5. Warren Buffett Stock Basics

welcome to the course 1 unit 1 lesson 5 Warren Buffett Stock Basics In this lesson we have 4 objectives of the lesson the first objective of the lesson is to learn Warren Buffett's four rules for buying

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s the second objective is the basic techniques of Warren Buffett's valuation The third objective of the lesson is Warren Buffett's opinion on the market and the objective of the fourth lesson is to understand Buffett's opinion on patience and individuality, so let's start right, this lesson is just a description Quick and brief overview of Warren Buffett's fundamentals as you go through the rest of the website.

You'll get a lot more information about everything that's contained in this short lesson, so what I'm going to start off with is saying that Warren Buffett is a person who likes things simple and likes to focus on the fundamentals. He doesn't like to get into the weeds about certain things. He likes to see things from a very simplistic point of view and that's why he has four rules that he uses to invest in

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s, so the first rule is that stocks must be stable. and it is understandable that many people are attracted to a stock that could be volatile because it could have huge rewards in the end even though there is a lot of risk associated with it and the reason why Warren Buffett is not attracted to his stocks like that It is because you know that a stable and understandable stock is something that you can actually calculate, so that when the company produces the same profits year after year and its capital increases steadily at 10% per year or whatever the case may be. if he can predict what that company will be worth next year and the year after that, so one of his four rules that he absolutely adheres to is that he never invests in a company that he doesn't determine is stable and something he can understand, then , the second rule is that a stock must have a long-term perspective and what I mean by this is that you are not going to go out and invest in a company that sells television antennas.

He is the type of person who looks at a company. and he says whether this company will exist in 30 or 40 years and whether its products will still be something that the world will still need during that time period. The reason he does it is because he likes to buy a company and hold it. because when you have it, the growth of that company actually happens at the market price and then you never pay any taxes on that growth, so really the long-term outlook is something that's actually wrapped up in taxes and we're going to cover this.

Much more will be discussed in the second course of this website, but that is the second rule that you always follow whenever you buy stocks. The third one is a little harder to evaluate as a small investor, not a big investor like him, and that is that a stock must be managed by vigilant leaders now, one of the things I include in this tenant is that the company has It has to be managed by people who manage debt well, so one of the things that I really stay away from and then Buffett really stays away from any company that has a lot of debt and I accumulate it under this rule, so for us It's kind of hard for your career as a standard investor who's not worth nearly the amount of money that Warren Buffett is, it's kind of It's hard to go there and have a meeting with the CEO and determine if he's an ethical person who doesn't care.

It would matter to own part of your business, so that's the third rule and the fourth rule that we have is that Warren Buffett never buys a stock that is above its value he should buy stocks that are undervalued, so what he does is come in and like I said before, he determines what he thinks the intrinsic value of a stock is and therefore if he determines that the stock is worth $50, he's always going to try to buy that stock for less than what he determined it to be. the value, let's say $40, is what you would be comfortable buying the stock because you're never going to overpay for that, so the name of the game really comes down to finding that intrinsic value and that's the fourth tenant.

Now I would like to say that each of these rules, each of these four rules, must be followed. He never comes out and says, "Well, rules number three and four are true, so I'm going to buy this." company, he always makes sure that these four rules are followed or he never buys the company and I recommend you do the same because it really works well, so let's quickly look at rule number four, where a stock must be undervalued now. I would like to highlight that in course two I have an entire unit dedicated solely to calculating intrinsic value and while I know a lot of people would like to jump right into that and start determining what some of these companies are worth, there are a lot of takeaways that really You must learn to understand all the terms and intricacies of calculating the intrinsic value of a company, but now I am going to teach you a little trick that Warren Buffett did every time he worked for Benjamin.

