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Investing Books > Warren Buffett Investment Strategy > Flashcards

Warren Buffett Investment Strategy Flashcards

1
Q

What is Market Price

A

It is what people in the market are currently willing to buy and sell a stock for.

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2
Q

What is Book Value

A

This is the value of the business if it stopped production or work right now. The Book Value should (ideally) increase by at least 7% every year.

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3
Q

What is Intrinsic Value

A

This is the value smart investors calculate the business to be worth.

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4
Q

What are Treasury bills, notes, and bonds?

A

Treasury bill matures in 1 year or less. A treasury note matures in 1 to 10 years. A Treasury bond matures in 20 or more years.

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5
Q

What does Shares Outstanding mean?

A

It is the total number of shares the business is broken down into.

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6
Q

What does EPS mean?

A

EPS stands for Earnings Per Share. It is calculated by dividing the company’s total earnings for the year by the number of shares outstanding. EPS, or Earnings Per Share, indicates the portion of a company’s profit allocated to each outstanding share of common stock, serving as an indicator of a company’s profitability.

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7
Q

What does P/E ratio mean?

A

P/E, or Price to Earnings ratio, is the company’s current market price divided by the company’s annual earnings per share (or EPS). The P/E ratio, or Price-to-Earnings ratio, indicates the amount investors are willing to pay per dollar of a company’s earnings, providing a measure of the company’s relative value.

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8
Q

What does Volume mean?

A

Volume is the number of shares traded on any given day.

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9
Q

What does Dividend Rate mean?

A

It is the amount of money the company will currently pay you annually for owning one share of the business.

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10
Q

What does Dividend Yield mean?

A

The Dividend Yield tells us the percentage of a company’s share price that it pays out as dividends each year to its shareholders. Dividend Yield is the dividend rate divided by the current market price.

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11
Q

What does Debt/Equity Ratio mean?

A

The debt/equity ratio is a financial metric used to assess a company’s financial leverage. A high debt/equity ratio indicates that a company relies heavily on debt financing, which may increase its financial risk. Warren Buffett typically likes businesses to carry a debt / equity ratio lower than 0.5. Debt/Equity Ratio is calculated by taking the company’s total debt and dividing it by the total equity.

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12
Q

What does Price / Book Value (P / BV) mean?

A

This ratio is a way to determine the premium investors are willing to pay over the book value (or equity) of the business. Substantially high P / BV ratios (anything over a 3.0) typically means unstable and unpredictable earnings. Warren Buffett typically looks for companies that possess a price / book ratio between 0.6 and 1.5.

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13
Q

What is the rule of thumb for considering an investment worthy based on P / BV and P / E?

A

If the P / BV * P / E < 22.5 then it was worth a look.

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14
Q

What is ROE and how is it calculated?

A

ROE stands for Return On Equity and it is calculated as ROE = Net Income / Shareholders’ Equity.

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15
Q

What is ROE?

A

ROE measures a company’s profitability in relation to shareholder’s equity, indicating how effectively management is using a company’s assets to create profits. ROE is calculated as ROE = Net Income / Shareholders’ Equity. The desired ROE for an investment is consistently above 10%.

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16
Q

What is the Current Ratio?

A

The Current Ratio indicates a company’s ability to pay short-term obligations or debts due within one year The current ratio is calculated as the current assets divided by the current liabilities. As a conservative investor, the desired current ratio is higher than 1.5.

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17
Q

Buying stocks during fear vs greed cycles

A

During fear cycles (recessions): Least risky and most profitable time for purchasing stock

During greed cycles (bull markets): These are the most risky and least profitable times for purchasing stocks

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18
Q

Buying bonds during fear vs greed cycles

A

During fear cycles (recessions): These are the most risky and least profitable times for purchasing bonds

During greed cycles (bull markets): These are the least risky and most profitable times for purchasing bonds

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19
Q

Minimum investment return over 10 year federal note to be considered

A

1.75x -> 2x

20
Q

When does the Federal Reserve lower interest rates?

A

During recessions. It wants to spark spending in the economy.

21
Q

When does the Federal Reserve increase interest rates

A

During bull markets. It wants to slow down spending to control growth.

22
Q

What is the Federal Reserve?

A

The Federal Reserve is the central banking system of the United States. The Federal Reserve manages the nation’s monetary policy and maintains the stability of the financial system.

23
Q

What is a Treasury Inflation-Protected Security (TIPS)?

A

It is a type of bond that protects about the vulnerability of inflation. The federal government increases and decreases the principal of the TIPS investment at the same rate as inflation. When a TIPS matures, you are paid the adjusted principal or the original principal, whichever is greater.

