What makes a company valuable and what makes a stock a "Buy"?

Buffett: Ownership of commercial "cows" (first class businesses) over any extended period of time will prove to be rewarding and by far the safest.

Our first two categories, namely cash and gold, 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, 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.

http://www.berkshirehathaway.com/letters/2011ltr.pdf

Growth Investing Examples from Berkshire Hathaway

-  On September 16th we acquired Lubrizol, a worldwide producer of additives and other specialty chemicals. The company has had an outstanding record since James Hambrick became CEO in 2004, with pre-tax profits increasing from $147 million to $1,085 million. Lubrizol will have many opportunities for “bolt-on” acquisitions in the specialty chemical field. Indeed, we’ve already agreed to three, costing $493 million. James is a disciplined buyer and a superb operator. Charlie and I are eager to expand his managerial domain.

Comment:  Lubrizol grew its pre-tax profits from $147 million from 2004 to $1,085 million.   Thus its pre-tax profit has grown at the compound annual growth rate of 33.05% over 7 years.

• Buffett likes this company for its good earnings growth.  
• The good earnings growth rate also is reflective of the good business fundamentals of this company.
• Buffett loves buying / owning wonderful company (that are growing).

-  Our major businesses did well last year. In fact, each of our five largest non-insurance companies – BNSF, Iscar, Lubrizol, Marmon Group and MidAmerican Energy – delivered record operating earnings. In aggregate these businesses earned more than $9 billion pre-tax in 2011. Contrast that to seven years ago, when we owned only one of the five, MidAmerican, whose pre-tax earnings were $393 million. Unless the economy weakens in 2012, each of our fabulous five should again set a record, with aggregate earnings comfortably topping $10 billion.

Comment:  

1994:  Mid American contributed pre-tax earnings of $393 million.

2011:  BSNF, Iscar, Lubrizol, Marmon Group and MidAmerican Energy earned $9 billion pre-tax.

• BSNF and Lubrizol are recent acquisitions of Buffett.  
• Buffett likes these companies for their earnings and growth.  
• Buffett even projected that their aggregate earnings will top $10 billion next year, 2012 (a growth rate of 11%).

-   In total, our entire string of operating companies spent $8.2 billion for property, plant and equipment in 2011, smashing our previous record by more than $2 billion. About 95% of these outlays were made in the U.S., a fact that may surprise those who believe our country lacks investment opportunities. We welcome projects abroad, but expect the overwhelming majority of Berkshire’s future capital commitments to be in America. In 2012, these expenditures will again set a record.

Comment:  

Yes, to grow one has to re-invest.  Looks like Buffett reinvest all the free cash flows ($8.2 billion capital expenditure) for future growth.

http://www.berkshirehathaway.com/letters/2011ltr.pdf

WHAT WARREN BUFFETT SAYS ABOUT PREDICTING FUTURE CASH FLOWS

DISCOUNTED CASH FLOW (DCF)

This method of valuation is often referred to as the Discounted Cash Flow (DCF) valuation method, but, as Buffett has said in relation to shares, it is not easy to predict future cash flows and this is why he sticks to investment in companies that are consistent, well managed, and simple to understand. 

A company that is hard to understand or that changes frequently does not allow for easy prediction of future earnings and outgoings.

WHAT WARREN BUFFETT SAYS ABOUT PREDICTING FUTURE CASH FLOWS

In 1992, Warren Buffett said that:

‘Leaving question of price aside, the best business to own is one that over an extended period can employ large amounts of capital at very high rates of return. The worst company to own is one that must, or will, do the opposite – that is, consistently employ ever-greater amounts of capital at very low rates of return.’

It is well worth reading Buffet’s analogy relating DCF to a university education in his 1994 Letter to Shareholders.

So, it would seem that the intrinsic value of a share in a company relates to the DCF that can be expected from the investment. 

There are formulas for working out discounted cash flows and they can be complex but they give a result.

EXPLANATIONS OF DCF

The best explanation that we have read of DCF is by Lawrence A Cunningham in his outstanding book How to think like Benjamin Graham and invest like Warren Buffett.

A good online explanation is available here.

http://www.buffettsecrets.com/price-to-pay.htm

GOOD MANAGERS AND BAD BUSINESSES

Buffett does acknowledge that even the best managers will founder if the business is not intrinsically sound. 

His most telling comment on management is: 'When a management with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.’