Graham for a few years and this is a really cool, quick and easy way to pick out companies that are worth investigating and companies that aren't. As we looked at the last four lessons, we learned that the market values ​​earnings and book value were three very important terms and what Warren Buffett and Benjamin Graham did was put these three terms together in a quick way to value a company, so when we looked at Nancy's ice cream stand from the previous lessons, we took her. ice cream stand and we divided it into 10,000 shares and when we did we discovered that the market price of one share because she wanted $100,000 for the business that the market price of the shoe asking for the business was ten dollars, we saw that her net income was twenty thousand dollars when we split the shares, his earnings ended up being two dollars per share and then the seven thousand dollars in equity that he had off his balance sheet when we divided it by ten thousand gave us seventy cents in Book Value, so these were really the important terms that we learned in the first four lessons and what Warren Buffett does with this quick little assessment tool that I'm going to teach you here is he rolls all three terms into one. quick assessment and what we're going to do is look at the earnings that tell us our potential returns, you're going to take that and combine it with your book value, which is your assessment of your margin of safety and you're going to get a quick and easy way to evaluate the company, so let's move on to the next slide and as we look, I'll start with earnings, so that was the middle number, so earnings here I'm just going to talk to you, we talked about the price-to-earnings ratio in one of the previous lessons. and what the price-earnings ratio does is we take the price and we look at the earnings, the price is $10. and their names are $2 and all you're doing is just dividing those terms or taking the price divided by the earnings, which is 10 divided by 2 and that gives you a ratio of 5 and, as you learned in the previous lesson, The way Where you look at that relationship is you say this saying: for every $5 I'm going to spend on buying this business, I can expect a $1 return a year later, so when we look at the P/E of five, what does that really mean if the The company can convert all of those profits into money that goes into your pocket, which is really what we're going to discover in course 2 of this website, but let's assume that all of those profits go into your pocket and it will give you 20%. and the only way to calculate it is to just take the $2 and profits divided by the market price of $10 and that's 20%, so what I want to do is show you when you go to a website, you're searching for a company and you see that the p/e is equal to 25 as we move to the chart on the right, when the p/e is 25, that actually gives you a 4% return and that assumes that if the company You can convert all the earnings in money that will actually materialize in your pocket.

The best you can do is 4% with a P/E of 25. Now when you look at the 20-year P yield, it goes up to 5%. and so, as we get down to the p/e of five, which is what we had for Nancy's business to come back, we're actually going to clarify that 20%, which is quite high, now what we need to realize is when the p/e If it is really low then your return is really high, what you can expect in the margin of safety is for your margin of safety to get worse, so let's go ahead and just look at the price to earnings, now let's look at the price to book value this is a ratio that we haven't looked at yet and it's called the price to book ratio okay and we're doing pretty much the same thing that we did with the price/earnings ratio and now we take the price which is $10 and we divide it by the book value and when we do that you get a ratio and if you look there, we take $10 divided by 70 cents and that gives us, a ratio of 14.3, okay, so what is 14.3?

Well, if you go back to the similar phrase that we said before, every fourteen point three dollars that you spend on purchasing this company, you will have one dollar of equity in the business, so that's not very good and just like PE, how much The lower the number you get, the better it will be for you because you will have more security in your investment, so let's go ahead and look at the price to book compared to security here. So if you had a company that had a price/book ratio of five, that means that only 20% of what that company is buying, let's say it was a hundred thousand dollar business, only twenty thousand dollars would go into . be the capital of the business, so if you bought it for a hundred thousand dollars and you needed to close the deal today, you would only get twenty thousand dollars and as you go down, those numbers from three to one and a half to one and then point seven, you can see how security and price change to book value when it's one, that means if you would buy the business today, okay, and let's buy the business for a hundred thousand dollars, that's if you would sell it. the business immediately after you bought it, you can liquidate it and get a hundred thousand dollars, that's what that price, the book of a1 is now equal to the book price of 0.7 means that you could actually buy the business with all those stock and the business and actually make money because the book value is actually more valuable than the price you bought it for and believe it or not, there are actually companies in the stock market that trade just like that We learned in the last slide, when the price of the book.

It's that low guess what the really bad profits are probably, so there's your trade-off: when the price of the book is really low, your profits will probably be really bad and when the profits are really good, the price of the book will probably be really bad. bad, so that's your compensation, so what does all this mean that we're talking about here? What I've done is on the left side, those are the P/E ratios, that's our price on our and then on the right side we have the price to book value, we know that their earnings speak to the return that we're going to get from our money and we know that the book value speaks of the security that the investment implies, so what?

Warren Buffett and Benjamin Graham did it and this was before they had the Internet where they could just do a search query on where they wanted the numbers that resulted in really big books and in these books they had all these ratios. and the prices of all kinds of different stocks that were listed on the New York Stock Exchange, so what Buffett did was go through all the columns of these books because, being really big, you know this book was huge and he Booked through the book and I would see a ticker and then I would see you know the trading price, I would see the PE ratio, I would see the price to book ratio and a quick way to determine if it was a company I wanted to go to or not, you would find the P/E that was low and you would look at the book value that was low and looking at this, the P/E that you were really focusing on. and that I was trying to find, as I was always trying to find a business that had a P/E of 15 or less, so as you can see there, I have highlighted that 15 or less is what I was really looking for, so I was looking for a yield of something that was better than 6.6 percent, that's what I was looking for and then on the book price, which is our safety net, I was always trying to find a company that had a better book price. . or less than 1.5 because you can see that that's where all your security was, so he approached him and Benjamin Graham came up with a great idea: Well, if we're always trying to find a company that has a P/E less than 15 and We are also trying to find a company that has a reserve price less than 1.5, why don't we take those two numbers and multiply them and multiply 15 by 1 point 5 which is equal to 22 point five.

