Have an obsession for cash flow conversion. What is the free cash flow of the company?

Charlie Munger:  If you take a business that is a GOOD business but not a fabulous (GREAT) business, they tend to fall into TWO categories:

One is the business where the whole reported profit just sits there in surplus cash at the end of the year and you can take it out of the business and the business will do just as well without it, as it would if it stayed in the business

The second business is one that reports the 12% (return) on capital but there's never any cash.  (This) reminds me of the used construction equipment business of my old friend John Anderson and he used to say in my business every year you make a profit and there it is, sitting in the yard.   There are awful of businesses like that where just to keep going (and) to stay in place, there is never any cash.  Now that business doesn't enable headquarters to drag out a lot of cash and invest it elsewhere.  We hate that kind of a business.  Don't you think that is a fair statement?

Warren Buffett:   Yeah, that is a fair statement.

https://www.facebook.com/reel/507646045755285

Summary:

2 types of Good Businesses:

One that generates a lot of free cash flows; you can take this cash out of the business and the business will just do as well without it.

One that generates little or no free cash flows, as it requires a lot of working capital or capex to maintain and sustain its business.

Great, Good and Gruesome Companies. Studying their financial statements.

 

?? INCOME STATEMENT:

1: Gross Margin

?? Equation: Gross Profit / Revenue

?? Rule: 40% or higher

?? Buffett's Logic: Signals the company isn’t competing on price.

2: SG&A Margin

?? Equation: SG&A Expense / Gross Profit

?? Rule: 30% or lower

?? Buffett's Logic: Wide-moat companies don’t need to spend a lot on overhead to operate.

3: R&D Margin

?? Equation: R&D Expense / Gross Profit

?? Rule: 30% or lower

?? Buffett's Logic: R&D expenses don't always create value for shareholders.

4: Depreciation Margin

?? Equation: Depreciation / Gross Profit

?? Rule: 10% or lower

?? Buffett's Logic: Buffett doesn't like businesses that need to invest in depreciating 

asset to maintain their competitive advantage.

5: Interest Expense Margin

?? Equation: Interest Expense / Operating Income

?? Rule: 15% or lower

?? Buffett's Logic: Great businesses don’t need debt to finance themselves.

6: Income Tax Expenses

?? Equation: Taxes Paid / Pre-Tax Income

?? Rule: Current Corporate Tax Rate

?? Buffett's Logic: Great businesses are so profitable that they are forced to pay 

their full tax load.

7: Net Margin (Profit Margin)

?? Equation: Net Income / Sales

?? Rule: 20% or higher

?? Buffett's Logic: Great companies convert 20% or more of their revenue into net income.

8: Earnings Per Share Growth

?? Equation: Year 2 EPS / Year 1 EPS

?? Rule: Positive & Growing

?? Buffett's Logic: Great companies increase profits every year.

? BALANCE SHEET:

9: Cash & Debt

?? Equation: Cash > Debt

?? Rule: More cash than debt

?? Buffett's Logic: Great companies don't need debt to fund themselves.

10: Cash & Debt

?? Equation: Cash > Debt

?? Rule: More cash than debt

?? Buffett's Logic: Great companies generate lots of cash without needing much debt.

11: Adjusted Debt to Equity

?? Equation: Total Liabilities / Shareholder Equity + Treasury Stock

?? Rule : < 0.80

?? Buffett's Logic: Great companies finance themselves with equity.

12: Preferred Stock

?? Rule: None

?? Buffett's Logic: Great companies don't need to fund themselves with preferred stock.

13: Retained Earnings

?? Equation: Year 1 / Year 2

?? Rule: Consistent growth

?? Buffett's Logic: Great companies grow retained earnings each year.

14: Treasury Stock

?? Rule: Exists

?? Buffett's Logic: Great companies repurchase their stock.

?? CASH FLOW STATEMENT:

15: Capex Margin

?? Equation: Capex / Net Income

?? Rule: <25%

?? Buffett's Logic: Great companies don't need much equipment to generate profits.

