The important tenets of his investment philosophy and mythology

Warren Buffett is considered by many as the most successful investor of the 20th century and named “one of the most influential people in the world” by Time magazine in 2012. In this article we look at Buffett’s investment mythology and analyse some of the most important tenets of his investment philosophy.

Finding low-priced value
While evaluating the relationship between a stock’s level of excellence and its price, Buffett asks himself several questions to find low-priced value:

Has the company consistently performed well? 
He looks at a company’s return on equity (ROE) and determines whether or not they have consistently performed successfully, compared with others in the same industry. However, looking at the ROE of a company over the last year alone isn’t enough. To get a better perspective of historic performance, investors should view the ROE from the past 5-10 years.

Has the company avoided excess debt? 
Buffett also considers the debt/equity ratio of a company, as he would prefer to see minimal amounts of debt, meaning that earnings growth is being generated from shareholders’ equity and not from borrowed money. A high level of debt compared to equity will result in volatile earnings and large interest expenses.

Are profit margins high? Are they increasing? 
Not only does the profitability of a company depend on a good profit margin but also their margins consistently increasing. A high profit margin means that the company is not only executing its business well, but increasing margins means management has been efficient and successful at controlling expenses. Investors should look back at least five years to get a clear indication of a company’s historical margins.

How long has the company been public? 
One of Buffett’s criteria is longevity: value investing means looking at companies that have stood the test of time but are currently undervalued. He will usually consider companies that have been around for at least 10 years, meaning that he would not consider most of the technology companies that have had their initial public offerings (IPOs) in the past decade. Historical performance is also crucial – determining if a company can perform as well going forward as it has done in the past is tricky, but Buffett is very good at it.

Do the company’s products rely on a commodity? 
He will usually steer clear from investing in companies whose products are indistinguishable from those of their competitors; if they don’t offer anything different than another firm within the same industry, Buffett sees little that sets them apart. He uses the term ‘economic moat’ as a way of describing any characteristic that is hard to replicate; the wider the moat, the harder it is for a competitor to gain market share.

Is the stock selling at a 25 per cent discount to
its real value? 
The most difficult part of value investing is determining whether a company is undervalued, and is Buffett’s most important skill. Investors must analyse a number of business fundamentals, including earnings, revenues and assets, to determine a company’s intrinsic value, which is usually higher than its liquidation value.
Buffett will then compare it to its current market capitalisation. If his measurement of intrinsic value is at least 25 per cent, he sees the company as one that has value – the key to this depends on his unmatched skill in accurately determining this intrinsic value.

The proof is in the pudding
As you can see from the above examples, Buffett’s investing style reflects a practical, down-to-earth attitude. This value-investing style is not without its critics, but nobody can question the success it has brought. The thing to remember is that the most difficult thing for any value investor is in accurately determining a company’s intrinsic value.

Information is based on our current understanding of taxation legislation and regulations. Levels and bases of and reliefs from taxation are subject to legislative change and their value depends on the individual circumstances of the investor. The value of your investments can go down as well as up and you may get back less than you invested.

Uncertain election results rekindle euro-crisis fears

The prospect of a long period of political uncertainty following elections in Italy, the euro zone’s third-largest economy, has shattered months of uneasy calm in European financial markets and demonstrated that the currency union remains prey to shocks.

Italy’s protest vote against the Eurocrats has wrenched market attention away from the hunt for yield and back onto political risk. The social disaffection caused by youth unemployment has been strikingly reflected by the surge of the Five Star movement.

Italian economic fundamentals are fragile and the recession still deep. At best, the political impasse in Italy will push back the market’s expectation of a recovery there. At worst, the contraction could deepen as consumer and business confidence cowers under an extended period of political uncertainty.

Austerity-first solution
The elections have also emphasised that the most powerful opposition to the euro-zone crisis managers’ austerity-first solution to the bloc’s financial crisis could come from the ballot box. Three polls last year—a referendum in Ireland on new fiscal rules and elections in the Netherlands and Greece—went in favour of the euro’s political masters, in Greece’s case only just. However, in Italy, the euro zone seems to have run out of luck in a vote interpreted as a rejection both of the country’s traditional political class and of the austerity many Italians see as being imposed on them by Brussels and Berlin.

Financial-market tranquillity
The return of growth in Southern Europe is officially projected to be reached in the next 12-18 months, but may have been further postponed due to recent uncertainty. But there was no sign of any rethink: euro-zone governments and the European Commission have urged Italy to stick to the path of economic overhauls and budget stringency. The election has challenged the optimism beginning to emerge among politicians that the crisis was over, which had been encouraged by the financial-market tranquillity following the promise from European Central Bank President Mario Draghi in July to “do whatever it takes” to save the euro.

