 100 = 13.28% on our current
purchase
 To get better return either buy stock less than $14.80 or sell greater than $51.52
33

 Financial Equation #6 – Understanding Warren's Preference for
Companies that Earn High Rates of Return on Equity: -
 Company – A
 Assets = $10 million & Liabilities = $4 million, Equity = $6 million
 Earnings = $1.98 million
 ROE = Earnings / Equity = 33%
 Owner will sell business if he will get same earnings as today in bonds 8% (Fixed
Income)
 Owner’s Selling Price = $1.98 million / 8% = $24.75 million (4 times of equity &
12.5 times of earnings)
 Company – B
 Assets = $10 million & Liabilities = $4 million, Equity = $6 million
 Earnings = $0.48 million
 ROE = Earnings / Equity = 8%
 Owner will sell business when he will get same earnings as today in bonds 8%
(Fixed Income)
 Owner’s Selling Price = $0.48 million / 8%= $6 million (1 times of equity & 12.5
times of earnings)
 Suppose we bought the business, in 1st year we will earn 8% return in both
businesses.
 Warren is not interested in 1st year earning. He is interested in what the
company will be earning after 10 years.
34

 Financial Equation #6 – Understanding Warren's Preference for
Companies that Earn High Rates of Return on Equity: -
 Company – A: - After 10 years I want to sell business that I bought at
$24.75 million (Held Business for past 10 years)
 11th Year Equity = $103.91 million (Compounded at 33%)
 11th Year Earnings = $34.29 million
1) If we Sell Business at 11th year’s Book Value = $103.91 million
 Compounding rate on Investment = (($103.91 million / $24.75 million) ^ (1/10) – 1)
* 100 = 15.43%
2) If we Sell Business at 11th year’s earnings relative to bond’s interest
= $34.29 million / 8% = $428 million
 Compounding rate on Investment = (($428 million / $24.75 million) ^ (1/10) – 1) *
100 = 33%
3) Instead of buying at $24.75 million, you bought at $59.4 million (10
times of equity & 30 times of earnings) & sold it at $428.64 million (12.5
times of earnings)
 Compounding rate on Investment = (($428.7 million / $59 million) ^ (1/10) – 1) *
100 = 21.8%
4) You bought at $79.2 million (10 times of equity & 40 times of
earnings) & after 10 years sold it at $428.64 million (12.5 times of
35

 Financial Equation #6 – Understanding Warren's Preference for Companies that
Earn High Rates of Return on Equity: -
 Company – B: - After 10 years I want to sell business that I bought at $6 million (Held
Business for past 10 years)
 11th Year Equity = $12.95 million (Compounded at 8%)
 11th Year Earnings = $1.04 million
1) If we Sell Business at 11th year’s Book Value = $12.95 million
 Compounding rate on Investment = (($12.95 million / $6 million) ^ (1/10) – 1) * 100 = 8%
2) If we Sell Business at 11th year’s earnings relative to bond’s interest = $1.04 million /
8% = $12.95 million
 Compounding rate on Investment = (($12.95 million / $6 million) ^ (1/10) – 1) * 100 = 8%
 Conclusion: Company – A is more profitable even if we buy at 12.5, 30, & 40 times of
earnings (or 4, 10, 13 times of equity) compared with company – B which we bought at 12.5
times of equity or 1 times of equity.
 .
36
Company - A Company - B
Year Equity (Million) ROE Earnings (Million) Equity (Million) ROE Earnings (Million)
1 USD 6.00 33% USD 1.98 USD 6.00 8% USD 0.48
2 USD 7.98 33% USD 2.63 USD 6.48 8% USD 0.52
3 USD 10.61 33% USD 3.50 USD 7.00 8% USD 0.56
4 USD 14.12 33% USD 4.66 USD 7.56 8% USD 0.60
5 USD 18.77 33% USD 6.20 USD 8.16 8% USD 0.65
6 USD 24.97 33% USD 8.24 USD 8.82 8% USD 0.71
7 USD 33.21 33% USD 10.96 USD 9.52 8% USD 0.76
8 USD 44.17 33% USD 14.58 USD 10.28 8% USD 0.82
9 USD 58.74 33% USD 19.39 USD 11.11 8% USD 0.89
10 USD 78.13 33% USD 25.78 USD 11.99 8% USD 0.96
11 USD 103.91 33% USD 34.29 USD 12.95 8% USD 1.04

