Tags: Buffett | PE | great | invest

Words of Wisdom from the Oracle of Omaha

By Sean Hyman   |   Monday, 29 Oct 2012 07:34 AM

When I was a young man in my late teens to early 20s, I didn’t know much about money. But I heard about the richest investor in America, Warren Buffett, so I picked up some of his books.

I figured if I could gleam soothing from his thinking about investing and businesses I’d stand a good shot at being a successful investor one day too.

So I read some of his books and also I read books from his mentors, as well. Then after that, I’d occasionally dig into one of his famous letters to his shareholders. You see, these weren’t just the “here’s how our company is doing” type of shareholder letters. They were also teachable moments too. Warren would spend a bit of time educating his investors about what is important to look at as far as “what makes a company great” and how investing should be viewed.

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For instance, back in his letter to shareholders in 1993, he wrote:

“At Berkshire, we have no view of the future that dictates what businesses or industries we will enter. Indeed, we think it’s usually poison for a corporate giant’s shareholders if it embarks upon new ventures pursuant to some grand vision. We prefer instead to focus on the economic characteristics of businesses that we wish to own …”

What was he saying in a nutshell? Here’s what I believe he was saying (my paraphrasing).

He was saying, we can’t tell you what is going to happen in the future or what the economy is going to do necessarily. We’d rather not waste too much of our time thinking about that. Instead we’d rather focus on individual businesses and how solid they are fundamentally and what we feel their earnings potential is no matter how the broader economy might do.

I find it interesting that the richest investor in America didn’t have strong opinions so much on where the overall economy would go as much as he did how well he thought an individual business would do instead.

In other words, whether we go through “good times” or “tough times” he knew that by picking great businesses he’d stand the best chances of weathering the tough times and reaping handsomely in the good times too.

Well, as you know, I do have strong opinions on where the macro economy is going and where the global economy is going, but at the end of the day, I do something similar to what Mr. Buffett does. I pick solid companies at great discounted valuations.

Simply put, let’s say you saw two local pizza joints for sale. They both earned $100,000 in profit for their owners each year, but they were selling their businesses for two different prices.

One owner wanted $600,000 for his business and the other wanted $1,000,000 for his business. Well, the first pizza company has a price-to-earnings ratio of 6, but the latter company has a price-to-earnings ratio of 10.

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This is one of the big keys in sizing up great companies. It’s the price that you pay for that great company that determined how quickly you’ll recoup your original investment and what your percentage of return will be over time.

Some people just buy a stock “because it’s a great company.” But it’s all a matter of how much that “great company” costs you. A great company is not a great company at just any price.

When you’re buying a business, you’re really buying an earnings stream. In other words, what is their power to earn? And what does it cost you to buy that income stream?

In the Ultimate Wealth Report, I’ve bought companies that were trading for as little as 6 to 8 times their earnings. That’s dirt cheap. And while I was buying them at these prices, the Standard & Poor’s 500 was trading at 15 to 16 times its earnings.

In other words, we bought our pizza joints at $600,000 to $800,000 rather than the $1.5 million to $1.6 million the market would pay for them.

Buying great assets cheaply is one of the huge keys to successful investing. So learn to not overpay even for a great company. I’m snatching up bargains for my subscribers, I hope you’re doing the same in your own investing.

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of Ultimate Wealth Report. Discover more by Clicking Here Now.

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