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The Warren Buffett Way Synopsis

The Warren Buffett Way Synopsis

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Published by blockeisu
Summary of The Warren Buffett Way. Useful in gaining insight into Buffett's investment strategies.
Summary of The Warren Buffett Way. Useful in gaining insight into Buffett's investment strategies.

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Published by: blockeisu on Apr 13, 2010
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05/13/2013

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Team Shark 
 Analysis of The Warren Buffett Way
February 11, 2007
 
Throughout
The Warren Buffett Way
, many measurements, numbers, and ratios are usedin evaluating a business. When evaluating the business, it is important to remember management is also taken into consideration along with these figures. The following arewhat we have determined to be the most important.
Return on Equity (pg. 110)
When evaluating annual performance, Buffett states that return on equity isimportant to look at. He believes that it is a more important measurement than earnings per share. This measurement is defined as the ratio of operating earnings to shareholders’equity or total equity, which is found on the balance sheet. However, Buffett does notuse the ROE stated in the financial statements; he tells us that several adjustments should be made to this ratio to make it more accurate. The first adjustment he suggests is thatsecurities should be valued at their purchase price rather than their current market pricewhen determining shareholders’ equity. The second adjustment that is recommended is toremove all capital gains and losses, and any extraordinary items when figuring operatingearnings.This measurement is important to Buffett because it demonstrates management’sability to generate above-average returns with the amount of capital employed. SinceROE is the product of profit margin on sales, total asset turnover, interest burden, tax burden and financial leverage, Buffett looks favorably on high ratios in all of these,except having high financial leverage. He does not like high financial leverage because itimplies a lot of debt. To Buffett, good quality companies should be able to produceenough cash without using much debt. Somewhat comparable to ROE, he does not like
 
earnings per share in this instance because the numbers can be manipulated byaccounting to reflect higher values.
Owners’ Earnings (pg. 113-114)
Owners’ earnings is an important measurement tool to Buffett since it is a keymeasurement in evaluating a company’s intrinsic value. To find the intrinsic value of acompany, one must project a series of cash flows for a company out into the future andthen discount them back to a present value. But, the important part is that there aredifferent cash flow interpretations people can use. Buffett uses what he calls owners’earnings instead of just the overall cash flow value off the cash flow statement. Buffett’sowners’ earnings not only equal the company’s net income plus depreciation, depletion,and amortization, but it also includes a subtraction of capital expenditures and workingcapital.Buffett takes into account capital expenditures because he believes it should beexpensed as an everyday item like labor and utility costs. If it isn’t, the profitability of the company would decrease due to the long term deferment of expenses. The only bad part of including capital expenditures is how they are very hard to predict. Nevertheless,Buffett clearly states how a prediction in this category is better than not including one atall.
Intrinsic Value (pg. 13-15, 122-130)
Though owners’ earnings is very important, it is just a component in finding acompany’s overall value, or rather what Buffett calls its intrinsic value. While there are

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