I found this invaluable list of Berkshire Hathaway shareholder letters from 1977 through 2005. These will take a long time to read. I would suggest reading one per night for the next month. Really take your time with them. Buffett likes to keep things simple, so the ideas from these letters will not be over your head, even if you are a novice.

These letters alone are worth more than a collection of a dozen other investment tips books, or hundreds of “get rich quick” books and newsletters. Simplicity in investing at its best, and proof that you don’t (and shouldn’t) need to trade stocks every hour, or every day, or even every month to be a solid investor. The next time someone tells you value investing is boring, ask them, “what’s so boring about Warren Buffett’s multi-billion dollar fortune?” Point out how many new Ferraris it could buy.

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Yesterday, I looked at how Warren Buffett thinks. Today, we take a look at how he does it. Here are some of his preferred methods:

Return on Equity = Net Income / Shareholder’s Equity. Look at this stat over 10 years for a company. Yes, that does involve a lot of math. You need to understand how this type of investing works and the time it involves.

Debt Equity Ratio = Total liabilities / shareholder’s equity. You want a low number here. A high number indicates the company is financing itself with debt. That means they are more volatile, and interest rate hikes could hurt this company more than a competitor without as much debt.

Profit Margin = Net income / net sales. Is this number high? Is it increasing? That would be a very good sign. These numbers usually only increase when management has firm control over costs while at the same time driving good sales numbers.

Other questions (and Buffett’s preferred answers):
Has the company been around for 10 years or more? (Yes)
Does the company rely heavily on one commodity, such as oil or steel? (No)
Is the stock selling at a 25% discount to real value? (Yes)

This is not set in stone. You can go back and find many great Buffett investments that did not meet this criteria. That said, if you can find a few stocks that meet everything above, you will have a very good chance of seeing nice returns over the next few years.

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I had to revisit the “How to Think Like Warren Buffett site, because I think it’s a great resource for investors everywhere. The ideas behind Buffett’s investments are much more important than their names or even how they performed in the long run. Trying to copy Buffett’s success by investing in what he’s bought recently is about as useful as trying to win the World Series by signing players from the 1975 Cincinnati Reds. What was good once may be on social security now.

Berkshire Hathaway’s success can be traced to the kind of investments they make. People call their investments old-fashioned, centered around companies that make things like food and furniture. That statement might be partially right, but it misses a key concept. Buffett has always preferred investing in companies that he can understand. He wants to know how they make their money, what their market is, what the rational future expectations might be. Older companies just tend to be simpler to understand.

A candy maker pays for sugar, other ingredients, and manufacturing equipment, along with employee wages. Their revenue comes from selling the candy. They will probably also have marketing costs. Add up the revenue and subtract the costs and you’ve got a good idea how much money they make.

Check out the trackback for more information on thinking like Buffett, although I doubt anyone can really get into his mind. I’m told he’s always been a bit of a savant with numbers, with the ability to look at a balance sheet and figure out what numbers look wrong in mere seconds. It was a feat his mentor, Benjamin Graham, was also known for, although not on Buffett’s level. In order to make up for that lack of skill, you’ll have to put in even more hours pouring over the numbers.

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