Bullbear Buffett

Keep INVESTING Simple and Safe (KISS) ****Investment Philosophy, Strategy and various Valuation Methods**** The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.

Wednesday, 19 November 2025

How can I value this stock using the equity bond concept of Warren Buffett?

I have a stock A. It pays steady growing dividends for decades. It is in a great business and has grown its revenues and earnings consistently for decades. How should I value this stock? Warren Buffett advises to treat this company like a equity bond. How can I value this stock using the equity bond concept.

Excellent question. This "equity bond" concept is a powerful mental model directly from Warren Buffett's playbook, and it's perfectly suited for the type of stock you're describing.

Let's break down how to value your stock using this framework.

The Core "Equity Bond" Concept

Buffett's insight is simple yet profound: treat a wonderful, predictable business not as a volatile stock, but as a bond-like instrument where the "coupon" (earnings) grows over time instead of being fixed.

A Traditional Bond: Has a fixed coupon and a maturity date. Its value is the present value of those fixed, certain payments.
An "Equity Bond": Has an initial "coupon" (current earnings per share) that is expected to grow predictably over time. Its value is the present value of these growing, owner-earnings.

This shifts your focus from short-term price fluctuations to the long-term, predictable economics of the business itself.

Step-by-Step Valuation Using the Equity Bond Method

Here is a practical guide to applying this concept to Stock A.

Step 1: Identify the "Coupon" (Owner Earnings)

For a bond, the coupon is clear. For an equity bond, we need to find the equivalent. While dividends are a good starting point, Buffett focuses on the earnings power that is ultimately available to the owner.

Primary Metric: Earnings Per Share (EPS). Use the company's normalized, or owner earnings. This means adjusting reported EPS for one-time charges/gains to get a true picture of recurring profitability.
Example: If Stock A has reported EPS of $5.00, but this includes a one-time gain of $0.50, its normalized EPS might be $4.50. This $4.50 is your starting coupon.

Step 2: Estimate the Perpetual Growth Rate ("The Coupon Growth")

This is your estimate of how much the company can grow its "coupon" (EPS) per year, forever. Be conservative.

The Anchor: The growth rate cannot exceed the long-term nominal GDP growth (say, 3-5%). A wonderful company might sustainably grow slightly faster than GDP for a long time.
Base it on History and ROIC: Look at the company's long-term track record. A company that has grown EPS at 8% annually for decades might be reasonably expected to grow at 5-6% in perpetuity, assuming it can reinvest its earnings at a high rate of return (a high ROIC).
Example: Let's assume a conservative and sustainable perpetual growth rate for Stock A of g = 5.0%.

Step 3: Determine Your "Equity Bond" Yield (The Discount Rate)

This is the most critical step. Instead of using the complex CAPM, Buffett simply uses the long-term government bond yield as his benchmark and then asks, "What yield do I require for this superior but still somewhat risky asset?"

Start with the Risk-Free Rate: Get the current yield on the 30-Year Treasury Bond. This is your opportunity cost. Let's say it's 4.5%.
Add a Minimal Risk Premium: Because Stock A is a wonderful, predictable business, it is less risky than the average stock. However, it's not completely risk-free. You deserve a small premium over the risk-free rate to compensate for business risk and uncertainty.
Your "Equity Bond" Yield: For a stellar company, this might only be 1-3% above the long-term bond yield.
- Example: 30-Year Treasury (4.5%) + 2% Equity Risk Premium = 6.5%.

This 6.5% is your discount rate (r). It is your required return for this specific "equity bond."

Step 4: Calculate the Value Using the Growing Perpetuity Formula

This is mathematically identical to the Gordon Growth Model, but the inputs are framed differently.

Equity Bond Value = Current "Coupon" (EPS) / (Your Required Yield - Growth Rate)

Value = EPS / (r - g)

Using our example:

EPS (Coupon) = $4.50
r (Your Required Yield) = 6.5% or 0.065
g (Perpetual Growth) = 5.0% or 0.05

Value = $4.50 / (0.065 - 0.05)
Value = $4.50 / 0.015
Value = $300 per share

Interpretation and Comparison

Your Calculated Value: $300 per share. This is the intrinsic value of your "equity bond."
Current Market Price: Let's say it's $250.

