Important Note: Below you will find the first several pages of an in-depth 20-page special report -- Investing Like Buffett. In this report StreetAuthority.com founder Paul Tracy and his staff deliver an extensive analysis of investing legend Warren Buffett. After introducing you to a host of concepts that Buffett looks for in a quality value investment, the report then analyzes a variety of ways for you to profit from Buffett's wisdom.  These include investments in various mutual funds that track Buffett's moves, an analysis of specific companies that Buffett currently owns, and an in-depth look at five additional top-notch firms that Mr. Tracy and his staff feel meet many of Buffett's stringent investment criteria. We sincerely hope that you benefit from the following investing ideas and analysis. Although we're happy to provide you with the initial few pages of this report free of charge below, please note that to read the full version of this report, you'll need to take action in one of the following ways: Gain immediate access to this report when you sign up for a subscription to Paul Tracy's biweekly Market Advisor newsletter. Learn more about the subscription options for that publication and view a listing of reports available with each subscription term. If you've already gained access to this report through a recent subscription, then you will now be able to review this report in its entirety. Note: If you're already a paid subscriber and would like to view a complete listing of all reports and courses you have access to, please visit this link.

Investing Like Buffett
How to Profit from the Wisdom of the "Oracle of Omaha"

Born, raised and residing in Nebraska for most of his life, Warren Buffett is affectionately known to many as the "Oracle of Omaha."

Buffett remains the most successful and best recognized value investor in modern stock market history. And there’s good reason for that fame. According to the Forbes list of wealthiest people, Warren Buffett is the second-richest man in the world with a total net worth in excess of $30 billion. Even more importantly, he is one of only a handful of names on that list to attain virtually his entire wealth via investments in the stock market.

(1.)  THE EARLY YEARS

From an early age, Warren Buffett exhibited a strong penchant for business and the market. But Buffett’s skills weren’t pure instinctive talent; on his path to riches the Oracle was influenced by several prominent financiers of his day. Chief among them was Benjamin Graham, who gained fame as an investor in the wake of the 1929 crash, a time when most shunned stocks as investment vehicles. Graham was badly burned by the Great Crash, and the highly defensive investment philosophy he developed in the 1930s was molded by that adversity. In fact, many know him as the father of value investing; Graham looked for stocks that were trading well below their actual values and that offered what he called a "margin of safety."

The influence of Graham runs deep in Buffett’s philosophy. Buffett read Graham’s book, The Intelligent Investor, while studying at the University of Nebraska. Later in life he referred back to it often, indicating that it was, "By far the best work on investing ever written.” Buffett also studied under Graham at Columbia Business School, earning the only A+ ever awarded to a student for that course. What’s more, in the 1950s Buffett briefly worked for Graham’s company.

But that’s not to say that Buffett is just a carbon copy of Ben Graham. The father of value investing was focused mainly on balance sheet analysis--looking for companies with assets that far exceed their stock market values. He wasn’t overly concerned with management or even a particular firm's business model. Instead, he focused primarily on what the company’s assets were worth and how that figure compared to the firm's market value. Back in Graham’s day, there were a number of companies that fit his strict investment criteria; the Crash of 1929 scared the investing public away from stocks for years. As a result, many stocks were trading at extremely low valuation levels. By the 1960s, however, stocks that met Graham’s value criteria became far less common. By that point in time most businesses were valued at levels that, in addition to the value of their current assets, at least partially accounted for the firm's future growth prospects.

Buffett clearly modified his mentor’s strict value approach as he began his investment career in 1956, forming the Buffett Partnerships mainly with investments from family and friends. For example, as my staff and I will discuss in greater detail below, Buffett studies management teams very carefully before investing. In addition, he is always firmly focused on what a company does and the value of its business model, not simply the value of its asset base. What has endured from his Graham mentorship, however, are the concepts of a margin of safety and intrinsic value.

Buffett’s first partnerships were highly successful, as the Oracle of Omaha returned over +250% in his first five years as a manager compared to less than a +100% return from the Dow Industrials. Just ten years after he started the Buffett Partnerships, a still-young Oracle had amassed an investment portfolio of over $44 million; his initial investment of just $100 had ballooned in value to a stake worth nearly $7 million, an enormous sum in 1966.

By 1970, Warren Buffett had dissolved his partnerships, claiming he was unable to find any compelling values in the market. It was in that year that he took on the title of Chairman of Berkshire Hathaway (BRKa), which at the time was merely an odd hodge-podge of textile and financial businesses. Over the ensuing 34 years, Buffett has built the company into one of the most powerful financial conglomerates in the world, largely through his prowess in investing in high quality companies at bargain basement prices and holding on for long-term returns. Buffett's list of winning stock picks has grown quite long over that time period, and has included stocks like Coca-Cola (KO), Washington Post Co. (WPO), and, of course, insurance giant General Re.

