WARREN BUFFETT’S LETTER – 1994 – 1995

WB Letter 1994

Mr. Buffett has mentioned that they are ready to wait for opportunities within their comfort zone. They do not like to capture each and every opportunity but want to capture an opportunity within their circle of competence. He added that they have picked up their best investment when some of the macro factors are at the peak. Here, we can also make an interpretation that we also can make a good investment when the macro is at the peak of worst situations such as 2008 global crisis, 2013 depressed economic growth with policy paralysis, etc.

Own investment approach

Book Value and Intrinsic Value

Mr. Buffett has explained how we need to look at the growing business in-terms of earning and not huge growth into the book value.

Berkshire has made an investment into the Scott Fetzer at the beginning of the year 1986 with having a collection of 22 business which is the same in the year 1994. They paid $315.20 million for Scott Fetzer which having a book value of $172.60 million.

Performance of the book value given by Mr. Buffett of Scott Fetzer –

We can see that book of the company has not grown but earnings of the company have grown approximate double. Also when Berkshire has made an investment into the company then the company has debt on balance sheet and in the year 1994, the company becomes virtually debt free. Return on equity has been improved well.

Intrinsic Value and Capital Allocation

Whenever merger and acquisition made by a management then they should have the focus that whether the intrinsic value of the company is increasing or getting diluted.

We need not make a difficult investment for getting a good return if we can able to analyze business which is easy to understand and its economic characteristic are long lasting then we can get a good payoff for our investment.

They also give priority to the existing investment rather buy a new investment. They compare that which investment opportunity is more beneficial to them.

Mistake Du Jour

Mr. Buffett has mentioned that purchasing a USAir in the year 1994 as his mistake.

WB Letter 1995

Acquisitions

Mr. Buffett has explained regarding acquisitions that when the company has a business which is performed sometimes and worsen at few times then we need to sell the business when it is performing well. Majority of the company doing same so that when the acquisition of any company happens then majority of the time acquiring company does not get a benefit. We need to carefully analyze that whether acquisition increases a per share intrinsic value for shareholder or not.

Examples of wealth destructor companies through acquisition

One of the medical device company which has done reverse compounding of the wealth of investors –

One of the wind energy company which has done reverse compounding of the wealth of investors –

Helzberg’s Diamond Shops

Helzberg’s Diamond Shops was started by the grandfather of Barnett Helzberg, Jr. In the year 1915 with a single store which has increased to 134 stores in 23 states. Sales had grown from $10 million in the year 1974 to $282 million in the year 1994. Berkshire has taken stake into the company in the year 1995.

R.C. Willey Home Furnishings

R.C.Willey is the leading home furnishings business in Utah. Bill Child, CEO of R.C. Willey has taken over the business from his father-in-law in the year 1954 when sales were about $250,000 and he put efforts which resulted into the sales of $257 million in the year 1995. Company accounts for 50% of the furniture business in Utah.

According to Mr. Buffett, Retailing is a tough business –

GEICO Corporation

Mr. Buffett has bought GEICO into his personal account when he was at the age of 20 years.

Float

Berkshire has not only compounded business earnings but also compounded its float. Since the year 1967 to the year 1995, Company has compounded its float by the compounded rate of 20.7%.

Examples of the companies which generating 10%+ ROA and compounded float –

One of the automobile and commercial vehicle company which has created a huge wealth –

One of the automobile company which has created a wealth –

One of the FMCG Company which has created a huge wealth –

One of the Asset Management Company –

Charlie and Buffett believes to control being wrong and follow – “Just tell me the bad news; the good news will take care of itself”

Disney

The merger of Cap Cities into the Disney approved in the year 1995 where Cap Cities shareholders get a choice of cash or share of Disney (one share of Disney for one share of Cap Cities). Berkshire has selected share option for their 20 million of Cap Cities shares.

Mr. Buffett has been interested into the Disney since the year 1966 where Disney was available at ~23% of pre-tax earnings yield (23% = $21 million of pre-tax profit / $90 million of market value).

Berkshire always respects shareholders though they hold large size or small size.

