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  • The median age in the U.S. is 36.8
  • The median income in the U.S. is $51,939
  • The average 401k match is $1 for $1 up to 6%

A 36.8 year old investing 10% of their $51,939 income with a $3,116.34 match:
With just average stock market returns of 10% would have $1,114,479.31 by retirement.

Join 15,000+ other readers who have learned how anyone, even beginners, can easily make this desire a reality. Download the free ebook: 7 Steps to Understanding the Stock Market.




IFB144: Years of Budgeting Simplified with Andy Shuler

Announcer (00:00):

You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the number, your path to financial freedom starts now.

Dave (00:36):

All right folks, welcome to Investing for Beginners podcast. This is episode 140 tonight. Andrew and I have a little special guest. We have Andy Shuler with us tonight. Andy is a regular contributor to the blog that Andrew started einvesting for beginners podcast a while ago, and so we’re going to talk to Andy today about some of his ideas about personal finance. We thought we would go off topic a little bit and maybe move away from Coronavirus and all the death, doom, and despair that’s out there, and maybe guys give you guys some refreshing news and something good and fun that’s going on out in the world. So Andy, why don’t you tell us a little bit about yourself, where you’ve been, what you’re doing, kind of how you got started, all that kind of fun stuff.

Andy (01:16):

Yeah, sure thing. First of all, I want to say thanks for having me on. I’m happy to talk about this. As you said, I’ve been, I’ve, I’ve written quite a few blogs, so it’s, it’s kind of exciting to get back to the basics with all the coronavirus stuff going on. You know, you can kind of look at your personal finance, something you have a little bit more control over then than what you might have in the market at all times. But, so as you said, I’ve been doing this for a little while. Just a little background about myself. I’ve kind of, you know, been through all different, all different areas of life, especially when it comes to personal finance. I think I could probably write almost a book and all the mistakes you don’t want to make. I mean, I’ve opened credit cards in college and maxed them out, you know, with the sole purpose of not having to work a job. I was in school gone through times where, you know, I’ve cashed out a 401k or got a 401k loan, and you know, everyone talks about how those are probably one of them, the worst things that you want to do. But just really just gone through a lot of trials and tribulations. They’re all my time off, you know, learning mistakes or making mistakes, trying to learn from them. And my, my investing journey I’ll say didn’t fully kick off until,

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How to Use Enterprise Multiple to Put a Valuation on a Company

There are many ways to value a company, discounted cash flows, dividend discount models, value ratios, price multiples, and many more. In today’s post, we are going to discuss the enterprise multiple. This multiple includes the enterprise value of a company and a different measure of its revenue.

Using the enterprise multiple is a reasonably easy way to value the company, and it includes items such as debt, not often found in valuation methods.

The multiple has several different components to it, including the current price of the company. One of the ways that are unique about the multiple is that it looks at a company like a possible acquirer would, focusing on the debt of a company. When you purchase a company, you buy the whole thing, assets, stockholders’ equity, and liabilities, including debt.

To put this together, we will be:

  • Discussing the different components of the multiple
    • Enterprise value
    • EBITDA
  • How to calculate the multiple
  • What a good enterprise multiple means?
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Will the Coronavirus Go Down as the Worst Stock Market Crash, Ever?

In a recent episode of the Investing for Beginners Podcast, Andrew and Dave talked about the coronavirus and the impact that it has been having on the market and it really sparked my interest and posed the question – will the coronavirus go down as the worst stock market crash, ever?

I think that the first question that we need to ask ourselves is “what does the term ‘worst’ actually mean?” 

That’s simple – it means the WORST, right?  Well, is it the longest crash, the fastest crash, the deepest crash?  Worst can be relative depending on the situation that you’re in.

For the most part, the stock market crash of 1929 is largely considered the worst stock market crash of all time, and it’s where the term ‘Black Tuesday’ came about.  So, what happened in 1929 then?  The History Channel does a great job of summarizing the actual events and timelines, but essentially things were going really, really well in the economy and on Black Tuesday, 16 million shares were traded in the same day and it caused for the things to really spiral out of control and this is what kickstarted the Great Depression. 

The ‘Black Tuesday’ Stock Market Crash

On 9/16/1929, the S&P 500 was trading at $31.86.  How pathetic is that?  The S&P 500 just a couple months ago was around $3,400!  What peasants, right?