24
Q

What is the Par Value of a bond?

A

The amount of money you’ll receive when the bond is mature

25
Q

What is the term of a bond?

A

The length of time the bond will last until par value is repaid to the owner of the bond.

26
Q

What is the coupon of a bond?

A

The fixed annual payment an owner will receive until the maturity date.

27
Q

What are the four rules to purchasing a company (or stock)?

A

ALL rules must be met

  1. A stock must be managed by vigilant leaders
  2. A stock must have long-term prospects (10 years)
  3. A stock must be stable and understandable
  4. A stock must be undervalued
28
Q

Criteria for determining vigilant leaders

A

Quantitative (Managing debt flawlessly):
1. Debt/Equity Ratio below .5
2. Current Ratio minimum of 1.0, ideally above 1.5
3. Strong and consistent ROE (ideally above 10%, 7% average minimum)

Qualitative:
1. CEO who puts the interests of the employees before himself (employee benefits)
2. Composition of board of directors
3. CEO has a track record of conducting ethical business
4. CEO who doesn’t get paid outrageous compensations

29
Q

Criteria for a stable company

A

Look at 10 year trends

  1. Book Value/Share should be growing steadily
  2. Debt/Equity should be stable and well managed (ideally decreasing)
  3. EPS should be positive and growing steadily (consistent earnings is ok)
  4. Current ratio should be stable above 1 (and ideally growing)
  5. ROE should be stable, ideally above 10% (and ideally growing)

Graph the trends: https://www.buffettsbooks.com/how-to-invest-in-stocks/intermediate-course/lesson-20/

30
Q

What to look for when evaluating a company’s dividend payments?

A

If they have high dividend payments (around 75%), their book value is likely to remain constant or even decrease. Look for if the current dividend payment is sustainable.

31
Q

What is Benjamin Graham’s consideration for trading above book value?

A

He doesn’t find stocks trading at higher than 1.5 times their book value attractive. (Bit outdated ratio for today’s market, but important to keep in mind)

32
Q

What is operating activities in the cash flow statement?

A

All the activity that involves earning money

33
Q

What is investing activities on the cash flow statement?

A

This is all the activity that involves buying or selling assets

34
Q

What are financial activities on the cash flow statement?

A

The activity that involves acquiring debt or paying it off

35
Q

What does the income statement answer?

A

How much profit does a company make in one year?

36
Q

What does the income statement answer?

A

How much profit does a company make in one year?

37
Q

What does the balance sheet answer?

A

How much am I really worth?

38
Q

What does the cash flow statement answer?

A

What are the changes in cash over time?

39
Q

What is the 10K?

A

It is an annual report for all major business activities conducted in the last year

40
Q

What is the 10Q?

A

The 10Q is a quarterly report for all major business activities conducted in the last three months

41
Q

What is the 8K?

A

The 8K is required when companies have to report a major event that could have an effect on the company’s financial position. For example, acquisitions, mergers, bankruptcy, change in the board of directors, etc.

42
Q

Types of moats

A
  1. Brand/patents (intangibles)
  2. Low cost structure (Walmart gets products for cheap)
  3. Stickiness (difficulty switching, Windows, Apple)
43
Q

Gross Margin

A

Definition: Gross Profit divided by Revenue.
Relevance to Value Investing: Indicates the efficiency of production/sales operations.
Insight: Higher gross margin suggests the company can produce/sell products at a higher markup relative to cost.

44
Q

Net Margin

A

Definition: Net Income divided by Revenue.
Relevance to Value Investing: Shows profitability after all expenses (operational, interest, taxes) are taken into account.
Insight: A consistent or increasing net margin suggests effective cost management and strong profitability.

45
Q

Retained Earnings

A

Definition: Cumulative net earnings kept by the company (not distributed as dividends).
Relevance to Value Investing: Indicates the company’s ability to reinvest in its business or repay debt.
Insight: Growing retained earnings can show a company’s potential for future growth or debt management.

46
Q

Capital Expenditures / Net Income (CapEx/NI Ratio)

A

Definition: Ratio of how much a company is reinvesting in its business relative to its net earnings.
Relevance to Value Investing: Assesses the company’s reinvestment rate.
Insight: A high ratio can mean aggressive reinvestment for growth or potentially excessive capital spending; low ratio might suggest efficient capital management.

47
Q

Key parts of annual report

A
  1. Auditors report
  2. Financial statements
  3. Notes to the financial statements
  4. Management’s discussion and analysis

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