RESOURCES WARREN BUFFETT INVESTING COURSE
Enjoy 35 awesome video lessons for free! Scroll down to view the video lectures. The lessons are taught in chronological order, so don’t skip any lessons.
Lecture 1: What is Value Investing?
In this lesson, we learn about the fundamental approach Warren Buffett uses to invest his money. The method is called value investing and it’s based on the techniques Buffett learned from his college professor, Benjamin Graham. Graham was Buffett’s professor at Columbia Business School and very famous for writing the #1 selling investing book of all time, The Intelligent Investor. This lesson has the following important points.
1) Value Trading Versus Value Investing: When we talk about value trading, this is when a person buys an assets at a low price and expects to sell it at a higher price. This would apply to something like a commodity (like oil). When we think about value investing, we are not only buying an asset at a low price and expect it’s value to increase, but it also has a capacity to earn a consistent income. Assets (or securities) like Stocks and Bonds fit into this category. This concept is very important as you continue to learn more about determining the real value (or intrinsic value) of an asset.
2) Assets Versus Liabilities: Simply put an asset is something that’s going to continue to put money in your pocket, or it’s a safe store of buying power. A liability on the other hand is something that takes money out of your pocket over time. A liability is also a store of negative value for a business. For example, a loan would be listed a liability.
Lecture 2: How to Value A Small Business
In this lesson, we learn the basics of how to value any small business. The small business in the video is an ice cream store, but all businesses – whether large or small – are basically structured the same way. Companies create value for the customer, and in return take that profit and send it back to the owner at the end of the year. This lesson has the following important points.
1) The difference between revenue and profit: When we think of how much money a business is making, we often think about the revenue and not the earnings. This is logical since it’s the amount of money we are handing over when we buy a good or a service. We rarely think about all the costs associated for the business including material, labor, rent, taxes etc. .
2) How much will you pay for profit: If there is one law that everyone in investing should be aware of, it’s that the higher you pay for a part in the company’s earning, the lower your expected return will be and vice versa. Therefore, you should always carefully consider as to how much you are willing to pay for your investment.
Lecture 3: Margin of Safety and Balance Sheets
In this lesson, we look at the balance sheet of the company. Many investors tend to first look at the income statement since it states how much money the company is making. While this is also very important, the investors should also realize that he is not just buying a cash flow from the company, but also the assets that are producing it. This lesson has the following important points:
1) What is a Balance Sheet: The easiest way to think about a balance sheet is to consider what would happen if the ice cream business would liquidate right now. Imagine that the asset value of the ice cream stand is $10,000, and the debt used to finance the machine is $9,000. The remaining is $1,000, which is called the equity. It’s actually that simple. A balance sheet tells you how much the company owns, how much it owes in debt, and how much the owner would get if the company was liquidated.
2) What is Margin of Safety: This is a very important concept for value investors to understand when evaluating how much they are paying for a business. On one hand in your valuation, you don’t want to pay too much for $1 profit. But on the other hand, you don’t want to pay too much for $1 asset either. The less you pay for an asset, the wider your margin of safety is.
Lecture 4: What is a Share of Stock
In this lesson, we learn that a share is a part of a real business. In other words, if a business has 100 shares and you own 1 share, you own 1% of the business. This is no different than owning 1% of the ice cream stand and 1% of the machine. On the flip side, it also means that you are paying for 1% of the employee’s salary. This lesson has the following important points:
1) Value a Business versus a Single Share: When we deal with very large numbers when evaluating a large company, it can be hard to estimate if we’re buying it at a good price. The trick here is to think about the business on a per share basis, as there is no difference between valuing a single share or the entire company.
2) What is a P/E ratio?: Simply put, this is the same as asking the question: How much would you pay for a share that is making $1? You find the P/E of a stock by dividing the stock price and the earnings. So if the stock costs $20, and is making $1, the P/E is simply 20/1 = 20. You want to buy stocks with P/E that is as low as possible.
Lecture 5: Warren Buffett Investing Basics
In lesson five, we learn that Warren Buffett applies four rules to invest in stocks. All the rules must be met in order for him to purchase shares of a company. Those four rules are the following:
- Rule 1: A stock must be stable and understandable
- Rule 2: A Stock must have long term prospects
- Rule 3: A Stock must be managed by vigilant leaders
- Rule 4: A Stock must be undervalued
Warren Buffett learned a basic valuation technique in his first investment job working for Benjamin Graham, using price to earnings (P/E) and price to book value (P/BV). While we learned about the P/E in lesson 4, P/BV is a new but very important key ratio to know.
The P/BV is a measure of the price you pay for $1 of the book value in the business. If you buy a stock with a P/BV of 14.3, it simple means that you pay $14.3 for every dollar you would get back if the stock was liquidated right now. As an investor, you would like to have as much book value for your dollar as possible since it’s a measure of your safety.
- High P/BV = Low safety (typically above 1.5)
- Low P/B = High safety (typically below 1.5)
The basic valuation technique that Warren Buffett is using is simply multiplying the price to earnings (P/E) with the price to book value (P/BV). If it is no higher than 22.5, it is a strong indication that the stock might be undervalued. The reason for this is that a low P/E is an indication of a high return, while a low P/B is an indication for high safety.
In this lesson, we also learn that Warren Buffett only looks at the stock market as a place to go for buying and selling stocks. While you could bag great deals sometimes, it could also be equally horrible at other times. This also means that Warren Buffett is under the impression that you should buy stocks as if the stock market is closed for 5 years. This approach also explains Warren Buffett’s view on patience. He does not believe in getting rich overnight because massive return is often accompanied with massive risk. The trick to stock investing is to have sound rules that you do not deviate from. Other investors’ actions might tempt you to break them; however, there is no replacement for thinking for yourself. The financial crisis where high quality stocks were trading at low prices is an example of this. By selling at a rapid pace, investors convinced other investors to sell their stocks, but smart investors made their own analysis and bought instead of selling.
