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Searching For Fortune?

If you're searching for fortune in the stock market, then don't listen to Warren Buffett! For those who do not know him, Warren Buffett is the CEO of Berkshire Hathaway. He is the second-richest man in the world (Forbes, 2005). Buffett has amassed enormous wealth by investing in the stock market.

Buffett can best be described by this statement: do as I say and not as I do.

It is no secret that in order to be successful in the stock market your strategy must be different than what the "street" is doing. It is also clear that if Buffett reveals his-stock picking strategies, every so-called investor out there would simply copy him and Buffett's investing returns will become mediocre, by default.

Buffett has hinted several times in his letters to the shareholders' on his strategy. Most people now believe that Buffett's strategy is to buy stocks that are trading below its intrinsic value (i.e. the discounted present value of future cash flows). Buffett admits that his strategy only works for a very small number of businesses that are stable and those that he can understand.

Buffett was a friend and the favourite student of Benjamin Graham. Graham is considered the father of "value investing" and is the author of The Intelligent Investor and Security Analysis. Graham stressed the importance of the past performance of a company (not the stock) in order to get an indication on its future.

Buffett's concept of intrinsic value, on the other hand, is to look at the future cash in-flows and out-flows generated by the company, discount those at an appropriate rate, and come up with the stock's present value. The present value of a stock is normally arrived at by looking at the cashflows for the next ten years.

Now, no matter how stable a company is, it is incredibly difficult to predict its cashflows for the next year, let alone for the next ten years! Even stable companies can show large variations in cashflows from one year to the next. Therefore, coming up with a company's intrinsic value based on its future cashflows alone does not sound very intelligent and it is not characteristic of Graham's teachings whom Buffett had a keen interest in.

I think Buffett is misleading the public with his "intrinsic value" concept. Buffett has never revealed how he calculates the intrinsic value but he claims to do it in his head in under a minute. Although it is not too difficult to calculate the intrinsic value, its dependability is highly questionable. How good are the cashflow numbers for eight, nine and ten years into the future? It is also interesting to note that the bulk of the intrinsic value is made up of the cashflow figures for the later years, than the earlier years.

Buffett will have an edge over everyone else as long as he does not reveal his stock-picking strategies and the best way to maintain that edge is to send the "sheep" on a wild goose chase!

2 comments:

Intrepid said...

Very good one! There was also an interesting study done where it was found that any stock "tip" or "hot lead" usually works itself into the price of the stock in under three minutes! So much for the neighbourhood stock analyst recommendations...:)

Incidentally, since you asked on my blog, my company website is at http://www.niiconsulting.com

Anonymous said...

I think the author lacks even the most simple ideas of investing.

read more and then comment,

cheers

 
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