Robert W. Bruce Lectures 2004-2007 to Bruce Greenwald's Columbia Class – Page 6 – ValueWalk Premium
Market Psychology & Value Investors Sell Everything

Robert W. Bruce Lectures 2004-2007 to Bruce Greenwald's Columbia Class

2003

1.95

9.8%

2004

2.44

12.2%

2005

3.05

15.3%

2006

3.81

19.1%

2007

4.77

23.9%

2008

5.96

29.8%

2009

7.45

37.3%

2010

9.31

46.6%

If you must buy a stock, Buffett says, make sure that the company’s earnings coupons:

 

  1. Can beat inflation
  2. Can beat govt. bond yields, which are priced to reflect inflation
  3. Can rise over time

 

Assuming a constant return on reinvestment, the price you pay determines your return. Compare returns when paying $40 per share vs. $20 per share.

 

Year

EPS

Coupon Return on $40 Price

2000

$1.00

2.5%

2001

1.25

3.1%

2002

1.56

3.9%

2003

1.95

4.9%

2004

2.44

6.1%

2005

3.05

7.6%

2006

3.81

9.5%

2007

4.77

11.9%

2008

5.96

14.9%

2009

7.45

18.6%

2010

9.31

23.3%

 

Once again the reinvestment assumptions of how the company uses its cash flow are the ultimate determinants of return.  Of course, as a fixed income investor, you know the reinvestment assumptions are very important in determining your yield to maturity. The same is true with common stock because, instead of buying a predictable cash flow, you are buying an unpredictable cash flow. Once again, the price you pay determines the return you get. The investment assumptions are the ultimate determinate of the enterprise. But the idea here is to think of being an owner, owning a piece of the enterprise. You are buying for the long haul. The idea being that you will probably not sell it unless it (the price of the stock) gets sufficiently above its intrinsic value.

 

 

  1. IV.              Now, what kind of company to look for?

 

One thing that comes up all the time is how do you screen stocks, what is the first thing you look for?  What I look for ideally is for good businesses. These are businesses that are consistently above average in profitability because of that they generate free cash and because of that they have low or no debt–all of these things go together. If you find a business that is superior in profitability, you will find it has nothing but good choices as to what to do with its cash: pay out dividends, buy back stock, reinvest, etc. A company generating free cash doesn’t have to borrow money.

 

So look for companies that consistently earn superior profitability. When you find a company that earns consistent superior profitability, then you need to look a little further. What is it about this company that allows it to earn superior returns and prevents competitors from coming into their market and pressuring those above average profits? This is the idea of a franchise business with a moat around it or a niche business.

 

What is it about Clorox that allows the company to sell a toxic chemical at a larger mark-up than a generic brand? The answer is advertising, the brand coupled with customer captivity. There are companies with patents that have great efficiencies, they control a regional geographic market. Less so than in the past, but there are one paper towns–monopoly newspaper. Warren Buffett said of the Washington Post, that if you gave him a billion dollars to compete against the Washington Post, he would fail miserably and he wouldn’t be able to dent the franchise. This is an example of an entrenched franchise with a moat around it.

 

The reality is in the very competitive world we live in, there are very few businesses, which have permanent moats. Franchises are under constant attack. Rarely do you have a business that has a franchise value and also the opportunity to grow. Companies fortunate to have a franchise business, they reinvest as much in that business as they can and still earn a superior profit. Rarely do they have the opportunity to reinvest their cash and earn the same returns as their original business. Probably the greatest success of my career and one of the greatest successes ever in one generation is Wal-Mart. In the space of one generation, a fortune of close to $100 billion was created. Wal-Mart was extraordinary, something I have never seen again, Wal-Mart (WMT) earned 25% or more on its equity and it had the opportunity to reinvest all its profits every year in new businesses, in new stores and continue to earn 25% or more–a wonderful compounding went on for a long, long time.

 

In contrast, Microsoft has huge cash flow, but there is nothing they can do with that excess cash to earn the high returns of their core business. MSFT has a

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