Conclusion: The stock is trading at a 17% discount to your calculated intrinsic value ($250 vs. $300). According to Buffett's principle, this is a buy. You are acquiring a "bond" with a starting yield of $4.50/$250 = 1.8%, but one whose coupon is expected to grow at 5% per year, giving you a very attractive effective yield that will compound over time.

Critical Caveats and refinements

The "G" is Everything: The model is extremely sensitive to the growth assumption (g). If you change g to 4.5%, the value plummets to $4.50 / (0.02) = $225. Always be conservative with g.
The "No-Growth" Floor: A useful sanity check is to calculate the value of Stock A as if it were a true bond with no growth.
- Value (No-Growth) = EPS / r = $4.50 / 0.065 = ~$69
- The difference between $300 and $69 ($231) is the present value of the growth opportunities. This tells you how much you are paying for future growth.
Is the Growth Rate Sustainable? The model assumes the 5% growth can continue forever. You must be confident that the company's moat, market size, and return on invested capital (ROIC) support this.
Compare to Dividend Model: If the company pays out most of its earnings as dividends, the Dividend Discount Model from our previous conversation will give a similar result. The Equity Bond method is more powerful because it values all the earnings, not just the portion paid out.

In summary, by treating Stock A as an "equity bond," you shift your mindset from a speculator to an owner. You are not buying a ticker symbol; you are buying a claim on a stream of growing future earnings, and your job is to determine what that stream is worth to you today.

I was going to ask, why not use dividend in the equity bond concept to calculate the value of the stock. Why use earnings per share? When would using earnings per share preferred to using dividends, and vice versa?

This is an absolutely brilliant question that gets to the very heart of intelligent investing. The choice between earnings and dividends in the "equity bond" model is crucial, and the rationale reveals a lot about a company's quality and how you should think about returns.

Let me explain the core principle, and then provide a clear framework for when to use each.

The Core Principle: Ownership vs. Income

When you buy a stock, you are buying ownership of the entire company and its future earnings, not just a claim to its dividends. The "equity bond" concept values your share of the business's total profit-generating capability.

Using Earnings (EPS): Values the entire profit stream of the business. It answers: "What is the value of my share of all the money this company earns?"
Using Dividends: Values only the portion of profit that is paid out to you. It answers: "What is the value of the cash payments I receive from this company?"

Why Buffett Prefers Earnings (EPS) for an "Equity Bond"

For the "equity bond" concept, earnings are almost always preferred, and here’s the critical reason why:

Dividends are a decision of management. Earnings are the fundamental capability of the business.

Think of it this way: The "coupon" on a bond is the total interest it generates. You, as the owner, care about that total interest-generating power, regardless of whether you clip the coupon and spend it or let it compound.

Similarly, with an "equity bond":

The Earnings (EPS) is the total "coupon" the business generates.
The Dividend is the part of the coupon that management mails to you in cash.
The Retained Earnings (EPS - Dividends) is the part of the coupon that management reinvests back into the business on your behalf.

For a "great business" as you described, the primary source of your returns is not the dividend yield, but the growth of the underlying earnings, which drives the long-term price appreciation. Using dividends alone would ignore the powerful engine of growth that retained earnings fuel.

When to Use Earnings (EPS) vs. Dividends: A Decision Framework

Here’s a clear guide on which metric to use and why.

✅ Use EARNINGS (EPS) when...

1. The Company is a "Compounding Machine" (The Classic Buffett Stock)

Scenario: The company consistently earns a high Return on Invested Capital (ROIC). It can reinvest its retained earnings back into the business to generate high rates of return.
Example: Apple (AAPL) or Amazon (AMZN) in their growth phases. For decades, Apple retained most of its massive earnings to fund R&D, new products, and share buybacks, creating far more value for shareholders than if it had paid all earnings out as a dividend.
Valuation Logic: Using EPS captures the value of this reinvestment and future growth. Using dividends would dramatically undervalue the company.

