Why you shouldn't invest in companies whose business you don't understand?

You shouldn't invest in companies whose business you don't understand because you won't be able to judge their future potential and vulnerabilities.

While intimacy with a company's business is not essential to making a decision to buy the stock, later "hold" or "sell" decisions may be clearer if you understand its competitive position in the marketplace, the value of its products or services, and the character of its industry's problems.  These are common-sense issues for which a simple understanding of the business will suffice.

Buffett: BUY OUTSTANDING BUSINESS at a significant discount to its intrinsic value.

If we make mistakes, Buffett confesses, it is either because of

(1)  the price we paid,
(2)  the management we joined, or,
(3)  the future economics of the business.

Miscalculations in the third instance are, Buffett notes, the most common.

It is Buffett's intention not only to identify businesses that earn above-average returns, but to purchase these businesses at prices far below their indicated value.  The margin of safety also provides opportunities for extraordinary stock returns.

If Buffett correctly identifies a company possessing above-average economic returns, the value of the shares of stock over the long term will steadily march upwards as the share price mimics the returns of the business.  

If a company consistently earns 15% on equity, its share appreciation will advance more each year than the share price of a company that earns 10% on equity.  

Additionally, if Buffett, by using the margin of safety, is able to buy this outstanding business at a significant discount to its intrinsic value, Berkshire will earn an extra bonus when the market corrects the price of the business.

"The market, like the Lord, helps those who help themselves."  Buffett says, "But unlike the Lord, the market does not forgive those who know not what they do."

The First Secret of Small-Cap Investing: DEMAND PROOF OF MANAGERIAL EXCELLENCE

Great businesses are made, not born. And the secret to making a great business is having solid leadership in place — a management team that can drive a company on the route to sustainable excellence.

As with any stock investment, it’s imperative to establish that a small company’s leaders are more than competent — they have the skill and expertise to deliver profits to shareholders. Although there are many ways to determine whether a company’s management team is up to the task, a few factors rise to the top.

First, a company should have an operating history of at least three years. For companies that have recently gone public, this period could include years before its initial offering. There should have been no jarring changes of management during the company’s recent past as well. A company’s management can’t be evaluated without evidence, so the team responsible for the success of the venture to date must still be in place in order to make judgments.

Second, a company must be profitable to be considered for investment. The promise of future profits is not sufficient. Nor is it enough for a company to have recently turned the corner and posted positive earnings for the first time in its history. If a company has been able to deliver several recent years of profitability, management has passed the most important test of its skills.

But it’s not enough that a business’s management is merely competent. Our third suggestion is that stock investors strive for excellence — seek companies that meet or surpass the performance measures of their peers and competitors.

Fourth, the strength and consistency of historical growth is certainly area where investors can discern the hand of management in building a business poised for long-term future success.

Fifth, the trend and level of a company‘s pretax profit margins is perhaps the single most important comparative factor. Successful, quality companies can be identified by the margins they eke out on each dollar of revenue. Higher margins than competitors are almost always a sign of management expertise. Relatively stable annual margins are demanded of all companies. Growing margins are a positive.

To be sure, smaller companies may be in the phase of building their business, investing now to support greater success in the future, so the analysis of margins when compared with more established competitors should keep this possibility in mind.

A company’s return on equity should be reviewed carefully, but this measure not be less useful as a quality consideration for newer-stage businesses. Smaller companies can earn higher returns on initial equity, but these levels are not sustainable. Caution must again be exercised when comparing small businesses with established enterprises. Finally, any company included in a growth stock portfolio must have identifiable drivers of future growth. Tailwinds should be stronger than headwinds. No business can coast to success on the coattails of its past success, so management must be able to present a viable vision for how it intends to grow the business in the years ahead.

http://blog.betterinvesting.org/?p=2417

Evaluating a Company - 10 Simple Rules

Having identified the company of interest and assembled the financial information, do the following analysis.

1.  Does the company have any identifiable consumer monopolies or brand-name products, or do they sell a commodity-type product?

2.  Do you understand how the company works?  Do you have intimate knowledge of, and experience with using the product or services of the company?

3.  Is the company conservatively financed?

4.  Are the earnings of the company strong and do they show an upward trend?

5.  Does the company allocate capital only to those businesses within its realm of expertise?

6.  Does the company buy back its own shares?  This is a sign that management utilizes capital to increase shareholder value when it is possible.

7.  Does the management spent the retained earnings of the company to increase the per share earnings, and, therefore, shareholders' value? That is, the management generates a good return on retained equities.

8.  Is the company's return on equity (ROE) above average?

9.  Is the company free to adjust prices to inflation?  The ability to adjust its prices to inflation without running the risk of losing sales, indicates pricing power.

10.  Do operations require large capital expenditures to constantly update the company's plant and equipment?   The company with low capital expenditures means that when it makes money, it doesn't have to go out and spend it on research and development or major costs for upgrading plant and equipment.


Once you have identified a company as one of the kinds of businesses you wish to be in, you still have to calculate if the market price for the stock will allow you a return equal to or better than your target return or your other options.  Let the market price determine the buy decision.  

Knowing a Business Leads to Investing Success. Act Like an Owner

Investing is very similar. You must be able to:

1) value a business and
2) wait for the right price.

You should spend at least as much time reading annual reports as you do studying books on value investing. I’m not saying you don’t need to master the great books and writings on investing. On the contrary, this is essential too.