WHAT WARREN BUFFETT LOOKS FOR IN COMPANY GROWTH

An investor likes to see a company grow because, if profits grow, so do returns to the investor. The important thing for the investor, however, is that the company increases the returns to shareholders. A company that grows, at the expense of shareholder returns, is not generally a good investment. As Warren Buffett said in 1977:

‘Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say, a 10% increase in equity capital and a 5 % increase in earnings per share.’

WARREN BUFFETT AGAIN ON GROWTH

For Warren Buffett the important thing is not that a company grows (he points to the growth in airline business that has not resulted in any real benefits to stockholders) but that returns grow. In 1992, he said this:

‘Growth benefits investors only when the business in point can invest at incremental returns that are enticing – in other words, only when each dollar used to finance the growth creates over a dollar of long term market value.

In the case of a low-return business requiring incremental funds, growth hurts the investor.’

Warren Buffett and Keynes

WARREN BUFFETT AND KEYNES

In Warren Buffett’s own words, he did not invest in these companies, and many other successful investments, without acquiring as full a knowledge as possible about the company, its business, its management, and its financial position. He has advised individual investors to do the same, as did the great economist and successful investor John Maynard Keynes.

‘As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about …’ - Jim Keynes

What Warren Buffett says about Buying a Business

BUYING THE BUSINESS

Warren Buffett believes, as did Benjamin Graham, that investors should look upon share investment as buying a part of a business. Investors should take the same approach to buying shares as they would if they were buying a business. The only difference is that instead of buying the whole of the business, or a partnership in the business, they are only buying a tiny share.

A prudent investor never buys a business that they do not understand. Similarly, a prudent share investor should never buy shares in a company, whose business they do not understand.

WHAT WARREN BUFFET SAYS ABOUT BUYING A BUSINESS

In 1977, Warren Buffett told shareholders in Berkshire Hathaway that their company would only invest in a business that the directors could understand.. He has repeated this message many times since. In 1992, he expanded on this theme:

‘[W]e try to stick with businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change we’re not smart enough to predict future cash flows. Incidentally that shortcoming doesn’t bother us.’

WHAT WARREN BUFFETT SAYS ABOUT GOOD BUSINESSES

Good businesses with that ‘protective moat’ that Warren Buffett likes have the ability to cope with inflation by raising prices. As he said in 1993:

‘The might of their brand names, the attributes of their products and the strength of their distribution systems gives them an enormous competitive advantage, setting up a protective moat around their economic activities. The average company, in contrast, does battle daily without any means of protection.’

BERKSHIRE HATHAWAY HOLDINGS

Stocks held by Berkshire Hathaway in 2002, as stated by Buffett in his letter to stockholders include:

• The Coca Cola Company
• American Express
• The Gillette Company
• H and R Block Inc
• Moody’s Corporation
• The Washington Post Company
• Wells Fargo and Company

These are all companies with a unique or special product, or with a company brand name, or in a market domination position. They or their products have a loyalty (voluntary or otherwise) that means customers want or must come back.

Another desirable quality in non-commodity companies is repeat business. Customers drink their Coke, wear out their razor blades, or finish reading their Washington Post, and then, eventually have to replace it.

Have an opinion on future growth - How can the company increase its earnings?

It is only rational to have an opinion on future growth.  Otherwise, how could you ever choose a stock?

When forming that opinion, back up quantitative information with qualitative factors.

For example, ask what management is doing to make a positive impact on earnings.

According to Peter Lynch, there are 5 basic ways a company can increase earnings:

• reduce costs; 
• raise prices; 
• expand into new markets;
• sell more of its products to the old markets; or
• revitalize, close or otherwise dispose of a losing operation.

When management is enacting growth-promoting activities, earnings may be temporarily flat.  They often soon take a giant step up.

Benjamin Graham saw a vulnerability in a high growth rate and in high returns on capital - the two normally go together.

So what's there to worry about in good earnings?  Exceptionally high earnings often attract rough competitors.  

The good part is that high earnings lure enthusiastic new investors, who often bid the share into the stratosphere.


Comment:
Buy good quality growth companies.
Assess the quality of the business and the management.
Then do the valuation.
These are the basics of the QVM or QMV approach to investing.

Great Businesses According to Buffett

Great Businesses According to Buffett
Thursday, March 6th, 2008

I finished digesting the latest Berkshire Hathaway 2007 letter to shareholders today. I found the most interesting part of this year’s letter was Warren Buffett’s discussion of what kinds of businesses turn him on.

