What is investing with business sense?

Stocks are not simply ethereal numbers that fluctuate in the market based on supply and demand. That is a simplistic way of looking at investing, one that could lead you into speculation and increase your risk of loss.

Each outstanding share represents a percentage of ownership in some company. Holding multiple shares of the same company increases your exposure to the performance of the underlying business, which is the dominant factor in the stock’s valuation.

Time and value investment

Benjamin Grahamone of the most cited investors and authors in the stock market world, explained in Security Analysis y The Smart Investor that in the short term the stock markets behave unpredictably, but in the long term they are like scales.

Graham instructed Warren Buffett, the man who has won the most money in the stock market. For Graham, the best way to invest was based on the value of the company, based on metrics that help determine the intrinsic value of each company.

With that in mind, Graham invested in any company in the market that he judged to be trading below intrinsic value. His main thesis was that the market would reconsider his position and allow him to sell at an acceptable profit.

Buffet needed Munger

Although Graham’s way is better than speculation, it sometimes caused him to lose money when prices were slow to recover, hurting his annual profitability, also affected by inflation and taxes on realized gains.

There are times when the price of a company can remain below its intrinsic value for a long time. This was noticed by Warren Buffett, who decided to abandon Graham’s technique and adopt that of his partner. Charlie Munger in Berkshire Hathaway.

Academic and investor Mary Buffet (formerly Warren Buffet’s daughter-in-law) explains in one of her books that the nonagenarian investor chose to give his investment strategy a business twist, a decision that over the years made him a living legend.

invest like an entrepreneur

For an investment to make business sense, according to Warren Buffett’s requirements, you must treat earnings per share as your own. This forces you to look only for leading companies with high rates of return that can beat the market.

If two companies are sold for 10 pesos each share after subtracting the debt, but one had annual profits of 2.5 pesos per share (a return of 25%) and the other obtained only one, Warren Buffet would already think about reviewing the business of the first.

But one last step before doing so would be to compare the share price and rate of return per share to fixed income. The Mexican rate at 11%, for example, which is paid at a discount, would require investing 22 pesos to generate something similar.

Constancy is the key

As his theory suggests, Warren Buffet views his stocks as bonds, but they pay variable rates of return. The ideal would be to find constant rates that provide predictability, but have an increasing trend over several years.

The second point Warren would review would be the company’s ability to grow profits over time. He would check to see if growth is more or less constant, so he can calculate a predictable compound annual rate of expansion.

If it can be determined that a company’s profits grow at a five-year compound annualized rate of 10%, it would raise current earnings of 2.5 pesos per share to 4.03 pesos per share in five years, an increase of 61.2 percent.

What kind of companies does Warren Buffet buy?

Warren Buffett perfected the Charlie Munger technique: he invests only in leading companies, with key products and competitive advantage positions; simple or proven businesses that do not require constant investments to improve.

Another point that Buffet looks for in a company is that it has the ability to adjust its prices according to inflation; that you have such strong demand that increasing the price of your product will not negatively affect sales.

Finally, returning to the issue of profits, Buffett would like the company in question to have the ability to keep most of the profits and have them add value to shareholders, such as in share buyback programs.

The price determines the rate of return

Buffet’s investments meet the characteristics mentioned by his daughter-in-law Mary, especially those that have made him richer. Among them we can find two very famous, Coca-Cola and Apple, the latter is almost 50% of its portfolio.

But his style isn’t just about finding the best companies, it’s also about adding them to the portfolio at the right times. One of these moments is precisely when everything is irrational fear in the market and generates exaggerated falls.

Contrary to what the traderswho buy anything when the price enters an upward trend, Buffett is interested only in profitable companies and tries to make his purchases at the lowest possible price.

“A simple rule dictates my buying decisions: be afraid when others are greedy and be greedy when others are afraid.”

Investments for life

An investment, understood in the broadest sense of the word, should not be taken over short time horizons. Investing like Warren Buffet would, in theory, allow you to beat inflation and avoid the need to sell, which entails tax burdens.

As Benjamin Graham explained, in the short term the stock market acts irrationally, but it is time that puts everything in its place. The prices are adjusted to the quality of the deals and the patience of the investor is rewarded.

jose.rivera@eleconomista.mx