Nevertheless, as you master the framework and develop your own investing process, more and more of your time and energy shouldshift to studying businesses.

QMV approach

QMV approach

Q = Quality of the Business
M = Integrity and Efficiency of the Management
V = Value or Valuation

Quality first, Price second

Philip Fisher: Quality first, Price second

Fisher formulated a clear and sensible investing strategy (which I'll get to in a second), wrote one of the best investment books of all time, Common Stocks and Uncommon Profits, and made a good deal of money for himself and his clients.

His son wrote that Phil's best advice was 
-to "always think long term," 
-to "buy what you understand," and 
-to own "not too many stocks." 

Charles Munger, who is Buffett's partner, praised Fisher at the 1993 annual meeting of their company, Berkshire Hathaway Inc. (BRK/A): "Phil Fisher believed in concentrating in about 10 good investments and was happy with a limited number.  That is very much in our playbook. And he believed in knowing a lot about the things he did invest in. And that's in our playbook, too. And the reason why it's in our playbook is that to some extent, we learned it from him."

In addition to the warning against over-diversification — or what Peter Lynch, the great Fidelity Magellan fund manager, calls "de-worse-ification" — the book makes three important points:

(1)  First, don't worry too much about price.  (Quality first, Price second)
-  "Even in these earlier times [he's talking here about 1913], finding the really outstanding companies and staying with them through all the fluctuations of a gyrating market proved far more profitable to far more people than did the more colorful practice of trying to buy them cheap and sell them dear."
-  In fretting about whether a stock is cheap or expensive, many investors miss out on owning great companies. My own rule is: quality first, price second.
(2)  Second, Fisher says that investors must ask, "Does the company have a management of unquestionable integrity?" 

(3)  Finally, Fisher offered the best advice ever on selling stocks. "It is only occasionally," he wrote, "that there is any reason for selling at all."

Yes, but what are those occasions? They come down to this: Sell if a company hasdeteriorated in some important way. And I don't mean price! 

Fisher's view, instead, is to look to the business — the company itself, not the stock. 

"When companies deteriorate, they usually do so for one of two reasons: 
- Either there has been a deterioration of management, or 
- the company no longer has the prospect of increasing the markets for its product in the way it formerly did."

A stock-price decline can be a key signal: "Pay attention! Something may be wrong!" But the decline alone would not prompt me to sell. Nor would a rise in price. 

Time to sell? If you did, you missed another doubling.

"How long should you hold a stock? As long as the good things that attracted you to the company are still there."

Investing is simple. We need only to see the management do these!

In a nutshell:

*A company is a good candidate for investment if its management is capable of producing a solid history of steady and strong sales and earnings growth.

*If the management of such a company demonstrates it can consistently retain a steady or increasing profit from its revenues, its track record is likely to continue.

*In the long term, the price of a share of stock is tied to a company’s earnings hence, if earnings grow so will the price of that company’s stock.

*If you buy a good company’s stock when the ratio of its price to its earnings is at or below its historical average, you can expect the value of your investment to grow at or above the rate of its earnings growth.

*If the average annual earnings growth of the companies you invest in is fifteen percent or more, you can double your money every five years by holding on to those companies so long as that growth continues, and replacing them when it doesn’t.

*No matter how careful you are, one out of five companies you select will disappoint you and one will exceed your expectations.

This set of statements is elegant in its simplicity. Where in any of this do we find any need to explore how management accomplishes these feats? We need only to see that they do!

Profits for the Long Run: Affirming the Case for Quality

Buying shares in decent, profitable businesses is a good way of minimising risk, and thereby maximising overall investing returns over the long run.

Chuck Joyce and Kimball Mayer:

"Put simply, profitability is the ultimate source of investment returns. [And] contrary to popular belief, profitability can be forecasted, and superior profitability persists. Investors systematically undervalue the unexciting stability of [such] quality stocks, except during times of financial crisis. Rather than being beholden to some black box model... we would argue that a fundamental focus on profitability remains the best way to minimize the true risk with which investors should be concerned."

Read more here:  Profits for the Long: Affirming the Case for Quality

With the passing of time, the benefi ts of low-risk investing have become more widely accepted.  Today, a wide array of low-risk strategies is now available.  

From profits, come dividends. And from dividends, come investors' incomes.


The market tends to mis-price such companies, seeing them as dull dividend machines, when it should be valuing them as dull, safe dividend machines.


Read more here: http://www.fool.co.uk/news/investing/2012/06/12/profits-for-the-long-run.aspx

Five key questions in considering investment opportunities:

1.  Is this a good business run by smart people?

This may include items such as quality of earnings, product lines, market sizes, management teams, and the sustainability of competitive positioning within the industry.

2.  What is this company worth?

Value investors perform fair value assessments that allow them to establish a range of prices that would determine the fair value of the company, based on measures such as normalized free cash flow, break-up , takeout, and/or asset values.  Exit valuation assessment provides a rational "fair value" target price, and indicates the upside opportunity from the current stock price.

3.  How attractive is the price for this company, and what should I pay for it?

Price assessment allows the individual to understand fully the price at which the stock market is currently valuing the company.  In this analysis, the investor takes several factors into account by essentially answering the question.  Why is the company afforded its current low valuation?  For example, a company with an attractive valuation at first glance may not prove to be so appealing after a proper assessment of its accounting strategy or its competitive position relative to its peers.

