The Business of Value Investing.pdf

124 The Business of Value Investing

the leveraged portfolio equals a return on equity of 50 percent. The

same corresponding loss occurs with negative returns. Unfortunately,

most businesses fail to use leverage appropriately and opportunistically

and employ leverage at alarming multiples to equity. The results, as we

can clearly see, have been disastrous.

Wider margins are created in one of two ways: increasing prices

or decreasing costs. Very few companies can raise prices at will

without incurring competition or meaningful declines in volume.

Again, this is why Buffett bet so big on Coke. For decades, Coke has

been steadily increasing the price of its famous syrup with no mean-

ingful loss in market share as a result.

Profi ts count, but it ’ s what you can do with those profi ts over

time that really matters.

Key Takeaways

• Business valuation is a blend of art and science. Models are never com-
  pletely accurate. Compensate for this by always demanding a satisfactory
  margin of safety.


• Knowing the intrinsic value of a business allows you to apply the margin
  of safety. Understand that intrinsic value is an approximation and not a pre-
  cise fi gure.


• Seek out businesses with durable competitive advantages. They are
  the ones with the greatest ability to continue earning record profi ts, which
  increases the intrinsic value over time.


• Understand that the quality of the business comes before the quality
  of management. Fundamentally poor businesses are likely to stay that way
  regardless of the ability of management.


• When examining management, seek managers who eat their own cook-
  ing and are signifi cantly invested alongside their shareholders.


• Judge management on the increase in the book value of the company,
  over which it has complete control, not on stock performance, which is con-
  trolled by the market.


• Invest in businesses that demonstrate consistent ability to increase book
  value and returns on capital. Sooner or later, the stock price will catch up
  with improved fundamental performance.

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