Warren Buffett’s Letters 1957 – 2012

LEARNING INVESTMENT LESSONS FROM MOVIE “SANJU”

Previously I have written a post on learning investment lessons from movies such as “Chal Man Jeetva Jaiye”, “Dangal”, “3 Idiots” and “Rajneeti”. Now, I am going to write a few investment lessons from another movie “Sanju”. Sanju movie having very negative comments regarding the reliability of the story but not be go deeper into it. This movie has a very inspirational story and as well as many lessons which we can implement in our life & in our investment career.

• We need a mentor who helps us with identifying right or wrong decision

Extract from the movie – We have seen in a movie that Sanjay Dutt having a many up and downs in life and during those tough time Mr. Sunil Dutt has helped him with proper guidance. Due to his guidance and support, Sanju can achieve success. Many times, we require a proper guidance which can help us with making a difference between right or wrong decision.

We have seen in a movie that whenever Sanju get confused, Sunil Dutt has shown him a way to get out of such a situation. He has supported him, encourage him to achieve success. Sunil Dutt has encouraged Sanju to make a right decision and also support when Sanju got stuck into worst situation. Books also in our life work as a mentor. When we do not have a mentor, we can take a help of books which help us with a selection of the right decision. Mentor help us to come out from the struggling situations where we are not able to find out the proper way.

Co-relation in investment life – Our investing life is as similar, we require a true mentor who helps us with a proper guidance and supports us in identifying a right or wrong decision. Whenever we get confuse he can help us with his wisdom which can uplift us to the next level. If we do not have a proper mentor then we should select books and try to learn from it. I had a conversation with few of a successful investor and they told that they did not train by a mentor but they read books from Graham, Phil Fisher, and letter of Buffett and prepare themselves for an investment journey.

• Drugs and suicide are not a solution to any problem

Extract from the movie – We have faced many problems in our lives and we have to fight with those problems, not give up against those problems. Many a time, people do not just give up against problems, they also start taking shortcuts for getting solutions for staying away from problems such as alcohol, drugs & suicide. Shortcut never provide us with a permanent solution against problems, also its effect badly to our loved ones. We have to fight against those problems and solve it permanently. We have seen in the movie that Sanju has started to take drugs or choose to commit suicide to come out of the difficult situations but that did not provide him with a permanent solution. When he decided to fight against difficult situations then he got a proper permanent solution. I can say it from my experience, I have also faced a few situations which are similar to the movie, I also got depressed but I chose to fight rather take a shortcut. And I am sure many of us chose to fight rather to give up. Fight against difficult situation seems easy compared to short cut but always provide us a proper permanent solution.

Co-relation in investment life – Similar to our life, we have also face difficult situations in our investments career. Many of us face it, fight against it rather take a shortcut. We failed during our investment career many a time, our investment might work worst, and it might not perform as we have thought. If we learn from those difficult situations, increase our efforts to become stronger and decide to fight for the success of our investment career, then we can achieve success in our investment career also. Those who are not able to fight against difficult situations, they choose to take shortcuts such as leaving of investment field (suicide from investment career), taking investment ideas from others, getting dependent on others’ tips (such work as a drug for us). If we take a advice from the mentor for building our investment career more stronger and enhance our efforts to become stronger then it will be a permanent solution for the difficult situation during our investment career. We grow stronger, our investment decisions improve wiser when we face difficult situations and fight against it, learn from it.

• Sometimes music / other than core work helps to heal us

Extract from the movie – Whenever we are depressed or found it difficult to focus on our core activities then it is better to work something else which can help us to getting heal from our depression and with it, we need to keep on trying to get back to the focus on slowly to our core activities. When we are depressed, distracted or disturbed then it will be difficult for us to get back our focus on our core activities. So that first, we should try to come out of the depressed situation. This really helps us to get back our concentration and become normal from depressing situations. I usually listen to music, do a workout or take a sleep which has to help me a lot to come out of the depressed situation and I can able to again focus on my core activities. We have seen in the movie that whenever Sanju got disturbed, distracted from his acting career, Mr.Sunil Dutt has helped him with music and music has healed his depression.

Co-relation in investment life – Similarly when there is a depressing situation for us in our investing career then rather be getting panic, we should focus on the some of the activities which make us feel better and relaxed. This will reduce our stress, heal our depression so that we can again focus on the investing activities. We have faced such situations many a time during our investing career, investment does not work as we assumed, all assumptions are in place but still not perform in a manner it should perform, etc. These all make us depressed and if we continue to focus on investment with such a depressed mind then there will be a higher chance to make a huge error, bigger blunders. It is better first to be normal and be relaxed then need to again focus on investing activities. Many a time, Small happiness do big miracles. And making a temporary distance from core activities will help to come back with more strength.

