Part 1: Understanding Value investing
Part 2: Warren Buffett’s intrinsic Value Equations
Introduction…
- Warren is not interested in popular investments such as Internet Companies - Warren discovered that vast majority of stock market investors are short-term oriented, that they buy on good news and sell on bad - The short-term stock market mentality sometimes grossly undervalues the long-term prospects of a great business. - Warren likes to buy on bad news
Identifying the economic engine Warren wants to own
- Warren has separated the world of business into 2 different the healthy consumer monopoly type business and the sick commodity type business - A consumer monopoly is a type of business that sells a brand name product or has a unique position that allows it to act like a monopoly. - A commodity type business is the kind that manufactures a generic product or service that a lot of companies produce and sell
Commodity type business has the following characteristics:
- Low Profit margins on sales coupled with low inventory turnover - Low returns on shareholder’s equity - Absence of any brand loyalty - Presence of multiple producers - Existence of substantial excess production capacity in the industry - Profitability that is almost entirely dependant upon management’s anilities to efficiently utilize tangible assets
Consumer Monopoly…
- A consumer monopoly is a type of toll business. If you want to buy a certain product you have to purchase it from that one company and no one else. - Warren’s test for a consumer monopoly is to ask himself whether it would be possible to create a competing business even if one didn’t care about losing money. - A consumer monopoly sells a product where quality and uniqueness are the most important factors in the consumer’s decisions to buy - Consumer monopolies, though excellent business, are still subject to the ups and downs of the business cycle and the occasional business calamity
Can you identify if the business has a consumer monopoly?
1. Can you identify a consumer monopoly type product or service that the company sells?
2. Do Historical earnings show a strong and upward trend?
3. Is the company loaded with debt?
4. Does the company earn a high rate of return on shareholder’s equity?
5. Does the company have to spend a high percentage of its retained earnings to maintain its current operations?
6. Are retained earnings free to be invested in new businesses or used to repurchase the company’s shares?
7. Is the company free to adjust process for inflation?
8. Will the value added by retaining earnings lead to an increase in the stock market value of the company?
There are basically 4 types of consumer monopolies…
1. businesses that make products that wear out fast or are used up quickly, that have brand name appeal, and that merchants have to carry or use to stay in businesses
2. communications businesses that provide a repetitive service that manufactures must use to persuade the public to buy their products
3. businesses that provide repetitive consumer services that people and business are consistently in need of
4. Retail stores that have acquired a quasi-monopoly position selling such items as jewelry and furniture
Bad news that creates a buying situation…
1. Stock Market corrections and Panics
2. Industry Recessions
3. Individual Calamities
4. Structural Changes
Some links …
2. MSN Money
3. Value Line Investment Survey
Share repurchases…
- through the use of share repurchases it is possible for a company to cause an increase in per share earnings while increasing the ownership interests of the remaining shareholders - share repurchases leave the pie the same size while increasing the size of the slice - share repurchases make economic sense even at really high share prices - through the use of share repurchases it is possible for a company to cause an increase in per share earnings while actual net earnings remain the same - with share repurchases it is also possible for a company to enhance the economic performance of the company - share repurchases cans sometimes mask poor performance
The Grahamian Equation
The Buffettology Worksheet
1. Does the company have an identifiable consumer monopoly? 2. Do you understand how it works? 3. If the company in question does have a consumer monopoly, the nest question is: What is the chance that it will become obsolete or replaced in the next 20 years? 4. Is the company a conglomerate? 5. What is the company’s earnings per share history? 6. Is the company consistently earning a high return on shareholders’ equity? 7. Is the company conservatively financed? 8. Is the company in question actively buying back its own shares? 9. Is the company free to raise prices with inflation? 10. Is the company’s stock price suffering from a market panic, a business recession or an individual calamity that is curable? 11. What is the initial rate of the investment and its expected annual rate of growth? How does it compare to rate of return being on the US treasury bonds? 12. The company’s stock as an equity/bond calculation