Buffett and Beyond

Uncovering the Secret Ratio for Superior Stock Selection

Joseph Belmonte

• Publisher: Wiley
• Year: 2015
• Print ISBN: 9781118955772
• eBook ISBN: 9781118955789
• Edition: 2
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Construct a portfolio that is sure to outperform market averages

Warren Buffett had it right all along. Now it's your turn to learn how to construct a portfolio that is sure to outperform the market averages, as well as almost every professional money manager in the world. Warren Buffett's method of predictability can determine a future target price, which in turn determines his all-important purchase price. However, Buffett doesn't draw conclusions of his predictability method relative to the future total returns of portfolios. That's where Buffett and Beyond comes in, taking Buffett's method one giant step beyond, proving that if you select a portfolio of stocks using the predictability method in this book, you will outperform 96% of professional money managers over the long term.

In addition to the information in the book, readers will have access to a password-protected website that includes tutorial videos, PowerPoint slides, free trial access to a video newsletter, and a trial subscription to the author's computer program, which follows the research presented in the book.

• Explains Clean Surplus Accounting (CSA) to determine Return on Owners' Equity (ROE)
• Uses CSA to determine ROE in a unique way to verify Buffett's all-important purchase price
• Draws conclusions between Clean Surplus Return on Equity and future total returns
• Shows that every portfolio selected from the S&P 500 index with above-average Clean Surplus ROEs outperformed the S&P average during the test periods from 1987 to the present

If you're an investor, this book will impact your financial life forever.

Chapter 1
The Purpose of This Book—Your Journey

The purpose of this book is simple. It is written so that you, dear reader, can very easily develop your own set of portfolios, which should outperform most of the professional money managers of the world. It is written with the K.I.S.S. principle in mind: Keep It Simple, Silly!

Since the last publication of this book, we have proven that our growth strategy works as well as the doctoral research said it should. Our model portfolio has outperformed the S&P 500 Index by more than two to one over a 12-year compounded rate of return. Our model portfolio has also outperformed Buffett’s Berkshire Hathaway by almost two to one over this same time period. This outstanding performance was achieved without taking on more than market risk. And now, we show you how to hedge (insure) those portfolios in order to lower risk to a very manageable level.

During the interim between the first edition and this book, we’ve developed a dividend growth and income portfolio, which uses the Clean Surplus method as the basis for our stock selection. We want to select stocks with a 7 percent expected growth in dividends and another 8 percent anticipated growth in stock appreciation. This is a great portfolio, which all of us should have going into the future. We will show you how to structure your own dividend and income portfolio in Chapter 21.

We have added Chapter 25, which will discuss insuring our portfolios. Portfolio insurance costs money, but we will discuss how to generate extra money in our portfolios (enhanced income) in order to pay for that insurance.

The basis for our stock selection in both portfolios is our new computer program. Talk about making life easier in a manner that saves us hundreds and even thousands of hours. When I began my research, I had several classes of finance students who helped me with the original research. But they all eventually graduated, and I began to spend less time teaching and more time developing intellectual property. The answer, of course, was to find someone who could write a computer program that followed our proprietary algorithms. We will go over the use of the computer program we developed so that those who use it can structure their own portfolios. We’ve always had a computer program, but in the past several years we had a professional put his extensive touch on it, so even I can use it with great ease.

Finally, for folks who do not want to develop and monitor their portfolios themselves, we can direct you to professionals who are certified to use the Buffett and Beyond stock selection method to develop portfolios. This is one reason we developed our website, appropriately addressed as www.BuffettAndBeyond.com.

Please allow me some time to tell you what this book is not. This book is certainly not an accounting book. However, it does discuss Clean Surplus Accounting, which is very possibly the simplest accounting method based upon the easiest-to-understand principle in the world. It will be very easy for you to understand because you actually use it every day and so does someone who is admired by the entire investing world.

We will find out how Warren E. Buffett, the world’s greatest investor, utilizes this method. We will learn that a very simple ratio developed from this method (which you also use all the time) will tell us almost all we need to know about a company’s operating efficiency. We will then use this ratio to compare one company’s operating efficiency with another company’s operating efficiency. Following operating efficiency, the discussion will focus in great depth on why the most widely used ratio of comparison, return on equity (ROE), is so misused and misunderstood. Next, we will discuss why investors who use the traditional accounting ROE are doomed to underperform the averages.

The traditional accounting ROE cannot be used as a comparison ratio between companies. However, the ROE as configured by Clean Surplus is another story. In fact, it is our story.

Our next step will be to venture one step beyond and discuss my in-depth research on portfolio construction and how we can attempt to predict the future returns of our newly developed portfolios.

In other words, we will discover not only how to structure a superior performing portfolio, but we will also learn how to determine the predictability (or not) of the future total returns of that portfolio.

We will finally develop two very simple buy-and-hold portfolios. A buy-and-hold portfolio helps keep the taxman from becoming a partner in our everyday decisions, because it does not require everyday trading decisions. However, there are definitely rules on when to sell some of our portfolio positions.

I will always remember what a well-seasoned money manager told me just as I was beginning my education in the stock market. He wisely said that most times it was much better taking your client out to lunch rather than sitting in front of a computer screen trying to make those few extra dollars.

What he was trying to tell me was forget about short-term gains and concentrate on developing great long-term investment portfolios for the clients. Then you can spend all the extra time telling the clients about the merits of the superior portfolios you built for them instead of trying to trade those portfolios.

Thirty years later, this lesson helped me remember that I cannot single-handedly balance the U.S. budget deficit by paying extra taxes on those short-term gains that, to tell the truth, elude me to this day.

