Book Value Per Share: How Much is Your Equity Worth?

7 minutes

book value per share

Valuing a bank can be challenging and confusing, but it doesn’t have to be. Here’s the deal:

Book Value per Share is one the easiest accounting formulas out there that can help us determine the value of a bank or financial firms equity.

We will walk through this formula and how to find the numbers to plug into the formula, and voila! You will have a number that you can use to help you determine the value of that bank you are interested investing in once you find the right price.

I have said this before but valuing banks should be as straightforward as valuing any other company that you are interested in putting some money into.

There are just some different ratios and formulas that we need to know to help make it easier.

This idea comes straight from Warren Buffett, and if it is good enough for him, it is certainly good enough for me.

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Books on Investing: My 15 Favorite Books to Learn Investing

19 minutes

One of the best ways to learn about anything is reading. Books about investing get a bad rap for being boring, but I am here to tell you that is just not true.  Below is a list of my favorite books on investing. They range from beginners to more advanced books. They are all well written and very informative and have been a tremendous influence on me as well as countless others. Some of them are extremely well-known and are some of the best of investing classics. But they are still amazing and should be read by everyone.

I have said this before, and I will repeat it again. Learning about investing is like learning a new language. Reading is one of the best ways to immerse yourself in that language. As you learn more you will want to find out more; it is very addicting in that way. As you learn the language and build your knowledge, these following books will help you create more blocks to continue your learning.

There are affiliate links for these recommendations and based my choices on my opinion and the influence they have had on me and my journey. I hope you enjoy them as much as I have and am confident that you will benefit from them as well.

1. The Education of a Value Investor

One of my first books that I read about investing. Written by Guy Spier who is the manager of the Aquamarine Fund, which is a hedge fund that he runs out of Switzerland.

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Invest Like Charlie Munger Using His Four Filters

17 minutes

charlie munger four filters

“The difference between a good business and a bad business is that good business throw up one easy decision after another. The bad businesses throw up painful decisions time after time.”

Charlie Munger

We all want to know how to improve our investment decision making. How do we develop a better understanding of a company, its future, and present, its products? Over the years I have read all the Letters to Shareholders of Berkshire Hathaway. I have read most of the books and articles on Warren Buffett, and his mentor Benjamin Graham, and his partner Charlie Munger. I have also listened to hours of audio from interviews via Youtube. All in the effort to gain insights into how Warren Buffett developed their “framework” for investment decisions. And how they arrive at a winning investment decision.

During my research, I came across an interview that Charlie Munger gave to the BBC which discusses his thoughts on how a framework for making better decisions when making investment decisions. You can find the video here. The comments that we will be discussing occur at 5:59 of the video.

The framework is called the Four Filters, and it first appeared in the 1977 Letters to Shareholders in this form.

“We select our marketable securities in much the same way we would evaluate a business for acquisition in its entirety. We want the business to be (1) one that we can easily understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at an attractive price.”

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Return on Assets: How to Find Banks that Generate Profits

7 minutes

 

return on assets

How do normal investors like you and I invest in a bank? According to Warren Buffett, the answer is pretty simple. Look to the bank’s return on assets or ROA.

“Well, a bank that earns 1.3% or 1.4% on assets is going to end up selling above tangible book value. If it’s earning 0.6% or 0.5% on the asset, it’s not going to sell. Book value is not key to valuing banks. Earnings are key to valuing banks. Now, it translates to book value to some extent because you’re required to hold a certain amount of tangible equity compared to the assets you have. But you’ve got banks like Wells Fargo and USB that earn very high returns on assets, and they at a good price to tangible book. You’ve got other banks … that are earning lower returns on tangible assets, and they’re going to sell — they’re going to sell [for less].”

Warren Buffett

The attraction of return on assets is its simplicity. It captures so much of the essence of a bank, without getting caught up in the complexity of the big bank accounting mess.

In our continuing series of discovering the formulas and ideas to value a bank or financial institution, we will discuss the return on assets or ROA.

Definition of Return on Assets

So what is a return on assets?

According to Investopedia.

“Return on assets (ROA) is an indicator of how profitable a company is about its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings.”

This term is often referred to as return on investments or ROI.

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Efficiency Ratio: Is Your Bank Profitable?