2. The Payout Ratio is Low or Fluctuating

Scenario: The company pays out a small percentage of its earnings (e.g., a 20% payout ratio).
Logic: If you used the dividend, you'd be ignoring 80% of the profit-generating power of your asset. The "equity bond" coupon should reflect the full $4.50 of earning power, not just the $0.90 that gets paid out.

3. Share Buybacks are a Primary Method of Capital Return

Scenario: The company aggressively buys back its own shares instead of, or in addition to, paying dividends.
Logic: Buybacks increase your ownership percentage of the future earnings stream without you spending a dime. Using EPS captures this, as your share of earnings grows over time. A dividend-based model misses this entirely.

✅ Use DIVIDENDS when...

1. The Company is a "Mature Cash Cow"

Scenario: The business is stable but has limited high-return growth opportunities (e.g., a utility, a REIT, or a tobacco company). Its primary value proposition to the investor is the direct cash distribution.
Example: AT&T (T) or Southern Company (SO). Their main appeal is the dividend yield.
Valuation Logic: The dividend is the return. Since management has few good ways to reinvest earnings, they pay most of them out. The "equity bond" coupon is effectively the dividend.

2. The Payout Ratio is High and Stable

Scenario: The company pays out most of its earnings as dividends (e.g., an 80-90% payout ratio).
Logic: In this case, the dividend is a very accurate proxy for earnings power. The business model is such that earnings and dividends track each other closely.

3. You are Modeling an Income Portfolio

Scenario: Your investment goal is to live off the income generated by your portfolio.
Logic: You care directly about the safety and growth of the cash payments hitting your brokerage account. Valuing based on the dividend stream aligns perfectly with your personal financial goals.

Practical Example: Stock A Revisited

Let's apply this to your "Stock A."

If Stock A has a high ROIC and reinvests 60% of its earnings to fund 7% growth, it's a compounding machine. You must value it using EPS. This gives you the full picture.
If Stock A is a regulated utility with a 5% growth ceiling and pays out 75% of earnings, it's a mature cash cow. You could reasonably value it using Dividends Per Share (DPS).

The Hybrid / "Look-Through" Approach

The most sophisticated way to think about it is a hybrid:

Total Owner Return = (Dividend Yield) + (Growth in EPS from Reinvested Earnings)

The "equity bond" model using EPS inherently values both components. Using DPS only values the first one.

Summary

Metric	Best For...	Why?	Think of it as...
Earnings (EPS)	Growth Compounders, businesses with high ROIC, low payout ratios.	Captures the value of reinvested earnings and the company's full profit-generating power.	The entire pie the business bakes each year.
Dividends (DPS)	Mature Income Stocks, utilities, REITs, companies with high, stable payout ratios.	Accurately reflects the cash return to shareholders when growth opportunities are limited.	Your slice of the pie that management serves to you.

For your "Stock A" that is in a "great business" and has grown for decades, the odds are extremely high that it is the first type—a compounding machine. Therefore, you should value it as an "equity bond" using its Earnings Per Share (EPS). This is the method that truly honors Buffett's wisdom.

Summary:

| :--- | :--- | :--- | :--- |

| **Earnings (EPS)** | **Growth Compounders**, businesses with high ROIC, low payout ratios. | Captures the value of *reinvested earnings* and the company's full profit-generating power. | **The entire pie** the business bakes each year. |

| **Dividends (DPS)** | **Mature Income Stocks**, utilities, REITs, companies with high, stable payout ratios. | Accurately reflects the cash return to shareholders when growth opportunities are limited. | **Your slice of the pie** that management serves to you. |

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My 18 points guide to Successfully compounding your money in Stocks

Be a good stock picker.
Think as a business owner.
Always look at value rather than the price. Do the homework.
Buy and hold is alright for selected stocks.
Compounding is your friend, get this to work its magic.
Mr. Market is there to be taken advantage of. Do not be the sucker instead. BFS;STS.
Always buy a lot when the price is low.
Never buy when the stock is overpriced.
It is alright to buy when the selected stock is at a fair price.
Phasing in or dollar cost averaging is safe for such stocks during a downtrend, unless the price is still obviously too high.
Do not time the market for such or any stocks.
By keeping to the above strategy, the returns will be delivered through the growth of the company's business.
So, when do you sell the stock? Almost never, as long as the fundamentals remain sound and the future prospects intact.
The downside risk is protected through only buying when the price is low or fairly priced.
Tactical dynamic asset allocation or rebalancing based on valuation can be employed but this sounds easier than is practical, except in extreme market situations.
Sell urgently when the company business fundamental has deteriorated irreversibly.
You may also wish to sell should the growth of the company has obviously slowed and you can reinvest into another company with greater growth potential of similar quality. However, unlike point 16, you can do so leisurely.
In conclusion, a critical key to successful investing is in your stock picking ability.