Lecture 6: What is a Bond?
In this lesson, we learn that a bond is nothing different than a loan. As an issuer of a bond, you are effectively borrowing money from the investor at a given price. That price is called the interest rate. The higher the interest rate, the more expensive it is for the issuer to borrow money, and the higher the return is for the investor. However, the higher interest rate is typically associated with a higher risk since a bond is worthless if the issuers can uphold its payment obligations. This lesson also teaches you the following important points:
1) Why Issue a Bond?: Bond issuers are usually either big companies, municipalities or the government. With help from an intermediate like a bond, they can finance different investments. The benefit of issuing a bond compared to issuing equity is simply that the shareholders do not give up any control.
2) Why would I invest in a bond?: Bonds are typically preferred by investors because it gives them a stable income. If you buy a stock at 6% for $100, you can be sure of receiving $6 every year as long as the issuing of the bond is operating. The stability of that cash flow is a nice supplement to the stock investor who always operates in a volatile environment.
Lecture 7: The Component of a Bond
In this lesson, we learn bond terminology. While this might seem complicated on first glance, it’s easiest to think about the terminology as what describes the conditions in which a loan is obtained. You are paying an interest rate, which, in bond terminology, is called a coupon. If you were to loan money to someone else, what type of information would you require aside from the coupon? This lesson teaches you the following terminology:
1) What is the Face Value of a Bond: The face value of a bond, which is also called the “par value”, is the amount of money you get when the bond has matured. In other words, if you have a face value of a bond of $1,000, as an investor you would receive exactly that amount when the bond, which is essentially a loan, has expired.
2) What is the Term of a Bond: The term simply states when the bond is issued and when it matures. This is no different than if you take a 30 year loan to finance your home. Then the documents will also state when you have paid down the principal of the loan. As the investor, you would continue to receive coupons until the end of the term.
Lecture 8: Bond Value and Yield to Maturity
In this lesson, we will expand the simple framework we know about collecting coupon payment from bonds. In the simple version, we learned that if we buy a bond for $1,000 with a 5% interest rate, we receive $50 every year as a bond investor. In this video, we will expand the example to understand what happens if the investor does not buy the bond at face value. This lesson teaches you the following points:
1) What is the current yield? : If you pay less – say $800 – than the face value of a $1,000 bond with 5% coupon rate, your current yield will be higher than 5%. Why? Because you are not getting a 5% return on the $800 you are initially investing, but on the $1,000 which is the face value.
2) What is Yield to Maturity: The yield to maturity tells you the total return you can expect to get from the bond. This includes the current yield, and it also includes the difference from the price you paid for the bond to the face value. Let’s assume that you have paid $800 on a bond with face value of $1,000. In this case, the yield to maturity also covers the extra $200 you gain from buying the bond at a discount.
Lecture 9: The Stock Market
In this lesson, we learn the basics of the stock market. The easiest way to think about the stock market is to think that it’s like a market where people trade a share or business for money with other people. If we didn’t have a stock market, people would still be able to trade part of businesses, but it would be more complicated. You would have to match a buyer with a seller, and you would incur a lot of transactions costs while setting up every single deal. The stock market does all that for you. The buyer doesn’t even have to know each other, and a deal can be struck in less than a second. This lesson also teaches you the following points:
1) How Does the Stock Market Work: If you own a piece of a business, you can sell your share in the stock market. When a buyer and a seller agree on a price, the ownership of the stock is transferred and the money is going in the other direction. When you see that there are many sellers for a particular stock, the stock price will gradually decline, but it’s important to remember that there is always a buyer and a seller in each trade. If fewer people were interested in buying, the price would simply decline down to the best bidding price.
2) Who is Mr. Market: Benjamin Graham, Warren Buffett’s professor at Columbia, first introduced the fictitious character Mr. Market. Mr. Market is his metaphor for the mood of the stock market. When the market’s in a good mood and high in spirit, the prices soar. You can also advantage of that by selling your stock; however, when he is in a sour mood, the prices plummet; thereby letting you take advantage and buy at discounted prices. Graham taught Buffett that he should always remember that Mr. Market should be your servant and not your guide.
Lecture 10: Stock Market Crashes and Psychology
In this lesson, we learn about the psychology of the stock market. The prices of stocks in the short run are based on emotions of the participants. Who are the participants in the stock market? It’s basically everyone who is trading stocks. The one thing all participants have in common is that they’re all humans, and all humans have the emotions of being greedy and fearful. For you, as a stock investor, this has two very different implications that we will learn about in this video:
1) The market behaves differently in the short and the long run: What this means is that in the short run, the price and the value of the stock can be very different. If people are greedy, a stock can be priced very expensive and might lead to a bubble, but if people are fearful the stocks can be priced very cheap, which is the time you want to invest. In the long run, however, the price and the value of the stock will converge. This will reward shrewd investors who bought cheap and sold expensive, and punish the impatient investor that did the opposite.
2) Accumulating stocks vs. Trading Stocks: The right way to invest in stocks is to calculate the intrinsic value of the share and accumulate shares when the price is cheap. This approach is value based and is rooted in patience. Many investors, on the other hand, tend to look at stock investing in terms of trading shares. In other words, these investors looks at the price of the stock as the indicator of the performance of the company, and think that it’s best to buy more when the price has gone up.
Lecture 11: What is the FED?
The purpose of the FED is to control and stabilize the economy. One of the most important tools to do that is by adjusting the interest rate. When the FED lowers the interest rate, it gives the population an incentive to spend more money and for companies to borrow to invest in new equipment, thereby stimulating the economic activity. The reason for this is that it’s cheaper to borrow money. The lesson further teaches the following points:
1) How does the FED Stabilize the Economy and the stock market: If the economy is in a greed cycle where everyone is buying stocks, the FED can raise the interest rate. When it does that, it given investors an incentive to buy bonds contrarily to stocks which can counteract a bubble. If the economy is in a fear cycle, it will do the opposite and encourage people to spend more money on everything, including stocks.
