Price Is What You Pay – Value Is What You Get
The headline of this chapter is a quote from Warren Buffett, one of the most successful investors in the world. A man, I follow for decades and I very much recommend any new investor to do as well.
In short, with his investment philosophy, condensed in the title of this chapter, he became one of the richest man in the world. Therefore it might be helpful to listen what Buffett has to say about the stock market.
A few years ago, I had the chance to meet Warren Buffett in his hometown Omaha, Nebraska, in the american mid-west. No wonder, everyone I was telling about the trip, ask me to bring home some stock market tips from the ‘Sage of Omaha’ as Buffett is called.
But guess what – in the conversation he wouldn’t reveal a single tip, instead he gave an invaluable lesson how to find good stocks on my own. Here are the cornerstones of this lesson:
- People start to think about risk, when the market is down, you better take risk into account when the market is up;
- Only invest in companies or sectors you really understand. Buffett calls it the ‘circle of competence’. The size of this circle is not important, but it’s vital to know the boundaries;
- An investment decision based on emotion and ego most likely is a failure. People tend to look too much on confirmation of their opinion and overlooking the clear evidence that contradicts it;
- Buffett loves ‘to buy a value of 1 Dollar for 50 cents‘. To find stocks who offers value for an attractive price, he examines the long time performance, the debt and the margins of companies;
- Performance: Buffett is checking if the company constantly paid a dividend for the last 10 years.
- Debt: Buffett wants to own companies who’s growth is based on shareholders equity instead of borrowed money.
- Profit margin: Buffett wants to see not only a solid profit margin but the companies ability constantly increasing it. A high margin indicates a good execution of the business, a constantly increasing margin shows efficiency and successful cost control.
But to find companies who meet the mentioned criteria is not Buffetts only approach. His real and unmatched ability is to figure out how the stocks of these enterprises are valued by the markets.
Therefore he is calculating the ‘intrinsic value’ of a company, based on publicly available fundamentals like revenues, earnings and assets.
Then he adds the intangible assets, like the value of a brand, and gets the intrinsic value of a company.
Now, he compares this figure with the market capitalization of that company and if the intrinsic value is at least 25 percent higher than the market price, Mr Buffett goes shopping, or as he likes to say ‘bargain hunting’ at the stock market.
Now this procedure might be a little to much for private investors. But it should give you the idea that it is important not only look at the price but mainly at the value when buying a stock.
At the end of the conversation I asked him, what is the most important question an investor should ask, before buying a stock. His answer is crossing my mind ever since when acting on the market: ”if you had the money to buy the whole company, would you do it? If not, don’t buy a single share.”
Warren Buffett didn’t start with a silver spoon in his mouth, he was born into the great american economic depression in the 1930’s. Despite it’s huge business success, he remained a modest person. If you are curious about the person behind the investment genius, I recommend the book ‘The Snowball – Warren Buffett and the Business of Life’ (2001) by Alice Schroeder.
If you have not enough time to search for single investments, then why not buy a stock market-index? It’s easy and quiet cheap to participate – more on Dow Jones & Co. is coming up in the next chapter: http://www.theleader.ro/easy-entry/