Caveats:

1?? There are plenty of exceptions to these rules.

2?? CONSISTENCY IS KEY!

A simple approach to the present bear market (fair value, bargains, value traps)

So the stock market has gone down the last few weeks.  You as a value investor is excited, searching for companies to invest for the long term.. 

Here is a very simple way to look at the businesses that are in the stock market:

1.  Those that are still fairly valued, even though the prices are lower than before (FAIR prices).
2.  Those that are under-valued (BIG bargains at present day prices).
3.  Those that are value traps (the values of these companies may go down to zero, therefore these are BAD bargains here;  avoid, avoid and avoid.)

Price is NOT value.   Price is what you pay, value is what you get.

You are looking to buy GREAT COMPANIES AT FAIR OR BARGAIN PRICES.

You are also looking to buy GOOD COMPANIES AT BIG BARGAIN PRICES.

You should avoid buying GRUESOME COMPANIES AT ANY PRICES (VALUE TRAPS).


Wishing you success in your investing.  

Business Quality

Business quality is defined by the return on capital employed, calculated before goodwill.

The implication is that better returns are synonymous with a better-quality business.

How do you select your stocks: Quality First, then Value.

A great company deserves a higher valuation. It is possible that you paid a slightly higher price than you wanted to pay for the stock, which lowers your overall rate of return, but time is on your side and your long holding time minimizes the impact of the higher purchase price to your overall return. Also, you will always find the opportunity to add to your position at lower valuations, though not necessarily at lower prices.


Deep value investing investors need to be cautious and aware of this approach's inherent problems. Those companies dropping and appearing in the deep-bargain screen probably deserved to be traded by low valuations. Their stock prices were likely low for the right reasons, and buying these would likely have resulted in steep losses.


How do you select your stocks: Quality First, then Value.

There are many gruesome companies in the stock market. These companies operate in very competitive environments and have to be managed well to deliver good returns. In the business world, it is often the economics of the business that eventually triumph over the skills of the managers, however superb their skills maybe.

A company that performed well for 3 years and then lose its good performance subsequently is not a great company, by definition. A great company is one that can perform well, consistently and growing its earnings over 20 to 30 years.

Not uncommonly, these gruesome companies trade at below their net tangible asset prices. This is to be expected, especially if their businesses continue to be gruesome. Their low trading prices attract some investors who are enticed by the very low price relative to their net asset value.

Here is a very important point for any investor. When the price of a company falls, all its valuation ratios become very good. Its price to book value, its price to sales and its price to earnings ratios, all fall and its dividend yield (using last year's dividends) rises.

The uninitiated may think these companies are now undervalued using these financial ratios. Here lies the risk of searching for undervalued stocks in gruesome companies.

The more intelligent investors do not solely rely on these financial ratios alone, they require a lot more analysis. As a general rule, most shares are priced appropriately most of the time. It is only some of the time, when they are mis-priced too low or too high.

The risk in buying great companies is overpaying too much to own it. However, great companies do have earning power for many years, by definition. They continue to grow their intrinsic value over time. If you can acquire these companies at bargain prices (very rarely) or at fair prices (commonly), you should do well in your long term investing. Also, it is alright to pay a little bit more to own these companies as over the long time of holding them, they will still reward you handsomely. As these great companies are few, selling them only make a lot of sense if you can find another of equal quality (very difficult indeed) that offers higher reward to downside risk with high degree of probability. Well, not unexpected, this is not easy.

Buffett says: Buying a wonderful company at a fair price is better than buying a fair company at a wonderful price. He is absolutely right. Stay with quality first, then value; and your investing over the long term should be quite safe and mistakes, if any, will be few.

Great, good and gruesome businesses of Warren Buffett (Capital Allocation and Savings Accounts)

Buffett compares his three different types of great, good and gruesome businesses to "savings accounts."  


