Principles

• Think of buying stocks as buying fractional interests in whole businesses.

• Construct a focused low-turnover portfolio.

• Invest in only what you can understand and analyze.

• Demand a margin of safety between the purchase price and the company's long-term value.

Buy great businesses when they are having a temporary problem or when the stock market declines and creates bargain prices for outstanding franchises. Stop trying to predict the direction of the stock market, the economy, interest rates, or elections, and stop wasting money on individuals that do this for a living. Study the facts and the financial condition, value the company's future outlook, and purchase when everything is in your favor.

Dividend discount model: The value of any investment is the discounted present value of its future cash flow.

Business Tenets

• Is the business simple and understandable?

• Does the business have a consistent operating history?

• Does the business have favorable long-term prospects?

According to Buffett, the economic world is divided into a small group of franchises and a much larger group of commodity businesses, most of which are not worth purchasing. He defines a franchise as a company whose product or service (1) is needed or desired, (2) has no close substitute, and (3) is not regulated. Individually and collectively, these create what Buffett calls a moat --something that gives the company a clear advantage over others and protects it against incursions from the competition. The bigger the moat, the more sustainable, the better he likes it. A franchise that is the only source of a product people want can regularly increase prices without fear of losing market share or unit volume.

Conversely, a commodity business offers a product that is virtually indistinguishable fro the products of its competitors. Years ago, basic commodities included oil, gas, chemicals, wheat, copper, lumber, and orange juice. Today, computers, automobiles, airline service, banking, and insurance have become commodity-type products. Despite mammoth advertising budgets, they are unable to achieve meaningful product differentiation. Commodity businesses, generally, are low-returning businesses and "prime candidates for profit trouble." Since their product is basically no different from anyone else's, they can compete only on the basis of price, which severely undercuts profit margins.

Management Tenets

• Is management rational?

• Is management candid with its shareholders?

• Does management resist the institutional imperative?

Financial Tenets

• What is the return on equity?

The test of economic performance, Buffett believes, is whether a company achieves a high earnings rate on equity capital ("without undue leverage, accounting gimmickry, etc."), not whether it has consistent gains in earnings per share. To measure a company's annual performance, Buffett prefers return on equity--the ratio of operating earnings to shareholder's equity.

• What are the company's "owner earnings"?

Instead of cash flow, Buffett prefers "owner earnings": a company's net income plus depreciation, depletion, and amortization, less the amount of capital expenditures and any additional working capital that might be needed.

• What are the profit margins?

• Has the company created at least one dollar of market value for every dollar retained?

Value Tenets

• What is the value of the company?

Buffett tells us that the value of a business is the total of the net cash flows (owner earnings) expected to occur over the life of the business, discounted by an appropriate interest rate. He considers it simply the most appropriate yardstick with which to measure a basket of different investment types: government bonds, corporate bonds, common stocks, apartment buildings, oil wells, and farms.

• Can it be purchased at a significant discount to its value?

THE FOCUS INVESTOR'S GOLDEN RULES

1. Concentrate your investments in outstanding companies run by strong management.

2. Limit yourself to the number of companies you can truly understand. Ten to twenty is good, more than twenty is asking for trouble.

3. Pick the very best of your good companies, and put the bulk of your investment there.

4. Think long-term: five to ten years, minimum.

5. Volatility happens. Carry on.

MANAGING MONEY THE WARREN BUFFETT WAY We should not forget that over the years many devotees of Warren Buffett's investment approach have taken his philosophy and applied it to different parts of the stock market. Several prominent investors have bought stocks not found anywhere in Berkshire's portfolio. Others have bought smaller-capitalization stocks. A few have taken Buffett's approach into the international market and purchased foreign securities. The important takeaway is this: Buffett's investment approach is applicable to all types of businesses, regardless of industry, regardless of market capitalization, regardless of where the business is domiciled.