Warren Buffett has a reputation for being a value trader; this means he looks at a company as a whole before he invests. Millions of people flock to Buffett as one of the global leaders for investing advice. He believes investing activities include fully researching a company, their financials, and their profits before buying a stock from that company. His investing strategy has made him one of the richest men in the world. Read more about how Buffett chooses the companies he invests in.
Investing in stocks can be simple when following his methods, but keep in mind that it can be very time consuming. Keep an investing journal that will inform your investing plan, which should be organized on a spreadsheet or investing app.
Investing from a Business Perspective
Investing from a business perspective means valuing the stock based on what the company is actually worth, disregarding taxation and inflation. A company’s worth is an equation of the revenue stream times the amount of years the market will have left for the company to profit, plus the interest made over those years. This provides the investor with certainty of the annual rate of return.
Once the stock price is reported, you can compare it with other rates of return to calculate the annual compound rate of return. Buffet does this to determine if the rate of return makes sense to him. He determines the price today, as stocks tend to price upward, and if the rate of return matches what he has decided is a match, then he buys.
Buffet ignores the ups and downs, and he determines the right companies for his portfolio and the right price at which to buy by calculating their compounding rate of return. Stock is an equity bond which isn’t paid as taxable income unless paid as a dividend, and if a company invests their profits back into the company then that stock would increase based on the increase of profits, assets, or stock buybacks.
Companies whose value keeps expanding regardless of their actual profitability can be risky. Earnings needed to be predictable and expanding in order to warrant investment.
An Excellent Business Displays Certain Characteristics
There are a number of questions one can ask when doing their investing research to determine a good portfolio choice.
Does the business have an identifiable brand name? If so, products and services will be well advertised, making profitability more likely. On the other hand, a great product doesn’t always mean a great company.
How is the organizational management? Strong businesses are built on strong management strategies and leaders.
Are the earnings consistently strong and proving an upward trend? Annual per share earnings that are strong and show growth indicate a viable investment choice.
Is the company conservatively financed? Investors should be wary of long-term debt burdens. A strong investment choice will show little to no long-term debt that is less than 1X annual earnings. If there’s an acquisition ahead, make sure it’s not a commodity, if it’s a consumer monopoly, it could be fine. But if it’s a commodity that’s not a monopoly and management acquires it to use their monopoly to fund the commodity, there can be a lot of risk.
Does the business create shareholders equity? The business needs to have consistent high returns because the company’s total assets minus liabilities needs to leave enough room that profits can be invested into more assets, making more profits. These profits enable the company to produce more than the average market return of 12%. When determining his portfolio choices, Buffett looks for higher than 15% returns: for example, General Foods at 16%, Coca-Cola 35%, Hershey Foods 16.7%, Phillip Morris 30.5%, Capital City 18%, Service Masters 40%. Consistency is key.
Does the business get to retain its earnings? Buffet claims he doesn’t buy when the company is paying out high dividends; he prefers companies that invest earnings back into the company and gain over time via compounding. Find companies that retain earnings without having to maintain operations.
The Perfect Business
When choosing your stock investments, the following list of attributes can be a helpful guideline. Look for businesses that display the following traits:
~ A business that makes profit without high expenses
~ A business that shows operation records for capital requirements, research, investments and infrastructure
~ A business with less capital needs, freeing cash up to buy new business opportunities
~ A business in which management employs its earnings to buy more assets to make more money. When these companies have no new businesses to buy, they would allocate earnings by buying back shares, causing per share earnings to increase.
~ A company free to increase prices with inflation
~ Consumer monopolies are ideal because they can make more profits without spending too much on advertising
~ “Toll bridge” businesses – these are go-to companies for many others and will always be essential
~ A company with name brand products, and renewable products customers have to rebuy due to regular consumer usage or product wear
When choosing investments, understand what the company sells and how it’s used. The bottom line is to ask the questions that you can confidently answer to make sure a company makes money, will make money in the future, is managing their money wisely, and will prove that their company is valuable in the long run so that your stock becomes more valuable. It does require a lot of research, but when you’re buying stocks, you’re buying the company, so be sure you know who and what you’re owning. For more details on planning and executing your investment research strategy, read How to Research Investments that are Right for You and Investing Research Part II.
We live in a very different world than the one that made Warren Buffet rich. Economic and world affairs can make the market volatile, triggering rapid fluctuation, and consumer emotions can be set against a company within seconds based on news and bad press, which is instantaneous now via the internet. Spend some time finding what works for you, and be sure to research companies who have what it takes to keep their head above the fluctuations, and then don’t worry about the day to day losses and gains. A good company with good morals and ethics that profits consistently is sure to keep making it. Be mindful that investing is always risky, and there is no safety net. You might lose, or you might win. The more effort you put into learning and finding good companies to put your money on, the better chances you’ll have of winning. Enjoy the journey!
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