A Number That Warren Buffett Cares Very Much About
If you leave $10,000 in a bank savings account for ten years, you may have $10,500 by the end of that time period. It's hardly worth doing. But give that same $10,000 to Warren Buffett to invest (he has averaged 22.2% per year since 1965) and you would end up after ten years with about $42,000, which is $31,000+ more than you would have received by leaving that money in the bank.
Wouldn't it be nice to know exactly how Buffett does it? Perhaps Warren is privy to some trick or maybe there's a secret to investing that makes the process a whole lot easier but that the average investor has yet to learn?
I'm not suggesting that it's easy to earn large investment returns. But the basic process that Warren Buffett uses is a single, time-tested method that is very simple to understand.
Warren Buffett is able to produce high returns year after year by focusing on one aspect of any business he invests in: the business's ability to generate free cash flow.
There are different definitions for free cash flow but they basically all come to mean the same thing. Free cash flow is money that a company makes by doing business. It isn't money that comes from selling off assets, or getting a loan. Free cash flow is money that comes from doing business. And it's called "free" because it's money that management is free to do with as it pleases after it pays all the bills.
The method for calculating free cash flow is very easy to understand. You take a company's net income, and add back certain non-cash charges like depreciation and amortization. Then you subtract how much capital spending the company must do in order to stay in business. The resultant number is the free cash flow.
Knowing one year's worth of free cash flow is just the beginning of the process. To do what Warren Buffett does with the information, you'd have to make an estimate of free cash flow for each of the next seven to ten years. And then you have to account for the fact that a dollar ten years from now isn't worth as much today as a dollar two years from now.
The process is simple to understand, but actually doing it can be very complicated. So perhaps the best approach would be to just buy the Berkshire Hathaway B-shares, and let Warren Buffett do it for you!
* * * * *
Wouldn't it be nice to know exactly how Buffett does it? Perhaps Warren is privy to some trick or maybe there's a secret to investing that makes the process a whole lot easier but that the average investor has yet to learn?
I'm not suggesting that it's easy to earn large investment returns. But the basic process that Warren Buffett uses is a single, time-tested method that is very simple to understand.
Warren Buffett is able to produce high returns year after year by focusing on one aspect of any business he invests in: the business's ability to generate free cash flow.
There are different definitions for free cash flow but they basically all come to mean the same thing. Free cash flow is money that a company makes by doing business. It isn't money that comes from selling off assets, or getting a loan. Free cash flow is money that comes from doing business. And it's called "free" because it's money that management is free to do with as it pleases after it pays all the bills.
The method for calculating free cash flow is very easy to understand. You take a company's net income, and add back certain non-cash charges like depreciation and amortization. Then you subtract how much capital spending the company must do in order to stay in business. The resultant number is the free cash flow.
Knowing one year's worth of free cash flow is just the beginning of the process. To do what Warren Buffett does with the information, you'd have to make an estimate of free cash flow for each of the next seven to ten years. And then you have to account for the fact that a dollar ten years from now isn't worth as much today as a dollar two years from now.
The process is simple to understand, but actually doing it can be very complicated. So perhaps the best approach would be to just buy the Berkshire Hathaway B-shares, and let Warren Buffett do it for you!
* * * * *
posted by Bob Moser at
6:50 PM
0 Comments:
Post a Comment
<< Home