Learn to invest with Buffett

Chapter 36

Chapter 5 Section 8 Debt: A real good company is one without debt
The findings of the American "Fortune" magazine can prove my point is correct.In the ten years from 1977 to 1986, only 1000 of the total 25 listed companies in the United States achieved an average return on shareholders' equity of 10% during these 20 years, and none of them fell below 15% in one year.Of course, the stocks of these excellent companies also performed well.Among them, 24 stock indexes have surpassed the Poor's 500 index. The top 500 companies listed in "Fortune" magazine all have one thing in common: the financial leverage they use is very small, which is very insignificant compared with their strong payment ability.This fully proves my point: a really good company doesn't need to borrow money.And among these excellent companies, except for a few high-tech companies and pharmaceutical companies, most of the companies' industries are very ordinary, and the products they sell now are the same as they were 10 years ago.

--Warren Buffett
Buffett believes that an excellent company must be able to generate continuous and abundant free cash flow.Businesses should be able to maintain business operations on these free cash flows.A good company does not need to be in debt.Buffett believes that when investors choose investment targets, they must choose companies with low debt ratios.The higher the company's debt ratio, the greater the investment risk.In addition, investors should also try to choose companies with simple businesses.

In Buffett's view, most of the listed companies that can generate high profits every year operate in the same way as they did 10 years ago.Most of the companies Buffett invests in or acquires are of this type.Subsidiaries under Berkshire are creating outstanding performance every year, but they are all engaged in very ordinary businesses.Why can ordinary businesses be so successful?Buffett believes that the excellent management of these subsidiaries has made ordinary businesses no longer ordinary.They always try to protect the value of the enterprise itself, and consolidate the original advantages through a series of measures.They always strive to control unnecessary costs, and constantly try to develop new products based on the original products to cater to more customers.Just because they make full use of their existing industry status or work hard on a certain brand, they create high profits, generate a steady stream of free cash flow, and have extremely low debt ratios.

When Buffett chooses investment objects, he will pay great attention to whether the company has debts and how much debt it has.Buffett believes that it is relatively one-sided to only observe the company's debt status in the past year. We should focus on the company's debt status over the past ten years and the company's debt repayment ability.

Most of the companies Buffett invests in have very low debt ratios, and some even have no debt.

In 1987, Berkshire's net worth increased by $1987 million in 400, an increase of 19.5% over the previous year.The Buffalo Newspapers, Fitchheimer Suits, Kirby Vacuum Cleaners, Nebraska Furniture, Scott Fetzer Corporation, See's Candy Company, and World Encyclopedia Corporation had pretax profits as high as $1987 million.If you look at this profit alone, you will feel nothing special.But if you know how much money they have used to achieve such good results, you will admire them so much.The debt ratios of these seven companies are all very low.Last year's interest expense totaled only $8000 million, so the total pre-tax profit was $200 million.If these seven companies are regarded as one company, the net profit after tax is about 800 million US dollars.The return on investment of shareholders' equity will be as high as 57%.This is a very astonishing achievement.Even in those companies with high financial leverage, you will not find such a high return on investment of shareholder equity.Among the 30 largest manufacturing companies and 40.2 largest service industries in the United States, only six companies had a return on shareholder equity of more than [-]% in the past ten years, and the highest one was only [-]%.It is precisely because of the extremely low debt ratio of these companies that their performance is so attractive.

Of course, not all companies with high long-term loans are bad companies.Buffett believes that investors also need to consider the reasons for the company's debt.Some companies have excellent profitability and strong cash flow with little or no debt.Such companies are often favored by leveraged buyout firms.If the company is acquired successfully, the company is usually saddled with huge debts.Large debts can be reduced over time.But in the process, the debt will always exist.It cannot be said that because such a company has long-term loans, it cannot be judged that such a company is not a good company.

See's Candy Company is an example.When See's was acquired by Berkshire, See's had a book net worth of $800 million.Buffett paid $2500 million for See's.Among them, $1700 million was used to purchase See's intangible assets.After See's was acquired, the $1700 million became See's debt.It would be too subjective to conclude that See's is not a good company based on the $1700 million in debt alone.You know, in 1982 alone, See's generated an after-tax profit of $2000 million on only about $1300 million in tangible net assets.Such a high rate of return is even worse than many Fortune 500 companies.

Investment motto:

"A good company does not need to borrow money." Although it is impossible to judge a company's quality from the debt ratio absolutely, if a company can have a relatively impressive performance with an extremely low debt ratio, then this The company is worthy of serious consideration by investors.

(End of this chapter)