This week, we dive straight into a Margin of Safety analysis to evaluate a company’s future with simple financial calculations. In order to know what we’re buying is a good deal, we need to be able to project what it will be worth in the future.
In Episode 46 You Will Learn
- Why Warren Buffett believes ‘Margin of Safety’ are the most important words in investing.
- How to calculate margin of safety.
- How to calculate the growth rate of our hypothetical lemonade stand from Episode 45.
- How companies try to fool you by making their earnings appear larger than they really are, and what to do about it.
- How to average out the growth rate of a company.
- How to calculate the first half of a Discounted Cash Flow (DCF).
- Why investing should not be like gambling.
Margin of Safety Notes
Things you need to know in order to calculate margin of safety:
1. Current earnings for last 12 Months –Trailing Twelve Months Earnings (TTM Earnings).
- With where the company has been, we can predict where it’s going to be.
2. Growth rate of earnings through 10 years.
- If you can’t predict it, the company might be too volatile
3. Price Earnings Ratio (P/E Ratio)
- Will get bigger if a company is growing vs. not growing.
- Public companies sell for about double what a private company sells for.
4. Minimal acceptable rate of return (MARR).
- Finding how much to pay for business today given the projected growth rate in future.
- Rule #1 standard minimum acceptable rate of return is 15% rate of return.
Growth Rates of our Hypothetical Lemonade Stand
- Sales Growth Rate- 13%
- Earnings Growth Rater- 13%
- Free Cash Flow Growth Rate- 15%
- Book Value Growth Rate- 20%
What is an acceptable growth rate for the company if this lemonade stand grows like it did in the past?
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