• Need a good circle of buddy

Extract from the movie – We have seen in the movie that Jubin has the spoiled life of Sanju. Due to Jubin, Sanju has started taking drugs & became abdicated to it. Whereas Kamlesh has helped to Sanju for coming out of his drugs abdication and also supported in tough time. If we have a good circle of buddy then they help us to put forward our views and get right views from them. They do not show selfish behavior to us but they provide us a view which is right for us, not views which feel us good. They make a debate with us on views, opinions which create stronger decisions, stronger execution. So that we need a friend like Kamlesh not like a Jubin.

Co-relation in investment life – Similar to the investment field, we need a circle of a good friend who told us which kind of mistake we have made, who support us during our difficult time, who can make a debate with us on our investment ideas which make our decision stronger. This helps us to make a wise investment decision rather than a biased decision. We have to differentiate who provide us a right view and who provide us a view which makes feel us good. If we stay with the wrong circle of buddy then we always get biased views, they provide us a view which we want to hear. Such views feel us good but not build us wiser. Many a time, we may be missed some important points and if we have the good circle of buddy then we can make discussion with them, we get proper views. I learn that such circle should not be huge, we have few buddies, maybe a max circle of 3-4 members.

• People will comment negatively, they are judgmental. Shut their mouth with success

Extract from the movie – We have seen in the movie that people, media has made negative comments regarding careers, drugs addiction, consider him a terrorist, etc. But Sanju has made a comeback and achieve a success. Media has put a question mark on his career, also everyone considers that he is finished & never able to come back to his earlier success. He has put efforts to develop himself and come back to his earlier success.

Co-relation in investment life – Such kind of negative comments, we also get during our investment careers. When our investment ideas do not perform well, we have made some mistakes, we face the difficult time to get proper investment ideas; then we get criticism from people. Many negative comments we get from people, but rather getting depressed with those comments; we need to put efforts on our career. We should focus on putting efforts into our career rather than responding to people. We need to work on identifying our mistakes, learn from it and put efforts to build us wiser. We should work on identifying good investment ideas and build a good portfolio which helps us to create a wealth. Such wealth creation is a response to all negative comments made to us, rather to replying with words to everyone. Negative comments should work for us as a motivation to develop ourselves rather depress us. And if we found useless negative comments from people then need to remember ustaad no. 3 from the movie – “Kuch toh log kahege logon ka kaam hai kahena, chhodo bekaar ki baton mein kaheen beet na jaaye rainaa”

• Always hope for the best days coming after worst days

Extract from the movie – We should not give up by experiencing difficult days whereas we should hope for the best time. Our life also works in a cyclical manner, we have worst days also and best days also but never one remain forever. We have seen in the movie that Sanju became a drug addicted but after proper treatment, he again became normal. Also, he has faced many failures in acting career but after putting efforts, be able to achieve success.

Co-relation in investment life – Many a time in an investment career, we faced difficult days but we should put an effort also during those days with the hope of best time is on the way. Sometimes our investment does not work in terms of stock price but all our assumptions for investment are in place then we have to keep faith and hope for the best and have a patience.

• There is another side of the story, do not just blindly believe in whatever we see or hear

Extract from the movie – We have seen in the movie that Anushka Sharma has played a role where she does not believe blindly to any of the information. She searches for the evidence, truth, and meet people who can help her to reach for truth. If she believes in the information which was given by Jubin then she is not able to reach the truth of the story. But she takes his information as a starting point for an investigation and searches what is the truth.

Co-relation in investment life – It is very essential for us to not believe any of the information blindly. We always look at the information suspiciously and try to find out evidence for the information. If we blindly believe on the information and those information proves wrong then we may incur a huge blunder with our investments. We have to see the story from different angles then only we identify and reach the conclusion that whether it is correct in the way it seems on the first instants. As an investor, it is our duty to check the available information to us rather believe in it and make an action.

If we trust ourselves then we can achieve success in our life.