2) Do you want to own stocks or bonds: The rule of thumb here is really simple. When the interest rate is low, you want to be involved in stocks, and when the interest rate is high you’ll typically favor bonds. To figure out exactly which asset class is optimal, you need to compare the expected returns on the asset classes.
Lecture 11.1: Larger Market Cycles
This lesson was created by billionaire Ray Dalio. His net worth is $16 billion USD and he is the founder of the world’s largest hedge fund. In his video, you’ll learn that the economy is simply the aggregated sum of all transactions. The transactions are heavily dependent on credit, since more credit will create more economic activity and grow the economy, in the short run at least. Once you understand how credit works, you’ll understand the most overlooked and misinterpreted concept in larger market cycles. This lesson has the following points:
1) Why do we have cycles in the economy: The premises to understand the economy is to understand that one man’s spending are another man’s income. The natural implication of this is that the more we spend, the more the society earns. We can spend both the money that we have and money that we don’t have (credit) which will spur economic growth and a positive cycle. At some point of time, money has to be repaid, and we can now spend even less than our income. This is a negative cycle. Cycles simply comes from credit.
2) Is Credit Bad: It would be logical to assume that credit is bad, since a world with no credit won’t have cycles. However, credit is also a good thing. It’s good when it’s used to make investments that grow employment and in turn the economy. It’s bad when it’s used to buy useless things that don’t create income to repay your debt.
Lecture 12: Financial Risks
In this lesson, we will be looking at the top three financial risks. The top risk is debt. For a company, debt is like going faster in a car. If the road is smooth, you will get to your destination really fast, but if the road has curves you are likely heading for trouble. This lesson also includes the following points:
1) Why is it risky to overpay for an investment: The way Warren Buffett looks at the price of an investment is by saying, “The price is what you pay – value is what you get.” The intuition is very simple. All assets have a price and a value. If you pay more than the value of the asset, you are left with a small return. If you, on the other hand, buy at a price below the value, you can expect to grow your investment a lot faster. While the main financial risk is to lose money, having the opportunity to build wealth but doing it at a much slower pace is likewise risky.
2) Risk comes from not knowing what you are doing: Warren Buffett’s primary rule is to fully understand what he invests in. For instance, when you buy a car or even a home, you tend to do it after you completely comprehend what it’s worth and why it has the value that it does. When it comes to stocks, some people invest even when their knowledge is typically not as developed. This creates a new risk because not only do they now know what the value is, they also don’t know understand when the value changes, or why the price might change too.
Lecture 13: What is Inflation
When there is inflation in a country, it simply means that you can now buy less goods and services for the same amount of dollars. In other words, you can’t get the same item for $1 today as you could 10 years ago, and even less than what you could buy 50 years ago. Inflation occurs when the central banks are printing more money and thereby dilute the value of the existing dollars. This lesson has the following points:
1) Why does the government inflate their currency: You might have heard the government say that they aim for a specific target of inflation dependent on the current market conditions. While that might often be true, there is another reason why you can always expect government to want some kind of inflation. The reason is taxation. You are taxed on the nominal amount of your income and your asset. For instance, if you have a stock that is priced at $100 and the inflation is 2%, the price next year everything else equal is $102. That capital gain of $2 is taxable for you when you sell your security.
2) How does inflation impact bonds and stocks: Since bonds are fixed income assets, inflation has a drastic impact on the real return you can expect. While you might get a nominal 5% return, you need to subtract the inflation to find the real return. The real return is the gain in your purchasing power. Assuming that the inflation is 2%, you have a real return or the extra purchasing power increase of 3%. For stocks, the situation is different. Inflation will grow the earnings, though artificially, and the price of the stock will follow the inflation. The drawback for stocks is therefore less than bonds; however, the inflated capital gain or dividend still has to be paid taxes on.
Lecture 14: The S&P Rating
As a bond investor, you are not only looking at the potential return you can get in terms of the coupon rate. The return is also heavily determined by the risk of the company defaulting, in which you don’t get any future payments. This lesson will tell you about the credit rating agencies that can assist you in the process. The lesson also includes the following points:
1) Who are the major credit rating businesses agencies: Standard & Poor, Moody’s, and Fitch are called the “Big Three”. When investors look at the quality of debt for companies, the easiest way is to look up the credit rating from one of the big agencies and use that as an indicator.
2) What characterizes a good credit rating: The Big Three has somewhat of the same system when they rate company bonds. The notation is slightly different but if you see something called “Aaa” or “AAA” it’s a strong indicator that the risk of the company to default is very slim.
Lecture 15: What is a Yield Curve?
When it comes to stock and bond investing, everyone wants to know where the markets are heading. Clearly this is very difficult, but one thing that might give us an indication is the shape of the yield curve. Remember that the yield is the return you can expect to get from a bond. This lesson also includes the following points:
1) What is a yield curve: The yield curve graphs what type of return we can expect to get dependent on the term of a bond. For instance, if the yield curve is upward sloping it may indicate that we can expect a 5% return for a 30 year bond and a 3% return for a 5 year bond.
2) Can the yield curve predict the future market for stocks: While it’s not an indicator that is 100% accurate, the yield curve is mirroring how the FED looks at the current market conditions. For instance, if the yield curve is upward sloping, then it indicates that the FED wants you to spend your money right now, since you would otherwise only get a small return in the short run. More spending leads to a booming economy and higher stock prices. If the yield curve is flat or inverse it might rather indicate that the economy is booming and the FED wants you to slow down since you’ll get a nice return by investing in short term bonds.
