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12 Basic Immutable Tenets

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12 Basic Immutable Tenets

As we all know Warren Buffett may be the most successful investor in the world. Some people try to dismiss Buffetts' prowess of picking successful securities on the basis of a certain degree of luck or inside information that the regular small investor could never hope to have. However what many people do not understand is that, according to Robert G. Hagstrom, Buffett does not invest in stocks but in companies and their underlying businesses. and instead of luck Buffett uses his twelve immutable tenets. These twelve tenets are broken into four sections of the companies: 1) Business, 2) Management 3) Financial and 4) Market. By analyzing 3Ms' annual report, its financial statements, and by examining all aspects of the company and its' industry we can come to a conclusion of whether or not 3M would make an attractive investment to Buffett.

The first group of Buffetts' tenets is the Business tenets. The business tenets are broken into three areas of concentration. The first business tenet is the business must be simple and understandable. 3M has thousands of different products, a few of which are simple (and thus interesting to Buffett) such as Post-It Notes, Scotch Tape, adhesives, and cleaning agents. But some of 3Ms' other products are not as simple such as flexible circuits, and electronic and liquid crystal displays. These highly technical products would be out of Buffetts' "circle of confidence", products that Buffett does not know very much about and therefore Buffett would not be able to interpret and react to developments with as much confidence. The second business tenet is that the business must have a consistent operating history. Companies with a consistent operating history are firms that are in a stable industry, have spent years producing the same product, and that are not currently involved in changing directions. 3M could easily be categorized as having a consistent operating history as shown by its strong core products (Post-It notes, Scotch tape, Scotch guard etcÐ'...) which have dominated their market for years. Also 3Ms' consistency can be measured by its' longevity in the fact that 3M was established over 100 years ago in 1902. The last of the business tenets is favorable long term prospects. Favorable long term prospects can be generalized into whether or not the firm can not only sustain its market share but also if the firm has products being developed that can increase its' market share. 3M can be characterized as what Buffett refers to as a "franchise" or a company that provides a product that is needed, has no close substitutes, and is not regulated. 3M's core products are household products that are perpetually in demand with substitutes that are considered inferior by many because of the strength of the 3M brand name. Also 3Ms' outlook is attractive because of it's' position in overseas markets. In 2003 58% of all of 3M's sales were attributed to its international operations. With developing markets in Eastern Europe and its revenues from China and Korea growing 3M sees its international organizations as a major strength in the foreseeable future.

The second characterization of the immutable tenets is the management tenets. Management tenets are broken down into three sections: Rational Management, Candid Management, and the Institutional Imperative (or Lemming behavior). Rationality represents the most important aspect of management; the allocation of the firm's excess capital. Instead of spending capital on projects that don't earn a return in excess of the cost of capital or buy growth the managers at 3M decided to increase the quarterly dividends by 9%, in effect giving the companies shareholders money to invest themselves as they see fit to earn higher returns. Another tenet of business rationality is the resistance of the institutional imperative or the lemming effect. The lemming effect is the tendency of managers to do what everyone else is doing or imitate competitors. 3M has so far resisted the temptation of following everyone else in its industry. Recently 3M has reorganized its Research and Development department to increase the speed and efficiency at which its' innovative products move from development to commercialization. One of the reasons 3M has come up with so many pioneering products is that 3M has seven divisions devoted to developing new products. Where other companies grow by acquisitions 3M grows by coming out with new products that it's' competitors cannot keep up with. 3M managers also display the characteristics of Candor, the final management tenet. By recognizing that 3M did not have any new projects to invest their excess cash in the managers instead were honest with the shareholders and gave back to the owners their share to invest themselves. Overall 3Ms' management seems to be innovative, and upfront with the shareholders, and also seems to make sound decisions on what to do with their excess capital, all signs of rational management.

The four financial principles are the third group of the immutable tenets. The Financial tenets are compromised of focusing on return on equity, "owner earnings", high profit margins, and the "one dollar premise". The first of the financial tenets is concerned with how to measure the annual performance of the firm. Many analysts use earnings per share to gauge how well a company has performed, but according to Buffett earnings per share is a "smokescreen" since the measurement does not account for increases in a company's growing equity base (Buffett likens this to a checking account returning higher interest payments because the new



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