| On 10.16.09, In Uncategorized, by tilak |
Warren Buffet is known to be the ultimate and most original value investor. Like bargain hunters, value investors seek products that are beneficial and of high quality but under priced.
Warren Buffett firmly believes that an investor should leave a margin of safety in investing. He learned this concept at the knee of his mentor, Benjamin Graham, he taught his students to allow plenty of room for hidden problems. According to Graham, smart investors don’t buy stocks at fair value — they buy them when the stock is trading well below its fair value. In fact, a very rewarding strategy is to wait for a highly negative environment (like poor monsoons, or global slowdown) and then pick up such stocks.
In valuing the company, Warren Buffet uses 6 principal steps that he holds strongly;
First Step : ROE
ROE reveals the rate at which shareholders are earning income on their shares. Warren Buffett always looks at ROE to see whether or not a company has consistently performed well in comparison to other companies in the same industry. ROE is calculated as follows: ROE= Net Income/ Shareholders’ Equity.
Looking at the ROE in just the last year isn’t enough. The investor should view the ROE from the past five to 10 years to get a good idea of historical performance.
Second Step: Debt/Equity ratio
The debt/equity ratio is another key characteristic Buffett considers carefully. Buffett prefers to see a small amount of debt so that earnings growth is being generated from shareholders’ equity as opposed to borrowed money. The debt/equity ratio is calculated as follows: Debt/ Equity ratio= Total Liabilities/ Shareholders’ Equity
This ratio shows the proportion of equity and debt the company is using to finance its assets.A high level of debt compared to equity can result in volatile earnings and large interest expenses.
Third Step: Profit margins
The profitability of a company depends not only on having a good profit margin but also on consistently increasing this profit margin. This margin is calculated by dividing net income by net sales. To get a good indication of historical profit margins, investors should look back at least five years. A high profit margin indicates the company is executing its business well, but increasing margins means management has been extremely efficient and successful at controlling expenses.
Fourth Step : Market reputation
Buffett typically considers only companies that have been around for at least 10 years. As a result, most of the technology companies that have had their initial public offerings (IPOs) in the past decade wouldn’t get on Buffett’s radar. Warren buffet assume not to underestimate the value of historical performance, which demonstrates the company’s ability (or inability) to increase shareholder value.
Fifth Step : Reliability of the products
Warren Buffet tends to move away from companies whose products are indistinguishable from those of competitors, and those that rely solely on a commodity such as oil and gas. If the company does not offer anything different than another firm within the same industry, Warren Buffett sees little that sets the company apart. Any characteristic that is hard to replicate is a competitive advantage. The more competitive advantages that a company hold, the harder it gets for the market to compete with the company.
Sixth Step : Company value
By determining the intrinsic value of a company by analyzing a number of business fundamentals, including earnings, revenues and assets, Warren Buffett will obtain more understanding on the condition of companie’s financial health. A company’s intrinsic value is usually higher than its liquidation value – what a company would be worth if it were broken up and sold today. The liquidation value doesn’t include intangibles such as the value of a brand name, which is not directly stated on the financial statements.
Once Buffett determines the intrinsic value of the company as a whole, he compares it to its current market capitalization – the current total worth (price). If his measurement of intrinsic value is at least 25% higher than the company’s market capitalization, Buffett sees the company as one that has value.
Warren Buffett’s doesn’t listen to analysts or the press. Nor does he put much faith in management’s projections of what a company might earn five or 10 years down the road. He prefers to look at what a company has done in the past and uses that as a guide to the future. The most important think for Warren Buffet is that you have to believe on what your own analysis.
3 Responses
Warren Buffett takes this value investing approach to another level. He chooses stocks solely on the basis of their overall potential as a company – he looks at each as a whole. Holding these stocks as a long-term play, Buffett seeks not capital gain but ownership in quality companies extremely capable of generating earnings. When Warren Buffett invests in a company, he isn’t concerned with whether the market will eventually recognize its worth; he is concerned with how well that company can make money as a business.
Maxx {Student of Birmingham university}
Great One, for those who r new to the Investing Business…
Thanks Maxx for your valuable input. You are absolutely right that Buffet always suggest for long term investment and market leader. No worry about market price, sooner or later it jumps if the stock is lucrative passing above steps.
One interesting story of Buffet prove his value investing technique.
In 1988, Buffet started buying up Coca-Cola stock like an addict. His old neighbor, now the President of Coca-Cola, noticed someone was loading up on shares and became concerned. After researching the transactions, he noticed the trades were being placed from the Midwest. He immediately thought of Buffett, whom he called. Warren confessed to being the culprit and requested they don’t speak of it until he was legally required to disclose his holdings at the 5% threshold. Within a few months, Berkshire owned 7% of the company, or $1.02 billion dollars worth of the stock. Within three years, Buffett’s Coca-Cola stock would be worth more than the entire value of Berkshire when he made the investment.