Lecture 16: Find The Value of A Bond
In this lesson we learn how to calculate the value of a bond. The value of a bond is partly determined by the coupon, which is the money you get from holding the bond, and partly the term which defines for how long you can hold the bond. Further, the value is determined by the face value which is the amount of money you receive by the end of the term, and last but not the least, by the interest rate. This lesson has the following points:
1) What is the relationship between interest rates and the value of bond: The easiest way to think about interest rates when you buy a newly issued bond is to assume that the coupon rate is the same as the interest rate. Imagine that the interest rate is 5%, so you expect to get 5% coupon. Now assume that interest rate declines to 4% on the day after you buy the bond. What does that do to the value of your bond? It increases! This is very intuitive. You get 5% while all new investors can only expect to get 4% return on their investment.
2) What is the relationship between the interest rate, the term and the value of the bond: The concept that interest rates and bond prices always go in each direction is also valid when you account for the term. The remaining period of the term rather determines the magnitude of the change in the bond price. The reason is simple. If you get 5% on your bond and everyone only gets 4% it’s more valuable if you can hold that bond for 20 years than only 1 year.
Lecture 17: Warren Buffett’s 4 Rules
This very short lesson outlines the 4 rules that Warren Buffett uses when he selects stocks. The video emphasizes the following points that all rules with no exception have to be met. The rules are:
- A stock must be managed by vigilant leaders
- A stock must have long term prospects
- A stock must be stable and understandable
- A stock must be undervalued
Lecture 18: Rule 1 – Leadership
In this lesson we learn that a vigilant leader is always on the lookout for danger. We learn that the leader of the company is only an agent for you. As the shareholder you should consider yourself as the owner of the company, and always expect that the management is taking care of your interest. As an owner, you should look for two very important indicators that show how the management is handling the debt and cash flow. This lesson includes teaches you the following points:
1) Debt to Equity ratio <0.5 : The equity of a company can be seen as what the company owns when all debt is subtracted. After this, look at the total debt that the company has borrowed and compare the two. To feel comfortable as an investor and use the same rules as Warren Buffett, you want to find companies that have a debt to equity ratio below 0.5. In other words you want the company to own twice as much as it owes.
2) Current ratio > 1.5 : The current ratio measures how much cash the company expects to have the next 12 months compared to how much cash that is leaving the business. A company can actually grow and be profitable with a current ratio below 1 in the short run, but sooner or later all companies need cash to survive. To be sure of the longevity of a stock pick, Warren Buffett prefers a current ratio above 1.5. In other words, he wants the company to have at least 1.5 times of the cash flowing into the company as expected to flow out.
Lecture 19: Rule 2 – Long Term Prospects
In this lesson, we learn that Warren Buffett likes to invest with long term-prospects that he identifies by asking if the property of the product is subject to change. If we look at candy for example, it’s highly unlikely that we would consume candy differently or that the product will dramatically change. Compare that to an iPhone. Though it’s a great product, it’s equally highly unlikely that we will consume information and communicate the same way in 30 years. Warren Buffett wants a company with long term prospects that can continue to make a profit in the long run. Aside from the obvious notion that it’s nice for a company to generate profit, the additional reason is capital gains tax. In this lesson, we further learn the following points:
1) What is capital gains tax: If you buy a stock at $10 and sell it for $12, you are taxed on that $2 gain. In investing as with your personal life the biggest expense is typically what you incur and you want to pay as little as possible. If you incur the capital gains tax by selling your stock within one year, you are taxed heavier than if you hold it longer.
2) How to defer capital gains tax: The way to defer capital gains tax is actually quite simple: Don’t sell your stock! This underlines the importance of understanding the next level of Warren Buffett’s second rule. If the company has long term perspectives you’ll find that the stock continuously increases in value and you can defer taxes into infinity. Even if you eventually decide to sell, you’ll find that even at the same tax rate, it’s pays off to defer it as long as possible.
Lecture 20: Rule 3 – Stability
In this lesson we learn that Warren Buffett wants to invest in companies that are both stable and understandable. You can get a very good indication of this by looking at the key ratios for the previous 10 years for the company. This video shows you how and where you can find them, and also includes the following points:
1) Why is stability important for a stock pick: Warren Buffett always does a valuation before he buys a stock. It’s really hard to do a valid valuation if you don’t know where the business is tomorrow, and how much money it can expect to be making. Therefore he always makes sure only to buy into stable companies with proven track records.
2) Why is it important to understand the business model of your stock pick: You might be wondering how many things we use in our daily life and not fully understand. Do you really understand how a car works? No, not really, right? But you still drive to work every day. The reason why Warren Buffet wants to have detailed information about how a business makes money is because he can either add or eliminate his position in a stock. He makes that decision based on how he thinks the business is performing and where it’s heading, and he can only know this if he fully understands the business.
Lecture 21: Rule 4 – Intrinsic Value
This lesson shows the last of the four rules Warren Buffett always applies when considering a stock pick. It’s the most complicated, and the rule that you should look at only if the three previous rules are all met. Before buying a stock, you should always compare the current stock price with your estimation of the intrinsic value. You only want to buy stocks that you can find at a decent discount. This lesson also includes the following points.
1) How can we calculate the intrinsic value of a stock: The intuition behind stock investing is very simple. You put up an upfront payment to get a share of the company, in the hope that it will increase in value. The value of that single stock is in directly proportional to the discounted cash that you can expect to be taken out of the business in its remaining life. Remember a stock doesn’t have an expiration date!
2) Why is the federal note used as discount rate: The reason why we even discount cash in the first place is because cash changes value dependent on time. Everyone would rather have $100 today than in a year because you can either spend it and get more goods than in a year, or invest it and grow it to more than $100. Warren Buffett has said that he uses the federal note as a discount rate, because he knows that this is a risk free return. This should be seen as opposed to stock where the returns are always uncertain. In other words: If the risk free return – the interest on the federal note – is high, the value of the stocks gets lower, and vice versa.
