2. Buy only when the price is right when the business is selling at a significant discount to its value.
Buffett's basic goal is to identify businesses that earn above-average returns, & then to purchase these businesses at prices below their indicated value. Graham taught Buffett the importance of buying a stock only when the difference between its price & its value represents a margin of safety. Today, this is still his guiding principle. The margin-of-safety principle assists Buffett in two ways. First, it protects him from downside price risk. If he calculates that the value of a business is only slightly higher than its per share prices, he will not buy the stock. He reasons that if the company's intrinsic value were to dip even slightly, eventually the stock price would also drop, perhaps below what he paid for it. But when the margin between price & value is large enough, the risk of declining value is less. If Buffett is able to purchase a company at 75 percent of its intrinsic value (a 25 percent discount) & the value subsequently declines by 10 percent, his original purchase price will still yield an adequate return.
The margin of safety also provides opportunities for extraordinary stock returns. If Buffett correctly identifies a company with above-average economic returns, the value of its stock over the long term will steadily march upward. If a company consistently earns 15 percent on equity, its share price will appreciate more each year than that of a company that earns 10 percent on equity.
"Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised."
(Source: The Warren Buffett Way by Robert G. Hagstrom)
No comments:
Post a Comment