The companies that he and Charlie Munger look for are:

1. Understandable
2. Businesses with favorable long-term economics
3. Run by trustworthy management
4. Selling at sensible prices

Mr. Buffett once again reiterates that “a truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.” Fat Pitch Financials has been all about finding companies with wide moats ever since I first set up this blog in 2004. Given my economics background, I find Buffett’s arguement for the need for wide moats compelling. He argues that companies that lack a barrier to competition will succumb to the competitive forces of a capitalist market that tend to drive profits to zero. In this year’s letter, Buffett provides the example of GEICO’s and Costco’s low-cost production and Coca-Cola’s (KO) and Gillette’s world-wide brand as formidable barriers that are essential for maintaining enduring competitive advantages. Other durable competitive advantages include legal protections, high switching costs, the network effect and toll bridges. I discussed these barriers to entry in my review of Ten Ways to Build Moats to Hold Back Competition. The key is that these moats need to be “enduring” in order to avoid the creative destruction of capitalism. Companies in industries prone to rapid and continuous change are to be avoided, since it is unlikely their moats will be enduring.

In the past, Mr. Buffett often talked about return on equity, but many had assumed he actually meant returns on invested capital. This assumption was right since in this letter Mr. Buffett explicitly mentions returns on invested capital (ROIC). I think this is the first letter Warren Buffett has been so explicit about the importance on returns on invested capital. He actually also notes the importance of looking at a business’s returns on incremental capital invested when he discusses See’s Candy. Shai Dardasti examined Warren Buffett’s discussion regarding See’s Candy in a recent blog post that I highly recommend.

While Buffett says it is important to have trustworthy management, he also notes that if you restrict your investments to companies with durable competitive advantages that this “eliminates the business[es] whose success depends on having a great manager.” Invest in companies that can be run by an idiot because often one eventually will. Buffett reminds us in his letter that a great business should not require a superstar to produce great results. Buffett uses the example of a successfully growing medical practice led by a premier surgeon, but unlikely to be as successful if this leading surgeon leaves. However, the well know Mayo Clinic is likely to endure regardless of who is running it. This reminder makes me a bit nervous about my investment in Western Sizzlin (WEST), because I think Sardar Biglari is likely critical for that company to produce great returns. Of course, for many years it could be said that Warren Buffett was required to produce great results at Berkshire Hathaway (BRK-A).

Finally, Buffett also notes how advantagous it can be to have a business with low capital investment requirements. I can personally attest to that advantage. My online business has virtually no capital requirements, but has the ability continually increase its earnings.

Great businesses have sustainable competitive advantages, low capital investment requirements, don’t require superstar managers, and are in stable industries. Do you have any companies that fit these criteria? Share them below to see if they can hold up to Buffett’s criteria for great businesses.


http://www.fatpitchfinancials.com/772/great-businesses-according-to-buffett/

What is good business and what is good managers?

Good business is this: It generates more cash than it consumes.


Good managers is this: They keep finding ways of putting that cash to productive use.

In the long run, companies that meet this definition are virtually certain to grow in value, no matter what the stock market does.

http://hongwei85.blogspot.com/2011/03/what-is-good-business-and-what-is-good.html

The Mark of a Good Business: High Returns on Capital

The Mark of a Good Business: High Returns on Capital
Written by Greg Speicher on October 19, 2010

Categories: Buy Good Businesses, Warren Buffett

“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” – Warren Buffett, 1992 Berkshire Hathaway Shareholder Letter

A good business is one that can earn very high returns on capital. Rarely can such a business invest all of its capital back into the business. One way to find companies that can is to look for companies that have grown book value at a high rate on a per share basis.

A business can still be a good investment if it can’t reinvest all of its earnings back into the business. An example is American Express. Prior to the 2008 economic crisis, Amex was earning over 30% on equity but was only reinvesting about a third of its earnings back into the business. The remaining two-thirds were paid out in the form of dividends and share repurchases.

There are numerous ways to measure return on invested capital. None of them is perfect. Any of the various metrics and ratios investors use to analyze a business are abstractions and, as such, typically tend to oversimplify the economic reality of the business. They are short-cuts we use to point us in the right direction so we can spend our precious time researching businesses that offer the most opportunity.

Return on Incremental Equity

I like to look at the total amount of equity that has been added to a business over the past decade and then calculate the return on that additional investment. This approach also allows me to calculate what percentage of the company’s earnings was reinvested, which in turn is useful in forecasting the future growth in earnings.

I typically use Value Line when I do this because the layout is very conducive to this type of analysis. It is one reason why investors like Buffett, Munger and Li Lu like Value Line.