My staff and I could simply present you with a chart of Berkshire Hathaway's share price performance going back to the 1970s. As you might guess, it would show tremendous growth in value over that time. However, that wouldn’t be much in keeping with the Oracle’s own investment philosophy. Instead, check out our chart of the growth in Berkshire’s book value--theoretically the liquidation value of the company’s assets--since he first became involved with the firm in 1965. Buffett includes this book value data in his famous annual Chairman’s letter to Berkshire shareholders under the title “Berkshire’s Corporate Performance.” Amazingly, under Buffett’s stewardship, the company has produced an average annualized rise in book value of over +22%, more than double what the S&P 500 offered over the same period. As you can see from our chart, those market-beating returns really add up over time.

Berkshire’s performance is proof positive of the wisdom and value of Buffett’s approach. Not surprisingly, dozens of books have been written on the subject, probing virtually every aspect of the Oracle’s biography and all of his legendary investment decisions.

Of course, it’s impossible to neatly distill all of his wisdom into any single book or article. However, we can study some of the key concepts and fundamental criteria that underpin Warren Buffett's approach to investing. Some of the concepts that follow are rather nebulous and subjective. Meanwhile, others are more numbers and statistics based. However, the bottom line is that a solid understanding of each can help improve any investor’s performance. Let’s review:

Easy-to-Understand Businesses
If you’re a fan of retired Fidelity Magellan fund manager Peter Lynch, then you may remember his “buy what you know” concept. Buffett has long espoused a similar investing mantra. Essentially, Buffett believes in limiting your investments to companies with businesses that you can easily understand and analyze. After all, if you can’t understand how a business makes money and what sort of markets it’s involved in, then how can you possibly estimate its true value?

Even more importantly, it’s easier to forecast future results for companies with straightforward and uncomplicated business models. Buffett always strives to look into the future when he invests, searching for businesses that he feels will still look solid 10 or 20 years down the road.

While most investors nowadays are attracted to the vast profit potential from technology stocks, Buffett’s most successful investments have come from investments in more simple Old Economy businesses. As an example, take one of the Oracle’s first purchases--See’s Candy. See’s operated a small chain of retail candy stores in the western part of the U.S. When Berkshire Hathaway bought the company in 1972 the stores were well known for high-quality candy products that commanded premium prices.

See’s is a perfect example of an easy-to-understand Buffett business. The company boasts a profitable niche franchise and a lasting brand name. The candy business is also very simple--a few basic commodity raw materials like sugar and chocolate are manufactured into a variety of sweets, and these are then sold for a huge premium over their manufacturing costs. Demand for sweets is stable and unaffected by economic cycles, so it’s fairly easy to predict what the firm's earnings picture will look like 10, 15 or 20 years in the future.

The other implication of the easy-to-understand mantra is, of course, Buffett’s avoidance of the technology space. Buffett claims to have never fully understood all of the business and economic forces that are at work in this highly volatile sector. It’s also more difficult to understand exactly what these companies do, why businesses need to buy their products and how demand changes over time. Buffett, therefore, has largely ignored technology stocks. Ironically, despite a long-term friendship with Microsoft chief Bill Gates, Buffett never bought that tech blue chip.

But don’t assume that Buffett is just some investing dinosaur who invests in a bunch of readily understood consumer stocks. Berkshire’s most important single industry group is insurance; the company owns GEICO and General Re and remains one of the world’s largest insurers. You may think that insurance is a rather complicated business, but it still fits in well with Buffett’s investing mantra.

Buffett has spent years studying the insurance industry, and he now understands it better than most other insurance executives. For example, when he was still 21 years old his interest in Ben Graham’s teachings led him to visit GEICO, where Graham was chairman. Buffett traveled to Washington, D.C. and reportedly spent hours studying and discussing the company's books with its chief financial officer. More recently, Buffett knew General Re’s management team and basic business long before he purchased the reinsurance giant in the 1990s.

If you're looking to put Peter Lynch's "easy-to-understand" criteria into practice in your own investing, then perhaps the best advice comes from Lynch himself. He’s always said that if you can’t explain a business and why you own its shares in just a few, coherent paragraphs, then you should sell it. We think Buffett would agree.

Low Debt Levels
Buffett looks very carefully at a company’s debt burden before investing. Most of his big investing success stories have been in stocks like Coca-Cola, Washington Post and, more recently, Moody’s (MCO). All of these names sported relatively low debts when Buffett invested.

Investors largely ignored debt burdens in the 1990s, focusing instead on growth metrics. And over the past few years, some analysts have discounted the importance of debt; extremely low interest rates have made corporate debt burdens relatively easy to service. However, debt remains an absolutely crucial item to watch and Buffett hasn’t wavered in his focus on this metric. As Buffett himself so eloquently expressed in his 1987 letter to shareholders: “Good business or investment decisions will eventually produce quite satisfactory economic results, with no aid from leverage.”

