BOOK : The Buffet Way
— April 28, 2013Notes : ( Highlights )
Business Tenant :
Questions Before you invest :
1. Is the business simple and understandable?
2. Does the business have a consistent operating history?
3. Does the business have favorable long-term prospects?
Notes / Highlights :
- Business is very much profiting from lack of change. That’s the kind of business I like.
- I want to be in businesses so good even a dummy can make money.
- Turnarounds seldom turn ( avoid difficult business problems )
- Look for companies that can generate high ROIC
- Buy Franchises not Commodity Businesses
- A Franchise Business (1) products are desired or needed (2) Has no close substitute (3) is not regulated (4) people are willing to pay for quality [moat]
- Look for companies with Durable Competitive advantage
- Look for Increasing Profit Margins
Few Conditions :
– Business would have to be simple and understandable
– Demonstrated great deal of business consistency over the years
– long-term prospects would have to be favorable
– Market for the products continue to grow
– The Business has been and will be the leader in the segments it operates
– Business has low capital needs ( Not Capital intensive )
Filter :
+ve
Consistant High (Growing) ROIC
Consistant High (Growing) Profit Margins
-ve
Management Tenets
Management Questions :
1. Is the management Honest and competent whom you can admire and trust ?
1. Is management rational? ( in capital allocation )
2. Is management candid with the shareholders?
3. Does management resist the institutional imperative ? ( blindly following industry peers )
Important Questions : A company that provides average or below-average investment re- turns but generates cash in excess of its needs has three options:
1. Continue to reinvest at below-average rates
2. It can buy growth ( by acquisitions & mergers )
3. Return the money to shareholders ( Dividends / Share Buy Backs )
What should a Management Report to Shareholders :
(1) Approximately how much is this company worth?
(2) what is the likelihood that it can meet its fu- ture obligations? and
(3) how good a job are its managers doing, given the hand they have been dealt?”
What is the reason for foolish acquisitions or irrational decisions by managers ?
1. Lust for activity ( equating activity to progress & productivity )
2. Comparing earnings/compensation with other competitors / peers
3. Exaggerated sense of their own capabilities
4. Poor or no experience is capital allocation ( more CEO’s are promoted form sales/engineering etc )
5. Mindless imitation
How to find the quality of Management ?
1. Read the annual report of a company few years before and note the strategies and verify if they were fulfilled later
2. Pay attention to the direction of the company that was set in the previous year annual report, has it changed now ?
3. Pay attention to any news about the company or sector in the news paper
4. Obtain any presentation or speech made by company executives anywhere from the company website
Filter :
+ve
- Company buying back shares ( when the shares are down )
- Acquires companies that has competitive barriers, does not require extensive capital expenditures, and has reasonable pricing power.
- CANDOR – Candid and honest reporting of data as is ( Good or Bad )
- Managers are owners and own significant % of company ( 30-60% )
- Company stays with core Value Prop/Products ( does not invest in unrelated businesses where there is no synergy or economy of scale – ex : PEP buys chips )
-ve
- Company buying growth mindlessly
- Stock Options are not reported as expense in the balance sheet
- unintelligible footnotes – That you can’t understand
- Excessive executive pays
- Executives / Insiders dumping shares
- Be suspicious of companies that trumpet earnings projections and growth expectations.” No one can know the future, and any CEO who claims to do so is not worthy of your trust.
Financial Tenant
Notes :
- Always look for 5-10 year average for all figures
- Focus on return on equity, not earnings per share.
- Calculate “owner earnings” to get a true reflection of value.
- Look for companies with high profit margins.
- For every dollar retained, has the company created at least a dollar of market value?
ROE :
all marketable securities should be valued at cost and not at market value ( while calculating ROE )
exclude all capital gains and losses as well as any extraordinary items that may increase or decrease operating earnings ( anything thats not directly coming from business operations. ex – increased profits through acquisition one year with lot of leverage )
OWNER EARNINGS :
– Not all earnings are created equal
– EPS is starting point not end
Owner’s Earnings = a company’s net income plus depreciation, depletion, and amortization, less the amount of capital expenditures and any addi- tional working capital that might be needed.
Cash Flow = net income after taxes plus depreciation, depletion, amortization, and other noncash charges.
Note : Cash Flow leaves Capital Expenditure and other working capital needed during the time. This can be misleading as its not the true cash-flow ( cash in hand at the end of the quarter for Owners of the company)
Cash Flow – Owners Earnings = capital needs of the company
Profit Margins :
A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.
* Buffett has little patience for managers who allow costs to esca- late.
Metrics :
ROE | ROIC | EPS | Owners Earnings | Cash Flow | Profit Margins
Filter :
+ve
- Great companies have an average ROE of 28% or higher
-ve
- Good returns on equity only by employing significant debt.
- Company is fighting to increase market share in a stagnent market
Value Tenant
* Price is what you pay. Value is what you get.
Coupon = A coupon payment on a bond is a periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures.( similar to intrest rate for a dividend )
Value of a Business = value of a business is the total of the net cash flows (owner earnings) expected to occur over the life of the business, discounted by an appropriate interest rate. ( discounted interest rate is min = 10% or current U.S Govt bond rate )
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