Pearl Invest

We all have someone whom we admire and respect. For me one person on my shortlist is Warren Buffett who is sometimes referred to as the “Sage of Omaha“. I first heard about Buffett back in 2001 when I first started getting serious about investing and so I started reading all the titles with his name on it. Off course Buffett hasn’t actually written any of them but they were priceless none the less.

If you have never heard of Buffett, Forbes currently ranks him as the third richest man in the world and he is arguably the world’s greatest investor. He has amassed his fortune by making astute investment decisions and investing in businesses. Here is what I have learnt from Buffett:

1. Rich Is A State Of Mind
“I always knew I was going to be rich. I don’t think I ever doubted it for a minute.” – Warren Buffett

The difference between being poor and being rich is really just a state of mind. Poor people think thoughts of poverty and lack, rich people think thoughts of abundance and prosperity. Your beliefs are going to determine the way you perceive wealth, the decisions you make and the way you act towards it.

2. Success Is More Than About Your Bank Balance
When asked by CNBC what is the secret to success, Buffett replied “If people get to my age and they have the people love them that they want to have love them, they’re successful. It doesn’t make any difference if they’ve got a thousand dollars in the bank or a billion dollars in the bank… Success is really doing what you love and doing it well. It’s as simple as that. I’ve never met anyone doing that who doesn’t feel like a success. And I’ve met plenty of people who have not achieved that and whose lives are miserable.”

3. Spend Less Than You Earn
“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” -Warren Buffett

It seems like common sense advice and you’ve no doubt heard financial experts preaching about it for years. You can’t possibly get ahead financially if you’re spending more than your paycheck. Buffett is famous for living a simple and frugal lifestyle. He is the only billionaire I know that still lives in the same house he bought back in 1958 for $31,500. He drove a 2001 Lincoln Town Car for years which he bought second hand. Buffett has a net worth in excess of $52 billion and yet lives off an annual salary of $100,000. The relative percentage of his spending based on his overall net worth is minuscule.

4. Avoid Consumer Debt
The sooner we realize that consumerism is a social plague that has been propagated by billion dollar marketing machines to keep you shackled to your job, the sooner we can stop spending money on useless stuff. It is a fool’s game to spend today so that you can work tomorrow to pay it off. It is a losing proposition because one day your working days are going to be over but the debt is still going to be hanging over your head. Clever marketing has convinced our society that to be happy you have to have more, be more and do more. Buffett abhors consumer debt instead choosing to use debt wisely by leveraging it in investments. To help you deal with your debt consider reading “How To Get Yourself Out Of Debt“.

5. You Are Who You Associate With
“It’s better to hang out with people better than you. Pick out associates whose behavior is better than yours and you’ll drift in that direction.” -Warren Buffett

If you want to succeed financially you need to associate with people who are most conducive to encouraging and cheering on your financial journey. If the people you associate with see money as evil, object to capitalism and find wealth a foreign concept then your financial health and well being is going to be influenced by their views. Whether we like it or not we are all influenced to some extent by the people we spend our primary time with. If you aspire to achieve financial security then you need to find a mastermind of people in your life whom you can all encourage and help each other.

6. Gambling Is A Fools Game
“Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” – Warren Buffett

While we are young and naive we choose to take risks with our money that are dumb and stupid. Trying to hit a home run with your money every time is a losing proposition with long term consequences. To chase investments that offer a high rate of return you must also assume that it also comes with a higher rate of risk. Bill Gates once quipped “Warren’s and my betting has always been confined to $1 bets” when talking about them paying poker together. If two billionaires take risk management this seriously, it’s time we average punters did the same thing.