The great business is like an account that 

• pays an extraordinarily high interest rate 
• that will rise as the years pass.

A good one 

• pays an attractive rate of interest 
• that will be earned also on deposits that are added.

The gruesome account 

• both pays an inadequate interest rate and 
• requires you to keep adding money at those disappointing returns.

Read also:

The Great, Good and Gruesome Businesses of Buffett

The Three Gs of Buffett: Great, Good and Gruesome

There is no price low enough to make a poor quality company a good investment.

Be a stock picker: Buy GREAT companies and hold for the long term until their fundamentals change

Buffett: See's Candies - A Great, Not Just a Good, Business

Buffet never forgets that growth is good, but only at a reasonable cost.

In 2007, See's Candies sold 31 million pounds of chocolate, a growth rate of only 2 percent.  What does Buffett see that other misses?

1.  He paid a sensible price for the business.
2.  The company enjoys a durable competitive advantage:  Its quality chocolate is bought by legions of loyal customers.
3.  It is a business he understands.
4.  It has great managers.

But See's Candies possesses one more attraction.  It throws off cash and requires very little capital to grow. 

Here is Buffett explaining See's value proposition in his 2007 shareholder letter:

" We bought See's [in 1972] for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million.  The capital then required to conduct the business was $8 million.  (Modest seasonal debt was also needed for a few months each year.)  Consequently, the company was earning 60% pre-tax on invested capital.  Two factors helped to minimize the funds required for operations.  First, the product was sold for cash, and that eliminated accounts receivable.  Second, the production and distribution cycle was short, which minimized inventories.

Last year See's sales were $383 million, and pre-tax profits were $82 million.  The capital now required to run the business is $40 million.  This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth - and somewhat immodest financial growth - of the business.  In the meantime pre-tax earnings have totalled $1.35 billion.  all of that, except for the $32 million, has been sent to Berkshire."

Buffett uses See's cash to buy other attractive businesses. 

"Just as Adam and Eve kick-started an activity that led to six billion humans, See's has given birth to multiple new streams of cash for us.  (The biblical command to "be fruitful and multiply" is one we take seriously at Berkshire.) .. There's no rule that you have to invest money where you've earned it.  Indeed, it's often a mistake to do so:  Truly great businesses, earning huge returns on tangible assets, can't for any extended period reinvest a large portion of their earnings internally at high rates of return."

But a company like slow-growing See's is rare in corporate America.  In order to grow earnings like See's, CEOs in other businesses typically would need "to invest $400 million, not the $32 million" that See's required.  Why is this true?  Because most growing businesses "have both working capital needs that increase in proportion to sales growth and significant requirements for fixed asset investments."  Not so at See's.

Buffett opines that the great business, like See's, is like a savings account that "pays an extraordinarily high interest rate that will rise as the years pass." 

See's is not just the candy.  To Buffett, the company is a chocolate-powered cash machine.



Additional notes:  Great, Good and Gruesome Businesses of Buffett

Capital Allocation and Savings Accounts

Buffett compares his three different types of great, good and gruesome businesses to "savings accounts." 

The great business is like an account that pays an extraordinarily high interest rate that will rise as the years pass.

A good one pays an attractive rate of interest that will be earned also on deposits that are added.

The gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

Three categories of businesses based on the cost of business growth: Great, Good and Gruesome

Buffett uses a simple checklist to determine the attractiveness of businesses as investments.  To meet his tests, companies must possess:

1.  a sensible price tag
2.  durable competitive advantages
3.  business he can understand
4:  managers who have integrity and who are passionately involved in their business creations.

Even though he is not involved in the day-to-day operations, Buffett pays close attention to how much cash each business generates.  He determines how much is needed to maintain a rate of appropriate growth and how much can be invested elsewhere to build intrinsic value in the Berkshire enterprise.