It is useful here to remember Buffett’s reminder that it is not necessarily a cause for celebration if a business grows its earnings year after year. The same thing happens to a savings account if you add more capital each year, which does not make a savings account a good investment. It’s the return on this additional capital that determines whether something is a good investment or not.

To illustrate, let’s look at Johnson & Johnson (JNJ). In 2000, JNJ had shareholders’ equity of $18.8 billion. At the end of 2009, its shareholders’ equity had grown to $50.6 billion. We can calculate that, since 2000, JNJ invested $31.8 billion back into the business.

During that same time, earnings grew $8.1 billion, from $4.8 billion in 2000 to $12.9 billion in 2009.
By dividing the additional earnings of $8.1 billion by the additional $31.8 billion in capital, we can see that JNJ earned a return of 25.5% on its investment, which is very good.

It is also useful to look at what percentage of its total net earnings JNJ reinvested back into the business. The reason is that this is suggestive of how much of its future earnings JNJ is likely to reinvest. By multiplying the rate of reinvestment by the return on that investment, we can then calculate an expected growth rate for earnings.

Since 2000 through 2009, JNJ earned a total net profit of $89.7 billion. Since we already know that JNJ reinvested $31.8 billion over that same time period, we can calculate that JNJ’s rate of reinvestment is 35.5%.

If JNJ can continue to earn 25.5% on equity and reinvest 35.5% of its earnings, earnings should grow at about 9% (.255 x .355).

Keep in mind that this does not include dividends or share repurchases. The latter would cause earnings per share to grow at a faster rate. Also, it does not include an analysis of where JNJ is selling in relation to its intrinsic value which could have a material impact on the expected total return. Finally, this type of analysis works best with a stable business that enjoys durable competitive advantages, such as JNJ.

Another example is Southwest Airlines which is a successful airline that operates in the highly competitive and capital intensive airline industry. Between 2000 and 2009, Southwest’s shareholders’ equity increased by $2 billion. Earnings were $140 million in 2009 compared to $625 million in 2000 and have generally bobbed around over that time period. The return on that additional $2 billion has been relatively poor.

Calculating the return on incremental equity over a long-period of time should prove a useful tool in your analysis of prospective investments. Coupled with the rate of reinvestment, it can also allow you to get an idea of how fast a company can be expected to grow its earnings.


You can also use this approach to invert an expected rate of earnings growth to examine what combination of ROE and rate of reinvestment will be required to produce it.

In succeeding related posts, I’ll look at Buffett’s use of return on average tangible net worth and Greenblatt’s use of return on tangible capital employed to determine whether a business is good.

http://gregspeicher.com/?p=1660

----

The Mark of a Good Business: High Returns on Capital (Part 2)
Written by Greg Speicher on October 26, 2010 -
Categories: Buy Good Businesses, Warren Buffett

“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of incremental capital at very high rates of return.” – Warren Buffett 1992 Berkshire Hathaway Shareholder Letter

Last week, I wrote a post that looked at return on incremental equity. The post explained a way to measure return on incremental equity over a multi-year period. It also considered how, in a stable business with a durable competitive advantage, the return on incremental equity and can be used, in conjunction with the rate of reinvestment, to predict the growth in earnings.

Today, I am writing about another tool used by Buffett to measure the returns on an investment: return on average tangible net worth.

Beginning with the 2003 Berkshire Hathaway letter to shareholders, Buffett began providing a simplified balance sheet of the manufacturing, service and retailing operations segment, a widely diversified group which includes building products, carpet, apparel, furniture, retail, flight training, fractional jet ownership and distribution.

Buffett breaks out the four broad segments of Berkshire – insurance, utilities, finance, and manufacturing, service and retailing operations – because they each have different economics which are harder to understand if considered as one undifferentiated mass. This is obviously useful to remember when analyzing a business with two or more disparate operating segments.

When he reports on the results of the manufacturing, service and retailing operations segment, Buffett focuses on the return earned on average tangible net worth, which for example in 2003, was in Buffett’s words “a hefty” 20.7%.

To calculate tangible net worth, take the equity on the balance sheet and subtract goodwill and other intangible assets. Buffett averages the tangible net worth that is on the books at the beginning and end of the year so as not to upwardly bias the return if the earnings were in part the result of a large injection of capital into the segment during the year.

On average, the segment enjoys very strong returns on average tangible net worth, typically in the low 20’s. This is highly meaningful because it not only shows the excellent economics of these businesses, but also it shows the returns that can be expected from additional capital that is invested into these businesses.