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How Interest Rates and the Stock Market Are Intricately Intertwined

 “The most important item over time in valuation is obviously interest rates.”

Warren Buffett

Quite a statement and my thought is, how much do we understand interest rates and their effect on the stock market? In the chaos of the stock market today, with the extreme volatility we have been experiencing between the coronavirus concerns, ongoing oil war, and the abnormally low interest rates, there are a ton of worries right now as an investor.

Recently, the Fed lowered the interest rates by 50 basis points in the hopes that this might stop the bleeding in the stock market. It didn’t seem to make much difference, and there are rumors that the Fed will lower the rates a full percentage point, bringing the rates to lowest since December 2008 at 0.25%.

These rates are and would be the lowest in US history, and are historically low in the world. These rates have a significant impact on the stock market, as well as the bond market, mortgages, credit cards, and all credit devices.

In today’s post, we are going to discuss:

  • What Interest Rates Are
  • Fed Funds Rates
  • Interest Rates and the Bond Market
  • Why Do Interest Rates Change
  • How Interest Rates Affect the Stock Market
  • What Kinds of Companies Far Well in Rising/Falling Rates?
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Why a Scalable Income is Better Than an Hourly Wage for Wealth Building

I recently went through a very thorough review of The Essays of Warren Buffett and did a total book review and now I am on to my next book, Rich Dad, Poor Dad, and we’re tackling Chapter 1: discussing why scalable income is better than an hourly wage for wealth building.

I cannot speak specifically to this book as I am just now getting started reading it, but if you do any sort of research at all on it then you’re going to see that the book is widely renowned as one of the best investing books out there.  I initially heard about the book from Andrew Sather and he has a fantastic quote about Rich Dad, Poor Dad, saying, “The book might motivate you entrepreneurially, it may help your personal finances, and it will definitely inspire you to take investing seriously and start working towards financial independence.”

Not sure about you but reading that quote alone really motivated me to want to read the book.  I mean, if it has motivated Andrew entrepreneurially, financially and investing wise, then I’d have to hope I’d experience a similar sort of effect, and after all, isn’t that what we’re all after?

So, let’s get to the book (which I might add you can buy a version of this on Amazon for less than $6!)

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IFB143: Why It’s Hard to Invest in a Bear Market

Announcer (00:00):

You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern. To decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Andrew (00:35):

All right folks, so welcome to Investing for Beginners podcast. This is episode 143 tonight. Andrew and I are going to talk about why investing in a bear market is really hard in case you’ve lived under a rock recently. The stock market has been up and down, mostly down a lot over the last week to two. And so we thought we would kind of talk a little bit about a bear market because we’ve officially entered a bear market territory. As of today, I believe we were down around 23% so far for the year. So that is officially a bear market when we get below 20%. So Andrew thought this would be appropriate for us to discuss this. So, Andrew, I’m going to turn it over to you and let you get us started and then we’ll just kind of go down a rabbit hole.

Andrew (01:21):

Yeah, I love it. Watch our timing be that this bear market recovered by the time this goes live. Yeah. I guess last time we talked about Coronavirus, it just happened to be still relevant a week later. Podcasts see you gotta you got a little tape delay, not a little bit longer than what they do with live TV these days. A little bit longer than five seconds. Yeah, exactly.

Andrew (01:55):

I think there’s a lot of emotions that go on and certainly regardless of how experienced you are, how knowledgeable you are and how rational you believe you are when it comes to stocks when it comes to investing when it comes to the market how disconnected you think you are versus how ingress you are with everything that goes in the stock market. I think it’s safe to say that a lot of different thoughts go in your head that you don’t usually think when stocks are excellent and you know, their stocks are slowly climbing up, and you don’t see much volatility. Looking at a situation like this with the bear market and you know, a lot of macro trends that are very concerning. We have the Coronavirus which

Andrew (02:48):

As of late as of today, we had the NCAA championship close. The NBA season’s been suspended. Like you know, you name it right on top of that we have interest rates, baseball based. Sorry, Dave. I know, I know. Out of everything, that was the one thing that you lamented today. I texted you earlier, I think it was like, Oh, by the way, you know the stocks down 20%, whatever, 30%, and you’re like put baseball, and it’s only two weeks, two-week delay. I think you can hold off two more weeks. I don’t know. It’s going to be tough. Well, while the rest of the world burns and you worry about your little game over there, we have other things to worry about. We have rec, so we had the interest rates go so low that there was a record low 30 year fixed rates.