In his 2007 shareholder letter, Buffett offered a capsule view of how he assess companies based on their capital allocation profiles.  He sorts businesses into three categories based on the cost of business growth:  great, good, and gruesome.  This sorting allows him to see sizzle where others cannot.

Asking the ONE most important question: How much cash can be generated from the business?

Asking the ONE most important question: How much cash can be generated from the business?

If a businessperson is asked about what goes into consideration when purchasing a business, the number one answer should be:

How much cash can be generated from the business?


Other answers, though important, are of secondary importance, such as:

What is the business worth?
Who is the biggest competitor?
What is motivating the seller of the business?


Therefore, the businessperson when purchasing a business should examine the business aspects of his investments.  This involves looking at:

1.  the income statements
2.  the capital reinvestment requirements, and
3.  the cash generating capabilities of the business or investments.

The question of how to allocate profits is linked to where a company is in its life cycle

One of the most important decisions management makes is how to allocate profits.

The decision of what to do with earnings is linked to where a company is in its life cycle.

The question of how to allocate profits is linked to where a company is in its life cycle.

1.  Development Stage

In the development stage, a company loses money as it develops products and establishes markets.

2.  Rapid Growth Stage.

The next stage would be rapid growth, in which a company is profitable but growing so fast that it may need to retain all earnings and also borrow funds or issue equity to finance this growth.

3.  Maturity and Decline

In later stages, maturity and decline, a company will continue to generate excess cash, and the best use of this cash may be allocating it to shareholders.

My equity bond (Nestle)

Nestle Malaysia

Latest after-tax ttm-EPS is $2.39 per share

Nestle's underlying earnings are so consistent.

And Nestle is growing its earnings at about 8% per year.

A company with a durable competitive advantage, over time, the stock market will price the company's equity bonds or shares at a level that reflects the value of its earnings relative to the yield on long-term risk free interest rate.

Capitalized at the risk free interest rate of 3.5%, Nestle's after-tax earning of $2.39 per share is worth approximately $68.30 per equity bond/share.  ($2.39/3.5% = $68.30).


Here is a difference worth noting. 

Nestle is worth $68.30 per share  and it is trading today at around $68.00.  Therefore, for the Graham-based value investors, who wants to buy only at $40 per share, Nestle is not "undervalued"

But for those who are willing to apply their reasoning or thinking cap, just take a look at this scenario.

1.  You are being offered a relatively risk-free initial after-tax rate of return of 3.5% today when you buy at $68.30 sen per share.

2.  This after-tax rate of return is expected to increase over the next 20 years at an annual rate of approximately 8% per year.

3.  Then ask this question:  Is this an attractive investment given the rate of risk and return on other investments?

4.  What other attractive investment give the rate of risk and return of this nature?




I bought a long time ago at $10.20 per share

Thus, Nestle is my equity bond or share that is currently giving an after-tax yield of 23.4% ($2.39 / $10.20 = 23.4%) that is relatively risk-free and which is expected to increase over the next 20 years at an annual rate of approximately 8%. 

The Great, Good and Gruesome Businesses of Buffett

Buy good quality companies with durable competitive advantage and trustworthy managers and holding them for the long term. Just buy them at fair or bargain prices and never at high prices.

"It is better to own the great companies at good prices, than the good companies at great prices."

Here is a nice table summarizing the great, good and gruesome companies according to Buffett.

Let me give you some pointers:

1. Select a small cap stock.

2. The one that you have the confidence that it will grow its revenues and earnings for many many years to come.

3. The one with some durable competitive advantage (it can be difficult in early years to notice or identify this).

4. Get into this early.

5. Continue to monitor its performance.










Yes, you can hold for the long term too.

For this you need to assess its quality (both qualitative and quantitative, and the management).

Don't be too focus on the price of the shares (the least important in your assessment).

Warren Buffett: Why stocks beat gold and bonds

February 9, 2012:

In an adaptation from his upcoming shareholder letter, the Oracle of Omaha explains why equities almost always beat the alternatives over time.

