When investing, one should view oneself as business analysts—not as market analysts, not as macroeconomic analysts, and not even as security analysts. Warren Buffett does not think in terms of market theories, macroeconomic concepts, or sector trends. Rather, he makes investment decisions based only on how a business operates.
Three things that define investment:
- Changes in working capital,
- Capital expenditures (net of depreciation), and
- Acquisition (net of divestitures)
It is suggested spending a lot of time understanding how much money is going into a business, where it’s going and what kind of return it’s going to enjoy. The way to look at a business is to keep producing more and more money over time.
The idea of buying stocks without understanding the company’s operating functions – its products and services, labor relations, raw material expenses, plant and equipment, capital reinvestment requirements, inventories, receivables, and needs for working capital—is unconscionable, says Buffett.
Buffet criteria is to invest in a simple and understandable business with consistent earning power, good ROE, less debt and run by honest people whom we like, and priced attractively relative to their future prospects and good management in place. He is not interested in turnarounds, hostile takeovers, or tentative situations where no asking price has been determined. It makes no sense to invest in a company or an industry you don’t understand, because you won’t be able to figure out what it’s worth or to track what it’s doing: From “The Warren Buffett way” by Robert G. Hagstrom