Andrew (03:54):

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What the Berkshire Hathaway Owner’s Manual Says About Buffett’s Approach

Ever wonder what blueprint Warren Buffett uses? Or how he manages his company or decides what companies to invest in or buy outright?

Well, we are in luck because June 1996 Buffett published his first “owners manual” for Berkshire Hathaway shareholders. His manual provided information about the company’s goals, policies, and expectations. He recently updated the manual, as of the 2017 annual report.

As one of the leaders of the value investing model, Buffett has long believed that investors should only buy stock in companies that have solid fundamentals, strong earnings power, and the potential for continued growth.

These ideas may seem like easy concepts to grasp, but finding companies that exhibit these characteristics is not always that easy.

I believe this is one of the reasons that Buffett laid down this foundation with his “owners manual.” To help us understand how he uses his principles to find companies worth owning.

We can break down Buffett’s investing style into four categories:

  1. Business
  2. Management
  3. Financial Measures
  4. Value

We are going to take Buffett’s owner’s manual and break it down into the four categories and elaborate on how his ideas can translate to our investing approach.

For a full view of the Berkshire Hathaway Owner’s Manual, go here. There were originally 13 owner-related business principles, and he has since updated the list to include two more. You can also find the manual in every annual report that Berkshire has done since 1983.

Let’s take a look at each category, a word of note, the items listed on the manual are not necessarily in order of the categories so we may jump around a bit.

Business Tenets

  • Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owner partners, and of ourselves as managing partners. (Because of the size of our shareholdings we are also, for better or worse, controlling partners.) We do not view the company itself as the ultimate owner of our business assets but instead view the company as a conduit through which our shareholders own the assets.”

Buffett advises investors to view themselves as owners of the business rather than holding a piece of paper or ticker symbol that we can sell when the price changes.

The attitude of ownership separates investors from speculators and is the foundation of value investing. Think of it this way; if you own something, you are far less likely to sell it if you own it, as opposed to just borrowing an item. If you paid hard-earned money for that item, you are less likely to part with it.

Viewing buying a business gives you the same insight as if you bought an iPhone, and that is how you must think of owning a stock.

Buffett mentions that we should measure the success of our company’s by long-term progress rather than the month-to-month price changes. 

  • In line with Berkshire’s owner-orientation, most of our directors have a significant portion of their net worth invested in the company. We eat our own cooking.”

Eating your cooking is critical when looking for managers that have shareholders in mind. CEOs or other company officers that don’t invest in their own company is a HUGE red flag! The same rule applies to investment advisors who don’t buy what they suggest to their clients.

Charlie and Warren both have an extremely large amount of their wealth tied up in Berkshire, with Warren’s share stated as over 98%. Having skin in the game greatly enhances the desire for an operation to succeed, and both Warren and Charlie understand this idea.

Aligning ourselves with owners that belief in their company enough to tie their wealth to that company is a great way to sleep better at night.

  • Our long-term economic goal (subject to some qualifications mentioned later) is to maximize Berkshire’s average annual rate of gain in intrinsic business value on a per-share basis. We do not measure the economic significance or performance of Berkshire by its size; we measure by per-share progress. We are certain that the rate of per-share progress will diminish in the future – a greatly enlarged capital base will see to that. But we will be disappointed if our rate does not exceed that of the average large American corporation.”

They are not concerned with the overall size of Berkshire, only that the company performs to their expectations and produces for the shareholders the returns they deserve. They are finding a company that is concerned more about performance than growing for growth’s sake is a great lesson.

In other words, avoid serial acquirers that are more concerned with being bigger, as opposed to acquiring to create more value for the company and shareholder. Think Valeant, if you are not familiar with their story, Google Valeant and read about the history of the company.

Financial Measures

  • Our preference would be to reach our goal by directly owning a diversified group of businesses that generate cash and consistently earn above-average returns on capital. Our second choice is to own parts of similar businesses, attained primarily through purchases of marketable common stocks by our insurance subsidiaries. The price and availability of businesses and the need for insurance capital determine any given year’s capital allocation.”

Buffett comes back to the theme of return on capital over and over again in his letters to shareholders. This is a very important concept for all investors to embrace as returns on capital indicate a very strong company that can grow without borrowing or diluting shares.

