At the time Warren’s investing style, taught by Ben Graham, was to look for “cigar butt” stocks – stocks that were dirt cheap, but provided a “free puff” to investors willing to make the investment. Berkshire certainly could have filled that criteria, here is how Buffett tells the tale:
Breaking Down a Company’s Asset Growth With Analysis of the Changes in its Balance Sheet
Generally, increasing assets are a sign that the company is growing, but everyone can relate to the fact that there is much more behind the scenes than just looking at the assets. The goal is to determine how the asset growth of a company is financed.
To do so all we need is the last few years of a company’s balance sheet and the most basic financial statement equation:
The assets of a company are what the company owns. Typical examples of assets are; equipment to make a product, buildings owned, raw materials to create a product, inventory of the product to sell and cash in the bank.
Think of your household. Your car, your home, your furniture, TVs, Computers, bank accounts etc.
Generally, increasing assets are a sign that the company is growing, but everyone can relate to the fact that there is much more behind the scenes than just looking at the assets. Back to our household example:
Imagine watching a neighbor pull a sparkling brand new BMW into their driveway, getting out dressed in his fancy Italian suit, talking on the latest smartphone, and coming over to ask if you can watch his house for 2 weeks while he travels to sail in the Caribbean. You may think he is making it big, right? Maybe he got a big bonus from work, or a promotion…
That may very well be the case, or he may be racking up debt (liabilities) to finance these assets.
You may never find out which option applies to your neighbor, but thankfully the SEC requires publicly traded companies to be a little more transparent with their financials than your neighbors. [continue reading…]
What Can Shiller’s CAPE Ratio Tell Us About Future Stock Returns?
How can you tell if stocks are expensive?
Of course there is a thousand different ratios, indicators and indexes that attempt to measure the value in today’s stock market. Today we are going to look at one of the most popular ratios in particular, Shiller’s PE10 ratio, also known as CAPE ratio. What information can we get from looking at 100+ years of history between stock returns, treasury yields and CAPE ratio readings? [continue reading…]
How to Analyze a Company by Its Inventory
The basic operation of a business is centered around 2 steps:
Build a Product
Sell that product
And I would argue that step #2 is the most important. Of course quality of your product is important, but if your product isn’t selling – the business is not making money. Period.
Today we are going to look at a few ways to analyze the inventory on a company’s balance sheet to help us measure how well the company is doing selling its product.
Inventory is usually the largest current asset on a company’s balance sheet, and is therefore the company’s primary use of cash. We have all seen the new companies on Shark Tank who desperately need money for inventory (Or who have used up all their capital buying inventory). So learning a few basics on what a company’s inventory is telling you is very important.
How Much is TOO Much to Pay for a Wonderful Company? A Look at a Current Great Business, and Buffett’s Past Purchases
One of the more famous investment quotes, which represents a mindset that has created one of America’s most valuable companies, from one of the most successful investors of all time:
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” – Warren Buffett
And that got me thinking…At what price did Buffett purchase some of his “wonderful” businesses and how does that compare to some “wonderful” stocks today? And what is considered a “fair” price? [continue reading…]
How Do You Beat Your Benchmarks Over the Long Haul? – A look at Dimensional Fund Advisors
This week we have been looking at one of the fastest growing companies in asset management – Dimensional Fund Advisors (DFA). Our Quote of the Week looked at the CEO’s key principal for successful investing, our Chart of the Week looked at DFA’s outperformance. Today we look and see how they do it. [continue reading…]
Chart of the Week: What Could You Buy With $200 Billion?
Recently, Facebook’s market cap has surpassed $200 billion dollars. That got me thinking….
What other companies could you buy for $200 billion, and how do those companies compare to Facebook?
Quote of the Week: Why are Consistent Earnings so Important?
All of a sudden it is pretty apparent that the stock market has moved a long ways from the recession of 5 years ago.
