Posted by In this video, Preston says at 11:30 mark to pause the video and evaluate how much money you are willing to pay for this ice cream business:
I will look at following points to estimate what price am I willing to pay for the ice cream business:
# First of all, I will look what return am I getting risk-free. The State Bank of India gives 6.4% per year. You can check on its website here. So, if I am taking any little amount of risk, I will only invest if I get more than 6.4%. Hence, in no case, I should pay more than 16 times of net income (100/6.4~16)
# I will also look at the growth opportunity. Is there any possibility that, that 20,000$ per year could become 25,000$ per year. If that happens I would be willing to pay more for the business since my return on investment will increase in future.
On the contrary, I will also be willing to pay less if there is any risk of that 20,000$ becoming 18,000 or 15000$ per year.
Revenue
#I will look at the Industry structure, competition and company’s moat or unique selling proposition. How are they different from their competitors
# I will look at the simplicity and longevity of the business. Means people are going to need it for a long long time.
These two points ensure the revenue will keep coming from customers
Cost of revenue
#I will look at the employees, management and owners. Are the employees happy to work there? How likely are they to leave the company? Are they part of any union? What is the background of promoters? What is their lifestyle like? Are they extravagant or penny pinchers? What is the shareholding of promoters? What is the skill set of management as well as promoters? How competent are they?
#I will look at the raw material supply. Is it sustainable? Can they face problems in future on the supply side?
The first point ensures that the employees are capable to run the business and not quit. The second ensures the sustained availability of raw materials.
Taxes
# I will look at the government interference in that industry, The tax structures. Is the industry heavily regulated?
This ensures that government lets the businessman run his business peacefully and not tax and regulate him to death.
#In a nutshell, I will look at all the parameters which will ensure that I indeed will be getting the promised net income with very little risk over a very long period of time.
Now, let’s say I went through all my assessment and after considering all the risk associated and everything, I want to earn 10% on my money. So, I would pay 10 times (100/10=10) of net income or 200,000$ for owning the whole business. If I am, willing to earn only 8% then I could even pay more than 12 times the earnings.
That is how Warren Buffett evaluates the business. Once you evaluate the price of whole business, divide it by no. of shares outstanding and you get the price per share.This will be the intrinsic value of that business. The value that you think is fair for the business. Then, look price of that share in the stock market, if it is below your price you buy it if not, you don’t buy it and wait for a better price.
That is exactly what Warren Buffett does.
Whoa !!! A rather interesting and intriguing post after a long time…. The youtube link you’ve put and the simple mathematical analysis you have showed are not just helpful- they could also trigger a layman to accept that shares are not risky if worked out mathematically with right estimations… Of course it shows why people like Warren Buffet don’t hesitate in investing in shares…..
Thanks Bro! Actually investing is nothing but buying a piece of business. We should always, always remember that there is a company behind every stock and if that company makes money sooner or later the stock will follow.
Most of the people they treat shares as if they were some lottery tickets.
Good post…. It would be great if you could elaborate on the first point under the head ‘Cost of Revenue’ in the above post…. Especially on how can one get a peek into the lifestyle, zeal towards work and satisfaction of the employees of a company…… Also the other questions you have posed in that point…… May be you could write an entire post about it…..
Cost of Revenue simply means the cost incurred in generating that revenue like the raw materials consumed etc. You can get an idea of the lifestyle of owners by your art of judging people. You can search google the owner, search on Youtube you will get plenty of materials on them. For example, if you search about Vijay Mallya and Warren Buffett you can easily guess who is a careful spender and who is careless and extravagant. It is completely an art.
I have recently created this Resource Page, where I have listed all the sources from which I have built my current knowledge and understanding about money, business and investing. Do go through it. I will update it regularly. You too can develop a pretty good understanding of the game if you go through all of them.
So good from your part to have shared that resources page…. You can always promote that page and other posts with your answers on platforms like Quora or reddit, which shall help many other people know about the precise material to start from, in the investing sector… Thanks……
Actually, that is a great idea. I am renaming the resource page to start here 🙂