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Value investing - Warren Buffett Strategy

 

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"Though markets are generally rational, they occasionally do crazy things. Seizing the opportunities then offered does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals." -Warren Buffett

We often make investing harder than it needs to be. Warren Buffett follows a simple approach based on common sense. Everyone can certainly follow his investing tips. That doesn’t mean they are always easy to follow (and some are harder than the others) but persistence and knowledge expansion really goes a long way.

We can study long term value investing by following the Warren Buffett strategy. He has proven to be a disciplined follower of value principles for building wealth. By using his strategies we will definitely improve and sharpen our investment management skills.

Per Warren Buffett’s Value Investment Theory the buy decision should be based on several factors and value investor should have a list of questions to go thru while considering any stocks. Questions are not too complicated and it’s a great way to get introduced to some important concepts. To get answers to these questions, all that is needed is access to the company’s balance sheets and financial statements. You can find this information on the company website, or there is a host of resources such as Google Finance or Yahoo Finance.

  1. Do you understand the product or service offered by the company? (Make sure company is in your “circle of competence” and do not buy company you don’t understand!)
  2. Do you think people still be using company’s product or service in 10-15 years from now?
  3. Does the company have a low cost durable (lasting) competitive advantage?
  4. Is the company recession proof?
  5. Has the company had consistent earnings growth? (Generally EPS growth have to be over 7%)
  6. Has the company had consistent dividend growth? (Generally dividend growth have to be at least 7%)
  7. Does the company have low payout ratio? (We are looking for payout ratio 75% or less)
  8. Does the company have low debt? (Debt should be 70% or less)
  9. Does the company have a good credit rating? (must have minimum S&P credit rating of “BBB+)
  10. Is the stock undervalued?
  11. Company’s P/E Ratio must be below 15. The lower the better!
  12. Company’s current market price should be 20-30% less than calculated intrinsic value – “margin of safety price”.

Calculating and understanding intrinsic value of the stock is one of the most important steps in value investing but it doesn’t take a genius to do it.

 “Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.”  -Warren Buffett

The key is it to calculate the intrinsic value of a business correctly. If you are going to spend some money buying something or making an investment, you wouldn’t want to pay more than it worth. We don’t want to overpay. The tricky question is how to determine the real value of things? Because one thing is the price and other is the value.

There are few different approaches to calculate intrinsic value. Each approach has its own advantages and disadvantages. Even Warren Buffett and Charlie Munger use different models to calculate intrinsic value. 

For example, one way to calculate the intrinsic value is to use calculator based on Warren Buffett’s “Ten Cap Price” otherwise known as “Owner Earnings” calculation. After all, what could be more important than earnings, right? Warren Buffett calls Owner Earnings is one of the “most relevant item for valuation purposes – both for investors in buying stocks and for managers buying entire businesses.”

To calculate intrinsic value based on “Owner Earnings” we need several values. All those values found on company’s Annual Report.

  1. Net Income
  2. Depreciation and Amortization
  3. Net Change Accounts Receivable
  4. Maintenance Capital Expenditure
  5. Income Tax

Multiply result by 10 and divide by number of shares (you will get intrinsic value per share).

The logical question you would ask, is it possible for a good company to have the market price drop 20-30% bellow intrinsic value? The answer is: YES, It is possible due to various reasons. Those reasons are temporary and could include: bad news about the company, company's industry is out of market favor, market is in correction or recession...

YES, Recession! All statistical data show that we are in the next Market Bubble similar to "DOT-COM Bubble" of 2001 and "Housing Bubble" of 2008. It's just a matter of time before this Market Bubble will pop, presenting an opportunity for Value Investors to buy their favorite stocks for less than intrinsic value! In order to buy your favorite stocks for less than intrinsic value you need to be prepared. You need to know what this intrinsic value is and how to calculate it. Do your homework now! Prepare yourself for new opportunities! Be patient and keep emotions out of investing! Invest only in companies you thoroughly research and understand. The stock market will experience swings but in good times and bad stay focused on your goals. Raw intelligence is arguably one of the least predictive factors of investment success. Buffett believes the most important quality for an investor is temperament.

“You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ.” – Warren Buffett

 

Intrinsic Value Calculator 

Get it on Google Play

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Let us start with the disclaimer:

We are strongly believe in American Economy and we are strongly believe that we will prosper in a long term despite the overblown debt and eccentricity of our current president.  We also want to mention that our intention is not to spread the FUD (Fear, Uncertainty and Doubt) but quite the opposite, we want to show you how to preserve your savings/invesments and benefit from upcoming Recession of 2019 just by using simple principals of Value Investing.

 

We started to google "Signs of Recession" in September 2018 and we found a lot of statistical information about previous recessions confirming upcoming recession of 2019.  Our universe is based on "Cyclicity" starting with the light. Light is the wave that has ups and downs. The same concept is relative to the economy, it has booms and recessions. This is what we found on "Google". We will list the facts found on google based on importance and relevance to our current economy.

 

#1. First most important indicator of upcoming recession is

U.S. Federal Reserve raising Rates

You probably heard it many times for many years from different FED Chairman that the rate increase will decrease the inflation and benefit US economy.

