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Thinking Like an Owner: Buffett's Guide to Intelligent Capital Allocation

By sagebytes —

Warren Buffett's Investment Best Practices

From the 1984 Berkshire Hathaway Annual Letter

Core Investment Philosophy

  • Intrinsic Business Value: Focus on growth in per-share intrinsic business value as the true economic measurement, not accounting earnings.
  • Businesslike Approach: View investments (including bonds) through a businessperson's perspective - "Investment is most intelligent when it is most businesslike."
  • Long-term Thinking: Judge performance over extended periods, not yearly results. Berkshire uses a five-year rolling average for evaluating historical performance.

Equity Investment Principles

  • Quality Over Price: Seek exceptional businesses with outstanding economics, even at fair prices.
  • Management Integrity: Value shareholder-conscious management teams that demonstrate pro-shareholder actions.
  • Concentrated Positions: Maintain high concentration in a few well-understood investments rather than broad diversification.
  • Circle of Competence: Define your area of special competence with extraordinary realism and act decisively within it. Ignore propositions outside that area.
  • Patience: "Masterly inactivity" is often the hardest but wisest approach when no suitable investments present themselves.

Capital Allocation Wisdom

  • Reinvestment Criteria: Retain earnings only when there is reasonable prospect that for every dollar retained, at least one dollar of market value will be created for owners.
  • Share Repurchases: When companies with outstanding businesses find their shares selling far below intrinsic value, no alternative action can benefit shareholders as surely as repurchases.
  • Acquisition Requirements:
    • Large purchases (at least $5M after-tax earnings)
    • Demonstrated consistent earning power
    • Good returns on equity with little debt
    • Management in place
    • Simple businesses (avoid complex technology)
    • Fair pricing

Risk Management

  • Financial Strength: Maintain exceptional financial strength to capitalize on opportunities when they arise, especially during industry downturns.
  • Intelligent Risk-Taking: Be willing to make uncommon decisions with potential for criticism if the underlying economics make sense. "Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press."
  • Avoid Debt: Prefer businesses that earn good returns on equity while employing little or no debt.

Business Operations Wisdom

  • Operational Excellence: Study the Blumkin family's approach:
    • Apply yourself with extraordinary enthusiasm and energy
    • Define your area of competence and act decisively within it
    • Ignore enticing propositions outside that area
    • Behave with high integrity in all dealings
    • "Sell cheap and tell the truth"

"We have prospered in a very major way - as have other shareholders - by the large share repurchases of GEICO, Washington Post, and General Foods, our three largest holdings." - Warren Buffett