SIMPLE IS BETTER – ISSUE -11 – CASH FLOW STATEMENT

We have seen profit and loss account in Issue-8, Balance sheet in Issue-9 and Relationship between balance sheet and profit & loss account in Issue-10. After understanding of Profit & loss account and Balance sheet, we move forward to the third financial statement in the current issue that is “Cash flow statement”.

“The cash flow statement shows how much cash comes in and goes out of the company over the quarter or the year.” – Investopedia

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -11 – CASH FLOW STATEMENT

SIMPLE IS BETTER – ISSUE -9 – OUR LIFE AND INVESTMENT – 3

We have seen profit and loss statement in issue 8. Now, in the current issue, I am going to discuss on the balance sheet. The balance sheet is another important financial statement which is essential for analyzing the financial strength of the person and of the company.

“A Balance Sheet is a statement of the financial position of a business which states the assets, liabilities, and owners’ equity at a particular point in time. In other words, the balance sheet illustrates your business’s net worth.” – The Balance

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -9 – OUR LIFE AND INVESTMENT – 3

SIMPLE IS BETTER – ISSUE -7 – OUR LIFE AND INVESTMENT

I have talked about compounding and benefits of compounding in all of the previous issues of Simple is the better series. Now, from this issue, I am going to discuss similarities between our life & making an investment and how we can learn many things in investing from our life. We also can learn many things in our life of the equity investment.

We can able to create wealth while we have a thorough understanding of the business and the phase in which it is operating. We need to work hard on an understanding of the business for protecting damage to our wealth and also as an investor, we are becoming a partner of the business not an owner of a piece of paper.

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -7 – OUR LIFE AND INVESTMENT

BIBLIOPHILE: THE MOST IMPORTANT THING BY HOWARD MARKS “UNDERSTANDING RISK”

For making any investment decisions, we have to be dealt with the future, which is uncertain in nature. So, that when there is an uncertainty, then there is an involvement of risk and we cannot escape from the risk. We must have to focus on asserting risk while making any investment decisions.

When we focus on the return of the particular instrument, then we have concentrated our focus on half of the movie and rest half will get completed with asserting risk in that particular investment.

Traditionally, we all have learned, that in making a higher return, we need to take an incremental risk.

But we think logically about the same that if we get a higher return for the taking of incremental risk than there should not be a risk. We get rewarded by the returns for taking a higher risk.

Traditional risk/return graph has communicated the positive relationship between risk and return but ignored uncertainty involved for making such returns. Additionally, traditional risk/return graph has shown a risk as similar to volatility, but not focused on the danger which is involved in the investment.

Many a times volatility cannot be an as riskier as compared to other dangerous events for our investment.

So, that risk is not a volatility in the price of stocks, but the real risk is the permanent loss of our capital. And we must have to be worried about the permanent loss of capital rather than volatility. We must have to focus on the understanding of the risk which could have the probability of erosion of our capital.

Many a times risk is not only limited to, permanent loss of capital or to volatility, some kind of risk are objective and personal in nature; such as-

1) Falling short of one’s goal

Many investors have a different need, goals and not meeting those by investment results can be the risk for the particular person.

If someone just requires meeting the routine expenses, then getting a fixed return from fixed return instrument might not be at risk for the person, but if someone who wanted to build capital for investment then such a lower return can be a risk for that particular person.

2) Underperformance

Such kind of risk is related to the investment manager. If the investment manager cannot able to generate higher returns compare to index than the investment manager might lose his clients.

3) Career risk

This is an extreme form of underperformance risk. Continuous underperformance can have resulted in the risk to the career.

4) Unconventionality

This risk is connected with a being different while making an investment idea. If unconventional idea got wrong, then there might be a risk to the career.

We buy metals, sugar stocks, etc. (at the worst time of the cycle). Instead of buying pharma, IT, Banking which is a darling of the industry. And if our stock picks up doesn’t work, then we have to face trouble and extreme risk of loss of career.

5) Illiquidity

This risk arises when investors need a money for some urgency and unable to break his investment.

Let me take an example of the cricket match for understanding a risk.

The main risk in the cricket match is to losing the match, series, etc. as similar to losing our capital in investment. If all the players play a poor game, then definitely team will lose the match and similar to an investment; if all our investment resulted in poor returns or more risk oriented than we might lose our capital or lose real value of capital.

