Warren E. Buffet 2005 - Essay Example

All along Buffett created his own rules in the game of investments in the stocks and has achieved a fair degree of success. This paper critically examines the investment philosophies and decisions of Warren Buffett while detailing the performance and investments of Berkshire Hathaway, the flagship company of Buffett including the second largest acquisition of Buffett of Pacific Corporation, a regulated energy producing company in the United States. Profession Benjamin Graham of Columbia University was the mentor of Warren Buffett, under whom he was trained in the art of investment in securities.

Graham developed a method of identifying those shares whose prices are less than their intrinsic value and focused on other elements such as cash, net working capital, and physical assets. Buffett further modified this approach to include the focus on valuable franchises that do not go into the normal valuation of shares by the market. By the year 2005, on the basis of the letters written by Warren Buffett as chairperson to the shareholders of Berkshire Hathaway, the investment philosophy of Buffett has been expounded detailing the following important elements: The foremost p(1) Economic Realities Versus Accounting RealitiesThe foremost philosophy is to recognize and consider the economic realities at business level rather than the accounting realities, as the accounting reality is considered to be backward looking and mostly governed by the Generally Accepted Accounting Principles (GAAP) .

The rational behind adopting the economic reality at business level is that, it takes into account the value of intangible assets like patents, goodwill, trademarks and any special skills of managers, while the accounting reality does not consider the value of these assets.(2) Cost of Lost Opportunities'Cost of lost opportunity' is another important phenomenon advocated by Buffett to be considered in any investment decision. For Buffett, the comparison of a proposed investment, against the returns from alternative opportunities available in the market is an important benchmark consideration for investments. (3) Value CreationThe next philosophy advises that the investment should consider the intrinsic value of the shares as the present value of future expected performance.

This aspect is not being considered for investment decisions in the other methods. According to Buffett intrinsic value is the only logical measure to decide on the attractiveness and worth of any business investment decisions. (4) Gain in Intrinsic Value Versus Accounting ProfitBuffett strongly followed the principle that any investment should be capable of increasing the average annual rate of gain in intrinsic value of the business on performance-share basis, rather than, the increase in the accounting profits.

Buffett advocated that the gain in intrinsic value should be considered as analogous to the economic gains made by the business which is a true measure of financial performance.(5) Risks and Discounted Cash FlowsThe traditional method of determining the discount rates like Capital Asset Pricing Model (CAPM) would add a risk premium to the long term risk free rate of