Lecture 22: Preferred Stock
In this lesson, we learn that a preferred share is similar to a bond in the sense that you get a coupon. Where it is different is that the coupon is slightly higher, and that the management can choose to defer your coupon payment. The easiest way to understand a preferred share is to first fully understand the terminology for bonds that you can find in lesson 6-8. The reason that a company issues preferred stocks is the same as for bonds and stocks, namely to raise capital. The lesson also answers the following questions:
1) What is the difference between a stock and a preferred stock: You will often hear that a preferred share is more secure than owning a bond. The extra safety you gain from standing in line before the stock holders if the company is liquidated is very little. Usually bond holders take everything there is if the assets of the company are distributed. Another difference between conventional stock and preferred stock is that you don’t get the upside if the company performs very well.
2) Why should you read the certification of designation: The certificate tells you all the details of the preferred stock and you should never buy a preferred share without reading it in detail. One of the most important things to look for is if the stock is cumulative preferred or non-cumulative. You should only invest in the former since the company would be required to eventually pay out your dividend if the management decides to delay it.
Lecture 23: Preferred Stock Valuation and Yield to Call
In this lesson, you learn how to value a preferred stock. The final metric you are looking for after doing the calculation of the value is called the “yield to maturity”. This is really just a fancy way of saying: What return can I expect to get from the preferred share assuming that the company that has issued it doesn’t go bankrupt? The lesson also answers the following questions:
1) Where is the best place to conduct research about a stock: The best site is the free site Quantum Online. It provides you with a simple overview of the coupon rate, call price and all other relevant information about preferred stock you can think of.
2) Why is the call date important: Just like a bond, many preferred stocks have a given term when it expires; however, it’s not uncommon that you will find a preferred stock that doesn’t have a call date. What this means is that the management in theory can defer the payment indefinitely. While this is a drawback, it’s not plausible that the company wants to do so, since it can’t pay out dividend to the common stock holders in the meantime.
Lecture 24: Preferred Stock Book Value
This lesson teaches you how to account for preferred shares on the balance sheet. As preferred shares are another form of raising equity, the combination of common stock and preferred stock can distort the book value and thereby also your valuation and your assessment of the stability for the overall company. This video also answers the following questions:
1) How can you calculate the book value for your stock if it has issued preferred stock: As with the book value calculation for common stock, you should start your calculation with the equity. The next step is to look up the company’s 10Q and locate how much preferred stock the company has listed. By simply deducting the amount from the total equity, you find the company’s book value.
2) Where you do find the company’s 10Q: Any major financial information providers like Morningstar, Yahoo Finance, and MSN Money, has direct access to all listed companies 10Qs and other financial filings. It is required by the SEC that all listed companies provide detailed information of anything that is relevant financially to the potential stock holders, and therefore you can always retrieve the information for free.
Lecture 25: Income Investing
In this lesson we learn that Income Investing is a neat way of investing if you are planning your retirement. The simple concept is that you should acquire enough stocks and bonds to live off the income from future dividend payment and coupons. This lesson also answers the following questions:
1) How much should you have to plan for your retirement: A rule of thumb is that you should multiply the annual income you expect you can live off with 20-25.. If you expect to live comfortable for $50,000 a year, you should be prepared to set aside $1,000,000-1,250,000 before starting income investing. If you can make a consistent annual return of 4-5% you can maintain your principal.
2) What stocks should you choose: It’s not sufficient to only look at the current dividend payment and pick the best current returns when selecting stock. One key metric you should always have in mind in the company’s debt. If the debt is high, there is a high risk that the company will stop dividend payment if it eventually runs into problems. Another benefit of a well-run company with solid dividend stocks is that it increases the likelihood of compounding your monthly income from investing in lockstep with the performance. A rule of thumb is to find businesses that pay you 1/3 in dividend and reinvest 2/3 back into the business from which the company can grow.
Lecture 26: The Cash Flow Statement
In this video, we learn that cash flow statement is an additional statement that provides you with information that the income statement and the balance sheet don’t. Whenever a business is conducting a transaction, whether it is selling a good or acquiring a new piece of equipment, it’s logical to assume that all transactions are settled in cash. However, in reality it’s not the case. The cash flow statement tells the investor how the cash flows in and out of the business, thereby giving you a very accurate picture of the health of the business, and makes the business more transparent for the investor. This lesson also answers the following questions:
1) What are the components of the cash flow statement: The cash flow statement consists of 3 major parts: “Operating, investing and financing activities”. As an investor, you should always take a close look at cash from the operating activities. This is the cash the company generates from the core business. The operating activities capture the investments the company is making, while the financing activities measure how cash from debt, equity, and dividend payments flows in and out of the business.
2) What components of the cash flow statement should generate cash, and what components should rather spend cash: Intuitively, it would make sense that a business should generate as much cash as possible right? Unfortunately, it’s not that simple. The quality of cash is very dependent on where it’s from. As operating activities measure the cash the company makes from the core business, you want this number to be as high as possible. This is in contrast to the investing activities, which should be negative. If you spend cash on investments, it implies that the business is growing, while the opposite might imply that the company is selling off assets, which might be good for the cash holding in the short run, but bad for business in the long run. Finally you want financing activities to be negative. A positive number implies new debt and issuing new shares that dilute your ownership of the company.
Lecture 27: Cash Flow Statements Part 2
In this lesson, we learn how to read a cash flow statement by comparing the statements from four different companies: Walmart, Sears, Intel, and Kodak. This lesson also answers the following questions:
1) Why should you look for trends in the cash flow statements: We already learned which sign we want to see in front of the components of the cash flow statement. When we look deeper into the cash flow statement, we should pay close attention to the trend of the operating, investing and financial activities respectively as cash flow statement in a single year can easily be distorted, but over the long run, it gives an accurate picture of the health on the company.
