Rule #1 Investing Frequently Asked Questions

There isn’t any "blue book" for stocks, so how do you know the value of a business?

Here’s the key: you have to know that it is a wonderful company before you can figure the value. You simply can’t figure the value of a company that isn’t wonderful, no matter how much you want to.

A wonderful company has some sort of durable competitive advantage (Moat) and its future is predictable.

Once you find a wonderful company (and there are lots of them) that you understand (there are less of those), there are tools that will do the math for us, but if you don’t own them, you get out an Excel spreadsheet and do the following formulas:

1. =FV(): put in 10 yrs, the growth rate and the current EPS. You get EPS in ten years.

2. Multiply the future EPS by 2 times the growth rate. You get the future stock price.

3. =PV(): put in 10 years, 15% and the future stock price. You get what I call the sticker price – the value.

Understand that this is all useless if you don’t understand the Moat or if the business future isn’t predictable. In that case, move on. There are 14,000 businesses to look at. You’ll find a few that you want to own, that you understand and that you can put a value on.

If you don’t find any, don’t buy any. Staying in cash does not violate Rule #1. Buying something you aren’t certain about does.

How do I buy $1 for $0.50?

Read this post. If you're not using an integrated software program like Investools, read through all the 4M posts on the blog. These posts will show you examples of how to find the same data using Excel and data you'll find on Yahoo! Finance and MSN Money.  The difference is, doing it with free tools takes a lot longer.

What do you mean by a company's being “on sale”? How will I know a company’s sale price when I see it?

You can figure this out by knowing what this company is worth and checking your Internet tools regularly.

Here’s how. There are analysts whose job is to figure out how fast Bed, Bath & Beyond or Whole Foods are going to grow. They set up a system, available on your computer now, where you click a button and it gives you that information.

The only other part of the equation is: How much money do you want to make per year? Personally, I want to make 15% a year. That’s my minimum acceptable rate of return. So, if I know how fast the company is going to grow then it’s easy to grow today’s current price forward ten years and figure out what it’s going to be worth. The computer does that for me automatically. Then it tells me that if I want to make 15% a year, here’s the retail price, or what I call the sticker price. But I never pay retail, and neither do you.

You don’t go down to the car dealer and pay the sticker price. So, we take 50% off of that sticker price; this is our on-sale price. I also call it a margin-of-safety price, because it is half of what the business is worth.

Finally, it’s time to look at the actual market price and see if you’re going to be buying this business right away or not. You buy it when the market price matches or is below your on-sale price, your margin-of-safety price. Then you sell it when the market price gets back up to the sticker price.