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July 12 - July 20, 2018
They buy stocks with falling prices. …with falling profits. …that lose money. …that are failing. …that have failed. But they only do it when the stock is deeply undervalued.
Thinking like an owner implies three ideas: We should know what the company does. What is its business? How does it make money? We should know what it owns. What are its assets? What does it owe? We should know who runs it and who owns it. Is management doing a good job? Are the big shareholders paying attention?
Mean reversion pushes up the prices of undervalued stocks, and it pulls down the prices of expensive stocks. It returns fast-growing and high-profit businesses to earth, and it points business with falling earnings or growing losses back to the heavens.
Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly.
The Acquirer’s Multiple buys stocks with mixed profits; some are highly profitable, others break even, and others lose money. It relies on the price mean reverting to the value and the businesses improving.
Graham had another name for these 50-cent dollars. He called them cigar butts. A “cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the ‘bargain purchase’ will make that puff all profit,”
Combining a growing business with a bargain price meant great returns that kept going year after year.
This is the most surprising result of Buffett’s theory of value. Not all growth is good. Only businesses earning profits better than the rate required by the market should grow. Businesses with profits below that rate turn dollars in earnings into cents on the dollar in business value.
An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation. The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital.
Buffett says a wonderful company is one with a high return on equity. What does he mean? Return on equity measures how much money a company makes—the profit—for each dollar invested in it—the equity. The higher the profit on each dollar invested in the company, the more wonderful it is.
The Acquirer’s Multiple is the enterprise value divided by operating earnings.
Companies with enterprise values of $0 (and less) do exist. A low or negative enterprise value is a good thing to find. It means the company has little debt and lots of cash relative to the market cap.
Market Cap $1 Billion And Above
Why do fair companies at wonderful prices beat wonderful companies at fair prices? Because great businesses don’t stay great. They only look great at the top of their business cycle. Mean reversion pushes great business back to average.
Buy if the price is much less than the value. Otherwise pass. Sell if the price is more than the value. Hold otherwise.
simply, when it comes to long-term investing, doing ‘less’ is often ‘more.’