He also notates cash flow multiple times in the letters as well. Free cash is king, and any company that can generate free cash flow can use that money to reinvest in the company or return value via dividends or share repurchases.

Two of Buffett’s main tenets are buying companies with high returns on capital and are generating tons of free cash flow.

  • Because of our two-pronged approach to business ownership and because of the limitations of conventional accounting, consolidated reported earnings may reveal relatively little about our true economic performance. Charlie and I, both as owners and managers, virtually ignore such consolidated numbers. However, we will also report to you the earnings of each major business we control, numbers we consider of great importance. These figures, along with other information we will supply about the individual businesses, should generally aid you in making judgments about them.”

Buffett likes to ignore earnings season speculation because he feels it fuels Mr. Market and all the ups and downs of the market. He and Charlie prefer to use owner earnings as a way of determining the value of a company.

Additionally, with the change in accounting rules recently, Berkshire has seen tremendous swings in its earnings per share. The new rules state that unrealized gains or losses from investments now must be considered as revenue. Both Charlie and Warren think this rule is ridiculous, but, of course, they are following the rule.

Buffett recommends that we consider all factors when discussing the performance of any business. Using metrics such as profitability metrics, cash flow metrics, return on assets, return on equity, and so on will give a better overall barometer of the health of a business than the short-term idea of earnings.

  • Accounting consequences do not influence our operating or capital-allocation decisions. When acquisition costs are similar, we much prefer to purchase $2 of earnings that is not reportable by us under standard accounting principles than to purchase $1 of earnings that is reportable. This is precisely the choice that often faces us since entire businesses (whose earnings will be fully reportable) frequently sell for double the pro-rata price of small portions (whose earnings will be largely unreportable). In aggregate and over time, we expect the unreported earnings to be fully reflected in our intrinsic business value through capital gains.”

Buffett refers to the use of capital allocations from retained earnings in this quote. He feels that many outstanding businesses use their retained earnings to give back value to shareholders in the form of dividends or share repurchases. Or using those funds to reinvest back into the business at high levels of return on capital.

Another trademark Buffett investing tenet is to find great capital allocators. CEOs that use the business proceeds to increase shareholder value are gold to him. And, frankly, that is one of his best attributes as the CEO of Berkshire.

He and Charlie both regard look-through earnings as realistically portraying gains from operations for any business.

For those not familiar with that term. Look-through earnings are both monies paid out to investors, think dividends, and funds reinvested by the company, think the return on capital. Look-through earnings give a much more realistic view of the company’s annual gains, and the value created for the shareholders.

  • We use debt sparingly. We will reject interesting opportunities rather than over-leverage our balance sheet. This conservatism has penalized our results but it is the only behavior that leaves us comfortable, considering our fiduciary obligations to policyholders, lenders and the many equity holders who have committed unusually large portions of their net worth to our care. (As one of the Indianapolis “500” winners said: “To finish first, you must first finish.”).”

Both Charlie and Warren believe that debt is the devil and has lead to more failings on Wall Street than almost anything except, maybe greed.

Taking on debt to either purchase companies, pay dividends, or repurchase shares can be dangerous. Many companies use debt as a way to lever up their returns, and this can lead to a lot of problems. Warren mentions in the letter that he “would never permit our trading a good night’s sleep for a shot at a few extra percentage points of return.”

Berkshire is built upon the two sources of capital that allow it to own more assets, those being deferred taxes, and float from its insurance businesses. Not many companies enjoy this benefit, but Buffett has used this “free” capital to the shareholder’s great advantage.

  • A managerial “wish list” will not be filled at shareholder expense. We will not diversify by purchasing entire businesses at control prices that ignore long-term economic consequences to our shareholders. We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your portfolios through direct purchases in the stock market.”

Buffett and Munger only believe in growing the value of Berkshire through prudent acquisitions. When contemplating buying a company, you should weigh whether this purchase will improve your portfolio or if it is just plugging a hole.

Looking for companies that use their earnings to grow shareholder value is one of the keys to good investing. Bill Gates, during his tenure at Microsoft, acquired businesses that he felt could grow Microsoft. If he discovered a technology that he felt would benefit Microsoft and was such that they couldn’t create it themselves, then he would buy the company to grow Microsoft.

  • We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely.”

