What do Warren Buffett and Peter Thiel NOT have in common?

Below is a summary of Warren Buffett’s Principles and Rules from Warren Buffett Accounting Book. This book is the best book I’ve read on reading / understanding financial statements.

I finally think I understand the three statements –  and I’ve done an MBA. The book provides the perfect balance of simplicity without being condescending – a difficult feat, especially in finance literature.

Buffett’s Principles of Valuing Companies:

Principle 1: Vigilant Leaders
Rule 1 Low Debt
Rule 2 High Current Ratio
Rule 3 Strong & Consistent Return on Equity
Rule 4 Management based on Long Term Goals
Principle 2: Long Term Prospects
Rule 1 Company Must Have Persistent Products
Rule 2 Minimise Taxes
Principle 3: A Company Must Be Stable & Understandable
Rule 1 Stable Book Value Growth from Owner’s Earnings
Rule 2 Sustainable Competitive Advantage (“Moat”)
Principle 4: Buy at Attractive Prices
Rule 1 High Margin of Safety
Rule 2 Low Price to Earnings Ratio
Rule 3 Low Price to Book Ratio
Rule 4 Set a Safe Discount Rate
Rule 5 Buy Undervalued Stocks

Contrast these rules to Peter Thiel’s Zero To One, a book which covers tech investments – something that until recently Buffett wouldn’t touch.

Thiel’s summary quote on tech investments: “Most of a tech company’s value will come at least 10 to 15 years in the future. Thiel’s valuation rests on his “11 Key Questions to ask” one of which is “Durability” i.e. Will your market position be defensible 10 and 20 years into the future?

So using the model above, could you successfully value a tech company?

No. Why? Two major metric cannot be determined – Revenue and Free Cash Flow.

To place Thiel’s theories over Buffett’s Principles above, here’s where it falls over:

Principle 1 Rule 3 : Strong & Consistent Return on Equity (ROE)

  • No historical data available!

Principle 3 Rule 1 : Stable Book Value Growth from Owner’s Earnings

  • No historical data available!

You also can’t calculate:

Principle 4 Rule 5: Buy Undervalued Stock

This Rule is based on a Discounted Cash Flow Model. Determining this rests on working out the historical free cash flow (FCF) rate.

The best that Thiel’s model provides is a good assessment of the “Discount Perpetuity Cash Flow”

An understanding of past earnings and future earnings is so critical in investing.

Peter Lynch, one of my favourite investor’s says in One Up On Wall Street “If you can follow only one bit of data, follow the earnings – assuming the company in question has earnings…. sooner or later earnings make or break an investment in equities.”

Happy hunting.

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