7. Give Back To The Community
“Of the billionaires I have known, money just brings out the basic traits in them. If they were jerks before they had money, they are simply jerks with a billion dollars.” – Warren Buffett

They say that to have more you need to give more. A contradiction in terms, maybe, but it’s a simple truth that is as enduring as time. As the bible says “It is more blessed to give than to receive -Acts 20:35”. Buffett has announced in 2006 that he was giving away over $30 billion to the Bill and Melinda Gates Foundation making it at the time of writing the largest charitable donation in history. He also contributes large sums to his children’s charitable foundations.

8. Generosity and Abundance Goes Hand In Hand
“Even though Ben Graham [Buffett's mentor] had everything he needed in life, he still wanted to give something back by teaching, So just as we got it from somebody else, we don’t want it to stop with us. We want to pass it along too.” – Warren Buffett

A famous bible quote goes: “What benefit will it be to you if you gain the whole world but lose your own soul?” – Mark 8:36. The path to wealth isn’t a solo endeavor. How sad would life be if you come to the end of your life and there is no one to share it with. So as you journey on your path to financial abundance remember that there will be many people who generously helped you on your journey so it is only fitting to pay it forward when the opportunity arises. Generosity with your time, with your money, with your resources are great virtues to have. The greatest ally to building a strong friendship is to help others achieve what they want from life.

I leave you with this last quote “You only have to do a very few things right in your life so long as you don’t do too many things wrong.” – Warren Buffett

Written by Tezza  website: 4EvaYoung.com published under Creative Commons 3.0 License.

Get Benjamin Graham´s “The Intelligent Investor” now !

Get Benjamin Graham´s “Security Analysis” now !

The Intelligent Investor by Benjamin Graham is a classic. Considered by many to be the father of value investing and modern security analysis. Benjamin Graham started working on Wall Street in 1914, a time when portfolio management was based more on unsupportable impressions and inside information. Benjamin Graham brought a disciplined and intelligent approach to the profession.

After reading The Intelligent Investor in his senior year at the University of Nebraska, Warren Buffett was so impressed that he traveled to New York to study with Benjamin Graham at Columbia University.  Warren Buffett once said that he was “15 percent (Philip) Fisher and 85 percent Benjamin Graham.”  The training that Warren Buffett received from Benjamin Graham was critical to his success.  If you read this book, you’ll know why.

Benjamin Graham the mental founder of value investing always emphasized that it´s extremely important to know the difference between an investment and speculation. Nowadays many people believe that they are investors just because they read some news about the company they buy stocks of and think that the price will go up just because the stock chart is so and so.

However that´s not true in most cases value investors actually even don´t care about stock prices. An investment is present if it promises the safety of the set in capital as well as a profit on the set in capital after a detailed analysis, everything else is speculation. So according to Benjamin Graham if somebody buys a stock without analysing the balance, the environment and the cash flow statement of a company he is a speculator. Even if this person has read some news about the company and is sure that the price of the shares will rise this person is a speculator.

On the other hand an investor always analyses the balance and combines it results with the news and information of a company. In the end an investor should always get a value which defines what the company is worth in his eyes right now. Based on this value his either buys or sells a stock, but he would never buy a stock because he read a great article about this stock or the 38-days line crosses the 200 days line or something like this.

Nevertheless it has to be said that it´s not forbidden to practice speculation, there are also some guys who are quite good in this field. But it´s important to understand that there is a difference between building up a fortune by growing with a company and trying to get rich quick by trading in shares of a company.

Clayton’s lending operations, though not damaged by the performance of its borrowers is nevertheless threatened by an element of the credit crisis. Funders that have access to any sort of government guarantee — banks with FDIC-insured deposits, large entities with commercial paper backed by the Federal Reserve, and others who are using imaginitive methods (or lobbying skills) to come under the government’s umbrella — have money costs that are minimal. Conversely, highly-rated companies, such as Berkshire, are experiencing borrowing costs that, in relation to treasury rates, are at record levels. Moreover, funds are abundant for the government-guaranteed borrower, but often scarce for others no matter how creditworthy they are.

