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Buffettology
July 3, 2007, 8:36 am
Filed under: investments/finance/economics

Personal notes from Buffettology by Mary Buffett and David Clark

A real gem, because it is different from other Buffett books since it explains the quantitative techniques behind Buffett’s investment philosophy, instead of merely the qualitative aspects. Disclaimer: the quantitative methods in the book are not in anyway fully endorsed by Buffett himself; rather, it is Mary Buffett’s own interpretation of Warren’s techniques.

I photocopied the pages that explains the numerical methods; I can’t transcribe them here because it is simply too inconvenient to do so.

My basic takeaway from reading the book is that Buffett looks for predictable earnings and places a lot of emphasis on return on equity.

Earnings for each year is split into two: dividends and retained earnings. Retained earnings are used to expand the equity base, which in turn helps generate more earnings, hence leading to a compounding virtuous cycle that increases the value of a company. Hence a high ROE has a great compounding effect when combined with retained earnings on future earnings.

Buffett consider shares as an “equity/bond”; they have an expanding “coupon” that is basically the interplay between increases in earnings and ROE. Yields on amount of cash paid is compounded through the virtuous cycle. Hence it is possible to reach a rough estimate of future value of share by multiplying future earnings by the historical P/E, being as conservative as possible while projecting values. Businesses selling at “high” P/E are often still good purchases if they fetch a high ROE and good earnings yield, especially if the high P/E commanded persists or even increases in the future.

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