After a review of my investing plan, I went back and revisited Warren Buffet’s Berkshire Hathaway(股票代號: BRK-A; BRK-B) business acquisition criteria, that help shaped the basis of my investment criteria. The fact that we at tradeoptions4living.com here, on many occasions, advocate traders and investors to generate a list of investment/trading ideas that one should stick to and follow regularly, the criteria that I am going into detail here can help formed your watchlist.
The following is the acquisition criteria that has been in place at Berkshire Hathaway for a long time, it is “succinct and simple”. The difference between investing and trading is that, investing requires a very long horizon, patience, and does not usually require week in and week out getting in and out of positions. The idea is to identify excellent businesses that are temporarily trading at depressed market quotational price, preferably much lower than its intrinsic value, as calculated based on its high certainty future cashflows discounted back to the present with an appropriate discount rate.
The essence of trading is basically the pure capturing of the positive market quotational differences by identifying and following some sort of trends. Underlying businesses characteristics are of little use relative to the issue’s market price behavior. Trend analysis are usually achieved by technical analysis, which is useful in identifying short term prominent trends, supports and resistances. The time frame for trading is usually short, from fraction of a second to weeks or months. Therefore, options(short and especially long when done properly) are excellent vehicle for short term trading because of the capital requires(leverage).
Catalysts are very important in affecting a significant market quotational change. Investment at depressed price requires catalysts, also known as the generosity and subsequent agreement of the masses to bring prices back to the appropriate level. It is similar with trading in this regards that most traders are buying or shorting in anticipation of some catalysts kicking in to realize the significant price change, it’s just that technical analysts hope to shorten the time horizon with their fantastic tools. More importantly, it is the “right catalyst” that propel a stock price to behave the way traders expected them to behave. In this case, that’s why it is important for traders to “stop loss” if the catalyst(s) were wrong or fail to stimulate the price the way the traders envisioned from their technical analysis. On a more depressing note, the biggest whales such as Buffett, Icahn, Soros and big name fund managers can provide their own catalysts simply because they can make a lot of noises and are watched and followed religiously, while you and I, until we become whales, are at the mercy of others seeing what we saw in an issue. Please don’t forget about tradeoptions4living when any of you become a whale.
While this idea is not advocated by most financial planner and/or money manager, because investing(the Warren Buffett fundamental/value way) is different from speculation, legendary investor Warren Buffett is very comfortable putting the majority of his fund in one or a few companies. That is because he does not put a time line in his investments, he simply sits and waits, and lets the price runs its course. The duration is usually much longer than what traders have in mind, but because he purchased at a price so good that the annual return of his investments usually outperform the broadmarket index. Long term value investors, after doing their homeworks, do not stop loss simply because of daily market quotation loss, or sell because of a quick gain. They incorporate the criteria I am detailing here to ensure the investments, or more clearly, the underlying businesses, perform above average for a very long time with high return on capital. Make sure you do not mix trading with investing by not stopping loss with your long options. Long options lose time value everyday, and if the anticipated price movement do not occur within your “time frame”, or the movement go against your expectation, one must stop loss. Because intelligent investing is to avoid permanent capital loss, trading long options by definition is not investing buffett style(due to time value degradation), you must exercise cautions when determining what portion of your capital you should commit for long options speculation.
We are eager to hear from principals or their representatives about businesses that meet all of the following criteria:
(1) Large purchases (at least $75 million of pre-tax earnings unless the business will fit into one of our existing units),
(2) Demonstrated consistent earning power (future projections are of no interest to us, nor are “turnaround” situations),
(3) Businesses earning good returns on equity while employing little or no debt,
(4) Management in place (we can’t supply it),
(5) Simple businesses (if there’s lots of technology, we won’t understand it),
(6) An offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when price is unknown).
The larger the company, the greater will be our interest: We would like to make an acquisition in the $5-20 billion range.
Criteria #2 is what defines an excellent business. The crust of investing is defined at Berkshire Hathaway, the transfer of purchasing power to others now with the reasoned expectation of receiving more purchasing power-after taxes have been paid on nominal gain- in the future.
Consistent earning power-A trait only the very best businesses with a certain moat or moats protecting them from competition can demonstrate consistently, simply because in economics above average return on capital attracts competitions, and this tends to reduce the return back to around average. The very best businesses have characteristics either tangible and/or intangible that help them overcome their competitions.
The fact that future projection is of no interest to Buffett demonstrates the idea that his style on investing only allow this whale to swim in established businesses with great business models, and criteria #5 only stipulate that the business is easy to understand.
Criteria #3 is the definition of good return. During good time, debt tends to magnify the return earned on equity capital, but debt also enhance the inherent business financial risk. Do not be fooled by above average return utilizing a large amount of debt, one must check to see if this is a common characteristics among its industry, but even then, beware of high leverage as when the tide of good time is gone, you don’t want to be revealed as swimming naked.
Criteria #5 is very important for the average long term investors. A simple business that does not require constant innovation can usually operate with lesser working capital than technology intensive businesses. Or simply put, boring simple business protected by some form of moats that are easy to understand allows long term investor to assess, with relative ease, the long term performance of this business. This resonates with the idea of circle of competence. The average joe has a small circle of competence meaning they can understand the simplest businesses the best. As your investing and business intelligence increase, one can increase his or her circle of competence. For example, an engineer may know why the technologies at certain high tech firms help contributed to their dominance, and how these scenarios of market dominance may evolve, such idea of business projection may be out of the scope of the average joe but crucial in determining the business future if one can decipher such complications.
Master these concepts, and you are on your way to enhance the quality of the business names you will be following, and actually understand what makes you want to follow these names.