Warren Buffet Masterclass 2 - Buying Companies

Whether or not you will ever purchase a business, or sell one, the principles, as taught by Warren Buffett, are valuable because you can apply them equally to investing in shares and to valuing a company as a prospective employee.

Helping managers to win

Buffett has developed a highly effective approach to business management through buying companies and helping their managers to win outstanding results. As with his investing in stocks, Buffett rarely diverts from three clearly articulated principles:

Three Key Principles of Business Purchase
1 Buy good businesses at fair prices.
2 Insist on the seller offering a price.
3 Look for evidence of consistent earning power.

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Investment in the broadest sense

Even if you do not become a strict follower of Buffett, always have clear, effective criteria for your investment decisions, and always stick to those guidelines. If you are considering buying part of a business - that is, investing in stocks - study this Masterclass to enhance your abilities and success as an investor.

The principles are also a good guide to whether you should join a particular company. You are, in effect, an investor. You are investing part of your life - your most, valuable possession - in the employer. Use the Buffett approach to see whether the company is likely to give you full value in return. Unless it can, look for a better "investment" elsewhere.

When looking for a new employer, people are naturally anxious. Be just as cautious when making any decisions about the value of a company. Buffett, a superb acquirer, has written: "we face the inherent problem that the seller of a business practically always knows far more about it than the buyer". Remember that.

Stick to guidelines

Most managers who buy other companies do far worse than Buffett. That is because they depart from his guidelines, despite their crystal-clear logic. Buffett's advice adds up to a series of "don'ts".

Buy on beneficial terms

* Do not pay a premium over the intrinsic value of the business.

* Do not get swayed by emotion rather than reason.

* Do not use "funny figures" to make the buy appear better.

* Do not buy a company simply because it is cheap.

* Do not use shares in an acquisition if you will not get full value in return.

* Do not pay attention to the seller's forecasts of future earnings.

Full obedience to these "don'ts" would prevent most mergers and acquisitions from taking place: Buffett would welcome this. He believes that, however seductive the "strategic" motives, you should buy only on terms that benefit you financially. But truly beneficial deals are hard to find and execute, which is why you should be especially careful.

Measuring motives

There will always be more companies available than you can buy, whatever you can afford. You must also consider management capability; it is all too easy to "bite off more than you can chew". You will rarely find that mergers and acquisitions go as smoothly as you hoped, or yield all the financial benefits that were expected by the time they were expected. So, what are your motives?:

Do you find making this deal more fun than running the business, and is that why you are interested?

Are you pursuing the deal because you have a strategic purpose in mind?

If so, how exactly will achieving that purpose enhance the intrinsic value of the business?

If not, why are you considering the deal at all?

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Robert Heller has written Business Masterclasses for eight great gurus,including Warren Buffett. Download Warren Buffett's Masterclasses now with a free 2-month trial to Letter To Thinking Managers. If you choose to maintain your subscription you will receive all 24 Masterclasses free during your first year.