10 minutes

efficiency ratio

Banks are either hated or loved, depending on when you ask customers. If they’ve been approved for that loan or denied a refund of any fee, you will get different answers. As a value investor, banks and financial institutions can be a frustrating experience to try to value. They don’t fall into the same category that other companies do, so therefore they often get ignored. Today we will continue with our series of looking at the different formulas that can help us unravel the mysteries of these institutions. In this post, we will delve into the efficiency ratio and what it means, and how to calculate it.

“In the end, banking is a very good business unless you do dumb things.”

Warren Buffett

The cool thing about learning to value banks is that once you learn how to analyze one, you pretty much can analyze all of them. There are about 500 banks that trade on the major exchanges, so this should give you plenty of options to choose.

Now, don’t get me wrong they can be very complicated with all the financial instruments, heavy regulations, old account rules, macro factors, and the intentionally vague jargon to try to throw you off.

But at their core, all banks are similar in that they borrow money at one interest rate and then hopefully, lend it out at a higher interest rate, pocketing the spread between the two. Which is the main avenue that banks use to make money.

“You don’t make money on tangible common equity. You make money on the funds that people give you and the difference between the cost of those funds and what you lend them out on.”

Warren Buffett

Definition of Efficiency Ratio

The Efficiency Ratio is calculated by dividing the bank’s Noninterest Expenses by their Net Income.Banks strive for lower Efficiency Ratios since a lower Efficiency Ratio indicates that the bank is earning more than it is spending. … A general rule of thumb is that 50 percent is the maximum optimal Efficiency Ratio

Sageworks

Sounds and looks pretty simple, doesn’t it? And as ratios go it is pretty simple and straightforward.

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Owner Earnings: One of Warren Buffet’s Favorite Formulas

10 minutes

owner earnings

Earnings season is upon us, as Wall Street chooses which companies to reward for a good quarter or punish for a bad quarter. Wall Streets obsession with earnings happens every quarter, the give and tug of who is rising versus the fallen. As value investors we don’t necessarily play this game, we are much more interested in the long-term outlook, as opposed to the short-term focus of earnings season. Warren Buffett eschews this mania, and instead, he focuses on what he calls “owners earnings.” These earnings to him are a better representation of the true earnings of a company.

This short-term focus that Wall Street has can cause a stock to rise or fall quite quickly, sometimes in the same day. As the bears and bulls of each side of the trade rush in and out to try to get a better position. This volatility can be maddening, and certainly, test the will of many people.

Buffett rises above this madness and instead chooses to hold a long-term approach that focuses more on the fundamentals of the business as opposed to the short-term earnings of one single quarter. These earnings that everyone places so much focus on can, and have been manipulated before, sometimes to great effect.

Many investors have been blindsided by this manipulation and have lost a ton of money because of the greed and deceitfulness of others. One way to avoid this is to do your research, and another is to adopt a long-term view that focuses on the fundamentals of the business and to see that they are doing the right things to grow the business.

What are Owners Earnings?

In the 1986 Berkshire Annual Shareholder Letter Buffett outlined his thoughts on owners earnings.

“If we think through these questions, we can gain some insights about what may be called “owner earnings.” These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges such as Company N’s items (1) and (4) less ( c) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume. (If the business requires additional working capital to maintain its competitive position and unit volume, the increment also should be included in ( c). However, businesses following the LIFO inventory method usually do not require additional working capital if unit volume does not change.)” 

Hubba, what? That was a mouthful, wasn’t it? Ok, let’s break this down a little bit. I liken it to eating a pizza, you can’t eat it all at once, as much as you would like, but eating it one piece at a time –

Owners Earnings = Continue reading “Owner Earnings: One of Warren Buffet’s Favorite Formulas”

Breaking Down the Two-Stage Dividend Discount Model for Beginners

11 minutes

two-stage dividend discount model

Dividends are the best friend an investor has. They are the gift that keeps on giving and finding a company that pays them consistently over a long period of time is a great way to build your wealth. Finding the intrinsic value of a dividend paying company is paramount to investing with a margin of safety. This helps protect our investments and grow our wealth. Using the dividend discount model is a great way to find that intrinsic value, and the use of the two-stage dividend discount model is a fantastic way to get a more precise view of that value.

Our goal is to find the approximate value of a company, not to quibble about the minor details, we must remember that valuation is an art. What one investor sees as value, another might see as a liability, it can be seen as in the eye of the beholder.

The dividend discount two-stage model is a little more involved than the Gordon Growth model that we addressed last week, but it is definitely doable on our part. We will walk through all the steps to help you calculate it on your own and give you examples to help illustrate what we are doing.

What’s the big deal with dividends, and why do we keep talking about them?