What they do not explain is that Inflation was of their own making the same as all "Market Bubbles", created by FEDs during low FED Rates periods.

Every time FED decreased the Rate it caused non organic growth of US Economy resulting in Market Bubbles

And the longer FED have been keeping the Rate at the low levels the bigger Bubbles have been inflated.

The bigger the bubble the louder is the burst and more damaging is the recession that follows.

You all well know the harm caused by last 2 bubbles: "DOT-COM Bubble" and "Housing Bubble".

As for the current bubble, people already come up with the name: "Everything Bubble".

The next question you would probably ask is why does FED have been lowering FED rate after each Bubble was burst?

Very simple answer!

To keep Recessions created by bursting Market Bubbles due to FED Rate Hikes NOT to turn into

Great Depressions!!!

Look at the graphs below generated on 12/22/2018.

FED Rates since 1976

FED Rates History2

On this graph you would see FED Rates since 1976 till present. Gray Stripes represent Recessions.

 

10 - 2 year Treasury Yields Spread

FRED 10 vs 2 year spread

This graph shows impact to inversion of 10 - 2 year Treasury Yields Spread.

Most famously known as "Inverted Yield Curve" which preceded every Recession in the past.

 

Stock Market Capitalization to US GDP

Stock Market Cap to US GDP 2

This graph shows impact of low FED Rates to non organic growth of Stock Market Capitalization.

Values exceeding 90% corespond to Significantly Overvalued Stock Market -Market Bubbles!

 

 

#2. Second important indicator of upcoming recession is

The Spread between 10 and 2 year Treasury Yields

Historically the "Inverted Yield" when 10 year Treasury Yield is smaller than 2 year Treasury Yield have preceded all Recessions.

On the graph the RED circles show the Inverted Yield and the Gray Stripes are indicating the Recessions.

Currently as of 12/20/2018 the spread was as low as 10 basis points. The spread is getting smaller and smaller with every FED rate hike.

Soon no Hedge Fund Managers or Market Analysts would be able to deny the clear signs of upcoming 2019 recession.

 

10 vs 2 year spread

 

 

#3. Third important indicator of upcoming recession is

The spread between GDP and TMC.

GDPGross Domestic Product measures the value of economic activity within a country.

GDP is the sum of the market values, or prices, of all final goods and services produced in an economy during a period of time.

TMC - Total Market Capitalization or Total Stock Market Capitalization is the total value or the sum of all publicly traded stocks in the US.

Logically thinking the value of economic activity should be somewhat bigger than the sum of all publicly traded stocks, considering that some companies are private.

But in current reality on September 2018 TMC is about 10 Trillion dollars bigger than GDP!!!

YES it's not 10 Million or 10 Billion but 10 Trillion dollars bigger!!! 

The difference is  $10,000,000,000,000 !!!

On September 2018 the TMC was about 30 Trillion and GDP was about 20 Trillion dollars.

What this means is that US Market or the sum of all US stocks was overpriced by 10 Trillion dollars!!!

To simplify this fact, what it means is that if you were buying stocks on September 2018 you were overpaying about 33 cents on each dollar.

Guess what? This was the case before each recession in the past. Do you remember the DOT-COM Bubble Crash of 2001 or Housing Bubble Crush of 2008?

The graphs below would show how the "Everything Bubble" was growing overtime:

gdp vs tmc ratio 3

gdp vs tmc ratio 4

gdp vs tmc ratio

 Follow this -> Gurufocus link explaining GDP vs TMC in more details:

Market Valuation Gurufocus

 

  

For more signs of upcoming Recession follow these links:

U.S. Stocks Are In A Bubble - Part 1

U.S. Stocks Are In A Bubble - Part 2

 

 We hope the information we provided is sufficient to wake up your curiosity and would motivate you to do your own search.

 

Now as promised - the way you can benefit from the upcoming Recession of 2019.

We hope you are already moved your investments to cash, if not, cross your fingers and hope for another dead cat jump before it gets really ugly...

Considering that all Market Analysts and "Respectful" Fund Managers and CEOs shouting daily on the Bloomberg channel about how strong our economy is, would succeed in persuading the majority of uneducated investors to keep investing on the deeps, you might have another chance to move your investments to cash without loosing too much. To benefit from upcoming Recession you need to have a cash to invest when Stock Market becomes "Fair Valued" or "Undervalued". While waiting for the Stock Market to reach "Fair Valued" or "Undervalued" levels, use your time to educate yourself about Value Investing Theory defined by Ben Graham and proven by Warren Buffet.

Once you are familiar with basic concepts of Value Investing you need to identify the portfolio of stocks you are interested in.

If you don't have any ideas about what stocks would have competitive advantage in the future, then just follow one of the investment gurus.

Research and analyse your stocks, calculate the intrinsic value and wait till your stocks are priced close enough to your intrinsic value before you make a buy decision.

Use our Intrinsic Value Calculator available on Google Play to calculate intrinsic value for your stocks based on annual report.

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Read "Intrinsic Value Calculator" article to find out more.

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If you still didn't manage to move your investments to cash, don't worry the market would recover in the long term as it always did in the past.

 

Good Luck and Happy Hunting!

 

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