Unit 1 Lesson Plan

 

Lesson 5: Warren Buffett Stock Basics

Lesson Objectives

Lesson Objective 1: Learn Warren Buffett's 4 Rules for buying stock

Lesson Objective 2: Basic Warren Buffett Valuation technique

Lesson Objective 3: Warren Buffett's opinion on the market

Lesson Objective 4: Understanding Buffett's opinion on patience and individuality

Summary of this lesson

In lesson five, we learned that Warren Buffett has four rules that he uses for investing in stocks. All the rules must be met in order for him to purchase shares of a company. Those four rules are the following:

Rule 1: A stock must be stable and understandable

Rule 2: A Stock must have long term prospects

Rule 3: A Stock must be managed by vigilant leaders

Rule 4: A Stock must be undervalued

We also learned a very basic valuation technique that Warren Buffett used when he worked for Benjamin Graham. The technique multiplies the P/E ratio by the P/BV ratio and the result needs to be lower than 22.5.

A key fundamental of Warren Buffett stock basics is the idea that the stock market is nothing more than a location where he can buy or sell his shares. The market only provides a platform for him to purchase undervalued companies. He always buys on the assumption that they stock market could close tomorrow and not open for five years ñ and it would have no impact on his decision to buy a particular company.

Finally, we learned that Warren Buffett possess great patience. He never tries to make enormous gains, but instead consistent gains at reasonable levels. He always thinks for himself and always determines the value of a stock based on what HE thinks a company is worth - not the market.

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  • C1 U1 L1
  • Value Investing

    Value Investing

    Involves buying securities (or stocks and bonds) whose shares appear underpriced in a financial market compared to a fundametal analysis performed by the investor. (The fundamental analysis, or finding the investment's intrinsic value, is what this website teaches)

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  • Asset

    Asset

    Items owned, such as a building, copyrights, patents, businesses, stocks,... etc. An asset is something that helps put more money in the pocket of a person or business. When working with a balance sheet (from C1 U1 L3) you'll learn that an asset is any item that can be turned into cash and added to the equity of the business.

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  • Liability

    Liability

    Money owed to a creditor for debts such as loans and unpaid bills. A Liability is something that takes money out of the pockets of a person or business. When working with a balance sheet (from C1 U1 L3) you'll learn that a liability is any item that will subtract equity from the business.

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  • Intrinsic Value

    Intrinsic Value

    Simply put, it is the actual value of a security (a stock or bond) as opposed to the market price (or trading price of stock or bond). Your job as an intelligent investor is to determine an investments intrinsic value (follow the steps in this website and you should be on the right path).

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  • C1 U1 L2
  • Net Income

    Net Income

    This term is very important. It represents the total profit that a business has made after subtracting all of it's costs and taxes. The net income is found at the bottom of the financial document called the income statement.

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  • Earnings

    Earnings

    This is a very important term. It represents the total profit per share of a business. Therefore, all the costs associated with the business (i.e. employee salary, material cost, rental costs, morgages..etc) are all subtracted out. In the end, the earnings represents the profit per share of a business.

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  • Revenue

    Revenue

    Is all the money a business makes from the sale of their product. It is important to understand that revenue does not account for costs associated with the business.

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  • Cost of Revenue

    Cost of Revenue

    Is a summary of the costs directly related to selling a company's product. The Cost of Revenue is subtracted from the total revenue.

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  • Net Income before taxes

    Net Income before taxes

    This term is exactly what it says, it is the net income before subtracting out the taxes.

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  • C1 U1 L3
  • Total Assets

    Total Assets

    This is all the assets a company owns. To find this number go the company's balance sheet.

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  • Total Liabilities

    Total Liabilities

    This is all the liabilities a company owes. To find this number go the company's balance sheet.

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  • Equity

    Equity

    Equity is the total assets minus the total liabilities. If the company closed its doors and liquidated (a fancy way of saying they're going out of business), the equity would be the money that would be left after the company collected all their payments and paid all their debts. If you died today, the money your family would get would be your equity.

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  • Balance Sheet

    Balance Sheet

    A very important financial statement that shows a company's assets, liabilities, and equity for a specific period in time (i.e. January 1st, 2012).

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  • Margin of safety

    Margin of safety

    This is one of Benjamin Graham's most prized terms. Margin of Safety refers to the amount of money an investor pays for a business above the company's equity.

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  • C1 U1 L4
  • EPS

    EPS

    This is probably the most important number to understand. This is the earnings per 1 share or the profit for 1 share. To calculate this number divide the company's total net income by the common shares outstanding.

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  • Common Shares outstanding

    Common Shares outstanding

    This is the total number of shares a company has been divided into.

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  • Book Value

    Book Value

    This is a very important number because it represents the equity for 1 share. To calculate this number divide the total share holder equity by the shares outstanding.

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  • Market Price

    Market Price

    Also known as the trading price, this is the number you see on the stock exchange that represents the current price a share is trading for. Warren Buffett investors like to consider this price usually wrong. The importance of this site is to learn how to calculate the correct value (AKA the Intrinsic Value)

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  • P/E Ratio

    P/E Ratio

    This ratio is a comparison between the price you would pay to buy a stock and how much profit you may see from 1 share in 1 year.

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  • C1 U1 L5
  • P/BV ratio

    P/BV ratio

    P/BV ratio: This ratio represents the current market price divided by a company's book value. This ratio is a comparison of what you might pay for a company compared to what it's worth if the company liquidated (or terminated). A P/BV = 1 means that every dollar you spend purchasing the company also has 1 dollar of equity already in the business.

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