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Financial Cockroaches: Why Buffett Avoids Companies with Weak Accounting

By sagebytes —

Warren Buffett's Investment Best Practices

Based on Buffett's 2002 shareholder letter, here are the key investment principles and best practices he outlines:

Value and Price Discipline

  • Only invest when you see a "very high probability of at least 10% pre-tax returns"
  • Be willing to sit on the sidelines when attractive opportunities aren't available
  • "Occasionally successful investing requires inactivity"
  • Prioritize sensible purchase prices as part of your "entrance strategy"

Business Fundamentals

  • Focus on "conservatively financed businesses with strong competitive strengths, run by able and honest people"
  • Look for companies with economic characteristics "ranging from good to great"
  • Pay attention to a company's float and its cost when evaluating insurers
  • Be wary of businesses that are "overloaded with debt" or "operate in industries characterized by low returns on capital"

Management Quality

  • Assess both the ability and fidelity of managers
  • Look for management that thinks and acts like owners
  • Be suspicious of companies that regularly announce earnings projections and growth expectations
  • "Beware of companies displaying weak accounting" - poor accounting choices in visible areas often indicate similar issues elsewhere

Financial Reporting Red Flags

  • Watch for companies that don't expense options or make fanciful pension assumptions
  • Be wary of companies that trumpet EBITDA as their primary performance metric
  • "Unintelligible footnotes usually indicate untrustworthy management"
  • Remember: "There is seldom just one cockroach in the kitchen"

Long-term Perspective

  • "Buy to keep" rather than focusing on exit strategies
  • Avoid derivatives and complex financial instruments that create hidden risks
  • Maintain financial strength to weather any "megacatastrophe risk"
  • Be prepared for occasional large losses in certain investment categories

Stewardship Mindset

  • Treat business ownership as stewardship
  • Consider not just returns but also risk exposure
  • Maintain reserving discipline, particularly in insurance operations
  • Stay within your circle of competence