 Financial Equation #7 – Determining the Projected
Annual Compounding Rate of Return Part I: -
 Shareholders' Equity 2020 = $2,073 (Compounded at 23.3%
rate from 2010 – 2020)
 Future Compounded Shareholders' Equity 2030 based on past
10 year CAGR = $2073 * (1 + 23.3%) ^ 10 = $16836
 Minimum require rate of return that we are willing to take =
15%
 PV of Future equity at 15% = $16836 / (1+15%) ^ 10 = $4161
 Now my Minimum require rate of return changed to 20%
 PV of Future equity at 20% = $38911 / (1+20%) ^ 14 = $2719
 The price you pay determines your rate of return. Pay
more, get less. Pay less, get more.37

 Financial Equation #7 – Determining the Projected
Annual Compounding Rate of Return Part II: -
 Buy share numbers = 957200 @ $13 = $12.44 million
 EPS = $1.10 (35% retained & 65% paid dividend)
 Retained = $1.10 * 35% = $0.38
 Paid Dividend = $1.10 * 65% = $0.72
 PE = 4.48 times, Book Value = $2.90
 ROE = EPS / Book Value = $1.10 / $2.90 = 37.93%
 Yield of Retained = 37.93% * 35% = 13.25%
 Yield of Paid Dividend = 37.93% * 65% = 24.65%
 Projecting Future EPS based on ROE tread: -
 If we assume that Company – A, maintain ROE 37.9% for the
next 10 years & continue to retain 35% & dividend payout 65%
 Future EPS = $1.10 * (1+13.25%) ^10 = $3.81
38

 Financial Equation #7 – Determining the Projected Annual
Compounding Rate of Return Part II: -
 Projecting Future Share Price Based on Future EPS & PE : -
 Now if company trading at PE = 18 times
 Average annual P/E ratio for the last 10 years gives you best
picture especially if there has been a huge difference between
High & Low PE
 Also calculate return based on high & low P/E for the last 10 years
to know how well you could do or couldn’t do
 Share Price = PE * EPS = 18 * $3.81 = $68.58
 Total Stock Earnings = $68.58 * 957200 shares = $65.64 million
 Total Dividend Earnings = $15.79 * 957200 shares = $15.11 million
 Total Earnings = $15.11 million + $65.64 million = $80.75 million
 Compound Rate of Return (Without Dividend Earnings) = (($65.64 /
$12.44) ^ (1/10) – 1) * 100 = 18.10%
 Compound Rate of Return on Investment = (($80.75 / $12.44) ^
(1/10) – 1) * 100 = 20.57%39

 Financial Equation #7 – Determining the Projected Annual Compounding Rate of Return Part II:
-
 Now as we see below there is a difference between projected earnings & actual earnings
min 8% & maximum 32%
 In 2001 stock numbers was like below:
 Lowest Stock Price = $50 & Total Stock Earnings = $47.8 million & CAGR for 8 years= 18.3%
 Highest Stock Price = $70 & Total Stock Earnings = $67 million & CAGR for 8 years = 23%
 Add Dividend approx = $6.04 million
 At Lowest Stock Price, Total Earnings = $53.84 million & CAGR for 8 years= 20%
 At Highest Stock Price, Total Earnings = $73.04 million & CAGR for 8 years = 24.8%
 Stock market become aware of long term power of Company – A economic engine & stock price
go up between 20 & 27.
 Things don't always work exactly the way one plans, but if you have a durable competitive
advantage as strong as Company – A has, you will get great return on investment.
40

Chapter 19 - Thinking the Way Warren Does: The Case Studies of His
Most Recent Investments
1. Does the company sell any brand-name products or services that might have
a durable competitive advantage or does it sell a price-competitive product
or service?
2. Do you understand how the product or service works (usage of product or
services in our life)?
3. Is the company conservatively financed?
4. Are the earnings of the company strong & do they show an upward trend?
5. Does the company allocate capital only to businesses within its realm of
expertise? (Does this company acquired other type of business with no durable
competitive advantage or does they acquire company with durable competitive
advantage)
6. Has the company been buying back its shares? (This indicates that
management uses capital to increase shareholder value when it is possible)
7. Does management’s investment of retained earnings appear to have
increased per share earnings & therefore shareholder value?
41

Chapter 19 - Thinking the Way Warren Does: The Case Studies of His
Most Recent Investments
8. Is the company's return on equity above average?
9. Does the company show a consistently high rate of return on total
capital?
10. Is the company free to adjust prices to inflation? (Can increase
product prices with inflation rate?)
11. Are large capital expenditures required to constantly update the
company's plant & equipment?
12. If we can understand company & it has durable competitive advantage.
The next question (& its big one) is whether stock can be purchased at
a price that makes business sense.
13. Initial Rate of Return & Relative value to Government Bonds
14. Projecting an Annual Compounding Return Using the Historical Annual
per Share Earnings Growth
42

The New Buffettology

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