I’m not here to tell you all about the life of Warren Buffett, but rather how Warren Buffett selects stocks. I will show you how he uses just a few numbers from the Income Statement, at least to an extent that we can understand and utilize in a very simplified manner. Thus, this book will not go into detail about Mr. Buffett. There are so many wonderful books already written about him and every one of them I read is certainly worth reading more than once. He has been called the World’s Greatest Investor and the Greatest Investor of this century. Whatever we call him, I know this for certain: we all want to be like Warren.
A friend of mine who is an admirer of Buffett (like really, who isn’t?) once told me that just before he (my friend) died, he hoped Buffett’s life (and not his own) would flash in front of him.
We were sitting at a beachside bar in Florida, drinking one or four beers when he mentioned flashing lives, so I wasn’t sure if he was talking about Warren Buffett or Jimmy Buffett, but hey, we were happy talking about stocks (like Warren) and watching the ocean (like Jimmy). After all, isn’t that the way it’s supposed to be?
Now that we’ve discussed Warren Buffett’s life in such great detail, let’s talk about numbers. After all, I certainly believe that the numbers tell us almost everything we need to know about a company. Let me clarify this statement. If used properly, the numbers will tell us almost everything we need to know about a company.
If used properly, the numbers tell us almost everything we need to know about a company.
If we use the correct numbers in the correct way, the bottom line results will tell us which companies we want in our portfolio and which companies should be in someone else’s portfolio. The problem is most analysts out there in Investment Land are using the wrong numbers. But after you finish with this book, we really won’t care about the analysts out there in Investment Land.
Where is the Investment Land of which I speak? Top of the tower of Big Ben at midnight. Second star to the right and fly away ‘til morning. Yes folks, many analysts and portfolio managers really believe that Never Never Land is the same place as Investment Land.
Most investment analysts use the wrong numbers for stock selection. I know, I’ve taught many of the present and future analysts in my college classes.
How do I know most investors are using the wrong numbers for stock selection? I’m a college Professor (my 3rd career). I teach my students finance the way (well, almost) the academic community demands finance be taught. My students then go out into the real world and use these very methods taught to them by the academic community. Most of the academic community truly believes that if you know accounting and finance, then you know how to select stocks for a portfolio.
Folks, this just ain’t necessarily so and I’ll teach you why very soon. Let’s just say this for now. As long as students are taught finance by the present establishment and then go out and use this knowledge in the investing community, Warren Buffett will always have job security as the world’s greatest investor. Even in Never Never Land.
Learning about finance and learning about investments are two totally different subjects. The problem is that most investment analysts don’t know this.
How do I know that the stock valuation models taught in colleges and universities don’t work very well? If they did, all the college professors would be as rich as Warren Buffett. And guess what? They’re not. They (the academics) think Buffett is just plain lucky. Oh believe me, the academic community has all the answers to the “luck” syndrome, but the bottom line is even though Buffett (and some others) have great track records, it doesn’t matter to the academic community. Students just aren’t taught the methods that produce the extraordinary results because in the academic community extraordinary is considered luck and luck cannot be predicted or tested through statistical analysis. But always remember what I say about luck. It is when opportunity meets preparation.
I’ve alluded to the fact that Warren Buffett uses a method called Clean Surplus analysis. How do I know this? Please remember that I wrote and published a several-hundred-page research paper (my dissertation) on the predictability of Clean Surplus. Please trust me that I know what Clean Surplus looks like when I see it.
One of the courses I teach at a nearby university is entitled Advanced Managerial Finance. The first case we analyze each semester is entitled “Warren E. Buffett, 1995.” Yes, and on page 15, Exhibit #5, is a chart on Scott & Fetzer, which was a company purchased by our idol, Warren Buffett. The chart came from the Berkshire Hathaway, Inc. Annual Report, 1994, p.7. Well, the chart was a chart of the Clean Surplus method of analysis. But it was very strange because the author of the text did not mention anything about Clean Surplus. In fact, the chart was just sitting there alone with nothing much said about it. Just another exhibit in a case study designed to confuse the student.
Ahh, but my students were not confused because they knew what Clean Surplus looked like and they recognized the great importance of Exhibit #5 on page 15. My students understood what Warren Buffet saw in Scott& Fetzer and it is what you will see in many stocks once you finish this book.
Clean Surplus analysis is not taught in our fine business schools. This is why Warren Buffett has job security.
The second and even more important instance of Warren Buffett using Clean Surplus analysis can be found in the book “Buffettology” by Mary Buffett and David Clark. Mary is Warren’s former daughter-in-law and I would imagine she knows something about her father-in-law. Right there on page 124 in her workbook is a chart (spreadsheet) of Coca Cola. I know you know what the chart was. Yes, it was a chart showing Owners’ Equity configured through the use of Clean Surplus analysis.
However, neither Mary nor David mention the term Clean Surplus. Not a mention of Clean Surplus is made in either “Buffettology” or the text I used in my advanced finance course. However, “Buffettology” begins to talk about predictability and Warren’s use of this predictability. In no other book I’ve read on Warren Buffett will you see the mention of predictability. Dear reader, you will certainly see a lot of it in this book. So read on.
By the way, Mary and David’s book is very good. Many of the books written about Warren Buffett do not cover the numbers extensively because Buffett’s life is so very interesting the authors just do not have time for numbers. However, “Buffettology” covers the numbers and does so in great detail
In summary, you will not learn a great deal about Warren Buffett’s life in the following pages. However, you will learn how Warren Buffett uses Clean Surplus and more importantly, why he chooses to do so. After that, we will discuss my research and see if Clean Surplus analysis can truly be used for predictability. I don’t want to make you crazy and let you guess so I’ll tell you right now.
My work shows that yes indeed, Clean Surplus analysis shows predictability just as was suggested by the fragmented literature that spans almost a century.
You see, we all know Warren Buffett is doing something right and after you read this book, you will know just exactly what he is doing right. And what he is doing right is called by us mere mortals Proven Success.
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