Tuesday, 28 February 2012

Learning from Annual Report 2011 Warren Buffett

"Vic Mancinelli again set a record at CTB, our agricultural equipment operation. We purchased CTB in
2002 for $139 million. It has subsequently distributed $180 million to Berkshire, last year earned $124
million pre-tax and has $109 million in cash. Vic has made a number of bolt-on acquisitions over the
years, including a meaningful one he signed up after yearend." - Annual Report 2011 Berkshire Hathaway

This is one way I like to use for valuing a business.

Warren Buffett bought Vic Mancinelli in 2002 for 139m. From 2002 to 2011, the business distributes 180m to Berkshire. And earning in 2011 was 124m.

From these two lines of simple statements, it is very clear to everyone this is a good investment.
There is no need to do complex DCF,  complicated the issue with discount rate,  interest rate, alfa , beta,  gamma etc. Neither need to measure an investment success through everyday stock price , be it up or down from the price we invested.

Buffett seldom mentioned about stock price in his writing. But in most of his writing, he talks about how much he paid, and for the coming few years, how much the business earnings or dividend belong to his % of share.

What I learn from this:

1. To develop this mindset and habit, to focus on profit, or free cash flow or real cash and dividend. This will help to shift an investor's focus away from daily stock price.

2. How we can use the above backward looking statement to derive a value of a business.
- make a wild guess on the future earning or free cash flow.  If you can predict whether this company has a high probability of making an ADDREGATE profit of $xxx for the next 3, 5,10 or even longer time, you had roughly get the value of the company.

Of course our understanding and the FORESIGHT about the prospect of the industry, competitiveness of the company will help a lot on the probability and accuracy of our wild guess. No matter how good you think your guess is. Margin of safety is still the most important. Mean your aggregate profit shall be very large compare to the price you pay.

1 or 2 year of earning unlikely provide you any good margin unless u ASSUME very high growth ( This will increase your risk). Rather you should aim for longer term, say 5 to 10 years. By guessing today's market leaders to continue delivering good profit for long time in a long lasting industry is a safer guess. The payoff of longer term is a larger return.

I realise we also face another challenge when dealing with number. Apart from reading and taking the financial figure, we should think if the number looks logical. Had gone through quite a lot of fake figures in the past few years. Experience accumulated from going through more and more and more similar companies in the same industry helps you to understand what is logical figure in certain industry. By understanding what is realistic margins , revenue,  costs, profit, capex is more important. So good at spreadsheet won't help much, but good at understanding the business nature, environment etc will help you make a better judgement (businessman strength). 


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