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Mary Buffett, David Clark - Buffettology 48

The document discusses several mathematical tools and calculations that can be used to evaluate businesses as potential investments. It explains that the first test is to simply look at reported earnings per share over several years to determine if earnings are consistent or inconsistent, and whether they trend upward or fluctuate up and down. Additional calculations explained later can help determine if a company's management can effectively allocate capital and whether the stock is attractive at its current price based on the economic nature and predictability of the business. Proper use of these tools provides a better understanding of a business's economic realities and long-term prospects.

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Asok Kumar
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87 views1 page

Mary Buffett, David Clark - Buffettology 48

The document discusses several mathematical tools and calculations that can be used to evaluate businesses as potential investments. It explains that the first test is to simply look at reported earnings per share over several years to determine if earnings are consistent or inconsistent, and whether they trend upward or fluctuate up and down. Additional calculations explained later can help determine if a company's management can effectively allocate capital and whether the stock is attractive at its current price based on the economic nature and predictability of the business. Proper use of these tools provides a better understanding of a business's economic realities and long-term prospects.

Uploaded by

Asok Kumar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Page 48 of 86

businesses better than the run-of-the-mill, shortsighted analyst.


Your role, then, as an analyst/investor, is to identify those businesses that have long-term earning power. Then, depending on the return they offer, you make your investment
decision.
To gain a perspective on the prospective return a business may offer and whether or not its long-term prospects are decipherable, it is necessary that we learn to use several
different mathematical equations. These equations will help us get a better understanding of the economic realities of the business in question.

30
The Mathematical Tools
The mathematical tools that you will need in order to evaluate whether a potential investment makes business sense at a given price are for the most part fairly simple.
Before you start tapping away on your calculator, you must have established the nature of the company and answered the key questions necessary to determine the
predictability of the company's future earnings. Then you must decide whether the company is an excellent business that benefits from a consumer monopoly or a commoditytype business that is doomed to average results. You must also determine if the company is managed by people who are honest and competent and who function with their
shareholders' best interests in mind.
Although, as we know, Warren believes that it is hard to damage a great consumer monopoly by poor management, poor management can make it difficult for the investor to
profit from the economics of a great consumer monopoly. As we observed, Coca-Cola in the seventies is a prime example of this phenomenon. Coca-Cola has a fantastic
consumer monopoly but was run in the seventies by management that seemed uncertain about how to increase the per share value of the business. As a result, the company sat
dormant, awaiting more enlightened management. It arrived with the appointment of Roberto Goizueta as Coca-Cola's president in 1980. Goizueta immediately picked up the
ball and ran for touchdown after touchdown, which produced an increase in Coca-Cola's per share earnings, which caused the price of the stock to shoot up like rockets.
You, the investor, must also figure out if the company's management has the ability to effectively allocate capital in a profitable fashion. This can be determined with the help
of a number of calculations. After the economic nature of the business is determined, you can use several other calculations, explained in detail on the pages that follow, to
determine whether the stock is selling at an attractive price.

31
Test #1, to Determine at a Glance the Predictability of Earnings
This is the simplest test you can perform and it is probably the most basic. Although every security analyst performs it the first time his or her eyes scan a Moody's or Value
Line, few will acknowledge it as a calculation. But it is, because it is the first place you must start the process of statistical analysis. To put it simply, you merely look at and
compare the reported per share earnings for a number of years. Are they consistent or inconsistent? Do earnings trend upward, or do they jet up and down like a roller coaster?
The investment survey services, such as Moody's and Value Line, make this comparison of yearly figures very easy by providing you with a list of earnings dating back a
number of years.

file://D:\Users\vbhatnag\Documents\E Books\Stock\Investing\Warren Buffet Style Investi...

23-Oct-10

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