This from Buffett’s thought, much better than I can add.

I should have written the “five-year rolling basis” sentence differently, an error I didn’t realize until I received a question about this subject at the 2009 annual meeting.

When the stock market has declined sharply over five years, our market-price premium to book value has sometimes shrunk. And when that happens, we fail the test as I improperly formulated it. In fact, we fell far short as early as 1971-75, well before I wrote this principle in 1983.

The five-year test should be: (1) during the period did our book-value gain exceed the performance of the S&P; and (2) did our stock consistently sell at a premium to book, meaning that every $1 of retained earnings was always worth more than $1? If these tests are met, retaining earnings has made sense.”

Management

  • We will issue common stock only when we receive as much in business value as we give. This rule applies to all forms of issuance – not only mergers or public stock offerings, but stock-for-debt swaps, stock options, and convertible securities as well. We will not sell small portions of your company – and that is what the issuance of shares amounts to – on a basis inconsistent with the value of the entire enterprise.”

Be fearful of companies that state that they are undervalued during an IPO; these CEO may be undervaluing their use of the shareholder cash once they are public. When investigating any company spend time researching the management as well, the numbers can help tell a story.

Think about a company that is extremely over-levered, and then they start issuing more shares to create more capital. Are they doing the shareholders any favors by diluting their shares will not pay down that debt? These are all questions we must ask ourselves when analyzing any company.

  • You should be fully aware of one attitude Charlie, and I share that hurts our financial performance: Regardless of price, we have no interest at all in selling any good businesses that Berkshire owns. We are also very reluctant to sell sub-par businesses as long as we expect them to generate at least some cash and as long as we feel good about their managers and labor relations. We hope not to repeat the capital-allocation mistakes that led us into such sub-par businesses. And we react with great caution to suggestions that our poor businesses can be restored to satisfactory profitability by major capital expenditures. (The projections will be dazzling and the advocates sincere, but, in the end, major additional investment in a terrible industry usually is about as rewarding as struggling in quicksand.) Nevertheless, gin rummy managerial behavior (discard your least promising business at each turn) is not our style. We would rather have our overall results penalized a bit than engage in that kind of behavior.”

Beware of companies that are struggling, throwing more money at the problem is not always the answer, nor is replacing management with “better” managers. Sometimes it is best just to cut the company that is struggling, the industry they are in may be going through changes or is on the way out. Think bookstores, Borders wasn’t able to adapt, neither was Radio Shack, and this led to their demise.

  • We will be candid in our reporting to you, emphasizing the pluses and minuses important in appraising business value. Our guideline is to tell you the business facts that we would want to know if our positions were reversed. We owe you no less. Moreover, as a company with a major communications business, it would be inexcusable for us to apply lesser standards of accuracy, balance and incisiveness when reporting on ourselves than we would expect our news people to apply when reporting on others. We also believe candor benefits us as managers: The CEO who misleads others in public may eventually mislead himself in private.”

Finding a company that is candid in its communications will reap benefits in the long run. When reading through any communications from the CEO, either in the annual letters, 10-ks, or the quarterly earnings call, pay attention to the wording and tone that the CEO projects. That attention to detail will help you determine whether they are open and honest, or if they are just repeating corporate speak. You can smell it a hundred miles away.

Several CEOs that I have studied who I think is on the level with their businesses are Jamie Dimon of JP Morgan, Wendell Weeks of Corning (GLW), Jeff Bezos of Amazon (AMZN), Jeremy Grantham of the asset firm GMO, Howard Marks of Oaktree Capital, Tom Gaynor of Markel Insurance (MKL).

That is just a shortlist of the letters that I have either read or currently read for companies that I own or are interested in owning someday.

Opposites of this would be someone like Elon Musk; his letters are a smattering of promises, most of which never come true and dreams, as opposed to laying out the difficulties the company faces and how they plan to overcome those difficulties.

Not everything is always roses, business is hard, and running any company is difficult, and you want a leader that is both positive, but realistic about the challenges ahead.

  • Despite our policy of candor, we will discuss our activities in marketable securities only to the extent legally required. Good investment ideas are rare, valuable and subject to competitive appropriation just as good product or business acquisition ideas are. Therefore we normally will not talk about our investment ideas. This ban extends even to securities we have sold (because we may purchase them again) and to stocks we are incorrectly rumored to be buying. If we deny those reports but say “no comment” on other occasions, the no-comments become confirmation.”

