Last time we stated it’s better to buy a great company at a fair price than a fair company at a great price. Last time we looked at what constitutes a great company. Now let’s concentrate on what’s a fair price. It’s very important, because long-term economic value is the secret to exploiting short-term market folly.
The reason may seem evasive, but it is fundamental to Buffett type investing. You see, buying stocks is risky, at the best of times. So, in order to purchase, you need a ‘margin of safety, determined by the stock’s price. In short, “Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised,” says Buffett. According to Benjamin Graham, Buffett’s teacher, there must be a “margin of safety.”
That’s why Warren Buffet advises to “Look at stock market fluctuations as your friend rather than your enemy - profit from folly rather than participate in it.” Fortunately, you are never forced to buy at a given price. “The stock market is a no-called-strike zone. You don’t have to swing at everything-you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, “Swing, you bum!” says Buffett
But it is also important not to buy cheap stocks. It is more important to buy stocks cheaply. Buying cheap stocks is the cigar butt approach to buying stocks – “You have a few good puffs before they expire, says Buffett. This is not the approach Buffett advocates.
So what’s a fair price in mathematical terms? There’s no simple answer and it’s not an exact science. As Buffett says, “We don’t need a number to say when a person is fat. It’s self evident.” Still, numbers help.
Let’s look at those numbers. Let’s look at Coca cola in 1988. That year Buffett bought 113,380,000 shares at $5.22 a share. What made it a good buy was that it paid more money than a long term government bound. This came in two forms –a dividend equal to 14.2% and returned earnings of 33.6%. Because of this value, Buffett would have seen that this represented excellent value when he bought it.
I am not a great statistician, so I find values like this hard to use. I do find however charts provided from the Canadian Share Owner Club very useful. Owner John Bart keeps these up to date and I’d recommend you give them a look.
Buffett’s main philosophy is simple. “Be greedy when others fearful and fearful when others greedy. If you cannot be greedy when others fearful, at least be not fearful. That’s the key to success.”
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