Warren Buffett has also formulated some pretty sound investment principles over the years. Let’s learn from “the great one” and try not to reinvent the investing wheel. The man doesn’t hide his thoughts or actions from us. It would be a foolhardy person who ignores Buffett’s proven method of success.

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SUMMARY

1. This book will show you a very simple system designed to exhibit the predictability (or not) of a company’s operating performance.
2. We will learn how to structure a superior growth portfolio.
3. We will learn how to structure a superior dividend and growth portfolio.
4. You will learn how Warren Buffett, known as the world’s greatest investor, uses this very simple system.
5. We will then discuss the research, which shows how to use the predictability of the simple accounting system called Clean Surplus in order to obtain superior portfolio performance.
6. We will later discuss some of the aspects of a company that Buffett looks for, which have earned his proven and successful results.

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Chapter 2
About Warren Buffett

I’m not here to tell you all about the investing life of Warren Buffett. What I will discuss with you is how he uses just a few numbers from the income statement, at least to an extent that we can understand and utilize, in a very simplified manner. Thus, this book will not go into detail about Mr. Buffett. There are so many wonderful books already written about him, and every one of them I read in the past is certainly worth reading more than once. He has been called the “world’s greatest investor” and the “greatest investor of this century.” Whatever we call him, I know this for certain: We all want to be like Warren.

A friend of mine who is an admirer of Buffett (like really, who isn’t?) once told me that just before he (my friend) died, he hoped Buffett’s life (and not his own) would flash in front of him.

We were sitting at a beachside tiki hut in Florida, drinking one or four beers, when he mentioned flashing lives, so I wasn’t sure if he was talking about Warren Buffett or Jimmy Buffett, but hey, we were happy talking about stocks (like Warren) and watching the ocean (like Jimmy). After all, isn’t that the way it’s supposed to be?

Now that we’ve discussed Warren Buffett’s life in such great detail (I’m joking of course), let’s talk about numbers. After all, I certainly believe that the numbers tell us almost everything we need to know about a company. Let me clarify this statement. If used properly, the numbers will tell us almost everything we need to know about a company.

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If used properly, the numbers tell us almost everything we need to know about a company.

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If we use the correct numbers in the correct way, the bottom-line results will tell us which companies we want in our portfolio and which companies should be in someone else’s portfolio. The problem is most analysts out there in “Investment Land” are using the wrong numbers. But after you finish with this book, we really won’t care about the analysts out there in Investment Land.

Where is the Investment Land of which I speak? Top of the tower of Big Ben at midnight. Second star to the right and fly away ‘til morning. Yes folks, many analysts and portfolio managers really believe that Never Never Land is the same place as Investment Land.

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Most investment analysts use the wrong numbers for stock selection. I know; I’ve taught many of the present and future analysts in my college classes.

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How do I know most investors are using the wrong numbers for stock selection? I’m a college and university teacher (my third career). I teach my students finance the way (well, almost the way) the academic community demands finance be taught. My students then go out into the real world and use these very methods taught to them by the academic community. Most of the academic community truly believes that if you know accounting and finance, then you know how to select stocks for a portfolio.

Folks, this just isn’t necessarily so, and I’ll teach you why very soon. Let’s just say this for now. As long as students are taught finance by the present establishment and then go out and use this knowledge in the investing community, Warren Buffett will always have job security as the world’s greatest investor. Even in Never Never Land.

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Learning about finance and l...

Table of contents

• Cover
• Titlepage
• Copyright
• Dedication
• Preface: From Then Until Now
• Introduction: A Sea Story
• Chapter 1: The Purpose of This Book—Your Journey
• Chapter 2: About Warren Buffett
• Chapter 3: Determining the Earning Capacity of a Company (Now Really, Can It Be This Easy?)
• Chapter 4: My Theory of Why Most Money Managers of the World Cannot Outperform the Market Averages
• Chapter 5: A Very Simple Income Statement and an Even Simpler Balance Sheet
• Chapter 6: The Return on Equity Ratio
• Chapter 7: The Return Portion of the Return on Equity Ratio
• Chapter 8: The Equity Portion of the Return on Equity
• Chapter 9: How to Determine an Equitable Equity Number
• Chapter 10: The Predictability of Finance Valuation Models
• Chapter 11: Clean Surplus ROE—the Only Comparable Efficiency Ratio
• Chapter 12: What Buffett Looks for in a Company, or How Clean Surplus Accounting Recognizes the Quality of a Company
• Chapter 13: General Electric Then and Now
• Chapter 14: General Motors Then and Now
• Chapter 15: The Beginning: The Initial Research
• Chapter 16: Continuing Research: The Doctoral Research on the S&P 500
• Chapter 17: Rules for Structuring a Great Growth Portfolio
• Chapter 18: Great, Great Job, but You’re Fired
• Chapter 19: Stocks on Our Radio Show
• Chapter 20: Stories of Audience Hecklers
• Chapter 21: A Great Dividend Income and Growth Strategy—Part I: The Economic Spectrum of Dividend Stocks
• Chapter 22: A Great Dividend Income and Growth Strategy—Part II: Selecting Stocks That Are Growing Their Dividends for Our Portfolio
• Chapter 23: A Great Dividend Income and Growth Strategy—Part III: Selecting Stocks That Are Growing in Price for Our Portfolio
• Chapter 24: Enhanced Income
• Chapter 25: Portfolio Insurance
• Chapter 26: What Have You Learned? A Summary
• Chapter 27: We Won’t Leave You Out There Alone
• About the Author
• Index
• End User License Agreement