Warren Buffett and the Interpretation of Financial Statements - Deepstash

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Institutional investors

1. Institutional investors โ€œsellโ€ themselves to the masses as highly skilled stock pickers.

2. Stock pickers buy on good news and sell on bad news.

3. when stock picker sent prices spiraling to insane lows, graham saw a fantastic opportunity to make money.

pankaj pawar

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Oversold Businesses

4. โ€œoversold businessesโ€ at prices below their long-term intrinsic value, eventually the market would acknowledge its mistake and revalue them upward.

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Graham's View

Graham really didnโ€™t care about the kind of business he was buying, in his world every business had a price at which it was a bargain.ย 

Graham was focused on finding companies trading at less than half of what they held in cash. He called it โ€œbuying a dollar for 50 cents.โ€

Graham had other standards as well such as never paying more than 10 times companyโ€™s earnings and selling the stock if it was up 50%. if it didnโ€™t go up within two years, he would sell it anyway.

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Drawback's with graham's approach

ย Drawbacks- Not all of Grahamโ€™s undervalues businesses were revalued upward; some actually went into bankruptcy. With every batch of winners also came quite a few losers, Which greatly dampened overall performance.

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How Graham tackled with Drawbacks

graham protected himself with diversification.ย 

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Warren's view

Warren noticed that prices of some stocks soar far above where they had been when graham unloaded them.

these โ€œsuperstarsโ€ all benefited from some kind of competitive advantage that created monopoly-like economics, allowing them either to charge more or sell more of their products.ย 

ย companyโ€™s durable competitive advantage made these business investments a self-fulfilling prophecy.

Because these business economics working in their favor, there was zero chance of them ever going into bankruptcy.ย 

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Warren's view

Because these business economics working in their favor, there was zero chance of them ever going intoย bankruptcy.ย 

The lower stock stock price also meant a greater upside potential for gain.ย 

Warren realized that he no longer had to wait for wall street to serve up a bargain price. He could a pay a fair price for one of these super businesses and still come out ahead, Provided he held the investment long enough.

ย warren holds stocks for longer just so that he can avoid paying tax on his profits.

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Warren's view

Time will make him superrich when he invests in a company that has a durable competitive advantage working in its favor.

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Questions to ask yourself while doing your detective work

Does the company have any identifiable consumer monopolies or brand-name products.

Do you understand how it works?

Is the company conservatively Financed?ย 

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

The company allocates capital only to those businesses within its realm of expertise?

ย How frequently does the company buy back its own shares?

ย How does the management spend the retained earnings of the company?

ย The companyโ€™s return on equity above average?

ย Is the company free to adjust prices to inflation?

ย 

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Questions to ask yourself while doing your detective work

Do operations require large capital expenditure to constantly updateย the companyโ€™s plant and equipment?

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Initial rate of return and relative value of government bonds

Divide EPS by share price to get Initial rate of return (initial rate of return is the minimum return that you can expect from a stock)

Divide the EPS of the particular stock by the long term government bond interest rate

The value that you get after doing so is the amount that you pay towards the stock to get the investment that you would get from government bonds.

ย 

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Present value and future value formula:

PV = FV/(1+r)^n

FV = PV(1+r)^n

ย r = (FV/PV)^1/n - 1

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Projecting annual compounding rate of return using historical annual per share earnings growth rate:

Predict the Future EPS using annual earnings growth rate

Now look for the range in which the stockโ€™s PE ratio isย and multiply the PE ratio to the EPS from previous step

Now add all the dividends collected during this periodย 

Repeat the process with the stockโ€™s Highest PE ratio

ย 

After you get the future value of the stock just calculate R(compounding rate of return) using the formula for R

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