The above idea is an idea that Buffett excels at, he is more than willing to share his ideas on investing and business. He is like the parent that teaches us to not only fish but also how to cook the fish. Think of the phrase, give a man a fish, feed him for the day, teach a man to fish, and you teach him to feed himself for life.

Buffett gives us all the information we need to invest for ourselves. He has spent countless hours writing and speaking about his ideas and methods of investing; it is up to us to decipher those ideas and determine how to best adapt them to ourselves.

He expresses a ton of gratitude for Ben Graham and his teachings, and he feels compelled to pass along what he has learned in the hopes that we pick up the mantle and carry the torch forward even if that creates more competition for him in the future.

Value

  • To the extent possible, we would like each Berkshire shareholder to record a gain or loss in market value during his period of ownership that is proportional to the gain or loss in per-share intrinsic value recorded by the company during that holding period. For this to come about, the relationship between the intrinsic value and the market price of a Berkshire share would need to remain constant, and by our preferences at 1-to-1. As that implies, we would rather see Berkshire’s stock price at a fair level than a high level. Obviously, Charlie and I can’t control Berkshire’s price. But by our policies and communications, we can encourage informed, rational behavior by owners that, in turn, will tend to produce a stock price that is also rational. Our it’ s-as-bad-to-be-overvalued-as-to-be-undervalued approach may disappoint some shareholders. We believe, however, that it affords Berkshire the best prospect of attracting long-term investors who seek to profit from the progress of the company rather than from the investment mistakes of their partners.”

Buffett is discussing having a long-term view and believing in the valuation of the company to be as fair-valued as it can be, and that we are patient when buying a company. The gains will come from the long-run, not overnight.

Remember Buffett’s favorite saying, never own a company for five minutes that you wouldn’t own for five years. If you look at the short-term of just about any company, you might or not see gains, but if you look at the longer horizon of a wonderful company, you will see gains.

  • We regularly compare the gain in Berkshire’s per-share book value to the performance of the S&P 500. Over time, we hope to outpace this yardstick. Otherwise, why do our investors need us? The measurement, however, has certain shortcomings that are described in the next section. Moreover, it now is less meaningful on a year-to-year basis than was formerly the case. That is because our equity holdings, whose value tends to move with the S&P 500, are a far smaller portion of our net worth than they were in earlier years. Additionally, gains in the S&P stocks are counted in full in calculating that index, whereas gains in Berkshire’s equity holdings are counted at 79% because of the federal tax we incur. We, therefore, expect to outperform the S&P in lackluster years for the stock market and underperform when the market has a strong year.”

Measuring against a yardstick is a great way to measure your performance, and the same applies to the stock market. But you need to understand that yardstick and how your company’s performance will be compared to the yardstick. A cyclical company will have many ups and downs compared to that yardstick, which doesn’t mean that it is good or bad, it means you need to understand that industry and how the company sits in that industry.

Also, different industries are going to go through periods of being out of favor, such as financials currently. In the past, it was energy, or oil, and then retail. It will ebb and flow, but it is important to understand the cycle and the industry, plus doing your analysis of your company.

INTRINSIC VALUE

“Now let’s focus on a term that I mentioned earlier and that you will encounter in future annual reports.

Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. 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.

The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised.

Two people looking at the same set of facts, moreover – and this would apply even to Charlie and me – will almost inevitably come up with at least slightly different intrinsic value figures. That is one reason we never give you our estimates of intrinsic value. What our annual reports do supply, though, are the facts that we use to calculate this value.”

Buffett meant what he said; he has never revealed how he and Charlie calculate intrinsic value; they have intimated and discussed discounted cash flows.

The methods of calculating the intrinsic value for Buffett have been per-share book value, discounted cash flows, owner earnings, return on equity. The inputs that he uses are a complete mystery, as well as how he calculates them.

My opinion is that he has left that up to us to figure out the clues from his writings and interviews and do our work. I have written about all of these methods in the past, and my thoughts have evolved as I have learned more. I think it is a combination of all the above methods, plus his overall mastery of business and the markets.

Intrinsic value is both an art and a science, using the tools is the science part, but his knowledge, experience, and wisdom is the art component.