So what did he say? It's just that I'm looking at this big book of all these proportions and terms. I can quickly assess if a company is something I'm interested in by taking that and multiplying it by the price of the book and if the number is less than twenty. two point five, this is probably a company that I really want to take a closer look at and the reason I was doing this is because, as you can see here, thelittle triangle I have that compares price to earnings and book value. Which incorporates all the variables that we were really worried about, we are worried about what price we are buying this at.

What do we think the returns will be and how much security does this investment entail? And all of those terms come down to just taking the p/e and multiplying it by the book price and making sure that number is below twenty-two point five, so that's a really quick and easy tool that Buffett used to use when he was older. young and working for Benjamin Graham: I would go through all these big books and try to find companies that were below twenty-two point five. Now, as we go through this site and you really get into the course, you're going to find that valuations get a lot more complex than this simple little model, but if you want to go out and try this with real companies, I think. you'll find that it actually gives you some really good options for such a short and easy evaluation of just taking two ratios and multiplying them and seeing if the numbers below twenty-two point five are okay, so I did this real quick with Nancy's business.

If you remember, the P/E for Nancy's business was five and then her book price was fourteen point three, so what I did was I multiplied the five by fourteen point three and that equaled seventy-one point five, so you can see. that if we tried to manage Nancy's business through Buffett's little tool, his low valuation tool, she would have failed by a longshot, she was very overvalued because we want the number to be below twenty-two point five and she was at seventy. one point five, okay, so let's transition into something like this: This is not something we've really talked about, but in unit three of this first course, the entire unit is focused on understanding the market, but Warren Buffett always look at the market itself.

It is nothing but something that can make it easier for you to buy companies at a low price. his market opinion falls into rule number four, which is that a stock must be undervalued. you use that market to your advantage, as opposed to something that scares you, so you have the opinion and this is your quote, I buy it assuming that the stock market could close tomorrow and not reopen for five years, so That's how he sees it when he buys that company, he really plans to own that company forever and that stock forever because he's buying it based on the assumption that I'm buying this company that's going to give me a ten to fifteen percent return. based on what I am buying and there is no reason why I would want to sell a company that is paying me that. type of return, so you don't care what you do on a day to day basis, all you are doing is moving forward, you are looking at what you think a company is worth and if the market offers you a price that is much lower than he thinks he is.

It's worth it, so he buys it. The general view that he has on the market is that some days they will offer you great buys and other days they will offer you horrible deals, but your job is not like that when it's a bad deal and all. you don't accept it, the last thing I want to talk about is Warren Buffett's opinion on patience and individuality, so his opinion on patience is that there is no way for you to be a successful trader unless you have absolutely patience and stick to your fundamentals, you know, I love the saying that pigs get fat but pigs get slaughtered because it's so true when the person goes out and tries to find the company that will give them double or triple their money.

Unfortunately for that person in three months, I don't think he's going to have much success long term. You have to be a very patient person who is happy to get a ten to fifteen percent return on your money and, if you can, do it consistently, you will probably be very successful in the long run. The other thing that Warren Buffett is very important about is thinking for yourself. I can't emphasize this enough. Never base your stock investment on other people's stocks. opinions, when you do that you will probably find yourself in trouble. I remember back in 2008-2009 when the market was very low and for me I was very excited because I was able to buy companies with incredible values ​​and they had almost no debt, almost all the companies I was buying back then still had no debt, but still They were trading at great values ​​and I looked around and everyone was screaming bloody murder that, you know, all economies are collapsing and that, you know, the world was going to end and everything else, but that was the time to buy big companies and I was thinking for myself and you know it was really worth it and the same applies whenever the stock market is doing great and you get to work. and you hear everyone talking about what they're buying and that's probably a very good indicator that you probably shouldn't buy stocks.

I found that if I always did what everyone else did, I was probably doing something wrong, so that's something. I would recommend that as you get out there and start getting more involved in the stock market and also with bonds, which we'll discuss in the next unit, if you're doing what everyone else is talking about, you're probably falling into the trap of that you may not be doing things right, so always think for yourself, make your own valuations on what you think things are worth and then go to the market and see if the brands are offering you a decent price for that value that you You Think It's Worth It, In lesson five we discussed four different lesson objectives.

The first objective of the lesson was to learn Warren Buffett's four rules for buying stocks. The second was to discuss a real basic valuation technique that Warren Buffett used whenever he worked with Benjamin Graham. The third was Warren. Buffett's view on the market and the fourth was understanding Warren Buffett's view on patience and individuality, so I hope you learned a lot here in the first unit and I look forward to working with you in unit 2 where we will discuss techniques and Basic bond valuations.