As we have seen in Indian cricket history that Mr. Sachin Tendulkar, Mr. Rahul Dravid has played very well and created the record, they don’t always come to the ground for making a century or creating a huge score but always played well for protecting their wickets. Their focus on protecting their wicket helps them to play well for the longer period of time. And on against to them, many other players came to Indian cricket history and gone also; cannot able to stay for a longer period of time. They just have focused on making a score and sometimes due to the luck they can able to make good score but not always.

If players do not able to play well on a continues basis, then they will have lost the opportunity of staying with the cricket team (Career Risk). Also, we have seen that Mr. Mahendra Singh Dhoni has taken a many unconventional decision for the team during the match. Many of his decisions got success and many not. When he filled with his unconventional decisions, he has to face the anger of the people. This is as similar to our unconventional investment decisions and has to face anger from our clients if we filed into the unconventional decisions.

It is not necessary that we only can be incurred a loss by buying weak fundamental stocks. If we bought the comparatively lower fundamental company at a very lower price than that investment turns out to be a successful investment.

We can see that if we have bought the comparatively lower fundamentally good stock at a cheap price than this stock has generated a higher return compared to the good fundamental stocks in last 5 years.

Also, not good macro environmental promises of safety. Because too positive news brings up prices at too high and any small adverse development can be enough for damages to our wealth.

People generally tend to associate with the things that are doing well. And that investment might be able to fulfill expectations for a while and thereafter small negative event can damage much higher. Such scenario having an involvement of higher risk.

So, that value investors believe in achieving higher returns from lower risk. We have to be ready with underperformance risk while we are buying bargains and market is in a heated bull phase. We need to accept it rather than incurring losses.

Investment is dealing with the future and the future is highly uncertain. And it’s impossible to know anything about the future.

Risk means more things can happen compared to what happened in the past. Understanding of risk requires a second level thinking and it’s not an easy task. The risk of losing money is observed by one that’s similar is not observed by another one.

Read for more detail: The Most Important Thing Illuminated by Howard Marks

SIMPLE IS BETTER – ISSUE -6 – HEALTH IS WEALTH

In the last five issues, I have discussed regarding compounding and its power and how we can able to take benefits of compounding for a longer period of time. But for taking a benefit of compounding, we need a time – a long time; with a good health. Otherwise, we cannot able to enjoy our wealth or might not be there to enjoy our wealth. So, that, in issue 6, I am going to discuss on our real wealth which is our health and how it is as similar as we make an equity investment. Also, additionally to improve our health and wealth which can help us in a longer period of time.

By getting the benefits of compounding our money, we can be able to become a wealthy person, but if we do not have a good health then that compounded wealth is of no use. So, that we also need to compound our strong health for enjoying our compounded wealth in a longer period of time.

For Detail Issue, Click here —> SIMPLE IS BETTER – ISSUE -6 – HEALTH IS WEALTH

Equity Investment is as similar as a Human Life

This article born at the train yesterday when I was coming back to Surat from Mumbai after attending wonderful seminar of Dr. Vijay Malik Sir. A good utilization of spare time which I got at train.

Yes, there are some of the similarities between our life and stock market or equity investment. Our life is as similar as we make an equity investment.

I basically try to encourage equity investment and sharing my learning in simple manner as much as possible.

As I always consider our life and equity investment in a similar manner. But I got inspiration to write this post from article (15 unknown flops of successful people) which I read few days back.

From that article I inspire to connect dots and try to explain that our life is as similar as an equity investment.

 

So how there is a connection between Human Life and Equity Investment????

Let me take examples of few successful persons.

1) Steve Jobs

One of the person whose life has impact on my life. We know him today as a very successful person but have we check that how was his earlier life when he was struggling.

In today’s world, we known him as a highly successful person but in his previous life, he also got many shock. And he fights against those shocks and run for his dreams.

We never try to focus on the pain which any successful person faced.

Let me take one another example of our most favorite person in the investment field.

2) Warren Buffett

We currently seeing him as a very successful person. But what about the pain he faced in his earlier life.

You all might thinking that at investment blog why I talking about philosophical talks. So let me give you an examples of few successful stories from our investment world.

1) Infosys

We everywhere found that Infosys is one of the biggest wealth creator. But my dear friends have we check pain which company faced at different phase of its life cycle.