A grand coalition
We can now expect weeks of hiatus in the Italian political system as political leaders discuss whether they can form a grand coalition that can govern the country seems a certainty. Nothing formal can happen until March 15, at the earliest, when Parliament is formally convened. By May 15, President Giorgio Napolitano’s mandate will expire and a new president must be elected. An early decision to call new elections seems unlikely: to do so in an apparent effort to get the “right result” for the EU risks a further backlash among voters.

Fiscal discipline
The political will to preserve Eurozone stability has been proven in Greece. A new government in Italy, when it is eventually formed, is more likely to be unstable and ineffective than unorthodox and radical. Fiscal discipline is likely to be broadly preserved even if serious structural reforms are now off the agenda. Hence, the negative market reaction to events in Italy may provide an opportunity to buy into the periphery, albeit at significantly higher yields. It will be important to keep an eye on the rating agencies, who could well jangle nerves with another downgrade if policy uncertainty in Italy persists.

The UK has lost its AAA credit rating for the first time since the 1970s

The credit rating agency Moody’s, at the end of February, downgraded the UK’s sovereign debt rating from AAA to AA1, relegating the UK to the second tier for the first time since 1978. The announcement made headline news, but it was far from unexpected and the possibility of a downgrade had been predicted; the coalition government is taking longer than expected to reduce the UK’s sizable deficit and all three leading credit rating agencies – Fitch, Moody’s and Standard & Poor’s – had already placed the UK on a “negative” outlook during 2012, stoking expectations of a downgrade.

Government’s capacity to repay its debts
Credit ratings provide an indication of a government’s capacity to repay its debts, but any concerns about the downgrade leading to a rise in the borrowing costs for the UK appear overplayed, at least if the recent experiences of the US and France are any indication: the US lost its AAA status in August 2011 while France was downgraded in November 2012. The borrowing costs of both nations have declined since their respective downgrades while their main stockmarket indices have risen significantly.

Fiscal consolidation programme
The implications of the UK’s downgrade are likely to prove more political than economic. Moody’s announcement highlighted the challenges that “subdued medium-term growth prospects pose to the government’s fiscal consolidation programme” and the coalition government continues to face substantial challenges in its attempts to reduce the UK’s debt levels. Politicians have placed considerable value on the UK’s top credit rating – indeed, in the Conservative Party’s manifesto of spring 2010, George Osborne pledged to “safeguard Britain’s credit rating”. As such, the news of the downgrade puts more pressure on the Chancellor of the Exchequer than on the economy itself.

Catalyst for fresh trouble
Taking everything into consideration, a drop in the UK’s credit rating is not likely to make much difference to the fundamental performance or health of the country’s economy. Although Moody’s decision highlights the challenges that the government face, the downgrade itself is likely to represent a symptom of the existing problems rather than a catalyst for fresh trouble.

Promising growth prospects
The decline in the value of sterling is likely to continue, as investors move their money into currencies used by countries with more promising growth prospects. A weaker pound would certainly help exporters, but it also makes imports more expensive. The price of petrol has already risen over the past month, and further increases like this are likely to put more pressure on household incomes and company profits, as well as on economic growth as a whole. A lower credit rating could also make it more expensive for the UK to borrow money.

Longer to resolve than expected
In a similar way to borrowing from a High Street bank, if you are in a well-paid job and are living within your means, you will have to pay a lower interest rate on a loan than someone who the bank thinks is overstretched and maybe not able to keep up with repayments. At present, the UK needs to borrow more than £100bn a year from investors, both at home and around the world. It seems that the UK’s economic problems, in line with many other countries, will take longer to resolve than expected.

Measures introduced through the Care and Support Bill come into effect in April 2017

Bills for long-term care in old age are to be capped at £75,000 in England. The recent announcement for changes to social care is thought to be part-funded by a freeze on the inheritance tax ‘nil rate band’ threshold.

Chancellor George Osborne announced during the Autumn Statement 2012 that inheritance tax rates would rise from £325,000 (£650,000 for married couples and registered civil partners) to £329,000 (£658,000 for couples) in 2015/16. This will now be delayed until 2018/19. As a result of this three-year extension, more people could be subject to an inheritance tax bill. Inheritance tax is charged at 40 per cent and is payable when the value of an estate exceeds the available nil rate band threshold.

Disappointment at the level of the cap
Jeremy Hunt, the Health Secretary, told the Commons in February that the ‘historic’ long-term care reforms would save thousands of people from having to sell their family home to pay for care. Some campaigners voiced their disappointment at the level of the cap, which was more than double the £35,000 recommended by the independent Dilnot Commission in 2011.

Means-tested government support
Alongside the cap, Mr Hunt announced a rise – from £23,250 to £123,000 – in the asset threshold beneath which people will receive means-tested government support for care bills. He also announced a lower cap on costs for people who develop care needs before retirement age, as well as free care for those who have needs when they turn 18.

Andrew Dilnot, whose report recommended a cap of between £25,000 and £50,000, said he was disappointed by the government’s proposal of a higher level, but did not think it would undermine his system.