This unprecedented “spread” in the cost of money makes it unprofitable for any lender who doesn’t enjoy government-guaranteed funds to go up against those with favored status. Government is determining the “haves” and the “have nots.” That is why companies are rushing to convert to bank holding companies, not a course feasible for Berkshire.

Though Berkshire’s credit rating is pristine — we are one of only seven AAA corporations in the country — our cost of borrowing is now far higher than competitors with shaky balance sheets but government backing. At the moment it is far better to be a financial cripple with a government guarantee than a Gibraltar without one.

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 .

“Many people believe that the stock exchange is some kind of a casino and the only way to make money is to buy a stock cheap and to sell it to a higher price. Worse still is that many of these people also believe that you can get rich at the stock exchange very quick, they buy a stock because they believe that it´s gonna triple within the next weeks. However unfortunately that doesn´t work in most instances and in the end the people often sell their stocks with a loss.

That´s really stupid because in being interested in participating in the earnings of a company these people prefer to play a game with many other idiots who all evaluate the worth of the company every single day. Warren Buffett once said that when he buys a stock he actually never wants to sell it again. But what does he mean with this statement ? How can you make money at the stock markets when you don´t sell your stocks again ? The answer is you buy stocks with a high dividend yield.

In September 2008 for example Warren Buffett bought Goldman Sachs Goldman Sachs stocks at 115 USD. Actually now he could sell these stocks again and make a profit of 55 %. But he won´t do that, because Goldman Sachs pays him a dividend of 10 % on his stocks year for year for year. So Warren participates in the earnings of Goldman Sachs instead of taking care what others would pay for his shares.

Another fact is that a constantly high dividend yield is always a good sign for a sound company, because if a company is able to pay it´s investors a high dividend it has made high profits. Also Warren Buffett once said: “If a business does well, the stock eventually follows.” So if a dividend is getting higher and higher every year it´s a sign that the profits of the company are also getting higher and higher every year, which leads to a higher stockprice.

Last but not least there are many studies which underlie that stocks with a high dividned yield perform better than the total market.

One of Warren Buffett´s ways to success is the enormous concentration on a special industry. Bill Gates a good friend of Warren always wanted him to buy Microsoft stocks in the 90´s. We all know that the investment in Microsoft stocks wasn´t a bad one in the year 1990 and although Bill Gates the CEO of this Microsoft was a good friend of Warren, he did´t want to have them.

The reason for that was because the stocks were not in Warren´s sphere of competence. In Warren Buffett´s view every good investor should have a personal sphere of competence. This sphere of competence includes the industries and types of securities the investor is quite good at. Warren Buffett for example is at home in the insurance sector the consumer industry and the food industry and he would never buy a stock of a industry he doesn´t know.

In Warren Buffett´s view it doesn´t depend on the size of the sphere of competence of an investor it depends on the knowing the borders of your sphere of competence. This proceeding has several advantages:

1. It´s much easier to predict the trend of the industry you invest in.

When you are at home in a special industries, you know the effects of external happening on it. For example when you are at home in the chemistry industry you know that a high oil price could affect that hole industry in this or that way. When you are at home in the auto industry you know that a high or weak dollar could have this or that effect on the industry.

2. It´s easier to compare companies witch each other and to say if a company is under or overvalued.

Nowadays it´s very hard to say what´s the worth of a company. Of course we could easily have a look into the balance sheet and calculate the net asset value of the company, but there are always stocks of industries which cost a multiple of what they really earn and what their real net asset value is. Stocks of the IT industry for example usually cost a multiple of what stocks of the food industry cost. The reason is because people belive that the growth opportunities are the best there. So, when you are at home in a special industry you can compare companies which each other and you can say weather the company is cheap or not.

Warren Buffett once said: “Be fearful when others are greedy and greedy when others are fearful”, as I explained in chapter I the irrational Mr. Market, sometimes the estimations of companies are just irrational and do not reflect the true value of a company. This is because the people are too greedy when the price levels are high, because they also want to benefit however they are also too fearful when price levels are low because they already lost money or heared that others did that.