IPO of company got withdrew from market due to not reached at minimum subscription. Anyone had an idea at that point of time about the company which rejected by everyone and that becomes biggest wealth creator.

If we look at above chart of Infosys, then we can come to know that many a times price of the stock goes down with many of reasons such as IT bubble burst, 2008 crisis, Narayan Murthy resign, etc.

2) Wipro or Eicher Motors

See the wealth creators, all stocks having some down moves in stock prices. That can be with any of the reasons such as global crisis, recession, internal problems. But the good company with good jockey can come out of from all such problems and able to create wealth.

So try to connect dots with my above example of Steve Jobs and Warren Buffett with this stocks stories.

Do you able to make sense?

Let me explain my view point. The people who got failed at some point of time in their life but becomes huge successful by fighting against their failure.

As same as many good companies facing trouble at some point of time and try to fight against those problem and try to come out of those problems.

If we have make an investment in such a good companies our life also become successful.

Just leave these big names; highly successful people and put ourselves in place of them.

We also faced many problems in our life. From our childhood to our current life. Every day we are facing many events. Some events make us much happier and some make us unhappy.

So with happier events graph of our life goes up and with unhappy events graph of our life goes down.

So as similar as daily movements in the stock price. When we are not focusing on our own daily behavioral fluctuations then why we are much seriously focus on daily price fluctuations of the company???

As with the unhappy moods, we don’t stop living our life then why with some down price moves, we ready to take an exit from our stock investment???

As we are comparing our life’s progress at some intervals as similar to that we should compare performance of the company at some intervals rather focusing on daily price moves.

If I try to put our minutes to minutes’ behavior in graphical format, then it also looks as similar as price moves of the stocks.

Then why we are not ready with similar kind of behavior with stock investment.

We are not feeling risk by making many decisions related to our life but feel risk when it’s comes at an equity investment. What a funny behavior!!!!

According to me, actually our behavior having much more fluctuations compare to fluctuations in stock price.

The main problem is that we are not focusing on fluctuations in our life.

We take monetary fluctuations at a more serious manner then fluctuations in our own life.

So my purpose of writing this post is that equity investment is also as similar as our life which we are living. Thus, handle it as similar as we are handling our life. Also provide time to your investment as time we are living our life.

If we are ready with providing other chance to our life, then should also be ready with same kind of behavior with our equity investment.

But in actual manner, we are not doing it. We focus on very smaller fluctuations and make our decision based on those smaller fluctuations.

If we think on a longer horizon, then might found our such behavior as a very foolish.

So now at last conclusion time I just want to mention that as we provide motivation to our life when adverse events happened with us as similar with the equity investment, we should try to add additional fund when good company facing adverse time in form of motivation.

This additional motivation creates real difference and that decides rather we become successful or meet failure. Rather we become another Steve Jobs, Warren Buffett, Bill Gates, Henry Ford, Richard Branson or die as an unknown personality. As our investment becomes successful or we just become spectacular to watch wealth creation by other people.

So treat our equity investment as similar as our life and keep motivate our investment with additional funds when we get an opportunity to build good wealth.

Bonus

Friends keep motivate our good investment not our bad investment otherwise at the end we keep facing problems.

Stay away with such a bad horse with bad jockey or else we have to suffer a lot.

And at last we regret on our own decisions.

Disclaimer: The stocks discuss in above article is only for an example purpose. This is not a recommendation to Buy-Sell-Hold. And I am not a SEBI registered analyst.

What is RoE (Return on Equity)? And Why always consider debt when calculating RoE?

Dear friends,

Let me try to explain Return on Equity in a simple manner.

What is RoE (Return on Equity)?

“Return on equity measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested.” — Investopedia

Return on Equity = Net Income/Shareholder’s Equity

That means in a simple manner % return which we earn by making profit from amount which we have invested, our own money.

If I had put Rs.100 in bank FD and on that Rs.100, I get Rs.8 then my RoE (%) on that particular investment is 8%.

Higher the RoE (%) means we can able to generate higher profit by utilizing our funds. So that incremental profit generation helps us for fulfilling our wishes and also can able to secure our future also.

The same concept applies with company’s RoE (%).

Higher the RoE (%) means company can able to generate higher profit by utilizing their funds. So that incremental profit generation helps to the company to survive for the longer period of time and also can able to make good wealth creating decisions.

