The Warren Buffett Way

Some books tell the story of Warren Buffett's life, and some try to explain how he thinks when deciding where to put his money. The Warren Buffett Way, by American investment manager Robert G. Hagstrom, published in 1994, is the second kind: it nearly ignores his childhood in Omaha and goes straight to the point, which criteria Buffett uses to pick a company and which ones he uses to turn one down.

Hagstrom organizes those criteria into a checklist of four groups of tenets (business, management, financial and market) and tests each group against real Berkshire Hathaway purchases, such as the Washington Post and Coca-Cola. It is less life story, more X-ray of a decision.

It is worth reading even if you have no plans to become a stock investor, because much of the method works for evaluating any business: the corner diner, the shop a relative wants to open, or the company promising you a new job.

Benjamin Graham was Buffett's professor at Columbia and defended an almost mathematical discipline: buy a stock at a price well below what the company's numbers said it was worth, creating a cushion against miscalculation. It is a cold, spreadsheet-driven method that treats the market as a place to bargain-hunt for numbers.

Philip Fisher thought differently. To him, numbers alone don't tell the whole story, and it is worth talking to a company's suppliers, competitors and customers to understand whether management is good and the product has a future. Hagstrom calls this the scuttlebutt method: listening to everyone around the business before deciding.

Buffett started out leaning more toward Graham, buying cheap by the numbers, and gradually took on Fisher's focus on the quality of management and product. The method described in the book is born from that fusion: start with the numbers, finish by evaluating people and brand.

Charlie Munger pushed Buffett away from the strategy of buying a bad company just because it was cheap, which Buffett himself nicknamed taking one last puff from a cigar butt: a small, one-time profit before the business goes out for good.

The turning point, according to Hagstrom, was accepting a fair price for an excellent company instead of a low price for a mediocre one. An excellent company keeps generating profit year after year, while a bad company usually stays bad, only now with the investor's money inside it.

That change in criteria explains later Berkshire purchases that weren't cheap by Graham's classic numbers but were justified by the lasting quality of the business, a kind of bet the Graham of the 1930s would probably have turned down.