July 21, 2016
I stumbled upon this brilliant Youtube series on value investing and how to buy quality companies (whether through stocks or otherwise).
I have watched about 5/38 videos (total will be about 10 hours worth of viewing time), but I’ll probably get around to watching all of them eventually and they’re amazing from what I’ve watched so far. The first and most valuable video I watched so far was this one:
To summarize the first 5 videos of the series:
- equity = assets – liabilities (ie. if you own a $100k home but still owe the bank $80k from your mortgage, your equity is $20k)
- earnings = net income / # of company shares
- book value = equity / # of company shares
- P/E = price / earnings; this is a measure of profitability (ie. a P/E of 5 represents a 20% return in 1 year if the company maintains the exact same net income; for every $5 spent, you get $1 back)
- P/BV = price / book value; this is a measure of safety (ie. a P/BV of 1 means you would get 100% of your money back if the company liquidated right now; 4 would mean 25%)
- Graham & Buffet only looked at companies with a P/E under 15 and a P/BV under 1.5; they then created a new metric… P/E * P/BV and said it should be under 22.5 (15*1.5)
- This is a beautiful valuation method because it accounts for both potential return AND risk
- Lastly, why is the stock market so profitable? Because the general public doesn’t buy great companies, they trade stocks. Therefore, from time to time a great company will be on discount. Is it bad to buy an amazing pair of jeans for $70? No, but it would be so much sweeter if they were $50. Or $40. Or $30… etc. The general point the author made, is that the method of buying a business in real life is not different whatsoever than purchasing shares in a company, which is really cool IMO and valuable if you ever want to become an entrepreneur or business guru.
I think I’ll learn a lot more about this as I go through the videos so I’m super stoked and I’ll let you know when I learn other significant stuff. Or maybe you should watch em too!
Cheers,
Zach
“We make a living by what we get. We make a life by what we give.”
Update: I have since learned that there is much more to valuation than this. Please read my 2017 Annual Investment Review and Mid-August 2018 Update as I learn to apply other methods.
Furthermore, it was misleading of me to suggest that these are the metrics Buffett uses. Perhaps he did in his very early days, but his comprehension of value goes much deeper than this.
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