How to Use a Formula to Think Like Warren Buffet
Avoid technology companies if you cannot easily understand them., Avoid companies in industries with low profit margins., Look for high-quality companies with high-percentage net profits and high dividend yields., Look for companies with low...
Step-by-Step Guide
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Step 1: Avoid technology companies if you cannot easily understand them.
The same is true if they have competitors you cannot easily understand.
Any time that you're not able to decipher the purpose, mission or actions of a company (or those of its nearest competition), that should be a warning sign to you as an investor.
Invest in companies with strategies and goals that are transparent to you. -
Step 2: Avoid companies in industries with low profit margins.
Industries such as airlines, retail, entertainment, auto manufacture and other very competitive industries are not usually good long-term investments.
A very competitive industry that displays low net profit margins (net income divided by sales) cannot promise healthy profits over time.
Generally, net profit margins above 20 percent are excellent.
Those below five percent are unattractive. , A company is high-quality if it has a low debt-to- equity, has high interest coverage, is prominent in its industry, is large in size (annual sales of at least $100 million and total assets of at least $50 million), has at least some earnings in each of the past ten years, and has paid at least some dividends in each of the the past 20 years.
Net profits will grow the company and the stock price will follow.
Dividends will grow Buffett's portfolio.
He learned this concept of buying high-quality companies with good net profits from "growth" investor Philip Fisher and Buffett's business partner Charles Munger.
Buffett looks for a company with a "moat" around it––that is, a company with some form of durable competitive advantage.
He will avoid utilities, oil companies, transportation and retail stores unless a company has some form of evident monopoly or built-in advantage. , This concept Buffett calls the "Margin of Safety," which he learned from "value" investor Benjamin Graham.
This means that the value of a company's assets is not necessarily reflected in its stock price, a fact one might discern from viewing the company's balance sheet.
Here is what to do:
Add the percentage of net profit to the percentage of dividends paid, and divide that sum by the price-to-book ratio.
For example, the recent numbers for Coca-Cola were (23.82 +
2.81) /
5.19 =
5.1 If the ratio is less than 2, Buffett believes the stock will fall, and he would sell it.
If the ratio is in between 2 and 10, Buffett will hold the stock if he already owns it.
If the ratio is over 10, the stock will likely double in price.
If the ratio is over 15, the stock may well triple in price over the next few years.
If the ratio is over 20, the stock could quadruple in price over the next few years. ,, Buffett learned from Benjamin Graham that 19 times during a 100-year period (every
5.3 years on average) the stock market had some form of downturn due to economic peaks or war scares.
It is at such "dips" that Buffett will invest most of his money.
In early 2009 he invested 20 billion dollars he had set aside since the sub-prime meltdown of 2007 and
2008. -
Step 3: Look for high-quality companies with high-percentage net profits and high dividend yields.
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Step 4: Look for companies with low price-to-book ratios.
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Step 5: Buy only stocks that have ratios over 15.
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Step 6: Save your money and invest it after market crashes.
Detailed Guide
The same is true if they have competitors you cannot easily understand.
Any time that you're not able to decipher the purpose, mission or actions of a company (or those of its nearest competition), that should be a warning sign to you as an investor.
Invest in companies with strategies and goals that are transparent to you.
Industries such as airlines, retail, entertainment, auto manufacture and other very competitive industries are not usually good long-term investments.
A very competitive industry that displays low net profit margins (net income divided by sales) cannot promise healthy profits over time.
Generally, net profit margins above 20 percent are excellent.
Those below five percent are unattractive. , A company is high-quality if it has a low debt-to- equity, has high interest coverage, is prominent in its industry, is large in size (annual sales of at least $100 million and total assets of at least $50 million), has at least some earnings in each of the past ten years, and has paid at least some dividends in each of the the past 20 years.
Net profits will grow the company and the stock price will follow.
Dividends will grow Buffett's portfolio.
He learned this concept of buying high-quality companies with good net profits from "growth" investor Philip Fisher and Buffett's business partner Charles Munger.
Buffett looks for a company with a "moat" around it––that is, a company with some form of durable competitive advantage.
He will avoid utilities, oil companies, transportation and retail stores unless a company has some form of evident monopoly or built-in advantage. , This concept Buffett calls the "Margin of Safety," which he learned from "value" investor Benjamin Graham.
This means that the value of a company's assets is not necessarily reflected in its stock price, a fact one might discern from viewing the company's balance sheet.
Here is what to do:
Add the percentage of net profit to the percentage of dividends paid, and divide that sum by the price-to-book ratio.
For example, the recent numbers for Coca-Cola were (23.82 +
2.81) /
5.19 =
5.1 If the ratio is less than 2, Buffett believes the stock will fall, and he would sell it.
If the ratio is in between 2 and 10, Buffett will hold the stock if he already owns it.
If the ratio is over 10, the stock will likely double in price.
If the ratio is over 15, the stock may well triple in price over the next few years.
If the ratio is over 20, the stock could quadruple in price over the next few years. ,, Buffett learned from Benjamin Graham that 19 times during a 100-year period (every
5.3 years on average) the stock market had some form of downturn due to economic peaks or war scares.
It is at such "dips" that Buffett will invest most of his money.
In early 2009 he invested 20 billion dollars he had set aside since the sub-prime meltdown of 2007 and
2008.
About the Author
Kayla Ford
Enthusiastic about teaching home improvement techniques through clear, step-by-step guides.
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