The Four Filters Invention
of
Buffett and Munger
by Bud Labitan, MD, MBA
available at amazon.com
The Four Filters Invention
of
Buffett and Munger
Why is this a
major advance in
Behavioral Finance ?
The genius of Buffett and Munger's four filters
process was to capture all the important
stakeholders for business success.
( in a multi-variable equation or formula )
A.
B.
C.
D.
Products
Enduring Customers
Managers
Margin-of-Safety
Understand the
Business
And
Products
Seek
Sustainable
Competitive
Advantages
Seek
Able
Trustworthy
Managers
Bargain Price
is a
Margin of Safety
The Evidence:
Warren Buffett has written about the Four Filters in several ways.
This behavioral sequence is always similar: “Charlie and I look for
companies that have a) a business we understand; b) favorable
long-term economics; c) able and trustworthy management; and
d) a sensible price tag.”
Buffett has also phrased the Four Filter process in this slightly
different way: “When buying companies or common stocks, we
look for understandable first-class businesses, with enduring
competitive advantages, accompanied by first-class
managements, available at a bargain price.”
The History:
Where did these checklist influences came from?
Phil Carret and Philip Fisher both developed and used
quality checklists. You can also find Charlie Munger’s list
of human behavioral tendencies in my book.
Probability and Effectiveness:
Here is Warren Buffett’s Ted Williams analogy:
“I put heavy weight on certainty. Use probability in your favor
and avoid risk. It’s not risky to buy securities at a fraction of
what they are worth. Don’t gamble. You’re dealing with a lot
of silly people in the marketplace; it’s like a great big casino,
and everyone else is boozing. Watch for unusual circumstances.
Great investment opportunities come around when excellent
companies are surrounded by unusual circumstances that cause
the stock to be misappraised.
* What defines an excellent company?
The Variations of Use:
We want the business to be (1) one that we can understand, (2)
with favorable long-term prospects, (3) operated by honest and
competent people, and (4) available at a very attractive price.
Warren Buffett puts it this way:
“Seek whatever information will further your
understanding of a company's business.”
Framing:
• Framing can influence our choices. Tversky and Kahneman described
"Prospect Theory" in 1979 using framed questions. They found that
contrary to expected utility theory, people placed different weights on gains
and losses. Tversky and Kahneman found that individuals are much more
distressed by prospective losses than they are happy by equivalent gains.
• In 1992, Takemura showed that the effects of framing are likely to be
lower when subjects are warned in advance that they will be required to
justify their choices, and when more time is allowed for arriving at their
choices.
• Luckily, Buffett and Munger seem to have arrived at the practical use of
these optimal framing ideas earlier than most. Buffett and Munger make
good use of “justification,” “elaboration,” “elimination,” and “time.”
The genius of Buffett and Munger's four filters
process was to capture all the important
stakeholders for business success.
( in a multi-variable equation or formula )
A.
B.
C.
D.
Products ========== Understand The Business
Enduring Customers == Sustainable Comp. Adv.
Managers ========== Able & Trustworthy
Margin-of-Safety ===== Below “Intrinsic Value”
Questions ?
&
Thank You.
The Four Filters Invention
of
Buffett and Munger
by Bud Labitan, MD, MBA
available at amazon.com