Warren Buffett, the ‘Sage of Omaha', is generally considered to be the world’s most successful investor. His investment vehicle, Berkshire Hathaway, is legendary.

Below is a summary of Warren Buffett's investment phylosophy:

What is value investing?

Devotees of Benjamin Graham’s Value Investment theory, including Warren Buffet, argue that the essence of value investing is to buy stocks at a lower price than their intrinsic value. The intrinsic value is the discounted value of all future distributions. "If a business does well, the stock eventually follows."

Why does Warren Buffett believe in Value Investing?

Benjamin Graham was Buffett's mentor, and the source of Buffett's success. For more information on Benjamin Graham click here.

In his article The Superinvestors of Graham-and-Doddsville (Dodd was co-author of Benjamin Graham’s famous book, “Security Analysis”), Buffett refuted the academic Efficient-Market hypothesis, saying that beating the S&P 500 was "pure chance", and highlighting the huge number of successful students of the Graham and Dodd Value Investing school of thought.

Value Investing according to Buffett

Warren Buffett has taken the Value Investing concept even further as his thinking has evolved to where for the last 25 years or so his focus has been on "finding an outstanding company at a sensible price" rather than generic companies at a bargain price. "If you don't know jewelry, know the jeweler."

In his November, 1999 Fortune article, he warned of investors' unrealistic expectations:

“Let me summarize what I've been saying about the stock market: I think it's very hard to come up with a persuasive case that equities will over the next 17 years perform anything like they've performed in the past 17. If I had to pick the most probable return, from appreciation and dividends combined, that investors in aggregate - repeat, aggregate - would earn in a world of constant interest rates, 2% inflation, and those ever hurtful frictional costs, it would be 6%.”

Buffett’s guide to Value Investing

Stock investments should be looked at in the same way as buying a business. The stock investor is really buying a tiny share or partnership and should apply the same principles that they would in buying a:

1. The company should be soundly managed. Tests of good management include:

• Share buybacks

• Good use of retained earnings

• Sticking to what they know

2. The company has demonstrated earning capacity with a likelihood that this will continue. Tests of earning capacity include:

• Company growth

• Dealing with inflation

• Capital expenditure

• Look through earnings

• Brand names

3. The company should have consistently high returns. Warren Buffett would look at both:

• Returns on equity

• Returns on capital

4. The company should have a prudent approach to debt.

5. The businesses of the company should be simple and the investor should have an understanding of the company.

6. Assuming that all these thresholds are satisfied, the investment should only be made at a reasonable price, with a margin of safety. This is always a matter for independent judgment by the investor but it is relevant to consider:

• Price/earnings ratios

• Earnings and dividend yields

• Book value

• Comparative rates of return

8. Investors need to take a long term approach.

Other interesting Value Investing articles can be found by clicking here

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Sources and Further Reading

Buffettsecrets

Buffettsystem

Berkshire Hathaway

P. S. You simply have to invest when you find a good company in the software industry.

Here’s why.

A software company, once its development and fixed costs are covered, generates just about pure profit on each additional sale as the cost to produce an additional CD is virtually zero.

This month I stumbled onto exactly such a company when searching for an investment to recommend to my subscribers.

The company is trading at a price to earnings ratio of under 12. I agree this does not seem like a bargain but remember 2009 was a difficult year for all companies.

The company is even cheaper based on its price to free cash flow (operating cash flow minus capital investment) of 8.7 times. This means the theoretical dividend the company can pay with the cash it generates is nearly 11.5%.

The only valuation measure (I look at 7) the company is not cheap on is its dividend yield of only 2.1%. This is due to it using cash to pay down debt taken on to pay for an acquisition.

But as the debt is nearly all repaid there is a lot of room for a substantial increase.

To find out how you can also get ideas like this monthly click here.