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Get Alice Schröder´s “The Snowball” now !

“The Snowball” begins with a Buffett presentation to an elite 1999 group at Sun Valley, suggesting in a humorous manner that the “.com” frenzy was no more than a bubble. Then, its on to learning why his associate Charles Munger (an inseparable partner since 1959) is both the opposite and highly similar to Buffett. Warren Buffett, we learn comes from a heritage of very thrifty small business owners.

Unfortunately, his mother was somewhat unbalanced, directing frequent tirades at Warren and his sister, creating a lifelong need for the approval of women. Calculating the comparative life spans of religious song writers while in church led Warren towards religious skepticism at an early age.

Value Investing means to analyse and interpret the financial position of a company. So one of the first questions an investor should ask himself is: “is this company able to pay it´s liabilities ?”. In order to answer this question we should have a look into the balance. To be exact we should have a look at the ratio between liquid assets and liabilities to be paid.

The current ratio provides us information about the financial strength of a company. In order to calculate the current ratio we have to divide the current assets by the current liabilities of a company.

In my opinion for most businesses a ratio between 1 and 2 is ideal but this varies from company to company and depends on the industry. However a current ratio under 1 indicates liquidity problems and a current ratio above 2 lack of efficiency. By the way, Benjamin Graham always wanted a ratio of at least 2 to one.

The second key figure we can calculate is the so-called quick ratio or acid test ratio. This key figure provides more information about the cash position of the company. But it´s more focused on if the company is able to pay coming liabilities.

In order to calculate the quick ratio we divide the financial assets by the current liabilities of a company. The quick ratio should always be below 1. If this is not the case the company could really face problems to pay it´s bills.

The last ratio is the so-called cash ratio. The cash ratio is the most strictest form to calculate the accounting liquidity of a company. We divide just the liquid assets so the financial assets minus outstanding bills by the current liabilities. The result of this calculation should always be above 0.2 .

Price Earnings Ratio (P / E Ratio) :

The price earnings ratio or p / e ratio provides information about the earnings of a company in relation to the stock rate respectively the market capitalisation of a company. The p / e ratio is interesting in order to get information about the how much profitability you get for your dollars. A rule of thumb implies that a p / e ratio of 15 is optimal a p / e ratio above 20 implies that the company is too expensive or we could say overvalues and a p / e ratio under 10 is too cheap respectively implies that a company is often in trouble.

Ways to calculate the p / e ratio:

For example, if a stock is trading at $24 and the earnings per share for the most recent 12 month period is $3, then stock A has a P/E ratio of 24/3 or 8. Put another way, the purchaser of the stock is paying $8 for every dollar of earnings. Companies with losses (negative earnings) or no profit have an undefined p / e ratio (usually shown as Not applicable or “N/A”); sometimes, however, a negative p / e ratio may be shown.

Another way to calculate the p / e ratio would be:

For example if the value of the market capitalisation of a company is 1 million $ and the total annual earnings amount to 100000 $ the p / e ratio is 10.

But we have to be careful by using the p / e ratio because of several reasons.

1. When the p / e ratio of a company is very low it´s often the case the earnings of a company are going to fall and drag the low p / e ratio below.

2. The values the price earnings ratio is calculated on are mostly values from the past which don´t reflect the current situation of the company anymore.

However what is the p / e ratio good for ?

The p / e ratio is always interesting when we want to have a quick and dirty look at the current estimation of a company. At the times of the dot-com bubble in the year 2001 we could see many estimations where the p / e ratio was above 100. That means that the expectations to a company are very high, but the real earnings of a company didn´t correspond this high expectations, yet (in the most cases it´s also not very likely that they ever will). So the p / e ratio can give us quick information weather a stock of a company is undervalued or overvalued.