4.  How realistic is the most effective catalyst?

Catalyst identification and effectiveness bridges the gap between the current asking price and what value investors think the company is worth based on their exit valution assessment.  The key here lies in making sure that the catalyst identified to "unlock" value in the company is very likely to occur.  Potential effective catalysts may include the breakup of the company, a divestiture, new management, or an ongoing internal catalyst, such as a company's culture.

5.  What is my margin of safety at my purchase price?

Buying shares with a margin of safety is essentially owning shares cheap enough that the price paid is heavily supported by the underlying economics of the business, asset values, and cash on the balance sheet.  If a company's stock trades below this "margin of safety" price level for a length of time, it would be reasonable to believe that the company is more likely to be sold to a strategic or financial buyer, broken up, or liquidated to realize its true intrinsic value - thus making such shares safer to own.

Better Investing Philosophy

Fundamentals of Investing

 

Explaining the BetterInvesting Philosophy

 

Our February issue traditionally includes an invitation for you to bring a visitor to your investment club meeting so that they can discover how clubs can help them build wealth and can learn about BetterInvesting’s philosophy. Two years ago we published an article explaining our approach to investing that proved popular with readers. This month we’ll tackle the subject again. If you’re bringing a guest to a meeting or want to introduce someone to the BetterInvesting approach, you might consider giving them this issue.

Brad Perry, in his classic book Winning the Investment Marathon, wrote that investing “is pursued most successfully in a simple, straightforward way.” This is the Golden Rule for most investors who employ fundamental analysis and have a long-term perspective. Buy stocks of high-quality companies at good prices and continue holding them as long as the companies’ performance merits doing so.

Sales drives earnings; earnings drives the stock price. That’s what it comes down to for fundamental investors. You might hear of different ways to buy and sell stocks, and countless books have touted systems that promise great returns. But over the long term fundamental analysis is what works in building wealth.
   
Fundamental analysis comes down to studying a company’s financial performance. Broadly, there are those who look for growth stocks and those who look for value equities, but the line between value and growth investing is gray: As Warren Buffett says, value and growth “are joined at the hip.”
   
Value investing, as practiced by Buffett and his mentor Benjamin Graham, is a time-tested method involving fundamental analysis that has served many investors well. But for the typical person who has a job and family and who is managing his own portfolio while following Perry’s admonition to keep it simple, fundamental analysis focused on growth stocks might be more appropriate.
   
This is because individual investors can spot a good growth company quickly. BetterInvesting’s Stock Selection Guide arranges the fundamental data in a way that allows users to see a company’s growth and management performance as well as the stock’s investment possibilities in just a few minutes; see the Stock to Study SSG on pages 29 and 30 for an example. Meanwhile, the work required to spot a good value stock is a little more complex. But as we’ll discuss later, value should be a vital consideration as well.

The Three Most Important Ideas:
Management, Management, Management
The individual investors who belong to BetterInvesting ask two questions when studying a stock:

•  Is this a well-managed company?
•  Is its stock reasonably priced?
   
We seek great management because talented, capable executives know how to ensure their company thrives over the long term amid competitive battles and periodic downturns. These are the people, in other words, who are responsible for driving the sales and growth increases that fuel stock prices.
   
In assessing management, we don’t know everything about a company’s day-to-day operations and boardroom discussions. But as laid out in a methodology promoted by association co-founder George Nicholson, we do have a lot of the information we need. A first step in finding a well-managed company is to look at the history of sales and earnings growth. An important indicator of strong management is its ability to grow the business in good times and bad.
   
We also seek companies that are growing sales and earnings over the long term at a rate that’s high relative to their size. Smaller companies generally should be growing earnings by at least 15 percent a year; mid-size companies, by 10 percent to 15 percent a year; and large companies, by at least 7 percent annually.
   
We want smaller companies to have higher growth rates partly because they generally are riskier investments than large companies. The higher growth rate compensates us for this additional risk, and if we do a good job of assessing these companies, we’ll see handsome returns. As you’ll see in this issue in “Repair Shop” and “Watch List,” finding small companies can be challenging but also quite rewarding.
   
Finally, we favor consistent growth over the long term. In the graph on this page, for example, note the railroad-track-like growth of the company’s sales and earnings. Consistent performance reassures us about the capability of management. And although the past is no guarantee of future performance (as they say in the mutual fund world), history informs our decisions regarding future growth.
   
Two other tests help us assess the company’s management. First, we check the company’s profitability before taxes and other charges outside of management’s control. We like to see stable or growing profit margins. The other ratio is return on equity — how well management is using the equity invested in the company. Again, stable or growing ROE is preferred. Comparing the company’s growth rates, profitability and ROE with those of its peers helps determine whether this is a company built for a long voyage or is simply benefiting from the rising tide for its industry.



Evaluating the Investment Potential

Once we’ve determined the company in question is likely a high-quality one worth studying further, we next project sales and earnings growth. As fundamental investors, we know that in the short term, the market may not reward the company for its excellence. But over the long term, we trust that it will. So it’s the long-term projections — five years, very roughly enough for the company to go through a business cycle — we care about.
   
We start by forecasting sales growth because we need this for building our earnings projection. With the caveat that making long-term predictions can be a humbling experience, we have a number of data points at our disposal, including:

•  The company’s historical growth rate.
•  Company statements regarding growth goals.
•  Wall Street estimates of both short- and long-term growth. Long-term sales growth estimates can be difficult to find but are sometimes buried in analyst reports.
•  The industry’s historical growth rate and estimates of future expansion.
   