2) How is the cash flow statement related to the income statement: Your very starting point of the cash flow statement is the profit of the company. From that starting point, different items are taken into account. For instance, if you buy a car in cash, only a part cost of the car is recognized in the income statement, but you can see the actual cash outlay in the cash flow statement. There are no statements that are superior to the other, but you should rather think of the cash flow statement as a measure to validate the income statement.
Lesson 28: How to Sell Stock Like Warren Buffett
In this lesson, we learn that there are two general reasons why Warren Buffett sells stocks:
1) When a higher return is expected by trading with another asset (considering the capital gains tax): One thing that might be tempting to do is keep trading your stocks when you find a new company that you really like. The problem about this approach is that you have to pay capital gains tax every time you sell a stock with profit. We learned more about capital gains tax in lesson 19 and saw that it was a large expense that required unrealistic stock picking skills. Continuously paying tax on your profit instead of deferring your tax obligation implies that the amount of money that you invest for decreases.
Therefore, when you sell stocks, you should evaluate if the expenses you incur in terms of tax outweigh the higher expected return on the new stock pick.
To fully understand when you should sell stocks, it is recommended to fully understand the calculation of intrinsic value that was taught in lesson 21.
Assume your current holding is called XXX and the new stock you are looking at is called TTT. By following a few simple steps you can determine whether you should sell your stocks or not.
1.1) Calculate the expected annual return for stocks XXX and TTT based on the current market prices and intrinsic values
1.2) Subtract the cost of capital gains tax from stock XXX
1.3) Calculate whether stocks XXX or TTT yield the highest expected annual return based on a given time frame.
2) When the company changes the fundamentals: Another important factor Warren Buffett really looks for when selling his stocks in a company is whether the fundamentals of the business are changing. What that means in practice is whether the first three rules are being broken. As we have learned in lesson 18-20, that would happen in situations where: the company is no longer managed by vigilant leaders, the company no longer has long-term prospects, and where the company is neither stable nor understandable.
One final thing to take away from this lesson is that the process of determining if stocks should be sold or not is actually not as complicated as it may look at the face of it. With a little practice, it becomes fairly easy.
Lesson 29: What Is Return on Equity
In this lesson, we learn that the Return on equity (ROE) offers the investor a very quick glance at whether a particular stock that he may be interested to invest in is worth it.
A prerequisite for understanding Warren Buffett’s assessment of ROE is to know how he values stocks and bonds. According to Warren Buffett, bonds and stocks can be valued similarly. The value of a bond is simply the payment of coupon and the par value in the end. While the bond can be bought at a discount or a premium (below and above par value) it cannot trade at a premium at the end of the term.
The owners of stocks do not receive fixed coupons, but receive variable dividends instead. Warren Buffett compares the par value of a bond with the book value of a stock, with the clear caveat that a stock can trade at a premium and that there is no maturity date.
To understand the implication of this, imagine a company that has a book value (or equity per share) of $10 and retain $5 in EPS one year. That would mean that the book value of that same stock increased to $15 – a 50% gain on book value. In investment terms, this is called a 50% ROE. According to Warren Buffett, this will be reflected in a 50% increase in market price:
The percentage change in book value in any given year is likely to be reasonably close to that year’s change in intrinsic value – Warren Buffett
If you compare that to a $100 book value company ($100 in equity per share), which makes $5 per share, you can only expect this company to increase its equity and therefore increase the market price by 5%. In other words the ROE is 5%.
Lesson 30: What Is Stock Volume
In this lesson, we understand the importance of stock volume. Although the volume won’t help intelligent investors learn the intrinsic value of a company, it can be used as a tool to help predict market behavior.
Investors are often fooled into believing that the market price of a stock is determined by all the shareholders. This idea is false. When we look at the volume of a company on any given day, we can quickly get a sense of how many traders are actually determining the price of a stock when we compare this number to the shares outstanding. This ratio – volume/shares outstanding – provides a good idea about the number of traders moving into and away from the company. When the company trades at a very low volume, we can generally say that the shareholders agree with the market price. Likewise, if the volume is very high, we can generally say that the shareholders disagree with the market price.
In the video, we demonstrate this principal with Wells Fargo (WFC). When you look at the historical market price for WFC, you will learn that on the day the volume was the highest in ten years, the market price was at an all time low. This idea of shareholders disagreeing with the market price when the volume is relatively high is an important point that stock traders can use to their advantage. Always remember, volume can mean that the stock is overpriced or underpriced. The peak or valley is for you to discern.
The takeaway from this lesson can be summed up to the following:
- Remind yourself that traders only determine the price of the stock, not the value
- Stock volume can be an indicator for when to buy stocks or adjust your portfolio in general
Lesson 31: How To Calculate Stock Terms
In this lesson, we review all the important stock terminology we’ve learned throughout the website. This lesson’s purpose is to provide a location where you can reference all the terms and understand how the terminology is calculated. Learning all the lingo in investment can be a challeng. For this reason The Neatest Little Guide To Stock Market Investing by investment journalist Jason Kelly, is the number one resource for many stock investors. With this book you get a simple and strong building block to your investment skills. By following the link, you can see third party reviews for Jason’s book on Amazon. It’s a very good guide and I’ve personally read it.
Below is a list of all the terms described in the video with times in the video where you can access the information. For example, if you wanted to watch only the information pertaining to the P/E ratio, you would move the video timeline bar to 6:47.
Lesson 32: How To Use A Stock Screener
In this lesson, we learn how to use a stock screener. There is a variety of stock screeners on the market, but a great advantage with Google’s stock screener is that it is completely free. All stock screeners have one common purpose. Given the quantitative input criteria the investor puts in, the output will be the companies that meet those criteria.