Here is the simplified balance sheet for the years since Buffett began providing it along with the calculations.
Here are some additional observations.

Buffett also provides the returns on Berkshire’s average carrying value. This is the same calculation as return on average tangible net worth without subtracting goodwill. Berkshire had to pay a substantial premium over book value to purchase these businesses given their excellent economics. Over the long-term, the return on incremental equity will be the major determinant of Berkshire’s returns on these investments as the retained earnings become an ever larger portion on the capital employed. As an investor, you want to pay close attention to both the premium you pay to buy a great business and the returns on incremental capital.

Omitting goodwill and intangible assets from the equation is appropriate because Berkshire will not need to pay a premium on incremental capital employed in the existing businesses. Berkshire does, however, need to pay a premium going forward to acquire businesses to add to this segment. This is evident from the goodwill and intangible assets line item which has grown from $8.4 billion in 2003 to $16.5 billion in 2009. Overall, to put that in context, Buffett invested an additional $15 billion in that segment over the same time period.
In analyzing an investment, you want to consider whether future growth will come from acquisitions, in which case you can expect additional goodwill, or organic investment, in which case the returns on tangible net worth would be a more appropriate metric.


Unfortunately, from the standpoint of providing opportunities for Berkshire to deploy capital going forward, some of Berkshire best businesses, which are found in this segment, are both small in scale as compared to Berkshire as a whole and require very little incremental capital.

Finally, it is fairly clear that this segment’s earning power has been materially impacted by the recession. If it is able to return to pre-recession levels, this group should earn net income of approximately $3 billion.

http://gregspeicher.com/?p=1708

A brief appraisal of Crest Builder Holdings Bhd. (CRESBLD)

A brief appraisal of Crest Builder Holdings Bhd. (CRESBLD)

Cresbld is engaged in construction and property development.

Crest Builder is a class A contractor registered under catgory G7  with the CIDB which enables it to tender for any government and private contracts of unlimited value.  Not unlike the other listed contractors, CRESBD has also ventured into property development amid an extended gloom in the construction industry in the Nineties.

1.  Let's look at its historical Sales and Earnings

FY ending Dec 05  Sales 253 m  Earnings  11.7 m
FY ending Dec 06  Sales 318 m  Earnings  20.0 m
FY ending Dec 07  Sales 366 m  Earnings  40.2m
FY ending Dec 08  Sales 270 m  Earnings  12.3 m
FY ending Dec 09  Sales 325 m  Earnings  10.7 m



2.  The company is in a competitive business which is rather challenging.

(No economic moat).

3.  Future Growth Drivers

Not analysed.  However, you can get an idea of the present and future activities of this company by visiting these posts.  Courtesy of Eric Yong's Blog.

• Avenue Crest, Shah Alam.
• Northshore Gardens, Desa ParkCity - Updates.
• Chua Tower, Jalan Binjai - Updates.
• Crest Builder riding the development wave in PJU.

Past Projects:

• Property development called 3 Two Square in Section 14, PJ in 2007. The project comprising a corporate office tower called The Crest and retail shops and offices contributed materially to the record earnings in 2006 and 2007. CRESBLD has retained the Corporate Tower 'The Crest' and the car parks for recurring income, marking its entry into property investment/management.
• Mixed development scheme called Alam Hijau in Mukim Damansara.
• Other projects are located in Kelana Jaya and Mont Kiara.

4.  Long Term Liabilities and D/E ratio

FY ending Dec 05  LTL 78.8 m  D/E 0.71

FY ending Dec 06  LTL 67.6 m  D/E 0.53

FY ending Dec 07  LTL 90.4 m  D/E 0.56

FY ending Dec 08  LTL 45.6 m  D/E 0.54

FY ending Dec 09  LTL 111.46 m  D/E 0.65

Note:  The amount of net debts rose substantially in 2009.