More experienced investors might consider such factors as the percentage of recurring revenues, the value of projects under contract but not yet completed and historical organic growth and growth by acquisition. For retailers, they might look at projections for store and square footage expansion as well as same-store sales growth. But history is a powerful teacher for beginning and experienced investors alike.
   
We then estimate earnings growth in light of the sales projection. We’ll consider the company’s history of earnings growth and any goals it has stated. We can also access analyst reports and analysts’ consensus estimates, but these forecasts are usually overly optimistic.
   
Studying past and potential future profit margins and tax rates can help us understand the path revenues will take to earnings. We also want to think about what will happen to the firm’s number of common shares outstanding. For example, if a company regularly buys back shares to reduce the number of shares outstanding and is expected to continue this practice, we would expect future earnings to be spread among fewer shares.
   
When we’re finished, we use the earnings growth rate to arrive at an estimate of earnings per share five years from now. If we have forecast growth of 15 percent a year, and the EPS at our starting point is $1, five years from now EPS will be $2. Two things to keep in mind regarding projections:

•  It’s prudent to be conservative.
A firm might have increased earnings 25 percent annually over the past 10 years, but such performance is extremely difficult to maintain. Gravity will eventually take hold as a company moves from small to mid-size to large.
•  Earnings advances can outpace sales growth for only so long. Over the long term, they usually settle in at the rate of revenue growth. If you’re going to project EPS increases that are higher than sales growth, understand where the additional percentage points are coming from: Increased margins? Lower taxes? Fewer shares outstanding?

Checking Valuation

Once we’ve predicted the EPS five years from now, we’re ready to answer our second question: whether the stock is reasonably priced. Investors are good at discovering high-quality stocks but experience more challenges in determining the proper price to pay for the stock. Our first step is to study the stock’s price-earnings ratios over the past several years and forecast the likely high and low P/Es over the next five years. The P/E, the stock’s current price divided by a company’s EPS, is how much the market is willing to pay for $1 of a firm’s earnings; it’s the most common way to measure how expensive a company’s stock is.
   
Historical valuations can help us in this process, but P/Es often go through unpredictable periods of expansion and contraction as industries go in and out of favor on Wall Street. Another idea to keep in mind is that a stock can trade at extremely high P/Es for a while but eventually will drop — severely so when a high-growth company stumbles. P/Es also tend to contract in times of inflation.
   
After we have predicted what the high P/E for a stock will be, we’re ready to estimate a potential high price for our stock. It’s a matter of simple math: The high point of EPS — what we forecast the EPS to be five years from now — is multiplied by the high P/E to come up with a potential high price. For example, if we predict EPS will be $2 in five years and the high P/E will be 30, our predicted high price will be $60.
   
After projecting the low P/E, we can multiply it by the expected low EPS to come up with a potential low price. Since we’ve determined this is a growth company, we usually can use the most recent 12 months’ EPS as the low point for earnings. I can use other criteria for projecting a low, but this is a common method for determining this figure.

Return Expectations

Now that we have the stock’s potential range from low to high, we’re ready to see whether this stock will provide a suitable return. Our SSG divides the range into three zones: Buy, Maybe (or Hold) and Sell. The lowest 25 percent of the range is the Buy zone, and the upper-most 25 percent is the Sell zone.
   
We include the stock’s dividends — the cash payments of earnings to shareholders — in our return calculations. This gives us three ways to achieve a return on a stock: 

• through dividends,
• through the market increasing the stock’s price in concert with the earnings growth and 
• through the stock’s price rising because the market believes the P/E should be higher.

   
We aim for our stock holdings to return 15 percent annually on average over the next five years, or a doubling of return. That’s an aggressive target, but the idea isn’t to be disappointed if we fail to meet it. It’s to maintain our focus on seeking high-quality growth stocks. Achieving returns of, say, 10 percent yearly is pretty commendable.
Managing Risk

Investors can manage their risk in picking individual stocks by following some simple rules:

•  Require that the company have at least five years of financial history. Younger firms haven’t developed enough of a track record for assessing management performance.
•  Study only companies that have proven they can make money. Someone who invests in a company that has never reported earnings is speculating, not investing.
•  Understand the possible risk and reward of owning a stock.
•  Diversify your portfolio. Even if you’ve done your homework on every holding using all the information you need to make an informed decision, you’ll still make mistakes. If you have a good-size basket of stocks, however, you’ll also have some stocks that perform much better than expected.
   
Besides investing in high-quality growth stocks and diversifying your portfolio, two other simple principles can help you build wealth over the long term. 

• First, reinvest all your dividends and earnings. 
• Second, invest regularly in both good markets and bad; this is often called dollar-cost averaging.

   
The type of analysis I’ve outlined provides a lot of the information fundamental investors need to determine whether a stock is a suitable investment. But not everything. Reading annual reports, listening to conference calls and viewing company presentations will help you form a fuller picture of the company.
   
In today’s unpredictable, volatile market, fundamental analysis is even more important than usual. But for an investor using a simple, straightforward methodology that focuses on the long term, these are also times of great opportunity.

http://www.betterinvesting.org/Public/SingleTabs/BI+Mag/Articles+Archives/0210publiccs.htm

How to do a stock research & analysis.

