BURGOS, Maryden

BSACC 2-1 | Output in FINN22 Financial Management

CASE STUDY: Warren E. Buffet, 2005

What I have observed with the strategies of Buffet in investing is that they implicate a slowly but surely
outcome. This observation was proven with his statement stating that, “Lethargy bordering on sloth remains
the cornerstone of our investment style.” This means that he buys a huge amounts of stocks that he perceives
risk-free or certain and works on them for years by allowing those investments to slowly grow. Moreover, to
furtherly support this strategy by Buffet for the growth of Berkshire is that he always look for big acquisitions
which he prefers to call as “elephant.” Example would be when the Berkshire’s wholly owned subsidiary,
MidAmerican Energy Holdings Company acquired the PacifiCorp which is the currently leading, low-cost
energy producer and distributor at that time. It was stated that their previous investments amounting to $10
Million, or even triple of such value only increased their net worth by 1% or even as low as ¼%. With this
data, I agree with his strategy that instead of pooling low-quality investments, just focus on carefully seeking
the “elephant.” Also, it seemed like Buffet, or the Berkshire believed that those investments are actually good,
it’s just that the long-run effects for them was not as pleasant as they perceived. Therefore, I believe that
Buffet wanted to relay the message of finding the investment that suits your company and that will surely
produce big economic growth in the long run. For further digging on his investing moves, let’s take a look at
his investment philosophies.

Buffett’s Investment Philosophy based from the Bekshire Hathaway’s Annual Report on 2005 are the
following:

1. Economic reality, not accounting reality. As we all know, financial statements made by accountants
that follow the conventional GAAP generally portrays the overall performance and position of a
company in the market. However, for Buffet, these statements and whatever information accountants
may gather from their analysis of them do not really align with the real economic performance of the
company. He even furtherly stated that, “Accounting consequences do not influence our operating or
capital-allocation process.”

I somehow disagree with the idea of Buffet. Firstly, I believe that there’s nothing wrong with
accounting conservatism, and it’s actually a good practice. Why? Because accounting conservatism
requires accounts to be prepared with high degree of caution and verification in a way that companies
practice recording outright any probable losses while gains are not recognized until fully acquired. It’s
a good practice for it means that companies are not complacent and always have their guard up.

Secondly is that the Accounting is backward-looking wherein he refers, I believe, to the fact that in
accounting, accountants give so much importance to the historical data of a company when
formulating an analysis which I, again, believe to be a good practice. Because comparability is a great
measurement of the companies’ growth over time; if accountants will not go back to the previous
years’ records of a company, they would not be able to evaluate whether a company is growing or
declining, benchmarking with the outside market is not enough. Also, Buffet said that economic
reality is at the level of the business itself and not the market, the economy, or the security which is
the main essence of why accounting is backward-looking – to measure the growth of the company
based only on its very own performance.

Lastly is that accounting is governed by the Generally Accepted Accounting Principles or GAAP. He
argued that since accounting is governed by GAAP, factors such as intangible assets are given a very
small amount of significance which in economic reality might be very valuable in investment decision
making, and that GAAP is merely measuring the results of a company through net profit and through
its flows of cash. The latter statement is true because in GAAP, we have this principle called
Materiality wherein accountants should determine the significance of a transaction or a financial
resource based on its amount or the cash flowing from its usage. However, I don’t agree with the
BURGOS, Maryden
BSACC 2-1 | Output in FINN22 Financial Management

former for materiality principle suggests that may it be an intangible or tangible asset, if material then
considered to be a huge determining factor.

2. The cost of the lost opportunity. Buffet said that in testing the attractiveness of an acquisition or
investment, look at it as a “lost opportunity.” I agree with this idea for it looks at any investment
decision in a deeper manner. It’s like benchmarking and choosing which one will give you the biggest
lost and regret once not chosen. Hence, it just makes sense that he looks at his investment choices as
options and not a yes/no decisions. This, therefore, minimizes opportunity loss because of hasty
decision-making.

3. Value creation: time is money. Basically, what Buffet is trying to point out with this idea is that
intrinsic value is the only logical way to evaluate the attractiveness of investments and businesses for
intrinsic value is relatively the true value of an asset unlike the book value. I agree with this because
intrinsic value is futuristic in a way that it measures the value of an investment based on its future
cash flows and earnings potential which will encourage companies to look at sustainability rather than
quick profit.

4. Measure performance by gain in intrinsic value, not accounting profit. I somehow agree with this
because, again, intrinsic value is futuristic, which means that relying on intrinsic value as a metric for
economic performance of a company is relying on the investments underlying value and potential
flows of cash rather than just looking at its reported earnings in the financial statements. It is a
refreshing idea to do not only look at a surface level, but to also consider the future because looking at
intrinsic value triggers a long-term effects unlike focusing solely on the profitability since the latter is
only a short-term goal for the company.

5. Risk and discount rates. Identifying and minimizing risks have always been a crucial decision factor
in taking an investment. However, for Buffet, he dismissed the idea of having risks. He believes that
instead of finding or measuring the affiliated risks in an investment, why not find a risk-free
investment? He highly values certainty and believes that risk only comes from not knowing what
you’re doing.

I somehow disagree with this idea because I believe that there is no such thing as risk-free investment.
The rate of returns rooted from risks; hence, investments with higher risk offer higher returns. Also,
with regards to certainty, I think that it’s difficult to have a certain measurement of your potential
returns or loss in an investment for there are a lot of external factors in the market that could highly
affect the movement of your investment. Hence, the closest to certainty is the discounted rate for it is
used to discount future cash flows based on relative risks and time value.

6. Diversification. Buffet argued that instead of investing in different correlated assets to offset risks, it
makes more sense to just wait for one exceptional company for diversification is only a protection
against ignorance. I agree with Buffet here for I think that diversification is unnecessary because
instead of investing in a pool of low-quality investments why not just invest in a high quality one and
concentrate on figuring out how you can increase its value. However, diversification is still a good
strategy, especially to those investors who are very cautious because high quality investments
obviously will require higher risks.

7. Investing behavior should be driven by information, analysis, and self-discipline, not by emotion or
“hunch”. Buffet emphasized that awareness and information are the foundation for investing which I
highly agree because investing is a big step for an individual or a company for they will allocate their
assets in an uncertain project. Hence, being knowledgeable with how the market moves, being
financial literate, and having patient rather than being aggressive are very important skills an investing
BURGOS, Maryden
BSACC 2-1 | Output in FINN22 Financial Management

individual must possessed for investing is a long-term process and results or your expected returns
will not happen overnight.

8. Alignment of agents and owners. Buffet left the statement, “We will only do with your money what
we would do with our own.” He meant to say that the interests of agents and owners are always
aligned and should never contradict to avoid potential problems; in short, they will only do what’s
best for their investors. I highly agree with this because like financial managers, shareholders’
interests and how to increase their wealth are the top priorities of the company. Also, because the
wealth of the shareholders is a good measurement of the economic performance of a company for
they are a residual stakeholder in a way that they will receive what’s left after the employees,
creditors, etc. have received their compensation or payment. Therefore, if the dividends being
distributed to the shareholders increased, it means that the earnings of the company increased as well.