Thursday, 12 July 2012

Equity Bond

To Warren Buffet's way of thinking, companies with durable competitive advantage have such consistent earnings that their stocks become a sort of bond.  He calls the stock an equity/bond, and it pays an interest rate equal to the yearly return on equity that the business is earning.  The earnings-per-share figure is the equity/bond's yield.  If the company has a shareholders' equity value (book value) of $10 a share and net earnings of $2.50 a share, Warren would say that the company is getting a return on its equity/bond of 25% ( $2.50 / $10 = 25%).

But since a business's earnings fluctuate, the return on the equity/bond is not a fixed figure as it is with other bonds.  Warren belives that with an equity/bond, one is buying a variable rate of return, which can be positive for the investor if earnings increase, or negative if earnings decrease.  The return on the equity/bond will fluctuate as the relationship of equity (book value) to net earnings changes.

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