Today, OpenTable, with a net income of $33 million is being purchased by Priceline for $2.6 billion. Facebook, is now worth nearly $200 billion, twice the value of McDonalds despite having just one fourth of McDonald’s profits. And Tesla Motors is worth $33 billion – exactly half the value of Ford, despite selling just 22,400 cars in 2013. (To put that in perspective, that is how many F-150 pick up trucks ford sells in about 2 weeks, and is less than 1% of the total number of vehicles that ford sold in 2013).
Investors have one thing in mind when paying these exceedingly high prices – The prospects of future growth.
Neither of the companies mentioned above have the fundamentals to back up their sky high valuations, but that doesn’t seem to be stopping investors from dreaming.
The potential money to be made “finding the next google” will always blur an investor’s vision. Dreams of money to be made are like the beer goggles of the investment world – Investors immediately begin to make assumptions and ignore obvious risks for a chance to get lucky.
But, one day these investors will wake up and ask themselves “What the hell did I invest in?” [continue reading…]
Throwback Thursday: A look at Buffett’s 1988 investment in Coca-Cola
Buffett began purchasing Coca-Cola (Ticker: KO) shares in 1988. Today, Buffett has over $13 billion in gains from his investments in Coca-Cola alone.
With hindsight, it is always easy to say Buffett’s investment in Coca-Cola was anything short of genius, but at the time Coca-Cola was facing concerns over maintaining market share and its ability to grow.
However, Buffett recognized that Coca-Cola had a strong brand name, very consistent history of earnings, shareholder return and low debt. It has been a wild 26 year ride for Buffett, but the returns have been staggering!
At the time of Buffett’s initial purchase of Coca-Cola shares, its market cap was about $18.5 billion. Coca-Cola then had Revenues of $8.3 billion, a cash pile of $1.2 billion, a net income of about $1 billion and about $4.4 billion in retained earnings.
Buffett purchased about $1.3 billion in Coca-Cola initially, or about 7% of the company. Today his total Coca-Cola stake is worth over $15 billion, and pays him about $490 million in dividends each year! Incredible returns off of a $1.3 billion initial investment!
But its always easy to quickly glance over the last 26 years. The truth is that it took some major cahones to hold anything over the last 26 years.
Would you have been able to overlook the short term negative outlook for Coca-Cola in 1988?
Would you have had the confidence to hold through a 50%+ drop from its 1998 highs to 2004 lows? Or weather the 2008 decline?
Evaluating Financial Statements – Statement of Shareholder Equity
We have previously discussed the more well known financial statements; the balance sheet, income statement and statement of cash flows, but there is one additional financial statement you will see listed within every company’s 10-k report, the statement of shareholder equity. Value investors like Warren Buffett consider information within this report as some of the most important and telling signs of a company’s health. Here is why:
So really, shareholder equity should be considered the net worth of the company, or what the company is worth if all its assets were sold and debts settled.
The Statement of Shareholder Equity depicts the value of the company and describes where that value comes from and how it has changed over time for investors. [continue reading…]
Financial Friday: Leverage – What is it? How is it Calculated? And How it Destroyed One of America’s Largest Businesses in Days.
Leverage has been responsible for some of the most glamorous gains and disastrous declines in the financial world. Here we look at what leverage is, and show an example of its devastating potential.
What is Leverage?
Leverage is typically defined as your “exposure” relative to “actual capital”.
Where exposure is the value of your holdings, and actual capital is money paid or invested by you. The additional “exposure” comes from borrowed money, and this is why being “leveraged up” can be so dangerous.
In the most general terms, leverage is:
The most common form of leverage that consumers are familiar with deals with mortgages. Consider a family looking to purchase a $500,000 house. They likely cannot afford to write a $500,000 check. They will most likely go to a bank and put, say, $100,000 down and take out a mortgage for the remaining $400,000.
Here the family’s “exposure” is $500,000, the actual value of their house, but their “actual capital” is just the $100,000 they put down. [continue reading…]
Return on Equity (ROE) Tells More than EPS Growth
As another earnings season rolls around and companies EPS (Earnings Per Share) numbers are making headlines, here’s why you should pay particular attention to ROE (Return on Equity) instead. [continue reading…]