Learn to invest with Buffett

Chapter 27

Chapter 4 Section 5 The types of stocks that Buffett believes have investment value
The most important measure of management profitability is the return on invested equity capital, not earnings per share.

--Warren Buffett
For a stock investor who wants to maximize returns within the scope of his own risk, picking the right stocks is the only way to success.But what kind of stock has such a magical ability?Going on with that kind of blanket search is not a good answer.Buffett believes that rational investors should realize that high returns also mean high risks when buying stocks.When choosing stocks, you must carefully consider, and if you want a high rate of return on stock investment, you can choose stocks with the following characteristics:
1. Stocks with high return on shareholder equity

Buffett believes that the most important indicator for evaluating and measuring whether a company or company is good and has development potential, and can give investors substantial returns over a long period of time is the "return on shareholders' equity."The rate of return on shareholders' equity, also known as the rate of return on net worth, is the rate of return on investment obtained by ordinary stock investors, and is the most realistic and effective means of evaluation.

The importance of ROE is that it allows us to estimate how well a business will reinvest its earnings.Because this indicator focuses on evaluating a company from the perspective of shareholders' interests, and at the same time pays attention to the efficiency of the company's existing capital investment.In this way, it is possible to rule out the wrong practice of optimistically estimating the profits generated by debts, loans and other inputs based on the evaluation of the company's idealistic assumptions, and to evaluate the company's current situation realistically and truly select excellent companies .
For example, a company with a long-term return on shareholders' equity of 20% can not only provide twice the return of ordinary stocks or bonds, but also give you the opportunity to receive a steady stream of 20% returns through reinvestment.The most ideal business can reinvest all the surplus in the long run at such a rate of appreciation, so that your original investment will increase in value at 20% compound interest.

2. Stocks with low debt ratios
As for behaviors that hope to expand the scale of operation through borrowing, borrowing, etc. to obtain more profits, Buffett believes that it is a good idea to increase funds to increase profits and surplus when it is not [-]% sure that the invested funds will be able to obtain rich profits. kind of adventure.

Buffett only pre-borrows when he is confident that future operations will be more profitable than the current cost of debt.Moreover, there are very few truly attractive business opportunities, so Buffett hopes that Berkshire will stay safe.Buffett believes that an excellent company should be able to obtain a good level of profitability using only equity capital without resorting to debt capital.If a company earns its profits by borrowing heavily, the profitability of the company is questionable.

However, Buffett does not flinch when he does need to borrow.In fact, he prefers to borrow in anticipation of future usage, rather than cramming and borrowing in a pinch.Low-cost funds tend to increase asset prices, while high-interest rate funds tend to increase debt costs and reduce asset values.When the price of buying a company's shares reaches an optimal level, the high cost of capital (higher interest rates) often makes the opportunity less attractive.In response to this situation, Buffett believes that the company's asset and liability management should be independent of each other.

Buffett does not offer any advice on what debt ratio is appropriate.He believes that different companies have different levels of borrowing capacity according to their own cash flow.It should be pointed out that growing enterprises have the opportunity to reinvest most of their surplus at a high rate of return, and such enterprises are the most profitable.Most of Buffett's investments have this basic financial characteristic.

3. Earnings per share can be used as a reference

Some investment analysts usually use the after-tax profit per share (also known as earnings per share) to evaluate the company's operating performance.Did earnings per share improve last year?Is it high enough to be satisfactory?Buffett believes that earnings per share are a smokescreen.Since most businesses keep a portion of their previous year's earnings to raise equity capital, there's little reason to get excited about changes in earnings per share.It doesn't make sense for a company to increase equity capital by 10% while growing EPS by 10%.In Buffett's view, it's exactly the same as putting money in a savings account and letting the interest compound to grow.

Investment motto:

In the long run, all systemic risks in the stock market will be ironed out by time, and all rational investors need to do is to choose the right stocks and hold them for a long time.Therefore, investors must carefully consider when choosing stocks and choose those stocks with investment value.

(End of this chapter)