Opto Circuits India Ltd - Stock Research & Analysis
(15 Dec 2008)

Synopsis

Opto Circuits is a small company in Medical Electronics industry with focus in the niche areas of invasive (coronary stents) and non-invasive (sensors, patient monitors) segments. Prior to '2002 Opto's Revenues were less than Rs. 50 Cr. Today Revenues stand at Rs.468 Cr, with exports accounting for more than 95% of Revenues. Opto Circuits is based in Bangalore India and operates out of offices established in USA, Europe, South-East Asia, Latin America and the Middle East and boasts of a strong international distribution network present in over 70 countries.

The Numbers speak for themselves. Net profit margins are healthy (over 28%), great return on equity (~ 40%, unmatched in the Medical Electronics industry), and solid return on invested capital ratios (over 45%). Financial health has been steadily improving over the years with comfortable financial leverage (1.34) and Debt to equity (0.31), with solid Current & Quick ratios. However, Opto Circuits still has a long way to go before it can show loads of excess cash on its books, due to its aggressive business expansion. Free Cash Flow as a percentage of sales is ~6 percent. It has consistently increased Dividends per share and has a unique track record of rewarding shareholders with bonus shares every year, for the 7th straight year! Opto Circuits seems to enjoy an above-average Economic Moat and fares very well when compared to its peers in this Peer Comparison snapshot.

Though there are Significant Risks going forward, Opto Circuits has lots of positives going for it. Over the last 7 years since FY2002, Opto Circuits Revenues have clocked a long term sales growth of over 45% while long term EPS growth has galloped at a handsome 60% plus. It has been working steadily grow its business through pursuing organic growth through investments in manufacturing capacities and penetrating into newer markets, supplemented by inorganic growth through judicious acquisitions. To its credit Opto circuits has managed acquisitions so far quite well, drawing synergies by leveraging distribution networks and lower-cost manufacturing bases. There is some evidence of Sustainable Growth over the medium term. We posed a few questions to Opto Circuits Management to be able to understand and assess its longer-term prospects and growth sustainability, better.

Opto's track record so far evidences early signs of being served by a Competent Management Team. The stock is promising and there's nothing wrong with investing in a young growth company like Opto Circuits, as long as you know what you are getting into. It has a long way to go before it qualifies to be among the Core holdings in anyone's Portfolio. It’s a long shot, though one that might just pay you back many times over. However, this is only half the story because even the best companies are poor investments if purchased at too high a price. We cover Opto Circuits' stock valuation in the other half story. 

Read more here:

http://www.stock-picks-focus.com/opto-circuits.html#Profitability-Snapshot

7 Stock Investing Advices Warren Buffet Want You to Know

Good Stock Investing Advices

That All Beginners Need to Follow Religiously

Summarized Overview

In this article, you’ll find information on the stock investing ideas that Warren Buffet wants all stock investors to know, strategy he uses to maximise return, price of stocks that he willing to pay, key financial ratio that is so important to him, type of managers he loves, and kind of management he trusts.

7 Stock Investing Advices for Beginners

This stock market investing advice will help you on how to pick stocks Warren Buffet way.

Stock Investing Advices #1: Simple Business Model

It is not just about simplicity, but also something that you can understand. You must clearly define your circle of competence and stay where you are. It can be something that you learn while you are working or something that you spend time on to understand the business operation. To most, oil and gas business can be seen as so simple and yet very profitable, but to those who works in that industry will tell you, it is not as easy as what you think.  Do you know why this is so important?

When come to investing, predicting what will happen tomorrow is something that you can’t live without. Forecasting what the future will be is the only way you can estimate how much return you’ll be getting later on. So, if you really understand the business inside out, you can project how the company perform 30 years down the road; take into consideration the national economy, competition from others and change in customers’ lifestyle.

Stock Investing Advices #2: Wide Economic Moat

Simply said, the company should serve valuable niche market with price inelastic products or services. Warren Buffet himself avoids regulated industries, commodity businesses as well as capital intensive industries. 

He prefers stocks which can finance their capital from operating cash flow with less borrowing as well as has strong pricing power. Meaning, the company can price their products as much as they want. That is why, Warren Buffet love ‘franchise’, for example, Furniture Mart (the lowest cost in the industry), The Washington Post (market dominance and leader), Coke (strong brand name) and Candies (premium priced and high quality products that serve niche market).

Stock Investing Advices #3: Sustainable Growth

Serving the existing niche market is not enough. Instead, Warren Buffet wants the company to grow continuously and exponentially. Therefore, he looks for managements that have the ability to widen their economic moat consistently over the past years. Their businesses must be positioned where the demand able to grow continuously; Gillette is his best example. In the same time, always be ready for any possible trouble to the business, and most importantly back up your investment plan!

Stock Investing Advices #4: Excellent Capital Management

Every company that is listed in the stock market were entrusted to manage the business on behalf of their shareholders. Therefore, it is the managements’ duty to utilise the available resources for the highest possible return. To do this, they have to think and act like an owner and avoid the ‘institutional imperative’ style of management (think for themselves and don’t care what will happen 20 years down the road). When they don’t have the capability to create at least $1 value from $1 reinvestment, they should return the capital back to the shareholders by giving dividends or share buybacks.