FY ending Dec 05  Interest Expenses 4.79 m

FY ending Dec 06  Interest Expenses 4.70 m

FY ending Dec 07  Interest Expenses 8.05 m

FY ending Dec 08  Interest Expenses 8.03 m

FY ending Dec 09  Interest Expenses 8.28 m

5.  ROE

FY ending Dec 05  7.71%

FY ending Dec 06  11.11%

FY ending Dec 07  18.58%

FY ending Dec 08  5.55%

FY ending Dec 09  4.66%

6.  CAPEX required to maintain current operations

Not analysed

7.  Is Management is buying or holding the stock?

FY ending Dec 05  Mr.  Yong Soon Chow (Direct & Indirect) 43.66%

FY ending Dec 06  

FY ending Dec 07  

FY ending Dec 08  

FY ending Dec 09  Mr. Yong Soon Chow 34.61% Yong Tiok Chin (daughter of YSC) 6.18%

8.  Price versus Intrinsic Value

NTA per share

FY ending Dec 05  NTA/Share RM0.75

FY ending Dec 06  NTA/Share RM0.92

FY ending Dec 07  NTA/Share RM1.47

FY ending Dec 08  NTA/Share RM1.52

FY ending Dec 09  NTA/Share RM1.59

Given the strategic location of the properties namely, Corporate Tower 'The Crest' and the car parks, hefty fair value adjustments on investment properties lifted the NTA sharply (+61%) in 2007.

Present Price of CRESBLD share: MR0.69

Number of shares: 124.09 m

Market Cap 85.6 m

Warrants 24 m units Maturity 30/5/2013 Exercise Price RM 1.00


Well, will you buy this stock for long term investment?

I won't because this stock fails my tests for a GOOD QUALITY company.  It is neither a great nor a good, but a gruesome company by my definition.

I invest and I rarely speculate.

Which type of Company would you rather own?

Would you prefer to own:

A.  One that consistently posts better earnings and whose stocks plows steadily higher?

or

B.  One that made the same amount of money for six years but was (a) profitable and (b) disciplined in paying hefty dividends back to investors?  (Note:  These companies are harder to find, but in such situations, a no- or low-growth company may actually be OK.)

or

C.  One that has made the same amount of money for six straight years, has little sense of enterprise, and has a stock that is trading at the same price it was ten years ago?


Related:

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

Examples of companies in:

A - PetDag, PBB, LPI, PPB

B - Nestle, Guinness, DLady

C - Too many in this group in the KLSE.

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

All the above are GREAT companies.

NEVER buy these GREAT companies at HIGH prices.

You can often buy them at FAIR prices.

On certain occasions, you have the chance to buy them at slightly BARGAIN prices.

Rarely, for example during the recent 2008 Crash, you had the chance to buy them at GREAT prices.

It is better to buy a GREAT company at a FAIR price than to buy a FAIR company at a GREAT price.

It is safe to hold these stocks for the long term since these companies have competitive advantages, selling only when their fundamentals change.

The present prices of these stocks are near or above their previous high prices.

Those who bought regularly into these stocks would have capital gains, through dollar-cost averaging.

Further comments:

1. Warren, on the other hand, after starting his career with Graham, discovered the tremendous wealth-creating economics of a company that possessed a long-term competitive advantage over its competitors.  
2. Warren realized that the longer you held one of these fantastic businesses, the richer it made you.  
3. While Graham would have argued that these super businesses  were all overpriced, Warren realized that he didn't have to wait for the stock market to serve up a bargain price, that even if he paid a fair price, he could still get superrich off of those businesses.  
4. In the process of discovering the advantages of owning a business with a long-term competitive advantage, Warren developed a unique set of analytical tools to help identify these special kinds of businesses.  
5. Though rooted in the old school Grahamian language, his new way of looking at things enabled him to determine whether the company could survive its current problems.  
6. Warren's way also told him whether or not the company in question possessed a long-term competitive advantage that would make him superrich over the long run.  
7. By learning or copying Warren, you can make the quantum leap that Warren made by enabling you to go beyond the old school Grahamian valuation models and discover, as Warren did, the phenomenal long-term wealth-creating power of a company that possesses a durable competitive advantage over its competitors.
8. In the process you'll free yourself from the costly manipulations of Wall Street and gain the opportunity to join the growing ranks of intelligent investors the world over who are becoming tremendously wealthy following in the footsteps of this legendary and masterful investor.

Related:

The Evolution of Warren Buffett

Learning and Understanding the Evolution of Warren Buffett
Li Lu sharing his Value Investing Strategies (Video)
The Three Gs of Buffett: Great, Good and Gruesome

The GREAT company has long-term competitive advantage in a stable industry.  This company:

• takes a one time investment capital and 
• pays you a very attractive return (dividend + capital appreciation), 
• which will continue to increase as years pass by;

Here are the golden words of Buffett on the GREAT businesses to own:

1.  On 'Great' businesses, Buffett says, "Long-term competitive advantage in a stable industry is what we seek in a business.

