BUFFETT’S COMPANY ANALYSIS TEMPLATE.
Below is a Summary of what Warren Buffett targets in a company’s three Financial Statements and his use of his Equity Bond Theory in order to evaluate a company and to determine a preferable purchase price.
In my opinion, one could regard all these requirements as a form of COMPANY ANALYSIS TEMPLATE with which an Industrial type company should comply in order to satisfy Buffett’s Investment Criteria, which should, in turn, lead to a profitable long-term investment.
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INCOME STATEMENT.
GROSS PROFIT :- Gross Profit = Cost of Sales/Revenue >40%
SG&A EXPENSES :- SG&A < 30% x Gross Profit
R&D EXPENSES :- Little or Nil
DEPRECIATION :- Depreciation < 10% x Gross Profit
INTEREST EXPENSE :- Interest Expense < 15% x Operating Income (i.e. EBIT)
PRETAX INCOME :- VERY IMPORTANT NUMBER, especially for previous 12 months
NET EARNINGS :- Net Earnings > 20% x Total Revenue
EARNINGS PER SHARE :- 10 Year Trend showing Consistency & Upward Trend
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BALANCE SHEET.
ASSETS.
CASH & SHORT TERM INVESTMENTS :- Ongoing increase from Business Operations NOT from One-Time events
INVENTORY :- Corresponding Rise in both Inventory & Net Earnings
CURRENT RATIO :- Current Assets/Current Liabilities < 1, due to Strong Earning Power
PROPERTY, PLANT & EQUIPMENT :- Low as possible
LONG TERM INVESTMENTS :- Large as possible. Should be Quality Investments, preferably in other DCA companies
RETURN ON ASSETS (ROA) :- High BUT with Large Total Assets to reduce Vulnerability
LIABILITIES.
SHORT TERM DEBT :- Avoid bigger borrowers of Short Term money rather than Long term money
LONG TERM DEBT DUE :- Little or Nil
LONG TERM DEBT :- Long Term Debt < 3 x Annual Net Earnings
DEBT/SHAREHOLDER’S EQUITY :- Debt/S.H.Equity < 0.8 where S.H.Equity INCLUDES Value of Treasury Stock
PREFERRED STOCK :- Nil RETAINED EARNINGS :- Annual Increase > 7%
TREASURY STOCK :- Should appear and be regularly purchased
RETURN ON SHAREHOLDER’S EQUITY (ROE) :- Net Income/S.H.Equity > 25%
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CASH FLOW STATEMENT.
INVESTING OPERATIONS :- Based on +/-10 Year Period, Capital Expenditure/Net Earnings < 50% For DCA company this ratio is consistently < 25%.
FINANCING ACTIVITIES :- “Issuance (Retirement) of Stock, Net” to be a regular NEGATIVE Value. This indicates a NET Buying Back of its own Shares compared to a NET Issuance of its Shares. _______________________________________________________________
BUFFET’S EQUITY BOND. THE THEORY.
Companies with DURABLE COMPETITIVE ADVANTAGE (DCA) can be seen as an EQUITY BOND with a COUPON.
Equity Bond = Share Price Bond
Coupon = Pretax Earnings/Share
DETERMINE SHARE PRICE.
Stock Market will price a DCA company’s Equity Bond at a level that approximately reflects the Value of its Earnings RELATIVE to the Yield on LONG TERM CORPORATE BONDS (LTCB)
Equity Bond = Share Price = Coupon Rate/Long Term Corporate Bond Rate (LTCBR)
Coupon Rate/LTCBR = Pretax Earnings/LTCBR
WHEN TO BUY.
(1) Buy during Bear Markets or when share prices are depressed due to no fault of the company
(2) Buy when Share Price < Pretax Earnings per Share/LTCBR by a reasonable discount
WHEN TO SELL.
(1) Sell when presented with a BETTER company at a BETTER Price
(2) Sell when a current DCA company is losing its Durable Competitive Advantage
(3) Sell during Bull Markets or when prices are at unrealistically HIGH levels
(4) Sell when P/E ratios > 40+, especially if the stock’s price far EXCEEDS THE LONG-TERM ECONOMIC REALITIES OF THE BUSINESS
http://siliconinvestor.advfn.com/readmsg.aspx?msgid=26423391
Personal finance reporter Emma Wall
In the grand surroundings of St Andrew Square, Edinburgh, lies First State Investments. Famed for its long and successful track record in emerging markets equities and star managers such as Angus Tulloch and Martin Lau, you could forgive the preconception that behind the big glass door would be deluxe leather chairs, corner offices and traders barking orders into phones. I spent a day there to experience a fund manager's life at first hand.
8AM
At a time when most people are just leaving for work, a dozen members of First State's global emerging markets (GEM) and Asia Pacific investment teams are gathering round a table, preparing for a cross-continent meeting.