Stock Investing Advices #5: Effective Management Team

Invest in company that have honest and capable managers. They should be so capable that Warren Buffet himself admires the way the managers do things. In Berkshire Hathaway Annual Meeting year 2000, he once said, “we want managers who tell the truth and tell themselves the truth, which is more important”. He loves cost conscious and frugal type of managers who are honest and integrity as well.

Stock Investing Advices #6: Superior ROE

Why ROE, and not the other financial ratios? Well, return on equity indicates how effective the management team convert the reinvested money into cash. The higher the return, the more profitably the company can reinvest its earnings. The faster the company able to turn the reinvested earnings into profits, the faster its value increases from one year to another. And mind you, it is a big challenge to the management to consistently create value for every penny they spend. To prove this, not many stocks that has 15 per cent ROE consistently for the past 20 or 30 years, worldwide.

Stock Investing Advices #7: Buy at Discount Price

Once the good stocks have been identified, now is the time to buy them. To make sure every $1 investment will generate $2000 in just 30 years, Warren Buffet have to make sure he buys the stock at the lowest price possible. In the same time, he has to be real that not to set very low price till he misses the golden opportunity. Thus, he keeps himself buying the stocks when the prices are offered at pre-determined margin of safety. The margin of safety can be as low as 80 per cent discount from the calculated intrinsic value. Even if the stocks are so profitable but the price is too high, he will just passes the opportunity to somebody else.  

If you want to be as successful as Warren Buffet in stock investing, study each point thoroughly. Ignoring either one advice is enough to make you broke in stock market; simply because, in stock investing, due diligence counts. Intentionally not following the advice proves that you are not ready for investing; perhaps you are just looking for fast cash.

http://www.stock-investment-made-easy.com/stock-investing-advices.html

Value Investing Tips - How to Assess a Company's Management

Good managements produce a good average market price, and bad managements produce bad market prices.

Market Price Fluctuations:  An Added Consideration

Something should be said about the significance of average market prices as a measure of managerial competence. 

• The shareholder judges whether his own investment has been successful in terms both of dividends received and of the long-range trend of the average market value. 
• The same criteria should logically be applied in testing the effectiveness of a company’s management and the soundness of its attitude toward the owners of the business.

This statement may sound like a truism, but it needs to be emphasized.

• For as yet there is no accepted technique or approach by which management is brought to the bar of market opinion. 

On the contrary, managements have always insisted that they have no responsibility of any kind for what happens to the market value of their shares.

• It is true, of course, that they are not accountable for those fluctuations in price which, as we have been insisting, bear no relationship to underlying conditions and values. 
• But it is only the lack of alertness and intelligence among the rank and file of shareholders that permits this immunity to extend to the entire realm of market quotations, including the permanent establishment of a depreciated and unsatisfactory price level. 

Good managements produce a good average market price, and bad managements produce bad market prices.

The Approach Warren Buffett uses in deciding whether or not to invest in a company

BRINGING IT ALL TOGETHER

The remarks of Warren Buffet and analysis by Buffett authors suggest that, at the very least, Warren Buffett looks at the following aspects of a corporation and its operations. They can be put in the form of questions that any sensible investor should ask before considering a stock investment.

BASIC QUESTIONS TO ASK

1. Does the company sell brand name products that are likely to endure?
2. Is the business of the company easily understood?
3. Does the company invest in and operate businesses within its area of expertise?
4. Does the company have the ability to maintain or increase profitability by raising prices?
5. Is the company, looking at both long-term debt, and the current position, conservatively financed?
6. Does the company show consistently high returns on equity and capital?
7. Have the earnings per share and sales per share of the company shown consistent growth above market averages over a period of at least five years?
8. Hs the company been buying back its shares, and if so, has it bought them responsibly?
9. Has management wisely used retained earnings to increase the rate of return to shareholders?
10. Is the company likely to require large capital sums to ensure continuing profitability?

See case studies.

This would only be the first stage of the process. The next, and most important question, is determining the price that an investor such as Warren Buffet would pay for the stock, allowing for the margin of safety.

CASE STUDIES

These examples will take you through the method of company analysis advanced on this website, which we believe to be similar to the approach Warren Buffett uses in deciding whether or not to invest in a company.

COCA COLA - CASE STUDY

In answering the question for ourselves whether Coca Cola is a company worth consideration as an investment, at the right price, we have used summary and other figures available from Value Line.

QUESTION 1: DOES THE COMPANY SELL BRAND NAME PRODUCTS THAT ARE LIKELY TO ENDURE?

The answer to this seems quite simple. The major product of the company has been around for many years, is sold worldwide and is considered the best-known brand name in the world. More importantly, its customers would not do without it, and have demonstrated a loyalty that makes it unlikely it would change to other products. It also has other well-known brands on its books – Sprite, Fanta, Evian, Minute Maid, PowerAde.

2. IS THE BUSINESS OF THE COMPANY EASILY UNDERSTOOD?

We think so. Its core operation is the production and distribution, both for itself and under franchise, of non-alcoholic beverages and associated products.

3. DOES THE COMPANY INVEST IN AND OPERATE BUSINESSES WITHIN ITS AREA OF EXPERTISE?

We would think so. Consideration of the Value Line information suggests that the company restricts itself to its core operations. We do not see it dabbling in areas outside its expertise.

4. DOES THE COMPANY HAVE THE ABILITY TO MAINTAIN OR INCREASE PROFITABILITY BY RAISING PRICES?

The real question here is whether, if Coke were to lift its prices by a margin that would allow it to keep pace with inflation, sales would suffer. This is unlikely.

