This podcast answers the following questions:
- Who are Preston and Stig, and why did they create TheInvestorsPodcast?
- How does Warren Buffett invest?
- What is the intrinsic value?
- What is a share?
What do you love about our podcast? Here’s our guide on how you can leave a rating and review for the show. We always enjoy reading your comments and feedback!
Who are Preston and Stig, and why did they create TheInvestorsPodcast?
Stig has studied stock valuation at Harvard University, worked as a power trader (it was as stressful as it sounds!), and now works at a college professor in finance (more fun than it sounds!). Preston graduated from West Point with a degree in aerospace engineering. Together they have studied and written books about Warren Buffett and how he invests in stocks.
Preston and Stig decided to share their passion with the world, and stood up the site BuffettsBooks.com a few years ago. The next natural step has been creating this podcast to talk about Warren Buffett and other billionaire’s investing approach. In later episodes they will bring in guests to join the lively discussion.
How does Warren Buffett Invest?
Think about Tom Cruise in Jerry Maguire. He works as a sports agent and is being told to have one purpose: “Show me the money!!!”. Investing is really as simple as that. Warren Buffett wants to know how much profit a company is making. Ultimately there is no reason to buy a stock if it’s not profitable, or soon going to be profitabnle.
Valuation does not have to be hard. As a rule of thumb you can multiply the yearly net income of a company by 10. So a coffee shop with a net income of $10,000 could be valued at $100,000. This is the same as having a Price to Earnings ratio (P/E) of 10. In other words you pay $10 for $1 profit (or a 10% annual return). As you can see Warren Buffett wants to buy stocks with a low P/E. For example, if the P/E was 5, and the profit was still $10,000 for the Coffee Shop, that would offer the potential buyer the same business for $50,000 (or a return of 20%).
What is intrinsic value?
Intrinsic value is a fancy word for “what is the company really worth”? Warren Buffett is a smart guy, and always knows what the true value of a stock is before he buys it. Just like everybody else, Warren Buffett likes shopping and finding good products at discounted prices… However, when he shops, it is not at the local mall – he shops at the stock market. An important piece of the puzzle to figuring out the intrinsic value for Warren Buffett, is asking how much money the company is making, how much will it continue to make, and how much is he willing to pay for that profit, or net income.
What is a share?
A share is a small ownership of a real business. Think about it like this: A single slice of pizza has the same taste as the whole pizza. Unless you are very rich, you won’t have the option to buy the whole business. Businesses know that, and therefore break-up their companies into small pieces (or shares) so everybody can afford a piece. For just $20-40 you can buy a single share of some of the biggest businesses in the world. The great part is the share is completely proportional to every other share, therefore owning one share is no different than owning all of the shares.
Who said you need to be a genius to become a billionaire? This simple and fantastic quote from Warren Buffett pretty much sums up the most im
portant takeaway for the first episode:
“Rule #1, don’t lose money. Rule #2, don’t forget rule #1.“ – Warren Buffett
How to Buy Your First Stock
One of the most common questions we recieve is which broker do you use? We recommend TradeKing.com because they only charge $4.95 per trade and have no annual fees. Additionally, they will give you $1,000 worth of trades for opening an account and $150 if you switch from another broker. Watch the video above if you want to learn how to open an account.
Stig Brodersen studied at Harvard University and is now a college professor teaching economics, accounting and stock inventing.
Preston Pysh graduated from West Point with a degree in aerospace engineering. Later on, he took up lots of interest in investing, particularly the Buffett approach. Throughout years, he has studied Benjamin Graham’s books, the man Warren Buffett attributes all his success in investing.
Pysh and Brodersen started a website called BuffettsBooks.com. They aim to make Warren Buffett’s complex books easily understandable. The end goal of this podcast is to teach people how to invest in stocks and bonds like Buffett in a simple and energetic way.
This podcast will give you a basic good foundation on how to invest like Warren Buffett.
The first point to that is to treat these big multi-billion-dollar companies the same way an investor treat a small business. If not, he would have a hard time to succeed in investing.
For example, Stig owns a small business in a local town – a coffee shop. If another investor wanted buy that, what would be the first question to ask? It’s “How much profit is the company making?” The investor would look at what the business is doing and check its profit. He won’t buy it if it’s not profitable. It sounds basic, but it is crucial and important.
First, he needs to make sure that it produces $10,000 every year. The coffee shop business needs to be something that he can hold on to in the long run.
In investing, there’s this term called “PE ratio”. The PE ratio is the price divided by the earnings. This term is one of the takeaways in this episode. The profit is the bottom line often referred to as earnings or net income. Earnings or net income means profit.
If the investor would buy Stig’s coffee business, he would spend $100,000 to get an annual return of $10,000. In other words, it costs him $10 for every $1 profit in the company.