Stock screener provides a large number of different key ratios that all can be found useful depending on the investor and his investment strategy. In this lesson, BuffettsBooks.com is setting the criteria based on the following key ratios:
- Market Cap
- P/E Ratio
- Dividend yield
- P/B ratio
- Total Debt/Equity
- Current ratio
- Return on equity 5 year average
- Return on equity most recent quarter
It is really important to emphasize that there is no right or wrong criterion to use. For instance, Warren Buffett likes a P/E ratio below 15, but if you have a strategy where you would accept a P/E that is 20, it is completely fine. Also, in this lesson, we learn that the selected criteria depend on the general state of the economy. For example, in a very high stock market you need to loosen up on your criteria to find investment prospects, while a stock market crash would allow you to be very picky in your criteria for stock selection.
In the end, a stock screener is nothing more than a tool that gives you an indication of potential bargains. To figure out if it is a stock worth investing in, a comprehensive qualitative study must always be conducted as well.
Lesson 33: What Is Goodwill On A Balance Sheet
It’s a prerequisite to understand the difference between a tangible and an intangible asset at the very beginning of this lesson before we go into details. Examples of tangibles assets include a plant, inventory, or cash – it is physically tangible, which basically means that you can feel and touch the asset. Examples of an intangible asset include brand name, customer loyalty, and patents. You can’t touch an intangible asset.
While this lesson teaches us that the goodwill is in fact a tangible asset, a balance sheet would often show that goodwill is separated from intangibles.
Under all circumstances, the natural question arises as to how a company can list an asset on their balance sheet that is intangible. The principle is very simple: “The amount that the parent company paid more than the equity value of a subsidiary is listed as goodwill”.
Imagine that Apple (parent company) wants to buy a smaller company (subsidiary). If Apple would pay 50,000 and the equity in that company is $20,000, Apple can list goodwill of $30,000 ($50,000-$20,000). As the goodwill is listed as an asset, it would also be included as equity in the consolidated financial statements of Apple.
Remember that Apple also acquired the equity of $20,000 in that company; therefore, Apple can list the whole purchasing price of $50,000 of the subsidiary as an asset. Now, it is important to note that buying other companies is not a method to grow assets that are turned into equity. The $50,000 which was the purchasing price is money that Apple has earned previously, so basically Apple is simply moving things around on their balance sheet.
A question that logically arises when discussing goodwill is why a company like Apple would pay a premium for the equity in another company. The subsidiary might have capabilities that are of a high value, but at the same time they aren’t recognized in the financial statements. Examples include brand name, customer loyalty, patents, and employee knowledge.
The challenge in security analysis is to value a company that has goodwill. Warren Buffet doesn’t place a lot of emphasis on the goodwill you find on the balance sheet (called accounting goodwill) Instead, he places a lot of emphasis on what he calls the economic goodwill. Economic goodwill is what can be earned more than the market return from intangible assets. This is also why businesses can be worth far more than net tangible assets. An example of this could be a company with high brand recognition that can charge a higher price for their products because their customers are very loyal.
Warren Buffett is not only focusing on economic goodwill leading to a higher return right now. Another great argument is that while the economic goodwill is inflation proofed, the tangible assets that typically need to be replaced are not. For that reason, if economic goodwill is sustained, more profit will also be made over time.
Benjamin Graham has a different view on goodwill from that of his student, Warren Buffett. Benjamin Graham looks at a company as if it were prone to liquidate the very next day. If that should occur, net tangible assets are the only things left to value the business. For that very reason, he therefore believes that the margin of safety is the difference between the market price and book value. One thing to keep in mind though: When talking about Benjamin Graham, you must understand that he conducted a lot of his research in the 1930s after the great depression, and that might explain his more skeptical approach.
BuffettsBooks.com has the opinion that economics goodwill is great as it is inflation proofed, given that you plan to hold the stocks forever. Strong earnings and minimal debt is also a requirement. Still, a reasonable amount of tangible assets for safety is recommended.
Lesson 34: Warren Buffett’s Owner’s Earnings Calculation
In this lesson, students learn the difference between accounting earnings and Warren Buffett’s Owner’s Earnings.
When an Investor looks at the bottom line figure on the Income Statement, they find the Net Income. This is the profit the company has produced for the given time frame. Although many people use the net income to value a business, Warren Buffett takes a different approach, and calculates what he calls the Owner’s Earnings.
In order to understand the concept of Owner’s Earnings, one must understand the two paths taken by the Net Income after it’s produced. The first path is a potential dividend payment. Any funds that take this path are immediately valued as Owner’s Earnings. The remaining amount of net income after the dividend payment is then used to invest back into the business. This money also has two paths. While one path is to use the money to reinvest into the maintenance and care of the already existing equipment, the other path is to spend the money on expanding the assets of the company. If the funds flow in the first direction, called Capital Expenditures, the company’s book value will display little or no growth at all. If the funds flow in the second direction, the money will add new streams of income to the business and the asset will be added to the current equity of the business. This second amount is added to the dividend and the total is referred to as the Owner’s Earnings.
If an individual is interested in calculating the owner’s Earnings, he/she could simply take the funds from the Operating Activities section on the Cash Flow Statement, and subtract it from the Capital Expenditures — also found on the Cash Flow Statement.
Remember, the true Owner’s Earnings is nothing more than the book value growth and the dividends combined.
In order to read Warren Buffett’s exact notes on Owner’s Earnings, be sure to follow this link to his 1986 Shareholder’s Letter. The portion on Owner’s Earnings can be found at the bottom of this document.
The most important thing to take away from owner’s earnings is to understand the concept more than remembering simple formulas. As a shareholder you want to know the amount of value the company is making, and how much of that is flowing back to you. This is, in essence, what owner’s earnings are all about. Accounting both intentionally an unintentionally misleads the investor, but at the end of the day, the real value that is being created for the shareholder is all that counts.