5. IS THE COMPANY, LOOKING AT BOTH LONG-TERM DEBT, AND THE CURRENT POSITION, CONSERVATIVELY FINANCED?

a) Long term debt to profitability

The long-term debt of this company in 2002 was 2700 million dollars. The profit for that year was 4134 million dollars. At this rate, Coke could wipe out its long-term debt in .65 of a year, just over six months.

b) Current ratio

In 2002, Coke had current assets of 7352 million dollars and current liabilities of 7341 million dollars, a ratio of debt to assets of .99. This is lower than would be the desired ratio for industrial companies, but having regard to the nature of the business, and the ready cash flow, is acceptable.

c) Long term debt to equity

In 2002 the long-term debt was 2700 million dollars and shareholders equity was 11800 million dollars a comfortable ratio of .22.

6. DOES THE COMPANY SHOW CONSISTENTLY HIGH RETURNS ON EQUITY AND CAPITAL?

The company has shown an average rate of return on equity over the past five years of 37.08%. In the same period, it showed an average return on capital of 33.6% .The figures are consistent.

Year	ROE	ROC
1998	42.0	39.1
1999	34.0	31.5
2000	39.4	36.4
2001	35.0	31.9
2002	35.0	29.1
Average	37.08	33.6

7. HAVE THE EARNINGS PER SHARE AND SALES PER SHARE OF THE COMPANY SHOWN CONSISTENT GROWTH ABOVE MARKET AVERAGES OVER A PERIOD OF AT LEAST FIVE YEARS?

The figures for this period are as follows.

Year	EPS	+ or - %	SPS	+ or - %
1997	1.64		7.64
1998	1.42	-13.4	7.63	-.13
1999	1.30	-8.45	8.01	+4.98
2000	1.48	+13.85	8.23	+2.74
2001	1.60	+8.11	7.06	-14.2
2002	1.66	+3.75	7.92	+12.18

Looking at a five-year rolling period, we can calculate, using a hand-held Texas Instruments BA-35 Solar Calculator, the increase in earnings and sales over the rolling five-year period 1998-2002. For earnings, this is 16.9 %, for sales only 3.8%. The compound rate of return for earnings is 3.185, for sales, .75%.

This is not a strong rise in earnings or sales, and the question would be whether this is as a result of a slow-down in the US and world economies over this period or whether there is some more structural reason.

8. HS THE COMPANY BEEN BUYING BACK ITS SHARES, AND IF SO, HAS IT BOUGHT THEM RESPONSIBLY?

In 1998, the company had common shares outstanding of 2465.5 million. In 2002, the figure was 2471 million. The shares on issue are basically unchanged.

9. HAS MANAGEMENT WISELY USED RETAINED EARNINGS TO INCREASE THE RATE OF RETURN TO SHAREHOLDERS?

The company has the following earnings per share and dividend per share record over a five-year period.

Year	EPS	DPS
1998	1.42	.60
1999	1.30	.64
2000	1.48	.68
2001	1.60	.72
2002	1.66	.80
Total	7.46	3.44

The company has therefore retained earnings totalling $4.02. In 1998, the shares reached a low of $53.6. In 2002, the shares reached a high of $57.9. An investor who bought at the lowest price in 1998 and still had them at the highest price in 2002 would have been showing a profit of $4.30. Thus the shares would have just slotted into Warren Buffett’s requirement for showing an increase in market value of a dollar for every dollar retained.

Using the approach of Mary Buffett and David Clark, we could calculate the percentage increase in earnings per share resulting from the retained profits. EPS in 1998 were 1.42, and in 2002 were 1.66, an increase of .24. Thus, from the total earnings retained of $4.02, earnings have increased by a total of .22, a percentage increase of 5.97%: not high.

10. IS THE COMPANY LIKELY TO REQUIRE LARGE CAPITAL SUMS TO ENSURE CONTINUING PROFITABILITY?

Value Line suggests that in the two years following 2002, the company would be spending about .40 a share on capital items. The long-term average is .31, unadjusted for inflation. These figures seem to be in line with historical expenditures.

This case study is a demonstration only and is not intended to influence or persuade visitors to this site to make any investment decisions; they should make their own decisions, based on their own research, personal and financial circumstances, and after consultation with their own financial or investment advisers.

BOEING (BA) - CASE STUDY

In answering the question for ourselves whether Boeing is a company worth consideration as an investment, at the right price, we have used summary and other figures available from Value Line.

QUESTION 1: DOES THE COMPANY SELL BRAND NAME PRODUCTS THAT ARE LIKELY TO ENDURE?

The answer to this seems quite simple. The major product of the company has been around for many years, is sold worldwide, and is recognised as a brand name by airlines and air passengers. In recent years, other passenger brand names such as Airbus have added competition. The choice of which airplane an airline buys is a matter of preference, rather than compulsion, and will depend upon factors such as price, safety, back up and design.

The brand name is good, but so is the competition.

2. IS THE BUSINESS OF THE COMPANY EASILY UNDERSTOOD?

We think so. Its core operation is the design and manufacture of airplanes.

3. DOES THE COMPANY INVEST IN AND OPERATE BUSINESSES WITHIN ITS AREA OF EXPERTISE?

We would think so. Consideration of the Value Line information suggests that the company restricts itself to its core operations. We do not see it dabbling in areas outside its expertise.

