Test #2: Initial Rate of Return
Initial Rate of Return = EPS / share price
Test #3: Per Share Growth Rate
Use PV/FV Formula FV = PV (1 + r)T
Growth of Retained Earnings
Philosophies
Warren adopted Fisher and Munger’s philosophies
Superior economics working in their favor Selling at the “right” price
Warren did NOT adopt Graham’s philosophy
Selling at a “bargain” price
Warren’s Investing Beliefs
Consumer monopoly, with exceptional business economics, and shareholderoriented management
Bases investment decisions on 8 key questions
When to Sell
Graham’s Approach Sell when security reaches intrinsic
value
Warrens Approach Hold on to stock as long as possible
Possible only when investing in excellent business.
6. How much money does the business have to spend on maintaining the current operations?
7. How good is the management at reinvesting retained earnings, earnings in business opportunities and expansion of operations?
is business-like
Qualitative Analysis
Investing From a Business Perspective
Look at the economic ownership of businesses the common stock represents
Not a horse race with numbers found every morning on the Wall Street Journal
Life & Styles of Warren Buffet
Taro Aoki Jennifer Liu Niravughn
Agenda
Background Qualitative Analysis Quantitative Analysis McDonald’s Analysis Conclusion
Annual Compounding Rate of Return
1. Project Future EPS
PV formula
2. Project the Market Price
Market Price = P/E Ratio * EPS
3. Project the Annual Compounding Rate of Return
5%
10 yrs $ 162,889 20 yrs $ 265,329
30 yrs $ 432,194
10%
$ 259,374 $ 672,749
$ 1,744,940
15%
$ 404,555 $ 1,636,653
20%
$ 619,173 $ 3,833,759
$ 6,621,177 $ 23,737,631
Initial Rate of Return = EPS Stock Price
Earnings are either retained or paid as dividends
Retained Earnings grow at the same rate as ROE
Compounding effects takes place when the years of holding increase
8. Is the company free to adjust prices to inflation?
When To Buy
Businesses at their worst Businesses with excellent management will
survive recessions and likely come out of it in a better position Stock market can create situations that whipsaw security prices regardless of the underlying economics of the business.
A+ in one of Benjamin Graham’s classes
A Great Businessman
The second richest man in the world with $ 20 billion
Turned $105,000 into $300,000 in one year and returned 1,156% on the same portfolio after 10 years
earnings government
bonds
Determines the intrinsic value of the company
Compare this price with the market price
Short-Term Arbitrage Opportunities
Opportunities that arise upon the mergers or acquisitions of firms
Quantitative Analysis
Three Initial Tests
Test #1: Predictability of Earnings
Is the company strong? Does the company’s EPS have an upward trend?
PV / FV Formula
Increasing Shareholder Value
Stock Repurchases
Decreases # of shares outstanding Increases EPS Increase in share price Investor receives high return
8 Key Questions to Investing
1. Does the business have an identifiable consumer monopoly?
2. Are the earnings of the company strong and showing an upward trend?
Director of Berkshire Hathaway which has had stock highs of $80,000
A Great Businessman (cont.)
Was named CEO of Salomon Brothers in one day to solve bond debacle
they can find Do not care about the price at which
they sell you the stock, so NO bargains
Earnings
Give back in form of dividends
(-) Subject to capital gains tax (-) Cannot reinvest as well
“Never invest in a business you cannot understand”
Investing is Business-Like
Does not believe in the Efficient Markets Hypothesis
Believes diversification is for idiots Does not care about market fluctuations Thinks investing is only correct when it
Personal investment moves are mimicked by the market
Tenets of the Oracle of Omaha
Marginal gains are a stupid reason to hold stock
“Lethargy, bordering on sloth, should remain the cornerstone of an investment style”
Warren Looks at…
The annual EPS figure Its predictability The market price
Wall Street Looks at …
They work for a commission Interested in selling the priciest security