Three overriding factors inform this strategy. One is the company's position in its market. To be a "Buffett-type company," it must have a "durable competitive advantage", rather than being in a price-competitive or commodity-type business. The company should have an edge -- pricing power -- over the competition. Such an edge can come from name brands, patents, a great corporate name, a cost-competitive advantage and the like. In a moment, I'll talk about some stocks this strategy likes, and you'll see illustrations of Buffett-type companies. Once a company is deemed to have a durable competitive advantage, it must show it is strong financially. This includes having predictable earnings growth (EPS increases every year for the past 10 years), conservative financing (debt must be able to be paid from earnings in two years or less), a consistently higher-than-average return on equity, a consistently higher-than-average return on total capital (net earnings divided by total capital), positive free cash flow per share and a good return on retained earnings. Two ways of analyzing a stock's price are used -- one based on return on equity and the other on EPS growth. They are averaged, and the final number indicates the rate of return an investor can expect when buying the stock. This expected rate of return should usually be about 15% or higher. If it is, the stock is a buy; if not, the stock is not worth the investment risk, because, although the company may be great, its price already reflects the quality of the company, and it will be hard to make a decent profit on the stock.
0 comments:
Post a Comment