4. DOES THE COMPANY HAVE THE ABILITY TO MAINTAIN OR INCREASE PROFITABILITY BY RAISING PRICES?

This will totally depend upon the condition of the airline industry and the extent of the competition at any given time. The near certainty that people will continue to fly in ever-increasing numbers is dampened by the possibility of any one of a number of things that could reduce passenger flights – terrorism, crashes, other and more serious SARS type disease outbreaks.

5. IS THE COMPANY, LOOKING AT BOTH LONG-TERM DEBT, AND THE CURRENT POSITION, CONSERVATIVELY FINANCED?

a) Long term debt to profitability

The long-term debt of this company in 2002 was 12589 million dollars. The profit for that year was 2275 million dollars. At this rate, Boeing could wipe out its long-term debt in 5.53 years. This is a long period.

b) Current ratio

In 2002, Boeing had current assets of 16855 million dollars and current liabilities of 19810 million dollars, a ratio of debt to assets of .85. This is lower than would be the desired ratio for industrial companies.

c) Long term debt to equity

In 2002 the long-term debt was 12589 million dollars and shareholders equity was 7696 million dollars a very high ratio of debt to equity of 1.64. Benjamin Graham thought that an industrial company should not have a ratio in excess of 1.

6. DOES THE COMPANY SHOW CONSISTENTLY HIGH RETURNS ON EQUITY AND CAPITAL?

The company has shown an average rate of return on equity over the past five years of 20.12%. In the same period, it showed an average return on capital of 12.02% .The figures indicate that use of debt financing has helped to increase the company returns on equity.

Year	ROE	ROC
1998	9.1	7.4
1999	17.7	12.9
2000	22.8	14.7
2001	21.4	12.2
2002	29.6	12.9
Average	20.12	12.02

7. HAVE THE EARNINGS PER SHARE AND SALES PER SHARE OF THE COMPANY SHOWN CONSISTENT GROWTH ABOVE MARKET AVERAGES OVER A PERIOD OF AT LEAST FIVE YEARS?

The figures for this period are as follows.

Year	EPS	+ or - %	SPS	+ or - %
1997	.63		47.05
1998	1.15	82.54	59.87	27.25
1999	2.19	90.43	66.60	11.24
2000	2.84	29.6	61.36	-7.87
2001	2.79	-1.76	72.94	18.87
2002	2.82	1.07	67.61	-7.30

Looking at a five-year rolling period, we can calculate, using a hand-held Texas Instruments BA-35 Solar Calculator, the increase in earnings and sales over the rolling five-year period 1998-2002. For earnings, this is very high; EPS has risen from $1.15 to $2.82, a total percentage rise of 145.21 %. Sales have risen per share from $59.87 to $67.61, a total rise of only 12.92%. The compound rate of return for earnings is 19.65%, for sales, 2.46%.

The disparity between earnings growth and sales growth suggests that the company has, for whatever reasons, managed to increase profitability well in excess of the rise in sales. Any person considering investment in this company would try and find out why.

8. HS THE COMPANY BEEN BUYING BACK ITS SHARES, AND IF SO, HAS IT BOUGHT THEM RESPONSIBLY?

In 1998, the company had common shares outstanding of 937.6 million. In 2002, the figure was 799.6 million. The number of shares on issue has been substantially reduced, suggesting a share buy back that may be one reason for increased earnings per share ratios.

9. HAS MANAGEMENT WISELY USED RETAINED EARNINGS TO INCREASE THE RATE OF RETURN TO SHAREHOLDERS?

The company has the following earnings per share and dividend per share record over a five-year period.

Year	EPS	DPS
1998	1.15	.56
1999	2.19	.56
2000	2.84	.59
2001	2.79	.68
2002	2.82	.68
Total	11.79	3.07

The company has therefore retained earnings totalling $8.72. In 1998, the shares reached a low of $29. In 2002, the shares reached a high of $51.10. An investor who bought at the lowest price in 1998 and still had them at the highest price in 2002 would have been showing a profit of $22.10. Thus the shares would have easily slotted into Warren Buffett’s requirement for showing an increase in market value of a dollar for every dollar retained.

Of course, and this shows Mr Market as a real factor, an investor who bought at the 1998 high price of $56.30, and sold at the 2002 low price of $28.50 would be showing a substantial loss on the investment.

Using the approach of Mary Buffett and David Clark,in The New Buffettology,  we could calculate the percentage increase in earnings per share resulting from the retained profits. EPS in 1998 were 1.15, and in 2002 were 2.82, an increase of 1.67. Thus, from the total earnings retained of $8.72, earnings have increased by a total of $1.67, a percentage increase of 19.15%: above market rates of return.

10. IS THE COMPANY LIKELY TO REQUIRE LARGE CAPITAL SUMS TO ENSURE CONTINUING PROFITABILITY?

Value Line suggests that in the two years following 2002, the company would be spending about $1.00 a share on capital items. The long-term average is $1.33, unadjusted for inflation. These figures seem to be a little less than historical expenditures.

This case study is a demonstration only and is not intended to influence or persuade visitors to this site to make any investment decisions; they should make their own decisions, based on their own research, personal and financial circumstances, and after consultation with their own financial or investment advisers.

http://www.buffettsecrets.com/bringing-it-all-together.htm