Always high RoE (%) is good and should believe it blindly ????? And not to believe it blindly then why?????

Now, question is why always consider debt when calculating RoE????

What is debt?

“Debt is an amount of money borrowed by one party from another.” (Investopedia)

A debt arrangement gives the borrowing party permission to borrow money under the condition that it is to be paid back at a later date, usually with interest.

Means borrowing Rs.100 with conditions to pay back with Rs.110, if 10% interest rate.

Let me explain 3 different situations with an examples —

So that with a higher debt level, RoE (%) shows higher because of lower level of own fund and profit is excess of interest payment. But what if odds get wrong.

Risk and uncertainty never comes to us with prior intimations. So we must have to be very careful.

Sometimes its happen that we stay lucky enough to not faced risk in our life time but surprise and shock happens as it never happens before.

https://www.youtube.com/watch?v=hQs47IT-d78

Now, let me take an example with the situation where surprise come and start earning low profit —

Thus, as company or an individual who having higher level of debt then they only benefited till negative surprises not come to their life. But as negative surprises start coming then survival become a question mark for the companies as well as the individual.

This is only the reason why we try to select business having no debt because if worst happens then also business can able to survive.

And if we found business with debt then must need to check earning and interest payment situation. Earning must be much higher then interest payment; so that can chances to survive with the worst situations.

Bonus

Same we do also in the stock market —-

We forget worst scenario when surrounding us all happens good and start believing that

But my dear friends, time is always the same.

And then result of believing this time is different is —

Just one single moves enough to destroy us if we have built our portfolio on leverage or play with stock market with leverage.

Time always remain same; it’s a pendulum so not focus on making early huge returns which can cause to destruction of your life.

Inspired by — Safal Niveshak and Fundoo Professor

 

Pat Dorsey Moats

On 17th January 2016, I got an opportunity to address one group of investors. I am so thankful to all my friends who provided me such an opportunity.

Investor Philosophy – Pat Dorsey

This presentation (Click here Pat Dorsey) based on what I learned from Pat Dorsey and about his philosophy.

Company A earns High profit / High Return on Capital that attracts many players to the same industry; which resulted in a higher level of competitions. Higher competitions affect to the margins of the company A and continuously increasing competition affects to the earnings of the company A. and if company A doesn’t have any Competitive Advantage then the business of company A can be in problem.

So the question is what is the competitive advantage?

Now, let me explain with a simple example that how USP helps.

Above all are benefits of having a strong USP of Rajinikanth. Now, compare these benefits to the business class.

So before understanding, what is the competitive advantage? I explain what can not be a competitive advantage?

If a company cannot able to raise the price of the products/services then we should understand that there is an absence of competitive advantage. (Eg.: – ITC Ltd. – Budget imposes the duty on cigarette but company easily able to pass those costs to the customers and that’s the reason for the survival of the company in adverse situations.)

We can easily able to recall brands. Meggie is becoming synonyms for noodles, Fevicol becomes synonyms for adhesive, and Colgate is becoming synonyms for toothpaste.

Also, the company which has the ability to change consumer behavior that Amazon has done (From traditional bookstore to online bookstore).

Patents & Licenses can be useful for protecting the interest of business (not considering strong moats because after the expiry of patents other companies also can able to register it and licenses can fall in the compliance risk).

Any psychological barrier or any cost associated with a switch from using current product/service to other product/service.

As the addition of new users make the network more and more strong and replicating such model becomes very difficult.

Low-cost producer compares to other players in the same industry.

Wide and strong moat resulted in the long-term Return on Capital generation and if absent of moat not able to provide long-term Return on Capital to the business.

Bad managers destroy business for own enjoyment and ambitions.

Now, what to select and what to avoid is up to us. If we able to select good business with the good manager then wealth creation become more effective. That is like the good horse with the good jockey that can able to win a race.

For more details, Kindly check — Part 1 , Part 2

Inspired by — Pat Dorsey Moats

Disclaimer: This is not a recommendation to Buy-Sell-Hold. And I am not a SEBI registered analyst.

I am really grateful to – Mr. Neeraj Marathe Sir, Prof. Sanjay Bakshi Sir, and Mr. Vishal Khandelwal Sir.