Investments - As long as you don't lose, you win!

The concept sounds simple, right! Over the last few years, I've learned one single, all encompassing thing when it comes investing. Risk management is everything! It's a universal principle that applies to every area of investing from foreign currency to real estate to stocks and every other investment under the sun. Heck, it even applies to poker.

The single biggest mistake I've made up to this point is walking up to the plate, and trying to hit a home run with every investment I've made. The key that I've found to mastering risk aversion is to learn as much about a position before you enter it. It has to make sense from both technical & fundamental standpoints. The most important thing I've learned....don't try to reinvent the wheel.

With that being said, I found this great article on Warren Buffet - the man I consider the most successful investor of our time, and incidentally, who's triple A rating is darn near that of US treasuries!




Here are the highlights from the strategies that Buffet has implemented:

1) Has the company performed consistently well and is it currently undervalued? Undervalued positions can be found by searching out the company's ROE (Return on Equity). ROE refers to the increase that an investor sees in their share values over a period of time. The equation to determine Roe is as follows: ROE = Net Income / Shareholder's Equity A key thing to remember is that this figure you should be analyzed over a longer period of time, say from 5-10 years. Simply looking at 1 year is not enough.

2) How has the company handled its debts? The debt/equity ratio is a gauge of the strength of the company. A company with little debt means that the equity in the company is being built with shareholder equity, not by borrowing. The debt/equity ratio is determined by the following equation: D.E. = Total Liabilities / Shareholder's Equity. For a more stringent test, investors sometimes use only long-term debt instead of total liabilities in the calculation above.

3) Are the profit margins high, and are they increasing? The equation to discover the profit margin is: P.M. = Net Income / Net Sales. While a high profit margin is key, an increasing margin shows a strong management team is in place that continues to run the company well. P.M. should be analyzed going back at least 5 years.

4) How long has the company been public? Buffet only invests in companies that have been around for at least 10 years and are undervalued. He pins this on how he believes the company will perform in the future.

5) Do the company's products rely heavily on a commodity? Buffet tends to shy away from companies whose products are not differentiated from competitors. He also steers clear of companies that rely heavily on commodities such as oil or gas. Buffet only invests in companies that he understands, and he recognizes the importance of strategic differentiation. He refers to this differentiation as the company's "economic moat". The more differentiated the company is, the safer the company.

6) Is the stock selling at a 25% discount to its real value? This is the hardest part to recognize. To check this, an investor must determine the intrinsic value of a company by analyzing a number of business fundamentals, including earnings, revenues and assets. Once Buffett determines the intrinsic value of the company as a whole, he compares it to its current market capitalization - the current total worth (price). If his measurement of intrinsic value is at least 25% higher than the company's market capitalization, Buffett sees the company as one that has value.
One of the important elements of this figure is that Buffet does not merely value a company according to its liquidation value, but also by its intrinsic value. Things such as name brand value, and other things not found on the financial statement come into play.

"Conclusion
As you have probably noticed, Buffett's investing style, like the shopping style of a bargain hunter, reflects a practical, down-to-earth attitude. Buffett maintains this attitude in other areas of his life: he doesn't live in a huge house, he doesn't collect cars and he doesn't take a limousine to work. The value-investing style is not without its critics, but whether you support Buffett or not, the proof is in the pudding. As of 2004, he holds the title of the second-richest man in the world, with a net worth of more $40 billion (Forbes 2004). Do note that the most difficult thing for any value investor, including Buffett, is in accurately determining a company's intrinsic value. "

So that's all well and good, but what about Real Estate investing.

The real estate market has been in the tank lately, producing some great cap rate's for multi-family homes. I plan to do some more research on what makes a good investment property and blog about it here, but I have found one really great tool that I've been using for valuation purposes. The web site realestatecritic.com allows you to simply punch in the numbers on investment properties, and it automatically spits out any report that you are looking for. I've seen cap rates on the properties I've tested on it in the 5-35% range. Whether those numbers are good or not will be the tale for another blog entry!