Learn to invest with Buffett

Chapter 42

Chapter 6, Section 6, the sixth trick of the stock gods in stock selection: the manager of the company is also a factor to consider

Managers who see themselves as leaders of the company don't lose sight of the company's primary goal—to increase the value of shareholders' holdings.At the same time, they will make rational decisions in order to further achieve this goal.

--Warren Buffett
Managers are the leaders of the business.When choosing investment objects, Buffett attaches great importance to examining the quality of the business managers.Buffett believes that companies run by managers with the following three characteristics are the most worthy of investment:

1. Managers are rational
Rational managers can determine the fate of the enterprise.The best test of managers' rationality is how they distribute excess cash, that is, how they distribute surplus.

Generally speaking, in the first stage of a company's development, because of the need to develop products and establish a market, expenditures are often greater than income, and retaining all the surplus is not enough to meet the needs of development, and loans are needed.Decision-making at this stage especially requires rationality and logic, choosing the right development direction, determining a moderate investment scale, formulating an efficient marketing model, and laying a good foundation for the company's next stage of development.

In the second stage, the company's profitability has been greatly enhanced. The company's operating model has gradually revealed its own characteristics, and its products have gradually gained a firm market position. However, the cash flow required for internal production has also increased sharply, and the company's own cash flow is often insufficient. Meet the company's rapid expansion and development needs.Therefore, at this stage, the distribution of surplus needs to be considered comprehensively, taking into account not only the return on investment of shareholders, but also the development of the company.Retaining all earnings to feed the company is an option, but disregard for shareholder interests often leads to complaints.Therefore, managers should fully consider the interests of all aspects, raise appropriate debts, and choose other effective financing channels, or raise the funds needed for development by issuing stocks.Calmness and rationality are the basic requirements that the company puts forward for managers at this stage of development. Those managers who are at a loss or even dizzy in the face of difficulties will only ruin the company's development prospects.

The third stage is the maturity stage.The company slows down and begins to generate more cash than it needs to expand and operate.At this time, how to reasonably allocate surplus, plan the company's expansion plan, and allocate development funds will become a huge test for operators.

The final stage, the recession stage.Companies start to experience a simultaneous decline in sales and profits, but still generate excess cash.If the rate of return on reinvesting excess cash exceeds the company's cost of equity capital, the rate of return required by the company's shareholders, the company should retain all profits for reinvestment.On the other hand, if the rate of return on reinvestment is lower than the cost of capital, then it would not make sense to retain profits and reinvest them.

If a company generates more cash than it needs to invest internally and to maintain operations, but continues to invest in the company's business to obtain an average or below-average return on investment, then the company's managers are not profitable. There are three choices when allocating:

(1) Reinvest in the company's existing business.

(2) Buy growing businesses.

(3) Distribution to shareholders.

It is at this decision-making crossroads that Buffett pays special attention to the behavior of business managers.Because it is here that we can truly reflect whether the behavior of the company's managers is rational.

Buffett believes that the only reasonable and responsible way for companies with increasing excess cash but unable to create above-average reinvestment returns is to choose the third method: by increasing dividends or buying back stocks, the Earnings are returned to shareholders.

Case description:

A company whose stock market price is $30 has an intrinsic value of $60.

Every time a manager decides to buy back stock, he buys something worth $1 for $2.For the shareholders who hold the stock, the income is extremely obvious and very high.In this case, if managers actively repurchase shares, it shows that they are rational and wise, pursuing the maximization of shareholders' interests, rather than blindly pursuing the expansion of the company's scale and business.Such managers run companies that can be trusted to invest boldly in.

2. Managers are honest and pragmatic

Buffett believes that whether managers are honest and pragmatic to shareholders is an important factor in measuring the quality of stocks.Whether managers are honest and pragmatic mainly includes the following aspects:

(1) Whether managers can fully and truthfully disclose the company's financial status to shareholders, and explain the reasons for business success or failure.

Buffett has always respected those managers who fully and truthfully disclosed the company's financial situation to shareholders at the annual meeting of shareholders, explained the reasons for business success or failure, and admitted and corrected mistakes.They admit mistakes as much as they announce successes, and can be honest with shareholders.Buffett especially respects those managers who don't use generally accepted financial accounting principles to conceal and package the real situation of corporate performance.

Buffett emphasized that regardless of whether they follow generally accepted accounting principles, managers should truthfully answer three questions for shareholders:

①How much is the company worth?
② How likely is it that the company will repay its debts in the future?

③ What is the working status of the management personnel?Did they complete the tasks assigned to them?
Berkshire, which Buffett is in charge of, pays great attention to the interests of shareholders. At the annual shareholders' meeting, Buffett always keeps a low profile and introduces the annual investment status very sincerely.If he encounters an unsatisfactory investment year, Buffett always sincerely apologizes and explains the reasons to investors.Berkshire shareholders have always trusted and understood Buffett.Berkshire's annual report not only conforms to GAAP standards, but also provides a lot of additional information.Buffett details the individual earnings of Berkshire-owned businesses, as well as other relevant information that can help shareholders analyze the company's operations.Buffett respects corporate executives who use the same candor in their disclosures to shareholders.

(2) Does the manager have the courage to discuss failure?
In his decades of investment career, Buffett has always respected and praised those managers who have the courage to discuss failure.

According to Buffett, most annual reports are bogus.Every company will make some mistakes of varying sizes.He believes that most managers' reports are too optimistic to be true.This may take care of their own short-term interests, but in the long run, everyone will suffer.

Those managers who have the courage to discuss the company's failures with shareholders are very valuable, because most managers are used to reporting good news but not bad news.In fact, good managers should be able to admit mistakes as honestly as they publish their achievements, and be honest with shareholders in all aspects.

3. Managers have personality and not follow blindly
Some managers know that their management and operation methods are wrong, but when they see other companies, under the same management method, they can appear to be profitable every quarter on the surface (in fact, these companies have already begun to experience operational crises), Most managers then blindly follow others in the same wrong footsteps without taking the risk of trying to change the business model.resulting in failure.

Why do the management of these enterprises blindly follow others?
Buffett identified four factors that he felt most influenced management behavior:

(1) Most managers cannot control their desire to act.This desire to be hyperactive often finds catharsis when mergers and acquisitions take over other businesses.

(2) Most managers routinely compare sales, earnings, and executive salaries with peers and companies in other industries.Such comparisons, Buffett notes, trigger hyperactive behavior from corporate managers.

(3) Most managers often overestimate their own management capabilities.

(4) Copying what others say, not using their brains, imitating rotely.If more than three companies approach a problem in the same way, a fourth will follow suit without hesitation.

Investment motto:

Buffett pointed out that there are not many investors who can beat the market in the market and obtain huge returns. Following the crowd is equal to following mediocrity, because the behavior of the market public is often irrational or even very stupid.Operators must have their own personality, which is very important to the operation of the enterprise. A leader who has personality and does not follow blindly is the guarantee of stock profits.

(End of this chapter)