1. Investing Principles for mutual fund and stock investors University of Maryland November 19, 2009

2. Buffett’s Early Comments on Investing “You will not be right simply because a large number of people momentarily agree with you. You will not be right simply because important people agree with you.” “You will be right, over the course of many transactions, if your hypotheses are correct, your facts are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason.”

3. Performance of Investment Managers “In the great majority of cases, the lack of performance exceeding or even matching an unmanaged index in no way reflects lack of either intellectual capacity or integrity. I think it is much more the produce of: Group decisions – my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; A desire to conform to the policies and (to an extent” the portfolios) of other large well-regarded organizations; An institutional framework whereby average is “safe” and the personal rewards for independent action are in no way commensurate with the general risk attached to suck action; An adherence to certain diversification practices which are irrational; and finally and importantly Inertia.”

4. Active Management versus Ownership Mentality Actively managing a portfolio of stocks comes with costs: Taxes Short-Term Capital Gains – ordinary income Long-Term Capital Gains – 15% (likely going up to 20% or higher) Transaction costs Commissions Spread

5. Slow Growth High risk portfolio strategies can generate big returns and big losses. A management more geared to slow and steady can be as good of a wealth creator as one generating high returns with high “risk”.

6. Combining Ownership and Slow Growth When you factor in the benefits of less transaction costs, less taxes (i.e., tax deferral), and a slow and steady philosophy, you create a very powerful wealth creation mechanism.

8. Why Ignore Growth of Earnings? Companies that operate in a level playing field with no competitive advantages or barriers to entry have no value in their growth. Their return on capital equals the cost of capital

9. Asset Value versus Earnings Power Value If asset value > EPV, then company is underutilizing the assets to produce the level of assets. If asset value = EPV, then the company has no competitive advantage and future growth supports cost of capital If asset value < EPV, then the company has a competitive advantage.

10. Competitive Advantage Once a company with a competitive advantage has been identified you have to compare the EPV with the current market capitalization of the firm. Market cap = current stock price times number of shares outstanding. If EPV > market cap then buy IF EPV </= market cap then you have to determine if the competitive advantage is sustainable and worth the premium (i.e., understanding a business).

11. Intel versus VMWare Establishing Intel’s earnings power value and determining if it was a “value” buy? Adjusted earnings Establishing VMWare’s earning power value and determine if it is a “value” buy? Adjusted earnings

12. Understanding a Business Five competitive forces Entry; Threat of substitution; Bargaining Power of buyers; Bargaining Power of suppliers; and Rivalry among current competitors

13. Understanding Industry Growth Introduction Industries evolve because some forces are in motion that create incentives or pressures for change Growth The key to achieving industry growth when selling to repeat buyers is either stimulating rapid replacement of the product or increasing per capita consumption. Maturity Reduction of uncertainty may attract new types of entrants into the industry. Decline

14. Understanding Industry Evolution When growth levels off in an industry there is a period of turmoil as intensified rivalry weeds out the weaker firms. Remaining firms will experience above average profitability if there are competitive advantages. Entry and mobility barriers

15. Recap of information Develop your strategy and stick to it Low turnover and slow growth can win big Earnings Power Value Competitive Advantage Business and Industry Growth

16. Questions?