http://myinvestingnotes.blogspot.com/2012/07/my-18-points-guide-to-successfully.html

11 Lessons From Peter Lynch

Peter Lynch taught me:

1. Behind every stock is a company. Find out what it’s doing.
2. Never invest in any idea you can’t illustrate with a crayon.
3. Over the short term, there may be no correlation between the success of a company’s operations and the success of its stock. Over the long term, there’s a 100% correlation.
4. Buying stocks without studying the companies is the same as playing poker – and never looking at your cards.
5. Time is on your side when you own shares of superior companies.
6. Owning stock is like having children. Don’t get involved with more than you can handle.
7. When the insiders are buying, it’s a good sign.
8. Unless you’re a short seller, it never pays to be pessimistic.
9. A stock market decline is as predictable as a January blizzard in Colorado. If you’re prepared, it can’t hurt you.
10. Everyone has the brainpower to make money in stocks. Not everyone has the stomach.
11. Nobody can predict interest rates, the future direction of the economy, or the stock market. Dismiss all such forecasts and concentrate on what’s actually happening to the companies in which you’ve invested.

Lynch’s advice had a profound effect on my stock market approach. He taught me that investment success isn’t the result of developing the right macro-economic view or deciding when to jump in or out of the market. Success is about researching companies to identify those that are likely to report positive surprises.

Capital Expenditure

A great company with a Durable Competitive Advantage will have a ratio of Capital Expenditures to Net Income of less than 25%. Less is better.

Capital Expenditures are expenses on:
- fixed assets such as equipment, property, or industrial buildings
- fixing problems with an asset
- preparing an asset to be used in business
- restoring property
- starting new businesses

A good company will have a ratio of Capital Expenditures to Net Income of less than 50%.

A great company with a Durable Competitive Advantage will have a ratio of less than 25%.

Less is better.

Benjamin Graham's 113 Wise Words

The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more. Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement."

Philip Fisher's Wise Words

"The refusal to sell at a loss, while completely natural and normal, is probably one of the most dangerous in which we can indulge ourselves in the entire investment process.

More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other single reason. If to these actual losses are added the profits that might have been made through the proper reinvestment of these funds if such reinvestment had been made when the mistake was first realized, the cost of self-indulgence becomes truly tremendous."

(Common Stocks and Uncommon Profits)

The Ultimate Hold-versus-Sell Test

Here is the overriding primary test, followed by observations on why it is so critically important:

Knowing all that you now know and expect about the company and its stock (not what you originally believed or hoped at time of purchase), and assuming that you had available capital, and assuming that it would not cause a portfolio imbalance to do so, would you buy this stock today, at today's price?

No equivocation. Yes or no?

Answers such as maybe or probably are not acceptable since they are ways of dodging the issue. No investor probably buys a stock; they either place an order or do not.

Here is the implication of your answer to that critical test: if you did not answer with a clear affirmative, you should sell; only if you said a strong yes, are you justified to hold.

Some thoughts on Analysing Stocks (KISS)

Ideally a stock you plan to purchase should have all of the following charateristics:

• A rising trend of earnings dividends and book value per share.
• A balance sheet with less debt than other companies in its particular industry.
• A P/E ratio no higher than average.
• A dividend yield that suits your particular needs.
• A below-average dividend pay-out ratio.
• A history of earnings and dividends not pockmarked by erratic ups and downs.
• Companies whose ROE is 15 or better.
• A ratio of price to cash flow (P/CF) that is not too high when compared to other stocks in the same industry.

Margin of Safety Concept: Stocks should be bought like groceries, not like perfume

The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.

Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.

Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?