By Warren Buffett

FORTUNE -- Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire Hathaway (BRKA) we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power -- after taxes have been paid on nominal gains -- in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability -- the reasoned probability -- of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a nonfluctuating asset can be laden with risk.

Investment possibilities are both many and varied. There are three major categories, however, and it's important to understand the characteristics of each. So let's survey the field.

Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as "safe." In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.

Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as "income."

For taxpaying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor's visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It's noteworthy that the implicit inflation "tax" was more than triple the explicit income tax that our investor probably thought of as his main burden. "In God We Trust" may be imprinted on our currency, but the hand that activates our government's printing press has been all too human.

High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments -- and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.

Warren Buffett: Your pick for Businessperson of the Year

Under today's conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, primarily of the short-term variety. At Berkshire the need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be. Accommodating this need, we primarily hold U.S. Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions. Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

Beyond the requirements that liquidity and regulators impose on us, we will purchase currency-related securities only if they offer the possibility of unusual gain -- either because a particular credit is mispriced, as can occur in periodic junk-bond debacles, or because rates rise to a level that offers the possibility of realizing substantial capital gains on high-grade bonds when rates fall. Though we've exploited both opportunities in the past -- and may do so again -- we are now 180 degrees removed from such prospects. Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: "Bonds promoted as offering risk-free returns are now priced to deliver return-free risk."

The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer's hope that someone else -- who also knows that the assets will be forever unproductive -- will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce -- it will remain lifeless forever -- but rather by the belief that others will desire it even more avidly in the future.

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth -- for a while.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the "proof " delivered by the market, and the pool of buyers -- for a time -- expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: "What the wise man does in the beginning, the fool does in the end."

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.

Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today's annual production of gold command about $160 billion. Buyers -- whether jewelry and industrial users, frightened individuals, or speculators -- must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil (XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Admittedly, when people a century from now are fearful, it's likely many will still rush to gold. I'm confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.

Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard "cash is king" in late 2008, just when cash should have been deployed rather than held. Similarly, we heard "cash is trash" in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.

My own preference -- and you knew this was coming -- is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola (KO), IBM (IBM), and our own See's Candy meet that double-barreled test. Certain other companies -- think of our regulated utilities, for example -- fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.

Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See's peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Our country's businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial "cows" will live for centuries and give ever greater quantities of "milk" to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well).

Berkshire's goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety -- but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we've examined. More important, it will be by far the safest.

This article is from the February 27, 2012 issue of Fortune.

http://finance.fortune.cnn.com/2012/02/09/warren-buffett-berkshire-shareholder-letter/

http://warrenbuffettresource.wordpress.com/2012/02/14/warren-buffett-why-stocks-beat-gold-and-bonds-fortune/

Intrinsic value of Great Businesses: What's the business actually worth? Think long-term.

Company OPX

52 week high:  $52.99  (April 2010)  Market cap $960 million
52 week low:  $33.33 (July 2010)  Market cap $ 625 million
Variance:  35.2%


1.  Is the market really suggesting that this business was worth $960 million in April 2010, but only $625 million the following July?

2.  Yes, this is exactly what the market is suggesting.

3.  What's the business actually worth?

4.  Because it ought to be obvious that a fast-growing company cannot be worth $625 million and $960 million at roughly the same time.  

5.  Our goal as investor is to buy $960 million businesses when the market's charging $625 million.
6.  If you think these things don't happen, be assured:  They happen all the time.

7.  It is even better when we can buy a $500 million business for $300 million and watch the company grow into a $3 billion business.  

8.  It is this effect - the fact that great businesses make themselves more valuable over time - that keeps us from selling a $500 million business when its market cap increases to $600 million.

9.  After all, the $500 million valuation is based on our own analysis, and mathematically speaking, it's our single point of highest confidence in a range of values we believe the company could be worth.

