1. 1 Investments: Buffett Professor Scott Hoover Business Administration 365

2. 2 Investment Tenets  Business Tenets Is the business simple and understandable? Does the business have a consistent operating history? Does the business have favorable long-term prospects?  Management Tenets Is management rational? Is management candid with the shareholders? Does management resist the institutional imperative?

3. 3 Investment Tenets  Financial Tenets Focus on ROE, not EPS Calculate owner earnings to get a true reflection of value Look for companies with high profit margins For every dollar retained, make sure the company has created at least one dollar of market value.  Market Tenets What is the value of the business? Can the business be purchased at a significant discount to its value?

4. 4 Principles of Warren Buffett  Quotes 1977: While too much attention should not be paid to the figure for any single year, over the longer term the record regarding aggregate capital gains or losses obviously is of significance. 1977: Just as it would be foolish to focus unduly on short-term prospects when acquiring an entire company, we think it equally unsound to become mesmerized by prospective near term earnings or recent trends in earnings when purchasing small pieces of a company. 1978: While we believe it is improper to include capital gains or losses in evaluating the performance of a single year, they are an important component of the longer term record.  We should evaluate over the long-term and not the short- term.

5. 5  Quotes 1977: Most companies define “record” earnings as a new high in earnings per share. Since businesses customarily add from year to year to their equity base, we find nothing particularly [in this]. After all, even a totally dormant savings account will produce steadily rising interest earnings each year because of compounding. 1979: Earnings per share, of course, increased somewhat but we regard this as an improper figure upon which to focus. We had substantially more capital to work with in 1979 than in 1978, and our performance in utilizing that capital fell short of the earlier year, even though per-share earnings rose. “Earnings per share” will rise constantly on a dormant savings account or on a U.S. Savings Bond bearing a fixed rate of return simply because “earnings” (the stated interest rate) are continuously plowed back and added to the capital base. Thus, even a “stopped clock” can look like a growth stock if the dividend payout ratio is low.  EPS is a poor indicator of performance!

6. 6  Quotes 1978: The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed [i.e., ROE] In our view, many businesses would be better understood by their shareholder owners, as well as the general public, if managements and financial analysts modified the primary emphasis they place upon earnings per share, and upon yearly changes in that figure. 1977: reinsurance generates unusually high funds for investment as a percentage of premium volume. 1978: Ben Rosner, at Associated Retail Stores, continues to pull rabbits out of the hat - big rabbits from a small hat. Year after year, he produces very large earnings relative to capital employed - realized in cash and not in increased receivables and inventories as in many other retail businesses  Free cash flow is important

7. 7  Quotes 1977: A few shareholders have questioned the wisdom of remaining in the textile business which, over the longer term, is unlikely to produce returns on capital comparable to those available in many other businesses. Our reasons are several: (1) Our mills in both New Bedford and Manchester are among the largest employers in each town, utilizing a labor force of high average age possessing relatively non-transferable skills. 1978: We hope we don’t get into too many more businesses with such tough economic characteristics. But, as we have stated before: (1) our textile businesses are very important employers in their communities  Stakeholders are important (European view)

8. 8  Quotes 1977: In fact, if their business experience continues to satisfy us, we welcome lower market prices of stocks we own as an opportunity to acquire even more of a good thing at a better price. 1978: We are not concerned with whether the market quickly revalues upward securities that we believe are selling at bargain prices. In fact, we prefer just the opposite since, in most years, we expect to have funds available to be a net buyer of securities.  In contrast to our instincts, lower prices are good!

9. 9  Quotes 1977: Our experience has been that pro-rata portions of truly outstanding businesses sometimes sell in the securities markets at very large discounts from the prices they would command in negotiated transactions involving entire companies. Consequently, bargains in business ownership, which simply are not available directly through corporate acquisition, can be obtained indirectly through stock ownership. 1978: We make no attempt to predict how security markets will behave; successfully forecasting short term stock price movements is something we think neither we nor anyone else can do. In the longer run, however, we feel that many of our major equity holdings are going to be worth considerably more money than we paid, and that investment gains will add significantly to the operating returns of the insurance group.  The market is inefficient.

10. 10  Quotes 1977: …led again by the truly outstanding results of Phil Liesche’s managerial group at National Indemnity Company 1978: Home and Automobile Insurance Company had its best year since John Seward stepped in and straightened things out 1979: Milt Thornton at Cypress Insurance Company and Frank DeNardo at National Indemnity’s California Worker’s Compensation operation both performed in a simply outstanding manner. numerous other quotes  We should give credit where credit is due.

11. 11  Quotes 1978: We continue to look for ways to expand our insurance operation. But your reaction to this intent should not be unrestrained joy. Some of our expansion efforts - largely initiated by your Chairman have been lackluster, others have been expensive failures. 1979: Your Chairman made the decision a few years ago to purchase Waumbec Mills in Manchester, New Hampshire, thereby expanding our textile commitment. …the purchase was a mistake. While we labored mightily, new problems arose as fast as old problems were tamed.  Humility matters

12. 12  Quotes 1977: some of the problems have been of our own making 1977: Management also has been energetic and straightforward in its approach to our textile problems. 1977: Some major mistakes have been made during the decade 1978: we try to present to you a view of our various operating entities from the same perspective that we view them managerially. 1978: Neither this 25% equity gain from all sources nor the 19.4% equity gain from operating earnings in 1978 is sustainable.  Honesty and forthrightness should be valued