The proposed £75,000 cap from 2017 equated to £61,000 at 2011 prices, he pointed out.
The measures will be introduced through
the Care and Support Bill and come into effect in April 2017.

Have you fully used your 2012/13 ISA allowance?

In times like these, every penny counts. Interest rates are at historic lows and rising inflation can erode our buying power. But one way to mitigate these effects is to shield savings from tax by investing through an Individual Savings Account (ISA).

A flexible ‘wrapper’

An ISA is not itself an investment – it’s a flexible ‘wrapper’ under which a wide range of investments can be made, and the proceeds are free of capital gains or income tax. You can choose from two types of ISA – Stocks & Shares ISAs (shares, bonds or funds based on shares or bonds) and Cash ISAs. Stocks & Shares ISAs are also known as Equity ISAs.

Your questions answered
The 5 April ISA deadline is fast approaching and, if you don’t invest by then, you will lose your 2012/13 tax year ISA allowance forever.

Here are answers to some of the most common questions we get asked about ISAs.

Q. What is an ISA?
A. ISAs began on 6 April 1999. With an ISA you are entitled to keep all that you receive from that investment and not pay any tax on it. You can save up to
£11,280 in the current 2012/13 tax year. A tax year runs from 6 April to 5 April in the following year. The ISA scheme provides different ways of saving to meet people’s different needs. You can plan for the short term or put your money away for much longer.

Q. What are the different types of ISA?
A. There are two types of ISA: Cash ISAs and Stocks & Shares ISAs. In each tax year you can put money, up to certain limits, into one of each. Cash ISAs may be suitable for short-term savings, so that you can get at your money easily.

Stocks & Shares ISAs may be appropriate if you can afford to leave your money untouched for longer than, say, five years.

Q. Can I have an ISA?
A. You have to be aged 16 or over to open a Cash ISA, or 18 or over to open a Stocks & Shares ISA. You also have to be resident and ordinarily resident in the UK for tax purposes, or a Crown employee, such as a diplomat or a member of the armed forces, who is working overseas and paid by the government. The spouse, or civil partner, of one of these people can also open an ISA. You cannot hold an ISA jointly with, or on behalf of, anyone else.

Q. How many ISAs can I have?
A. There is a limit to the number of ISA accounts you can subscribe to each tax year. You can only put money into one Cash ISA and one Stocks & Shares ISA.
But, in different years, you could choose to save with different managers. There are no limits on the number of different ISAs you can hold over time.

Q. How much can I put into ISAs?
A. In the tax year 2012/13, which ends on 5 April 2013, you can put in up to £11,280 into ISAs. Subject to this overall limit, you can put up to £5,640 into a Cash ISA and the remainder of the £11,280 into a Stocks & Shares ISA with either the same or another provider.

So, for example, you could put:

£5,640 into a Cash ISA and £5,640 into a Stocks & Shares ISA; or
£3,000 into a Cash ISA and £8,280 into a Stocks & Shares ISA; or
nothing into a Cash ISA and £11,280 into a Stocks & Shares ISA

Q. What are the tax benefits of an ISA?
A. You pay no tax on any of the income you receive from your ISA savings and investments. This includes dividends, interest and bonuses. UK dividend income has been taxed at source at the rate of 10 per cent and this cannot be reclaimed by anyone. You pay no tax on capital gains arising on your ISA investments (losses on ISA investments cannot be allowed for Capital Gains Tax purposes against capital gains outside your ISA). You can take your money out at any time without losing tax relief. You do not have to declare income and capital gains from ISA savings and investments or even tell your tax office that you have an ISA.

Q. Can I put money into an ISA for my child?
A. Junior ISAs are a popular way for family and friends to build up tax-efficient savings and investments to help with the cost of university, provide a deposit for a house or simply give children a start in life. Any child resident in the UK qualifies who wasn’t eligible for a Child Trust Fund (CTF):

Children born on or after 3 January 2011
Children (aged under 18) born on or before 31 August 2002
Children born on or between 1 September 2002 and 2 January 2011 who didn’t qualify for a Child Trust Fund. Most children born between these dates did qualify for a CTF

The current maximum allowance per child per tax year is £3,600 and this will increase to £3,720 for the 2013/14 tax year. The account is held in the child’s name and a parent or guardian can open and manage the child’s account. Once a parent or guardian opens the account for their child, anyone, friend or family, is able to make a contribution up to the annual limit. No withdrawals are permitted until the child reaches the age of 18, at which point their account is automatically converted into an ‘adult’ ISA giving them full access to their investments and savings.

Past performance is not necessarily a guide to the future. The value of investments and the income from them can fall as well as rise as a result of market and currency fluctuations and you may not get back the amount originally invested. Tax assumptions are subject to statutory change and the value of tax relief (if any) will depend upon your individual circumstances.