At the end of the lesson four main pointers are provided:
- Fully understand the difference between owner’s earnings and accounting earnings
- Continue to value companies based off the book value growth and dividend
- When assessing the future earnings of the business, ensure that the estimate remains stable or is increasing
- Check the Cash flow statement quarterly, to ensure that the ratio between the operating activities and Capital Expenditures remains intact.
Owner’s earnings are just one example of how Warren Buffett has reinvented investment and seen new opportunities where he is one step ahead of the pack. Tap Dancing to Work by Carol Loomis gives you a unique insight of Warren Buffett’s more advanced thoughts and actions on investment. I’ve read this book and enjoyed it very much. Carol does an outstanding job capturing important Buffett topics.
Lesson 35: Warren Buffett DCF Intrinsic Value Calculator
The DCF calculator has a different approach to valuating a stock when compared to the intrinsic value calculator, which has been presented previously throughout the courses. The DCF calculator uses cash flows for valuation. The calculator typically first calculates for the coming 10 years, and then in addition it estimates the value of the stock if you hold it forever – this is also called perpetuity.
To get the easiest insight into how the calculator works and making it as user friendly as possible, the DCF calculator is broken down into 6 simple steps:
- Estimate the free cash flow
- Estimate the short term growth rate
- Determine the short term
- Determine the discount rate
- Determine the growth into perpetuity
- Input the number of shares outstanding
In the following lesson, a further elaboration of each step is shown. It is important to emphasize that when talking about estimates, estimates are exactly what you get. They are qualified guesses about the future – nothing more and nothing less. This is also why you will see that two people with the same information available will come up with two different numbers for the value of a stock.
- Estimating the Free Cash Flow (FCF) is the first step in the process and the investor is advised to look back at the 10 previous years to get an indication about the level of FCF the company can expect to make in the future. Remember that FCF is similar to what Warren Buffett calls the owner’s earnings, which is the money that is actually flowing back to you as a shareholder. BuffettsBooks.com has provided you with a tool that allows you to write a ticker, and automatically be taken to a site where you can copy paste the required data. FCF can change a lot from one year to the next dependent on the investment level, so it is important to look back in time.
- Estimating the short term growth rate can also be approached by an assisting tool similar to the one in step 1. While the past can be used as an indicator, it is very important to consider the growth/maturity state of the company. For very large companies you might only want to use a few percent, while smaller companies typically grow at a much larger pace.
- Determining the short run is interrelated with step 2. Many companies grow at a rapid pace for only a short period of time until they mature. For example, an IT company might be growing with double digit numbers for 5-10 years, followed by a more modest growth.
- Determining the discount rate is another way of asking which return you would require from a stock as an investor. While this might seem a bit redundant, it is a measure asking about how you deem the risk of the stock. For a new IT company you might require a larger return than for a large 10+ billion dollar net income company that has been around for over a century. At the final step of the calculation, BuffettsBooks.com has provided you with a simple solution if you want to leave the input at a generic 10% level.
- Determining the growth rate into perpetuity (forever) might seem like an impossible task. As a rule of thumb you are recommended to use 2-3%, which is simply the estimated inflation. It would be unrealistic to include a high growth rate forever.
- Input the number of shares outstanding. So far this calculation has been based on numbers for the whole company. This step takes the process down to a per share basis, making it comparable with the present share price of a single stock.
What has happened after all 6 steps is that the intrinsic value of a stock has been calculated for a single stock. This is done by discounting the estimated FCF that you, as a shareholder, would receive for holding the stock.
A few pointers that might be helpful:
- Intrinsic value > market price = opportunity for a good bargain.
- Intrinsic value < market price = risk of overpaying for the stock
Compared to the intrinsic value calculator in chapter 21, this calculator can be recommended to be applied for:
- Valuating high growth companies
- Companies having a large number of share buy-backs.
- Companies having stock splits
If you’re interested in a more detailed description with an outline of how this calculator works, it can be found in the “Warren Buffett Accounting Book”. This book was written by us, Preston Pysh and Stig Brodersen, and it contains all formulas and definitions.
Q: I just finished the course. What is the next step?
This is a great but also a tough question to answer since it depends on your investment strategy. For instance, the intrinsic value course is of little use if you’re solely into ETF investing, and you could bring the same argument to the table if you’re not into valuing individual stocks.
But I would complete the courses in the following order.
This course is a natural continuation of the free course that was created by both Preston and Stig. It continues in the same theme of understanding and in turn valuing individual companies. You can also download the calculator we’ve developed specifically for this course. The best way to understand the type of analyses you can conduct after completing the course is by studying one of our stock analyses.
This is a classic book in the value investing community for a good reason. It provides good arguments for a very quantitative approach to stock investing that has historically proven successful at the time of Benjamin Graham’s writing, and it still outperforms today. It also opens up the opportunity for the benefits of ETF investing, even though ETFs were not yet invented at the time.
ETF investing is a very appealing strategy for many investors because you can be wrong about the individual stock pick, while an ETF is a basket of stocks that ensure diversification. Still, investing in any ETF opens you up to multiple potential mistakes, so we created this course to address the best practices head-on.
This course is not directly applicable to a retail stock investor who focuses on the individual stock, but rather looks at portfolio allocation as a macro investor.
We hope you find the overview above useful. Please remember that we have a 30 days full refund guarantee for all of our courses. You can just send us an email if you’re not satisfied, and we’ll reimburse you within 48 hours.
Q: I have a question about the course. Who can I ask?
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© TIP Academy content is for educational purposes only. The calculators, videos, recommendations and general investment ideas are not to be actioned with real money. Contact a professional and certified financial advisor before making any financial decisions. Preston Pysh and Stig Brodersen are not professional money managers or financial advisors. The Investor’s Podcast and parent companies that own The Investor’s Podcast are not responsible for financial decisions made from using this course or the tools provided in the course.