To give you an example of the power of dividends, let’s take a look at our favorite guru, Warren Buffett. Over the years Buffett has grown his wealth by investing in and buying businesses with strong competitive advantage (moat) that have traded at fair or better prices.)

His favorite company to invest in is one that pays him a dividend. Did you know that:

  • Over 91% of his portfolio is invested in stocks that pay a dividend
  • His top 4 holdings, which make up over half of his holdings pay a dividend yield of 2.9%
  • Best of all, most of his stocks have paid a rising dividend for decades.

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Dividend Discount Model: A Simple Three Step Guide to Valuation

9 minutes

dividend discount model

In our quest to find the intrinsic value of stocks that we are interested in investing in, we have looked at several different types of formulas to help us determine that value. We haven’t considered the role that dividends play in these valuations, and as dividend investors, this is an important fact to factor in. Today we will discuss the dividend discount model to find the intrinsic value of dividend paying stocks.

Dividends are such an important variable to building our wealth, it is in our best interests to continue to add to our toolbox the different methods of calculating intrinsic value. The dividend discount model is simplicity itself and requires only three inputs to determine the value of a stock.

As we continue to strive to find the fair value of any stock that we wish to purchase, it is important to remember that the calculations that we do should never replace other methods of investigation, such as reading the 10-k, looking into other metrics, and doing our research.

In our efforts to narrow down our investing processes and learn more about different formulas to help us find intrinsic value, it is important to remember that we should try not to go down the rabbit hole in search of minutiae. A thought from Warren Buffett on intrinsic value.

“It’s better to be approximately right, than precisely wrong.”

That being said we should strive to be as accurate as we can, to help narrow down our errors in finding intrinsic value.

Dividend Discount Model Definition

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Return on Invested Capital in Two Easy Steps

12 minutes

Warren Buffett

“A truly great business must have an enduring “moat” that protects excellent returns on invested capital.”

Warren Buffett, 2007 Shareholder Letter

Return on invested capital is one of the best ways to calculate whether or not a company has a moat. Finding a company with a moat that gets a great return on its invested capital makes investing easy, not that this is an easy thing to find. The reason this makes it easy is the company can grow their value over the years and you can compound along with it. Helping grow your wealth as they continue to add assets and grow their business.

The trick to finding a company that is a great allocator of capital is finding a company that has had success in the past getting a great return on invested capital. The higher the percentage the better allocators they are.

Today we are going to look further into return on invested capital. We will take a look at what it means and how to calculate it, along with examples for you to follow along.

Let’s dive in.

Definition of Return on Invested Capital

What is a return on invested capital?

“Return on invested capital (ROIC) is a profitability ratio. It measures the return that an investment generates for those who have provided capital, i.e. bondholders and stockholders. ROIC tells us how good a company is at turning capital into profits.”

Investinganswers.com

“We prefer businesses that drown in cash. An example of a different business is construction equipment. You work hard all year and there is your profit sitting in the yard. We avoid businesses like that. We prefer those that can write us a check at the end of the year.”

-Charlie Munger2008 Berkshire Hathaway Annual Meeting

Another great thought from Charlie. I love this explanation and this is a great idea to strive for, finding a business that is conservatively financed that can write us a check every year. Better yet, would be a company that in addition to giving us a dividend would be fantastic compounders.

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GameStop: Is this Game Still Worth Playing?

9 minutes

 

GameStop

Recently GameStop (GME) has taken a beating in the market with the release of some very unflattering news. As we all know the stock market is a very unforgiving place.

GameStop came across my radar a few years ago when I was doing my regular screening looking for new opportunities. Until recently I hadn’t pulled the trigger on the company, but after digging into it a little more it appeared to be a great opportunity. In the light of recent news, I am wondering if I made a good decision or walked into a value trap.

I admit I was first attracted to the 6% dividend yield, which was very enticing. In addition to the low P/E ratio, it appeared this was a great opportunity, as well as other financial strengths.

In this article, I will take a look at my findings again and re-evaluate my decision to buy and whether or not to stay in at this point or to sell and just cut my losses.

Retail is a brutal environment and the competition can be fierce. With the recent announcement of Microsoft’s (MSFT) Xbox’s subscription service there has been a lot of concern among GameStop investors in how this will affect the company long-term.

Let’s take a look.

Business Overview

Founded in 1994 in Grapevine, Texas. GameStop operates more than 7600 stores now. These stores are located in the U.S., Australia, Canada, and Europe.

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