• If that comes with rapid organic growth, great. 
• But even without organic growth, such a business is rewarding. 
• We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere. 
• 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."

Wealth Maximising Strategies for your Portfolio

Buy only GREAT (good quality) stock.

Buy at a bargain price, when the upside reward/downside risk ratio is highest. Be patient.

Sell the losers.  Stay with the winners.

Sell the losers early.  Reinvest into GREAT stocks.

Sell the under-performers early.  Reinvest into GREAT stocks.

# Sell the overpriced stocks to lock in the 'transient bubbling' gains (PE > 1.5x Signature PE).  Reinvest into GREAT stocks.

Reinvest and Stay with the GREAT winners for the long term.

Stay concentrated.  Do not overdiversify. Invest big.

? Tactical Asset Allocation when the market is OBVIOUSLY too expensive or too cheap.  (Difficult strategy to apply consistently).


# Warren Buffett's investment in PetroChina



Also read:

Growing at 15% a year - what does this entail?

The Three Gs of Buffett: Great, Good and Gruesome

Let us examine Buffett's letter from the year 2007 to the shareholders of Berkshire Hathaway and see the investment wisdom on offer therein.

The Three Gs
Let us suppose that you are planning to lock away the surplus money with you in a bank savings account and three different banks approach you with three different offers:

1.  The first bank 

• takes a one time deposit and 
• pays you a very attractive interest rate, 
• which will continue to increase as years pass by;

2.  The second bank 

• pays a decent interest rate but 
• also asks you to increase your yearly deposits at a fixed rate, 
• which will also bear a decent interest rate; and

3.  The third bank 

• pays you a very poor interest rate and 
• also asks you to increase your deposits at a high rate, 
• which in turn yield the same poor interest rate.

It is difficult to imagine a depositor choosing any other sequence than the one mentioned above if asked to rank his preferences. However, while investing in companies, the very same depositor fumbles quite often. He ends up investing in firms that exhibit the characteristics of deposit schemes similar to options 2) and 3) listed above.

Buffett has mentioned that virtually all the businesses could be classified on the basis of three characteristics mentioned above and he has gone on to name these businesses as

1. Great, 
2. Good and 
3. Gruesome.

Needless to say businesses of the 'Great' kind are what excite him the most and he tends to avoid the businesses labeled 'Gruesome'.

Let us see what he has to say on the characteristics of each of these businesses:



The golden words


1.  On 'Great' businesses, Buffett says, "Long-term competitive advantage in a stable industry is what we seek in a business.

• If that comes with rapid organic growth, great. 
• But even without organic growth, such a business is rewarding. 
• We will simply take the lush earnings of the business and use them to buy similar businesses elsewhere.
• 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."

2.  Furthermore, Buffett likens "Good" businesses to industries like the utilities 

• where the companies will earn a lot more 10 years from now but 
• will also have to invest a substantial amount to achieve the same. 
• The returns though are likely to be satisfactory.

3.  Let us now move on to businesses that Buffett has labeled as 'Gruesome' and he proffers the following view on them.

• He says, "The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. 
• Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers."

Indeed, if investors stick to 'Great' and 'Good' businesses in their investment lifetimes and buy them at attractive prices, they are unlikely to end up poor.

http://www.equitymaster.com/detail.asp?date=10/22/2008&story=2

****Stock selection for long term investors

Overview of the the market and stock selection for long term investors

The Market

There is much volatility in the market. This is due to trading activities. The majority of trades are short term trading. Trading has increased in the market due to various factors:

• Increase turnover rates of mutual funds, hedge funds, off shore funds and pension funds.
• Decrease cost of trading.
• Speed of trading facilitated by technology innovations.
• Investing institution and managers are acting more as agents rather than as investors on behave of their clients.

A minority invests based on fundamentals.

Trading can be in derivatives. The nature of derivative securities is based on price or action of another security. Trading in derivatives has too increased.

Is trading a good thing? It does increase liquidity to the market and this is good. However too much trading and speculation has its downsides. This is akin to breathing 21% Oxygen (life-sustaining) versus breathing 100% Oxygen (too much oxygen has the associated danger of spontaneous combustion).

In this market downturn, questions we have been hearing the most recently are:

• Is it different this time?
  
• How long will it last?
  
• Have we seen the bottom yet?
  

Who knows? These questions are important but not knowable, therefore don’t waste time pondering on these.

The questions long term investors should ask are:

• Are you investing in an easy to understand, wide moat and well run business?
  
• Does that business generate consistent cash flows and has a clean balance sheet?
  