After the fall of Lehman there were a lot of stocks which had been terrible cheap just because the people were fearful that the company could also fall under chapter 11. One of these stocks for example was Las Vegas Sands NYSE:LVS. Sands had to stop their projects in Macao because they ran out of liquidity. The stock felled from 138 $ and a market capitalization of 91 BN $ in the year 2007 to a terrible low value of 1.77 $ and a market capitalization of 1.16 BN in 2008. Although Sands had big losses it was really not very sound that the worth of a company collapsed from 91 BN to 1.16 BN within one year. Today the sands stock has recovered to 15 $ again which is a plus of nearly 900 % from the low of 2007.

But the question I ask myself is are there sill any hot deals we can profit from ? To answer this question we should take a look at the sector the crisis rampaged best. The financial sector.

I took a look at this sector and found 4 stocks which could be interesting.

1. AIG Current Price 40.05

2. Fannie Mae Current Price 1.77 $

3. Freddie Mac Current Price 1.97 $

4. AMBAC Current Price 1.64 $

All of these stocks have nearly lost more than 90 % of their former market capitalization. The first 3 of them received a lot of help from the government and the net asset value of these companies is horrible. This is one side, but the other side is that the risk of a insolvency of one of this companies is not as high as many people think ( except Ambac perhaps ) and the bargains of these companies are still working. So I would recommend to have an eye on these stocks because in my opinion they are cheap enough to be the pearls of the month.

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.

In this Chapter we want to discuss why value investing works, but at first I want to do a little experiment. Image we trow a coin 6 times and everytime we do that we either get head (H) or a number (N), so what do you think which sequence is more likely to appear ? (H), (H), (N), (H), (N), (N)   or  (H), (H), (H), (H), (H), (H) the fact is that they are statistically completely similar. So what we can learn from this experiment is that the most people, despite they are well in numbers and stochastic would say that the first sequence is more likely to happen, because for them it´s not sound that the head of the coin appears six times in a row.

However why is this experiment interesting in order to understand why value investing works ? Well because that shows us that humans have their own subjective view of how the things are and these views are reflected in the sometimes strange movements of the stock markets. The Israeli psychologist Daniel Kahneman for example has won the Nobel price in economics for his work on behavioral finance, in which he discovered that irrational movements of the markets are the result of the collaborative opinions of single persons. Benjamin Graham the spiritual founder of the modern value investing described this phenomena with the help of the insane Mr.Market. He wrote, imagine there is a guy who comes to your home every day, just to tell you the price of your stocks. Actually this is a fine thing wouldn´t there be the fact that Mr.Market has a serious problem, because sometimes he is far too optimistic and tells you that your stocks will reach the heaven soon. And sometimes he is so the most depressive man in the world and predicts that your stocks will be worth nothing anymore soon. What Mr.Graham describes is just the behavior of the crowds. When they see that the markets are going up they want to participate on that, but when they see that the markets are falling they are feared to loose their money and start to sell their securities.

In order to explain how the reactions of the average investor are I took the following 10 years chart of the German stock index DAX.

1. The average investor starts to buy mostly overvalued stocks because he wants to participate at the rising markets.

2. The rally is over and the most winnings of the most average investors are zero again.

3. The average investor thinks that this was just a little break of the rally and buys again.

4. The markets are crashing the average investor sells his stocks and is frustrated.

5. Because the average investor is frustrated from his losses he made in 2003 his just starts to buy stocks in the year 2007 again and the whole game starts from scratch.

So the reason why value investing works is that value investors don´t care about subjective market fluctuations. Everything which counts for them are objective facts about the companies they buy. So the company is in their opinion undervalued because the for example the market capitalisation is worth far less than the actual assets of the company are.  Actually they don´t care about stock rates, because they know that they struck a bargain and on the long run the market will realize that.