WHERE BUFFET WENT WRONG....
Warren Buffet, considered one of, if not the great investor of all time, has few but significant flaws with both his qualitative and quantitative analysis of securities. I'm not saying he is sub-par by any means, but rather a few small valuation measures would have prevented him from buying some of his... let me see awful stock picks. I am referring to the financial industry ex-( goldmansachs and G.E as I believe their were stong political forces at work there).
1) To make this a short and informative post, I will list what warrent buffet looked for in a company
A) Good company with a comparative advantage, good managment, easy to understand, earnings predictability, etc.
B) He like low debt, high returns on total capital (net income/(bv equity+ bv debt), high return on equity, efficient utilitzation of retained earnings, consistent eps growth for 5-10 year and positive free cash flow. So what's missing? - His investment in wells fargo, US bankcorp, AXP clearly shows 2 major flaws in the quanatitive analysis in addition to a violation of his own regards to the qualitative.
i) He obviously didn't understand fractional reserve banking nearly well enough because his risk averse style of investing would have preventd him from purchasing financials. Sure they has all of the above characteristics and paid out excess profits if they couldn't get a better return on their investment. Althoug I'm a young man with exponentially far less funds than buffet, I had common sense to get 75% out of the market a few hundred points after the doe crossed 1200. I didn't know where the bubble was as the time, and found virtually no values in the market (Likely because I am extremely stringent). I say this because, The FED artificial manipulation of the Fed funds rate which indirectly effects the loanable funds market, caused the financial companies to act recklesslly (remember fractional reserve banking). In short, buffet didn;t practice what he preached. On one more note, it is virtually if not completely impossible to derive a positive value via discounted cash flow model.
ii) To really understand a company, one must be aware and knowledgable concerning the economic landscape. Buffet obviously thought 97'-2007' was just a period of great economic growth and the conitinous national and consumer debt were sustainable with a rather low chance of substancial defaults. He was blind to the fantasy world financed by credit and foreigners and his actions showed no cause for concern whatsoever. Why Do I Think This? He would have sold or trimmed american express, wells fargo, USB, ETC.
iii) Should he have incoporated the well known "magic formula" by Joel Greenblatt, he would have been forced to avoid all financial stocks to begin with. Not to dwell on this formula, but it is basically a measure of two things (earnings yield (Enterprise Value/ EBIT) & return on TANGIBLE CAPITAL( EBIT/(NET FIXED CAPITAL + NET WORKING CAPITAL). This metric would have ranked last of any industry, thus redirecting capital towards more favorable investments.
CONCLUSION: I'm not ripping on Warren Buffet by any means, but rather pointing out the shortcomings of a few particular investments due to the fact he ignored his own investment philosophy and lacked one small but extremely telling measure of the quality of earnings.