Value Investing lesson from Graham's brightest student Warren Buffett.

I listen this story on a business news channel which I want to share with my reader. We as an investor must know what it is to make our investing life simple and successful.

Let me start with this interesting story, by the way it is not just a story it also a lesson for us. Dating back to the 1930s Benjamin Graham whom we know as the father of value investing was an enterprising young analyst on wall Street. In the early 1930s, he made an interesting observations during the hay days just before the great depression. He noticed that hot stock pickers while caught up in the speculative frenzy would sometimes drive up the stock price to ridiculous levels in relation to the long term economic realities of the underlying businesses.

On the other hand, these same spectaculars would sometimes send stock prices spiraling to insane low that similarly ignored the business’s long term prospects. It was in these insane lows that Graham saw a fantastic opportunity to make money. his reasoning was simple and that was, if he bought these oversold businesses at prices below their long term intrinsic value. eventually the market would acknowledge its mistake and revalue them upward and once they were revalued upward he could sell them at a profit.

This is the basis for what we now know as value investing. Graham was the father of it so Graham would buy any stock that was oversold and was available at a deep discount to its intrinsic value.

He really didn’t care about what kind of business he was buying. In his world every business had a price at which it was a bargain.

So, when he started practicing value investing back in the 1930s. He was focused on finding companies trading at less than half of what they held in cash.

For instance, if a company had hundred dollars of cash per share, Graham would buy it the moment the stock fell below fifty per share.

He had other standards as well such as never paying more than ten times company’s earnings. Or a price to earnings of more than ten times and selling the stock if it was up 50%. Of course Graham’s mom also looked at the financial statement.

Financial statements and fundamentals like buying a stock price, stock that was available for less than two-thirds of the net current assets value.  Companies where debt equity ratio was less than one but his core mantra was buying stocks cheap and that is where he focused his sights on.

Let’s move to his brightest student that is Warren Buffett. Buffett learned value investing from Graham at Columbia University. In the 1950s, the right before Graham retired he went to work for him as an analyst.

After Graham retired Buffett return to his native place Omha where he had time to think Graham’s methodology. During this period, he noticed a few things about his mentors teaching that he found troubling the first things.

Buffett realized was that not all of Graham’s undervalued businesses were revalued upward. in fact some went to bankruptcy, so with every batch of winners also come also came a quite few losers which greatly dampened Graham’s overall performance.

Buffett also discovered that a handful of the companies he and Graham had purchased with had sold under Graham’s 50% rule continued to prosper year after year. In the process, he saw these companies stock prices soar far above where they had been.

When Graham sold them this is when Buffett decided that he could improve on performance of his mentor by learning more about the business economics of these superstar companies.

So, he started studying the financial statements of these companies from the perspective of what made them such fantastic long-term investments.

Buffett learned what was that these great companies all benefited from kind of competitive advantage, created monopolies like economics allowing them either to charge more for the products or to sell more of their products at higher price.

In the process, they made a ton more money than their competitors. Buffett realized, if a company’s  competitive could be maintained for a long period of time.

If the competitive advantage was durable than the underlying value of the business would continued to increase year after year.

Increase in the underlying value of the business it made more sense for Buffett to keep the investment as long as. This could give him a greater opportunity to profit from the company’s competitive advantage.

There was something else that Buffett found even more financially magical simply because these businesses has such incredible business economics working in their favour.

There was zero chance of them ever going to bankruptcy this meant the lower the speculators drove the prices of the shares the less risk Buffett had of losing his money.

When he bought in the lower stock price also meant a greater upside potential for gains and the longer Buffett held on to these positions the more time he had to profit from these businesses.

Great underlying economics this fact would make him tremendously wealthy, once a stock market eventually acknowledge these company’s ongoing good fortune.

See, how much wealth Buffett has created over these years and how much has his focus on durable competitive advantage.

His shareholders every US Dollar one invested in Berkshire Hathaway in 1964 has turned to five thousands one hundred thirty three dollars now compared to just sixty six Dollars in S&P 500.

So, that’s a kind of out performance but  Buffett has created by using his simple strategies. What Buffett found then has now become the holy grail of stock investing.

Which is the importance of reading financial statements to identify companies with durable competitive advantages. So, when you are looking at financial statements, it’s important that you look at them not just to read through the numbers and find what looks good and what looks risky.

But, more importantly to know whether the company under your observation has some durable competitive advantage or not. Although the word financial statements and accounting sent cold shivers down many people’s backs.

This is the language of business a language you need to know before buying stocks. The beauty is that you don’t need to be a finance expert to understand the basic of the three most fundamentals.

Financial statements which are the income statement or the P&L account. The balance sheet and the statements of cash flow all three of these statements are found in firm’s annual report.

The financial statements are a window into a company’s performance and health. The investors who get richer than others are the ones who know how to look through this window.

So, pic up the annual report lying untouched in your cupboard.

Whether the stock you are holding is real gem with a computable competitive advantage or a real  dud that will vanish in the next downturn.

That’s all for now, I hope this short story will be helping to take your investment decision wisely.