" I look for business in which I think I can predict what they are going to look like in ten to fifteen years' time. Take Wrigley's chewing gum. I don't think the Internet is going to change how people chew gum " - Warren Buffett
Oh No ... another Warren Buffett book but not written by him?
Well , I got this hard covered book at a discount sale so, I bought it cheap.
Did I get value? Well, here is the gist...
(1) Warren Buffett likes his companies old.
(2) All his companies has earnings growth in the region of 10%.
(3) He treats his companies like "equity bond". Since the companies are old , established names and has a "durable competitive edge" ( ie likely to stay in business for anther 10 years at least and beyond), the company behaves like a bond ( in that it has "predictable earnings" in the past , present and likely in the foreseeable future). And because of the earnings growth, the earnings will be translated into value in future.
(4) He likes to buy his companies at a discount. If the earnings are stable and growing, it is safe that the company's earnigss is likely to stay stable and growing in the future. But the price of the company stocks fluctuate, and hence the PE ( price earnings ) will fluctuate with the current economic situation. If the earnings are seen to be stable, an fall in price will enhance the yields. Say, if a company earns USD5 per year and grows at 10%, it is likely that the company will earn USD5.50 next year. Say this year, the price of the stock is USD75, then the pE is 15x. If the price of the stock is USD50 next year, then the PE has fallen to 10x. If the range of the PE is between 10x to 20X, then PE 10x is at the lower range and therefore a bargain. Assuming all the company fundamentals remain the same, buying at USD50 for an expected earnings of USd5.50 in the coming year is a bargain . In year 2 , the earnings is expected to be 10% more than USD5.50 at USd6.05. At the cost of USD50, the the return in the first year is 6.05/50=12% return in the 1st year!
Sounds good?
The trick is to find companies that grow 10%, and to buy and hold the comp[any forever.
And ... can the company you identify keep the durable competitive advantage forever?
A few calculators recommended ( found in pg34-36):
(1) To calculate the Internal Rate of Return ie how much the company has grown over an x amount of years :
http://www.moneychimp.com/calculator/discount_rate_calculator.htm
(2) To calculate future value of dividends after an x amount of years, growing at y rate of growth.
http://www.investopedia.com/calculator/fvcal.aspx
(3) After finding out the internal rate of return, and the future value of current dividend in 10 years, we can plug the lowest PE ratios for the company for the last 10 years ( to be conservative).
(4) Then we work backwards again to get the IRR from now to 10 years time.. Finally, we can find out if our investment at current price can meet the 10% return so sought after by Buffett.
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