Warrent Buffett

Warren Buffet’s investment philosophy

1. Economic reality, not accounting reality:

Financial statement may not represent the economic reality of a business. Accounting doesn’t consider intangible assets such as trademarks, patents and customer relationship etc, which are valuable assets. Investment decisions should be based on economic reality rather than accounting reality.

2. Discounted cash flow (DCF)

Intrinsic value of a business has to calculate PV of expected future cash flow. Also consider tax and margin of safety.

3. Opportunity Cost:

Comparing the return from opportunities is to decide on best available openings by using the potential rate of return.

4. Risk-free approach:

Use risk-free investment approach. No debt financing and preferred cheap stocks not cheap companies and mergers and acquisitions. To reduce risk he used risk-free rate of return with long term investment strategy.

5. Portfolio diversification:

Diversification is not necessary and investors should concentrate on business that they understand the most rather than businesses that they don’t know.

6. Performance measurement:

His performance measurement is based on intrinsic value and economic reality rather than book value.

7. Investment strategy:

Buffett preferred gathering all kinds of information and analyzing them against alternatives. He believed investing in stock is the same as investing in business therefore he preferred rational long-term investment approach.

8. Corporate governance:

He didn’t rely nor believed much in agency theory.

Comparing Warren Buffett’s investment philosophy with the theory of finance

Other differences: It is also different with respect to the diversification concentrating only on businesses that their portfolio can be understood as well as efficient capital market hypothesis (EMH) by considering undervalued companies and stocks as well as unrecognized franchises.