Saturday, 1 November 2014

Buying a company's asset vs company's earnings



Recently a book by Lawrence Cunningham, titled "Berkshire beyond Buffett" hit the shelves, I have not read it as yet, but I watched a book review  presented by Cunningham and hosted by Google a couple of days ago. I will not give an opinion on the book itself, but I like theme. The writer basically chronicled the buying pattern of Warren Buffett and how sustainable Berkshire Hathaway would be even after he is no longer with us.

Buffet prefers to buy assets as oppose to earnings and you should too when considering to acquire an investment opportunity. His focus is on the asset moreso because he is looking for that margin of safety should the price of the stock gets beaten down and he can acquire the entire business in order that his investment wont suffer permanent loss capital.He wants to be able to recover investment by selling the asset of company as he did with Berkshire Hathaway. 

A company's assets are really the supporting feature of the company's earnings. The assets can come in the form of cash on balance sheet, land and machinery, talent pool of staff or any other business system that generates revenue year on year (e.g. a franchise business). There is almost always some tangible or intangible asset form from which to rely for future income and as it is with all income, fluctuation is normal and should be expected. Corporate earnings are no different from fluctuating income, because it too fluctuates. 

Measuring these asset forms against the earnings will determine what price is paid to enter into an investment opportunity. The price of a stock will fluctuate at the uproar of the market beit an earnings call, an investors briefing or some other market event. The asset price of the company does not fluctuate in the same fashion and is more stable in nature. Earnings on the other side are unstable and are subject to greater market base volatility then assets. Stock exchange investors rarely ever look at the asset base of a company unless they are sophisticated or seek to inform themselves beyond the ordinary.

Don't get me wrong, earnings is very important and without earnings a company can’t make a profit let alone pay a dividend, but it should not be the sole basis for spending your money on a company stock. Take a look at the company's asset base firstly. Remember that you want to buy those at a discount.

Pick your investment opportunity subject to the company's asset base above the earnings when considering buying a company stock.

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FII