Warren Buffett's Three Favorite Books

by Preston Pysh

the root of the wealth equation is the firm understanding that stocks and bonds go together like a husband and wife.

the success of a stock pick heavily relies on the purchase price as much as the productivity of the already-successful business.

For every $1.16 I spend buying this company, I can expect $1.00 in earnings a year later.

“Be fearful when others are greedy, and greedy when others are fearful.”

The 10-year Treasury note, if purchased today, yields 2.125% per year. That means that a note purchased for $100 would send you a check for $2.13 each year for 10 years before returning your $100. If this Treasury note investment is considered to be risk-free, then why would anyone enter an investment that makes less than 2.125%?

One important thing to keep in mind is that if an investment is considered “high risk,” it’s not an investment. It’s a gamble. The wise investor will never fall for the “high-risk, high-gain” trap. If it seems really risky, it’s probably just a bad place for your money.

few things have an impact on the value of that bond: interest rates, inflation, and the financial health of the issuer.

When interest rates rise - Your bond values decrease

When interest rates decrease - Your bond values increase

They buy high-coupon bonds when interest rates are high. After acquiring the asset, they continue to collect the coupons until interest rates drop. When that happens, they sell the high-coupon bond for a premium and re-invest the money into new asset(s) that have better returns (most likely a stock at this point).

As a general rule of thumb, the average 30 year federal bond yields 5.4%.

The valuation of a bond is nothing more than three elements. First, how much money will I receive from all my coupons? Second, how much on average can I reinvest the coupons for? Third, how much money will I receive for the difference between my purchase price and the par value?

Par Value: This is the amount of money you’ll receive when the bond is mature. Term: This is the length of time the bond will last until par value is repaid to the owner of the security. Coupon: This is the fixed annual payment an owner will receive until the maturity date. Market Price: This is the price you can currently purchase the bond for.

When purchasing a bond at a high interest rate, I can’t wait for the day to sell the bond when interest rates crash. The great thing about this strategy is while you are waiting for the interest rates to significantly decrease, you’re collecting the coupon payments for owning the bond (which are high rates). By purchasing a long-term bond, you allow yourself enough time to experience the interest rate drop. When it happens, you get paid a great premium for owning the bond, and then you’ll have cash in hand to purchase really cheap and valuable stocks.

A great way to invest in bonds is through a bond index.

there are tax-free municipal bonds, corporate bonds, couponless bonds, inflation-proof bonds, and much, much more.

During times of greed, when people are making enormous amounts of money in the stock market, you need to be thinking the opposite. You need to be potentially purchasing an armory of bonds, all yielding a nice coupon (probably above 4-5%), preparing for the financial storm that’s bound to happen.

It’s only a matter of time before the stock market bubble will pop. When it does, you’ll be prepared with your fixed-income bonds, ready to feed the appetite of the fearful. You’ll then have the opportunity to sell those bonds (as long as they aren’t callable) for substantial premiums.

1. A stock must be managed by vigilant leaders. 2. A stock must have long-term prospects. 3. A stock must be stable and understandable. 4. A stock must be undervalued.

A CEO who puts the interests of his employees before himself (through employee benefits and such) -The composition of the board of directors -A CEO who has a track record of conducting ethical business -A CEO who doesn’t get paid outrageous compensations

The Debt/Equity ratio simply takes all the company’s debt and divides it by that equity number. As you can quickly see, a low Debt/Equity ratio is a good thing. In fact, you’ll find many companies that have a Debt/Equity ratio of zero. At the same time, you’ll find numerous companies that have a Debt/Equity ratio of 5 or higher. For a company that has a Debt/Equity ratio of 5, that means it’s got 5 times more debt than it has equity in the business. For me, that’s a scary amount of debt and not something I want to take a chance on.

(As a general rule of thumb, I try to always buy companies that have a Debt/Equity ratio below 0.50)

Current Ratio: This ratio is a comparison of the current assets divided by the current liabilities.

Current Ratio = Current Assets / Current Liabilities

As you put hypothetical numbers into this equation, you’ll quickly see that a 1.0 means the company won’t owe or earn capital. As the number becomes larger, it becomes evident that the company has an easier time paying its liabilities and won’t need to issue more debt. When I’m analyzing a business, I’ll never consider a business that has a current ratio below a 1.0.

A third way to evaluate a company’s fiscal responsibility is to review th...

You can find this rating on a lot of company websites under the investor relations tab. Although this is a quick and easy way to estimate the health, I still prefer to look at the D/E and current ratio first.

Future Cash Flows (ten year period) = Future Book Value + Dividend Payments

you’ve ever been around a person who trades a lot of stock, you’ll quickly hear “book value” being used. This term simply means equity per share.

Average annual book value growth is calculated by the following: (Present Book Value - Previous Year’s Book Value)/Previous Year's Book Value = Annual Book Value Growth (%) $20.95 - $20.66 = 1.4% (rounded) $20.66

Sum of Book Value Growth/Total Number of Figures = Average Book Value Growth Over “n” Years (1.4 + 12.5 + 19.7 + .66 + 12.2 + 4.5 + 21.5 + 18.3 + 18.3)/9 = 12.1% annual book value growth in 9 years

Since we just estimated that the book value will grow at 12.1% annually, let’s determine what the book value of JNJ will be in the year 2022. To calculate this problem, you’ll simply use the following equation: FV = PV (1+i)^n FV = Future Book Value PV = Present Book Value (or Current Book Value) i = Book Value Growth Rate n = Number of years into the future Therefore when we substitute our terms, we get the following: FV = $20.95 (1 + .121) ^ 10 FV = $65.65

Earnings Per Share (EPS) = Net Income / Total Number of Shares Outstanding

So how are you going to get that money in your pocket? Three ways: Completely through dividends or Completely through book value growth or Both dividends and book value growth

Benjamin Graham really tried to avoid buying companies that traded at a multiple higher than 1.5 times the book value.

Below is the order of precedence for a company bankruptcy: Bond Holders Preferred stock holders Common Stock holders

If owning a preferred share is something that interests you, you’ll want to become more familiar with a document called an indenture. This is the document that specifies whether a preferred share is participating versus nonparticipating, cumulative versus noncumulative, callable, convertible, or a combination of all these features.

Common Stockholders’ Equity = Total Stockholders’ Equity - Total Book Value of Preferred Stock

Operating Activities: This is all the activity that involves earning money. Investing Activities: This is all the activity that involves buying or selling assets. Financing Activities: This is all the activity that involves acquiring debt or paying it off.

It’s been my personal preference to invest in companies that consistently have an ROE over 7%.

(small-cap is when a company’s market valuation is below 2 billion, a mid-cap is when a company’s market valuation is between 2 and 10 billion, a large cap is when a company’s market valuation is above 10 billion)

I personally like to purchase mid-cap and large-cap companies because they don’t run as high of a risk for decreasing ROE.

An increase in volume means the traders believe there’s a discrepancy between price and value.