10.  It might be substantially more.  

11.  If you're disciplined enough to only buy companies when they are priced at the low end of your range of potential values, your returns over time are almost guaranteed to satisfy.

12.  Holding a company when it's in the higher end of your range of values leaves you somewhat susceptible to a stock drop, given the lower margin of safety.  

13.  But if you have properly identified the company as a superior generator of wealth, the biggest mistake you might ever make is selling it because its shares are a few dollars too high.

14.  If you bough company OPX back in December 1987, for example, your shares rose 75%, from $23 to $40 in about two months.

15.  That's great return - but over the next 20 years, the stock has risen another seven times in value - tax free.

16.  Ultimately, it is nearly impossible to manage superior long-term results by focusing on short-term aims.

17.  Company OPX has evolved from a regional small cap into one of the most important retailers in the world, generating spectacular returns for shareholders in the process.

Warren Buffett on how to obtain superior profits from stocks.

     An investor cannot obtain superior profits from stocks by simply committing to a specific investment category or style.  He can earn them only by carefully evaluating facts and continuously exercising discipline. 

     Common stocks are the most fun.  When conditions are right that is, when companies with good economics and good management sell well below intrinsic business value - stocks sometimes provide grand-slam home runs.  

• We often find no equities that come close to meeting our tests.  
• We do not predict markets, we think of the business.  
• We have no idea - and never have had - whether the market is going to go up, down, or sideways in the near- or intermediate term future.

Great Companies

"Great" Business Leadership Defined

"Great" business leadership refers to the world-class business leadership and financial results described in the business best seller,Good to Great - listed as one of Amazon's Top 100 books and one of Amazon's top leadership books for the last 10 years.

The book's research team analyzed the financial results of 1,435 companies (all companies listed on the Fortune 500 list, 1965-1995). After an extensive review of the financial performance of these companies, it was determined that 11 companies stood out from the rest.These companies achieved incredible financial results - going from "good" to extraordinarily "great" financial results.

"Great" companies achieved an 6.9x greater financial results than the general market
for 15 years following their transition point from "Good" to "Great" financial results. 

http://www.johnlutz.com/resume/ecommerce/good_to_great.htm

Warren Buffett - Avoid Bad Businesses

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.


http://equitybondtheory.com/cash-flow/capital-expenditures

There is no price low enough to make a poor quality company a good investment.

If you're in doubt about the quality of a company as an investment, abandon the study and look for another candidate.

When in doubt, throw it out.

Abandon your study and go on to another.  There is no price low enough to make a poor quality company a good investment.


The worse a company performs, the better value its stock will appear to be.

Because declining fundamentals will prompt a company's shareholders to sell, the price will decline.  This will cause all the value indicators to show that the price has become a bargain.  It's not!

When the stock is selling at a price below that for which it has customarily sold, you will want to check to see why - what current investors know that you don't.

Telltale signs of good cash generation are dividends, share buybacks, and an accumulation of cash on the balance sheet.

Economies of scale:  refers to a company's ability to leverage its fixed cost infrastructure across more and more clients.

Operating leverage:  The result of economies of scale should be operating leverage, whereby profits are able to grow faster than sales.

Low ongoing capital investment to maintain their systems:

The combination of operating leverage and low ongoing capital requirements suggests that the firms should have plenty of free cash to throw around.

Telltale signs of good cash generation are dividends, share buybacks, and an accumulation of cash on the balance sheet.


E.g.  Technology-based businesses:  A desirable characteristic of technology-based businesses is the low ongoing capital investment to maintain their systems.  For firms already in the industry, the huge upfront technology investments have already taken place.  And the cost of technology tends to drop over time, so upkeep expenditures are minimal.  The combination of operating leverage and low ongoing capital requirements suggests that the technology-based firms should have plenty of free cash to throw around. 

Understanding Free Cash Flow (Video)

Read more: http://www.investopedia.com/video/definitions#ixzz1yiD0k3ZQ

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   Understanding Free Cash Flow