Companies can generate cash to fund growth from two major sources: taking on debt or using internally generated cash in the form of retained earnings (profits made but not passed on to shareholders in the form of dividends). There is, of course, a third way--issuing more stock--but this hasn’t been very common in recent years, at least not in the U.S. Buffett likes to see companies that fuel future growth through shareholder’s equity, basically the sum of a company’s net assets (total assets minus total liabilities) and retained earnings.

Companies that can grow using only their shareholder’s equity are more or less internally financed. In other words, these firm's aren’t dependant on money from banks, new shareholders or bondholders to stay in business. By contrast, companies with large debt loads are usually reliant on external financing--in most cases this means the capital markets--to keep growing and operating.

There are risks to these external financing sources. We all know that conditions in the capital markets can shift on a dime. Back in 1999, for example, a tech company could get showered with cash by simply listing its stock for public trading. By 2001, however, a bear market in technology stocks essentially closed that window. The same can be said for the bond market--interest rates rise and fall and bond investors’ perception of risk sometimes changes overnight. Ultimately, these risks can result in a more volatile earnings stream.

When looking to measure a company’s reliance on debt, it's important to examine the firm's debt-to-equity (D/E) ratio. D/E can be easily calculated simply by dividing a particular company’s total debt load by its shareholder’s equity. Both of these key figures are located on the balance sheet. There’s no hard-and-fast rule for evaluating this metric, but as a broad average for non-financial companies, it's usually wise to look for firms with D/E ratios below 0.50 (50%).

Profitability and Return-on-Equity
A concept somewhat related to the D/E ratio is return on equity (ROE). In fact, if there’s one single piece of financial data that’s more often associated with Buffett than any other, it’s ROE.

The calculation of ROE is simple and it’s quoted on just about every financial website. Simply divide a company’s net income--defined as total profits after interest, taxes and depreciation--by its shareholder’s equity. This ratio measures how much profit a company produces relative to shareholders’ investment in the firm. In other words, ROE answers one critical question: How much money does a firm make for its owners?

But don’t assume that you can invest like Buffett simply by running a screen for stocks with very high ROEs. There are a couple of additional points to keep in mind. First, make sure to look for a stable or rising ROE over time. If a company has a particularly strong year, then its net income figure can be inflated, which can cause ROE to exceptionally strong. Such one or two-year blips have a tendency to fade quickly once the business environment becomes less favorable.

Many tech companies, for example, produced enormous ROEs in 2000 only to see reduced profitability (ROEs) in 2001 and 2002. Instead of looking at these figures in isolation, it's always important to examine ROE performance over a 5 or 10-year period. Check out our chart of the ROEs over time for Cisco Systems (CSCO) and Coca-Cola (KO). Coke’s return on equity has hovered above 30% over the past five years and has never varied more than a percentage point or two over that entire period. By contrast, Cisco's ROE dipped into the red in 2001 and never exceeded 15% until this year. Coke certainly seems to be the more dependable company.

The second point to consider is the relationship between ROE and D/E. By taking on additional debts, companies can effectively lower the amount of shareholder’s equity they need to stay in business. This has the tendency to inflate ROE. It’s crucial, therefore, to look for companies that have high ROEs and low D/Es.

END OF FREE CONTENT

Please note that the reminder of this report is available exclusively to paying customers.
In it, Mr. Tracy and his staff devote the next 15 pages to the following topics:

       -- Managerial Expertise  
       -- Intrinsic Value, Margin of Safety and Valuation  
       -- Economic Moats  
       -- Free Cash Flow and Owner's Earnings   

  3.  HOW YOU CAN PROFIT FROM BUFFETT'S WISDOM  
       -- Buffett's Picks  
       -- Betting with Buffett  
       -- Applying Buffett's Teachings

In the members-only sections listed above we introduce you to a number of other concepts that Buffett looks for in a quality value investment. The report then moves into an analysis of various ways for you to profit from Buffett's wisdom. These include investments in various mutual funds that track Buffett's moves, an analysis of specific companies that Buffett currently owns, and an in-depth look at five additional top-notch firms that Mr. Tracy and his staff feel meet many of Buffett's stringent investment criteria.

Important Note:  To gain access to the remainder of this report today, you'll need to complete one of the following steps: Gain immediate access to this report when you sign up for a subscription to Paul Tracy's biweekly Market Advisor newsletter. Learn more about the subscription options for that publication and view a listing of reports available with each subscription term. If you've already gained access to this report through a recent subscription, then you will now be able to review this report in its entirety. Note: If you're already a paid subscriber and would like to view a complete listing of all reports and courses you have access to, please visit this link.

Good investing!

Paul Tracy
Editor in Chief
StreetAuthority.com
Washington, D.C.

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