Again, the PE ratio is the price to the earnings of the company. A PE ratio of 20 is 10 times the earnings or profit that the investor is willing to pay for at that company. That $10,000 of profit remains constant year after year and he paid $100,000 to own it. His return is 10%, because $10,000 divided by $100,000 is 10%.
In another case, would the investor buy Stig’s coffee shop business at $300,000 knowing that the profit is $10,000? The profit he would get is only 3%, because of the high price he paid to get a 10,000-dollar profit. This isn’t worth it!
Most people buy a stock because they like it. That’s all. They buy it without thinking about how much the company is worth. The first question to ask when investing is always “What is it worth?” In stock investing, this is the last question people ask, unfortunately. That’s what sets Buffett apart from the others. He asks that question first.
The next question is “How much do I need to pay for that?” That’s where the price to earnings comes into the picture. Buffett finds a company with a low price to earnings ratio. The goal is to get as low price to earnings ratio as possible.
There are further metrics to come up with the proper valuation of the company, not just the PE ratio. The other metrics will be discussed in the following videos. First is to figure out what it’s worth and second is what the person is willing to sell it for.
If the investor will get 3% or 1% return at high risk, his analysis can stop right there. He doesn’t need to spend any more of his time because it’s not worth it.
The beauty about stock investing is there’s no need to swing at every pitch. If you don’t like the price, you can wait for the price to change or just wait for other better companies.
If the price of the coffee shop were now at $50,000 instead of $100,000, the investor automatically gets 20% return instead of 10%. It is important to know that the profit you get is worth the amount you paid for.
Third question is “How is one share of a business exactly the same as owning all the shares of the business?” It’s another thing that separates Buffett from the rest of the investors. When he bought a share of Coca Cola, he looked at that one share as if he owned every single share of that business.
When you make that leap in stock investing understanding like Warren Buffett, you’re going to value that one share as if it’s the entire business itself. What Buffett does is he makes business decisions and not stock decisions. For Coca Cola, he likes Coke, and he also thinks Coke is a good company to invest in. He bought it.
Buffett looks at the business as a business, not as something that he plainly likes because it tastes good or it looks appealing.
Most people don’t understand what a share is. A share is a proportional ownership of the equity of the business. Going back to the coffee shop, pretend that Stig divided the shop to 10,000 shares. Each share would cost $10. Remember, one share is the same as owning 10,000 shares from a proportional valuation stand point.
For example, the market price of the coffee shop at the stock market is $11. It automatically changes the valuation of the company to $110,000. Most people don’t treat the individual share price in the same proportional light that they would value the entire business. When you understand that one share is the same as owning all the shares, all that starts to come to clarity.
If an investor is buying 1,000,000 shares of apple, how much is that really worth? That’s what hard for people to valuate. Remember, one share is exactly the same as all the shares to do the valuation. Warren Buffett is exactly like that.
The next thing to understand is buying quality businesses – businesses with low debts and high quality. What does a share actually represent? The way you see things start to take an immediate turn from the way you might have been previously investing.
Would an investor want a business that has lots of competitors, lots of products, and low margins? The answer is no. Buying a high quality company with a good brand that will be around for the next 20 years is what’s worth owning. It will give the return projected.
Buffett often talks about competitive advantage. However, at the end of the day, almost all companies have that. Having a moat will make it a lot better.
To defend a castle, there is a moat in front of it, so anyone who wants to attack will have a difficult time. The wider the moat, the more difficult it is to attack.
When Buffett calls it a moat, he meant, “Does this company have some type of defense mechanism to protect it from competitors?” Credible brands have a secret ingredient to how it’s made. That is the moat. When Buffett buys a business, he finds one that has a large moat so it can protect itself from future competitors.
Walmart has a wide moat because they have low cost. It is not impossible, because they can buy lots of quantities. They are retailers. It is quite impossible to buy from suppliers that’s cheaper than how much Walmart sells. That’s why Walmart has a wide moat.
Being a millionaire can’t be achieved two years from now. It’s the approach. Good solid picks lead to success. The last thing an investor wants to happen is to lose the money he invested. To save that, he needs to put that money into investment to stable companies.
Buffett’s quote says “Rule #1, don’t lose money. Rule #2, don’t forget rule #1.“
Always ask, “What is the market offering me on the price?” Always start with what its worth is and how much its cost is. Treat one share just like how you treat as if you own all shares. It’s like eating one slice of pizza doesn’t change the taste compared to when you eat a whole pizza.
To wrap things up, if this is helpful, please leave a review on iTunes on how to improve this. You may also go to BuffettsBooks.com and watch the videos there. Everything in the website is completely free.