Warren Buffett has amassed a fortune of more than $60 billion. This book is a bit older so it only shows Mr. Buffett’s worth at $30 billion. The wealth and job creation based on his work is truly revolutionary. Berkshire Hathaway, which is the entity that he works out of, is a conglomerate of businesses that employ more than 250,000 people through companies like GEICO, Burlington Northern Railroad, See’s Candy and Helzberg Diamonds. When Warren Buffett evaluates a business it is a straight forward decision: YES, NO and Too hard. The too hard category keeps him focused on his circle of confidence which we will touch on in the book.
Why is this important to me?
I start all of the book summaries with this question because if we cannot answer it then there is no sense in wasting your time watching the video. The simple answer here is knowledge. One of the best ways to learn is by what I call OPE. OPE stands for other people’s expertize. Since Mr. Buffett probably won’t take my phone call and mentor me personally, does not mean that I can’t learn from him. Timothy Vick outlines in the book several things that Warren does to generate wealth. The real power in all of his strategies comes down to the power of compounding. Understand this concept and you too can benefit financially from this book.
OPT – Other people’s time is really where Mr. Buffett has been able to amass true wealth. Berkshire Hathaway’s tax return in 2009 was over 15,000 pages long. The corporate headquarters does not look like Enron. They have 20 people at corporate. The true value of OPT comes from betting on the right “Jockey”. All of the CEO’s that run the various businesses of Berkshire Hathaway are world class. This is a key component to investing in the RIGHT business. OPT is a critical component to how Mr. Buffett invests. He does NOT want to run the businesses. He simply wants to allocate capital.
If you know anything about Warren Buffett then you know that he loves to invest in Insurance Companies. This gives big tax advantages as well as access to free money known as “Float”. The float invested wisely can bring in big returns. This is the classic example of using other people’s money to make a profit. One other thing that is relevant under OPM is the concept, “Velocity of Money.” Understanding this concept can make you rich. Have you ever wondered how a grocery store can make a profit if their average profit margin is 2%? The answer is inventory turns which are a classic example of “Velocity of Money.”
Timothy Vick breaks down the book into 5 sections. I will cover portions of each section for the sake of time. Developing a mathematical Mind – Before you hit the pause button or jump away from this video let me put a disclaimer on this one. You do not need to be a math geek to do these principles. With the internet, all of this stuff is done for you. What I am going to highlight are the differences small movements make which can determine losses and gains.
1. Understanding Opportunity Costs – This concept is important for any part of your life. The concept is simple. If you decide to cook dinner tonight then you cannot simultaneously go out to dinner as well. You have chosen one over the other. If you buy a $50,000 car then you can NOT use that $50,000 to invest. Also, that car does not cost you $50,000 but costs you $1,000,000.
2. Price and Value compound together. Price and value are not the same thing in terms of investing. Some people would say that a $5 per share stock is cheaper than a $50 per share stock. Understanding value will let tell you if that is true or not. The $50 stock may be “cheaper. Buying at the right price and value together magnifies your results through compounding.
3. Hitting for a high average – Ted Williams was a great baseball player with a batting average over.344 in his career. He broke down the strike zone into areas that he could most likely hit successfully. Basically what this means is that he controlled his swing to make sure he had the highest success rate. Mr. Buffet does the same thing to guarantee a.900 batting average on his investing. Thus he only focuses on companies that he understands, great businesses that can be run by average people and buying at a cheap price.
One thing that value investors do is analyze companies to determine if they are overpriced or underpriced. I have invested in the stock market BEFORE learning these tools and I can tell you from experience that I have received everything but the kiss in terms of losses. These principles are an absolute necessity if you want to guarantee your financial future. Simply turning over your money to a quote “financial person” is not the way to secure your future.
1. Coveting Moats – This basically means that the company must have a durable competitive advantage. If you look at See’s Candy, this company has been in the business for 100 years and has a coveted moat. They make high margins in a relatively “Easy” business. They do NOT have to plow all of their profits into capital for the next model year. This means that this business is NOT capital intensive where a car manufacturer is capital intensive. Another Buffet owned company is Dairy Queen. I am sure you have heard of it. They sell ice cream and have a durable competitive advantage through their brand. The good news is you can measure the power of the moat through the numbers.
2. Rule Number One – There are two rules of investing that HAVE to be understood. Rule One is don’t lose money and Rule number two is don’t forget rule number one. This simple rule has power. Let’s say you invest $1,000 and you make a 50% gain. You now have $1,500. Let’s say you have a 50% loss instead. Now you have $500. For you to get back to even, you need a 100% gain on the $500. This is the hidden power of Rule one.
3. Valuing a business – This book along with a few others that we will profile in future videos describe in simple terms how to value businesses. Once you know how to do this then investing in stocks is much more comforting and easy. The goal here is to find a $2 value and pay $1 in price. If you buy stocks like you buy groceries then this becomes easy to do and takes the mystery out of all the tech terms of investing. Understanding Return on Equity, Free Cash flow, Sales Growth and other indicators is the key to valuation.
We have two main competitive advantages over Mr. Buffet today. When he started investing, he had to do all the calculations manually. He would read financial statements 12 hours per day. Today we can use the internet for all of our investigation and you can simple plug in numbers and do simple multiplication, division and addition to figure out future value of the companies you are interested in. Also, we have the BENEFIT of size. The average size of a stock market purchase is 400 shares. When companies trade a millions of shares per day then our orders do NOT affect price. When Mr. Buffet has to allocate billions of dollars, this action can move markets. The analogy here is Mr. Buffet is a freighter and we are jet skis. This means we can buy and sell before the market turns. An excellent follow up book which I will profile is called Rule One Investing by Phil Town. It really goes into detail on these points.