Final Thoughts

As always, Buffett does such a fantastic job laying out his thoughts in an easy, understandable way. Part of my attraction to him is his willingness to share his wisdom and knowledge with me.

The owner’s manual is part of teaching, but it is also a great start to a checklist to screen for companies. Using the framework that he lays out in this manual can help you find wonderful companies to analyze. Nothing he lists in the manual is hard, or complicated. Most of it is simple, straightforward ideas to follow.

I know that every time I read something from him, I learn something new. Nothing that we talked about is new territory, but it is always good to get a refresher.

As always, I hope you enjoyed our discussion on the Berkshire Hathaway Owners’ Manual and that you found something of value on your investing journey.

If I can be of any further assistance, please don’t hesitate to reach out.

Take care,

Dave

The Essays of Warren Buffett: A Complete Book Summary

I feel like I’ve been reading the Essays of Warren Buffett for literally a lifetime, and although it hasn’t nearly need that long, it does feel like I’ve obtained a lifetime of information from his book. 

essays warren buffett

Looking back at some of the previous summaries that I have written, Buffett does an amazing job of making sure that he starts off with a great foundation for the new investor and then by the end of the book, things are moving along at 70MPH on the highway so you better buckle up!

That might seem intimidating, but it shouldn’t.  It should actually make you happier that you might not understand it all because the that just means that it will be able to provide value to you now, and in the future, as your investing career continues.

Like I said – I’ve written quite a few different summaries on a lot of these chapters, and I’ve even skipped some really good ones so I wasn’t essentially rewriting the book, but I’ve narrowed my list down to my Top 5 chapters in The Essays of Warren Buffett for our beginner investor:

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How to Read SEC Filings – Dissecting the 10-k Annual Report

If you want to learn more about a company or invest in a company, you can find a plethora of information on the company’s annual report, otherwise known as a 10-K. The 10-K offers an in-depth look at a public company’s financials, the risks it faces, and operating results for the previous year.

Warren Buffett is famous for reading 500 pages a day, and the majority of those are 10-Ks. So if you want to invest like Buffett, you must do like Buffett.

With the most recent earnings season upon us, as well as the starting of the release of annual reports, I thought this would be the perfect time to explore the annual reports or 10-Ks more in-depth.

Are these reports always the most exciting to read, probably not, but there are ways to make them more enjoyable, in addition to more revealing. Think of reading a 10-K like a puzzle; it is our job to put all the pieces together to determine whether it is a wonderful company or not.

One of the practices that I picked up from Andrew was to create a spreadsheet and notate when the date each company that I own issues their annual reports so I can stay up to date on my investments.

There are many sections to the 10-K, some of which contain boilerplate language, which means that it is legal language; they must include covering any possible legal actions. As you gain more familiarity with 10-Ks, you will have the ability to skim over these sections and spend more time on the relevant sections.

Think of learning to read a 10-K like any other aspect of investing, another skill to learn that will come with practice, the more you do, the better you will get at them. The bonus is that once you get comfortable with a company, the easier it will be to read each successive year.

What we will cover today:

  • What is a 10-K?
  • What Sections are In a 10-K?
  • Where do We Find a 10-K?
  • How Does Warren Buffett Read a 10-K?

Ok, let’s get to it, shall we?

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What is High IV in Options and How Does it Affect Returns?

As you have learned from previous posts, trading options is buying the ability to buy or sell a stock at a certain strike price.  A call option means you are bullish on the stock and a put option means you are bearish on the stock.  Stocks can naturally move up and down on their own depending on certain market conditions, and under those natural market conditions you can trade options and make a nice profit.

High IV (or Implied Volatility) affects the prices of options and can cause them to swing more than even the underlying stock. Just like it sounds, implied volatility represents how much the market anticipates that a stock will move, or be volatile. A stock with a high IV is expected to jump in price more than a stock with a lower IV over the life of the option.

In this post, I want to cover some of the risks behind buying options with a high volatility.  A strategy that many traders use (maybe knowingly or unknowingly), but not one I would recommend, especially for beginners.

When I first got into options, I remember thinking, “Wow, trading options will be like shooting fish in a barrel around earnings time.”  While there are opportunities at these times, please keep in mind its not always that easy! 

When buying options that include the period of earnings announcements for the company, you will pay a much higher premium because the high implied volatility is already accounted for.  Why is this so risky?  I’ll try to explain with a quick example below.

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