• Finally, are you buying at a large discount to what the business is worth?
  

Strategies for selecting stock for the long term investor

Benjamin Graham: "Investment is best when it is business like. "

However, long term investing is not the only way to make money, there are other ways too.


These 4 strategies should aid one’s investment into equities:
1. Select the business that is long term profitable and giving good return on total capital (ROTC).
2. The business should have managers with talent and integrity in equal measures.
3. Understand the business reinvestment dynamics.
4. Pay a fair price for the business.

1. The business to invest in must make money over time.

• Examine how its revenues and profits are generated. 
• How do its products or services contribute to the value of its business? 
• What are its costs? 
• Look for a business that gives good RETURN ON TOTAL CAPITAL (ROTC), not just those with high ROE. 
• Be aware that high ROE can be due to taking on too much debt. 
• Avoid IPOs, start-ups and venture capitals.

2. Look for managers with a good balance of talent and integrity.

• Those with integrity but lack talent are nice people to have as friends, but they may not be able to deliver good results for the business. 
• Those with talent but lack integrity will harm your business and longer term investment objectives.

3. Is the company able to reinvest its money or capital at a better rate over time?

Basically, be conscious of the reinvestment dynamic of the company.

(a) There are companies giving good return on total capital and able to reinvest their capital at better incremenetal rates over time.

• Invest in these companies as they are effectively compounding your money year after year. 
• This is the powerful concept of REINVESTMENT COMPOUNDING seen in some companies, best illustrated by Berkshire Hathaway. (Reinvestment Compounding)

(b) Some companies have good return on total capital but can’t reinvest this at better rate over time.

• For example, a restaurant business may be dependent on the personal touch of the owner. 
• Expanding the business to another restaurant may not generate the same return on capital. 
• In such cases, the worse approach is to grow the business of the restaurant. This is unlike McDonald. 
• Those investing into such businesses should understand that their RETURNS ARE FROM DIVIDENDS and from RETURN OF TOTAL CAPITAL.

(c) Avoid those businesses with no return on total capital but use more capital all the time.

• An example of this is the airline industry. AVOID such investments.

4. Determining the fair price to pay for the ownership of the business is important.

• For the outside shareholder, the investment should earn the same returns as the company’s business returns.
• If the company earns 10% or 12% or 15% per year for 5 years, the outside shareholders should likewise aim to earn a return of 10% or 12% or 15% per year for 5 years by paying a fair price. 
• Paying a PE of 40 for this company may mean not earning such return as the price paid was too high. 
• On the other hand, paying a PE of 10 – 15 gives the investor a better odd of getting this fair return.
• Paying a fair price for owning a business is important. The company earnings maybe as expected but then your returns failed to match these as you have paid too much to own the business.

What about other factors?


The economy, interest rates, fuel prices, commodity prices, foreign exchange, price of gold and geopolitical situations; should not these influence your investing?

Yes, these are hugely important factors. However, they are not predictable and largely out of our control. They are not knowable in advance. It is better to distance oneself from thinking about them when assessing the business to invest in.

Therefore, the approach adopted should generally not be a top-down macroeconomic one, but a bottom-up microeconomic one. “The implication is with the passage of time, a good business over a long period of time produce results to the investor over time.”


Summary

Identify the company that is in a profitable business giving good return on total capital (ROTC).

The managers should be talented and honest, and have the interest of the shareholders.

The business should be able to reinvest capital at higher incremental rates of returns and with discipline. (Reinvestment compounding).

Also, acquire the company at fair price to ensure a fair return. Avoid paying too much for the current prospect of the company, look long term.

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Effectively the above is the same as the QVM approach.


Quality: A good quality company has consistent and/or increasing revenue, profit, eps, and high ROE or ROC.


Value: This is dependent on the price paid to acquire the business. Using earnings yield or PE enables one to determine the fair price to pay for this business.


Management: Look for businesses where the managers have these 2 qualities in the right balance - talent and integrity.


Search out for companies with high ROE or ROTC and low PE or high earnings yield (indicating "cheapness"). Relate the ROE or ROTC to the PE or earnings yield of the business.


A fair price to pay for the business will be the price that guarantees at least a return equivalent to the returns generated by the business you invest in.


Owning a good quality company with talented and honest managers at a good price (fair or bargain price) incorporates all the elements of investing preached by Benjamin Graham, namely the safety of capital considerations, reward/risk ratio considerations and the margin of safety considerations.

Also read: ROE versus ROTC