Basics

Buffett: Hagstrom Screen (THE TWELVE IMMUTABLE TENETS)

Written by Vanshika Kothari
Mon Sep 06 2021
Buffett Hagstrom Screen
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Buffett Hagstrom Screen
 

The Buffett: Hagstrom Screen is a screen based on the investing style of Warren Buffett. Many of the investors are in awe of the exceptional investment success of Warren Buffett. According to the Efficient Market Hypothesis, prices are never so low or so high that they can be taken advantage of which is why people say “You can’t beat the market.”

However, it’s possible for investors to beat the market, and we see every once in a while some do, although many more underperform. Warren Buffett and a few other legendary investors—including Ben Graham, Peter Lynch, Stan Druckenmiller, George Soros, and Julian Robertson—have outperformed by a big enough margin, for long enough periods of time, with large enough amounts of money. Their records show that exceptional investors can beat the market through skill, not chance.

Understanding the Approach

In his book The Warren Buffett Way, Robert Hagstrom identifies and explains in great detail the investment strategy implemented by Warren Buffett. He identifies 12 basic characteristics that a company should possess to be considered for purchase. Not all of Buffett’s purchases displayed all of these traits, but as a group, the principles help to establish a reasonable approach to selecting stocks. The tenets cover both qualitative and quantitative business elements and were used to create the Buffett (Hagstrom) screen Stock Investor Template.

Buying a Business: THE TWELVE IMMUTABLE TENETS 

Business Tenets

  1. A business must be simple and understandable.
  2. A business must have a consistent operating history. 
  3. A business must have favorable long-term prospects. 

Management Tenets

  1. Is management rational?
  2. Is management candid with its shareholders?
  3. Does management resist the institutional imperative? 

Financial Tenets 

  1. Focus on return on equity, not earnings per share. 
  2. Calculate “owner earnings.”  
  3. Look for companies with high profit margins. 
  4. For every dollar retained, make sure the company has created at least one dollar of market value.

Market Tenets 

  1. What is the value of the business? 
  2. Can the business be purchased at a significant discount to its value?   

Using MarketXLS Template

MarketXLS provides a template for this screen. All you need to do is Enter the stock ticker in cell C4 in the Active Template tab. The template will automatically pull the necessary quantitative factors and check whether it meets the criteria or not. For Qualitative Analysis, Check for qualitative check at your own discretion to input Yes / No in cells D8:D11. (Note: Only when all qualitative checks are met, will a stock qualify for Hagstrom screen). The final result if the stock qualifies for Hagstrom screen can be seen in the cell F3″

Get the template here: https://marketxls.com/template/buffett-hagstrom-screen/

A Common Theme

A standard refrain will be noticed if we study the case studies of Warren Buffet, he is not in a hurry to sell and earn short term profits. These quick appreciations do not interest him. Either the investment you hold is a better investment than cash or it is not, was one of the things Philip Fisher taught him. Warren Buffet’s favorite holding period is “forever.” He says that he is “quite content to hold any security indefinitely, so long as the prospective return on equity capital of the underlying business is satisfactory, management is competent and honest, and the market does not overvalue the business.” 

Portfolio Management

Source: https://www.veristrat.com/blog-valuation/portfolio-management/  

Investors often think that managing portfolios is a simple process of deciding what to buy, sell, or hold. These decisions are usually determined by comparing today’s stock price to its intrinsic value (also called the margin of safety). However, while this approach is crucial, it is not sufficient in itself. Hagstrom suggests to take into account three important portfolio management constructs that Buffett has developed: 

1. His way of building a portfolio for long-term growth. 

2. His alternative measuring stick for judging the progress of a portfolio. 

3. His techniques for coping with the emotional roller coaster that inevitably accompanies portfolio management. 

The three important portfolio management constructs can be well met by understanding ‘The Mathematics of Investing’ and ‘The Psychology of Investing’

  • The Mathematics of Investing 

It can be said that the stock market is a giant warehouse full of countless probabilities. There are thousands of single forces that combine to set prices, all of which are in constant motion, any one of which can have a dramatic impact, and none of which is predictable to an absolute certainty. 

Investors’ task is to narrow the field by identifying and removing that which is unknown mainly and then focusing on the least unknown. But, of course, these are nothing but the mathematical language of risks called probabilities.

Whether or not one recognizes it but nearly all decisions are made by exercising probabilities. It is critical that investors’ probability statement combines the historical record with the most recent data available for them to succeed.

“Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we ’re trying to do,” says Buffett. 

  • The Psychology of Investing

Buffett learnt the two very important lessons in the world of investing after his first loss. The first was the value of patience and second was short-term changes in stock prices may have little to do with value, but a lot do with emotional discomfort.

Certain aspects of human existence are more emotion-laden than our relationship to money, and when we are talking about the stock market this is particularly important. Much of what drives people’s decisions about stock purchases can be explained only by principles of human behavior. 

It is important to understand the behavioral aspect of finance since the market is the collective decisions made by all stock purchasers. 

Disclaimer

All trademarks referenced are the property of their respective owners. Other trademarks and trade names may be used in this document to refer to either the entity claiming the marks and names or their products. MarketXLS disclaims any proprietary interest in trademarks and trade names other than its own, or affiliation with the trademark owners.
None of the content published on marketxls.com constitutes a recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. The author is not offering any professional advice of any kind. The reader should consult a professional financial advisor to determine their suitability for any strategies discussed herein. The article is written for helping users collect the required information from various sources deemed to be an authority in their content. The trademarks if any are the property of their owners and no representations are made.

References:

How To Screen For Stocks Using 12 Buffett Investing Fundamentals 

AAII

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