We are crowded into what resembles a sixth-form common room, with photos of employees' weddings and nights out pinned to a board on the wall. At the foot of the table is a large television screen, where we are to expect images of similar scenes to appear, beamed from First State's Singapore and Hong Kong offices.
This is one of three meetings a week in which managers, directors and analysts meet to discuss companies in the region that may qualify for one or more of the GEM and Asia Pacific funds.
"If you took minutes of these meetings, you'd realise that we never draw any conclusions," said one of the team. "We often disagree about a company and one of us may choose to hold it in their fund while the other managers think it's a bad idea. There is not a house view."
After a few technical difficulties – "it was decided a while ago that Asia would call us, rather than us calling them, as we can't master the technology" – the meeting is up and running, chaired by Singapore-based Alistair Thompson, deputy head of Asia Pacific excluding Japan equities.
Themes discussed include infrastructure, currencies, interest rates and inflation – in Britain, Australia and Asia – as well as the hot topic of the moment, gold, and whether its price could double.
The group also reviews the big buyers and sellers of stocks – trades over $1m – that the funds hold and what this could mean for the funds' performance.
Banter is rife. Team members seem to revel in antagonising one another or demanding reasons for their stock positions, and there is little indication of hierarchy.
The First State approach to investing is to be accountable to investors rather than a benchmark. Managing partner Stuart Paul said investors knew their approach was as much about capital preservation as making returns. "You can outperform a benchmark but still lose money," he said. "That's not something we're interested in. Sometimes we might not make as much as an upmarket, but in 2000 when the MSCI emerging markets index lost 25pc, we only lost 9.5pc."
10AM
"We think it's in the interest of the client not to be too clever," said Mr Tulloch, explaining the absolute return style of investing his team champions.
Institutional investors make up just over half of First State's global emerging markets and Asia Pac Oeic (open-ended investment company) business. The team is required to keep in regular contact with its large clients, and so next on the agenda is a call to a European public pension scheme.
Mr Tulloch described how investors' location governed their interests, with Britain having a bias towards Asia Pacific and old Commonwealth allies, US investors preferring global emerging markets and in particular South America, and the Baltic region interested in Russia. This particular client has been invested since 2004 and is updated every quarter on the fund's performance, outlook and portfolio changes.
Staff changes within First State are explained, as are big buys and sells and any mistakes managers may have made. The client questions the impact of Chinese inflation on the fund and interest rates as well as property market speculation. Technological developments in 3G mobiles, the Thai elections and food prices are also on the agenda.
While this meeting is going on, other team members make research calls to Asia – these have to be in the morning because of the time difference. The team travels to meet remote companies, and is out of the country for about eight weeks a year. On top of this, members spend two months a year in either the Hong Kong or Singapore offices.
The house prefers not to have single-country funds, hence the Greater China fund is also invested in Taiwan, Hong Kong and Singapore.
Alan Nesbit, deputy head of global emerging markets, said they preferred not to match the index weightings, as that made you focus on the past. "If you follow the index, you are constantly looking in the rear view mirror," he said. "The biggest emerging market changes – not that long ago it was Mexico."
12.30PM
Over a team lunch – a rare treat, I am told – we discuss the First State philosophy further. Millar Mathieson, senior analyst and portfolio manager, explained how even though Mr Tulloch was the boss, they felt just as comfortable questioning his investment decisions as those of the junior members of the team.
"There is no hierarchy like that – as you saw this morning," one said. "One of us can disagree with another, and just because Angus or Stuart believe something doesn't mean we have to toe their line."
2.30PM
In the afternoon there is an office visit from a Malaysian manufacturer with links to the medical industry, who is pitching for First State to invest. The manufacturer brought material samples along so that the team could touch and feel them; they have fun passing the products around. The company is assessed not just on profits and financial performance but also on the company's culture and ethics – whether they source raw materials sustainably and the ecological impact of production and waste disposal.
4PM
Most of the team's time is spent researching companies and prospective investments. Even if a company is not suitable for investment now, it is monitored for potential in the future.
Jonathan Asante, the head of global emerging markets, said that when the team met companies they were often told they asked different questions from other investment houses. He said: "We are concerned about the companies' culture; whether they are trustworthy, honest and good to their shareholders. We don't want to see a spreadsheet and a business model, anyone can mock those up."
The biggest companies in emerging markets are often state owned, so First State spends some time educating companies about the value of small shareholders.
Since 2004 First State has been limiting new investment into the Asia Pacific fund and has actively discouraged new investors from the Latin America fund.
The team is finding that prices are high at the moment and the best companies come at a premium. "We have written to clients saying it is difficult at the moment – don't invest any more. Sit tight," Mr Asante said. "You can always find rubbish that's cheap, but we're not interested in rubbish."
4.30PM
I head for the exit, while Mr Tulloch and his colleagues continue to chew over the endless facts, figures and research notes that pass their desks. They tell me they rarely leave before 7pm.
