Watch PE when valuing a company

[scottleey]

Yes, although I disagree on the cashflow perspective part, I agree that it is the risk adjusted returns that counts.

Well there were separate occasions.
On his younger days, his hurdle rate was 15%.
An example of which is at http://basehitinvesting.com/how-warren-b...bout-risk/
Look at the video which schroeder talks about a little known company that buffett invested.
At 05:10, she described it.

More recently, at the 2003 Berkshire annual meeting, someone asked.
Question: What’s your investment hurdle rate?

Warren Buffett: 10% is the figure we quit on — we don’t want to buy equities when the real return we expect is less than 10%, whether interest rates are 6% or 1%. It’s arbitrary. 10% is not that great after tax.

[CM: We're guessing at our future opportunity cost. Warren is guessing that he'll have the opportunity to put capital out at high rates of return, so he's not willing to put it out at less than 10% now. But if we knew interest rates would stay at 1%, we'd change. Our hurdles reflect our estimate of future opportunity costs.]

And then there was this once I remember, if I am not wrong, Mohnish Pabrai asking him about his hurdle rate and he said it was 13%. Sorry I couldnt find the source. In anyways these are pre-tax numbers.

[specuvestor]

^^^ A preview in Forbes on his upcoming annual letter:
"In 1986, I purchased a 400-acre farm, located 50 miles north of Omaha, from the FDIC. It cost me $280,000, considerably less than what a failed bank had lent against the farm a few years earlier. I knew nothing about operating a farm. But I have a son who loves farming, and I learned from him both how many bushels of corn and soybeans the farm would produce and what the operating expenses would be. From these estimates, I calculated the normalized return from the farm to then be about 10%. I also thought it was likely that productivity would improve over time and that crop prices would move higher as well. Both expectations proved out.

I needed no unusual knowledge or intelligence to conclude that the investment had no downside and potentially had substantial upside. There would, of course, be the occasional bad crop, and prices would sometimes disappoint. But so what? There would be some unusually good years as well, and I would never be under any pressure to sell the property. Now, 28 years later, the farm has tripled its earnings and is worth five times or more what I paid. I still know nothing about farming and recently made just my second visit to the farm."

In investment, knowing the farming BUSINESS MODEL is more important than knowing how to farm.

"If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it."

http://finance.fortune.cnn.com/2014/02/2...re-letter/

And here in a widely known example of cashflow that Buffett explains the principle I am aluding to in simple layman's term: The classic lesson below... note that the CAPITAL value of Gold has increased from $7tr to $10tr and his tune remains the same.

“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion dollars – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion dollars…you could have all the farmland in the United States, you could have about 7Exxon Mobils, and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”

During another interview at a different time, Mr. Buffett said the following:

The value of all that gold at today's prices would be about $10 trillion.The cube of gold will produce nothing in the next hundred years (or, for that matter, thousands of years).

The cube of gold will not pay you interest or dividends, and it won't grow earnings.

You can fondle the cube, but it won't respond. If you had $10 trillion sitting around, instead of buying the cube of gold, you could buy all the cropland in America ($400 billion-worth) and 16 Exxon Mobils. And you would still have $1 trillion of "walking-around money."

Over the next hundred years, your cropland and Exxon Mobils would produce trillions of dollars of dividends (the size of which would be adjusted for inflation), and you would still have them at the end of the century, at which point you could probably sell them for vastly more than the $9 trillion you bought them for.

So, which investment would you choose?"

Speculator Bro,

Buffett did mention publicly a while back that he wouldn't have done the GFC pref share deal (i.e. either Goldman or GE, or both) without the equity options. Also, the BAC pref shares + option deal done in 2011 was at much lower than 10% (6%+ IIRC).

At the risk of appearing silly in front of a financial expert , I believe what Buffett look for (in this sequence) is, (1) he must like the stock and importantly at the exercise price (and hence the options); (2) downside protection via pref shares exposure rather than equity; and lastly (3) sweetener in the form of high pref share dividends.
My view if it doesn't pass screen (1), he probably won't proceed.

Hi Wee I actually dont recall his 6% coupon deal with BAC...only remember Temasek bought ... must be the age but from observation I think he does look at this "magical" 10% as a good gauge for capital preservation. He did also say that if he had US$700b he would absolutely do TARP himself so that shows he would buy America. I look at it as the cashflow is paramount to him, capital appreciation will come by itself as business recovers.

[wee]

Speculator Bro,

Buffett did mention publicly a while back that he wouldn't have done the GFC pref share deal (i.e. either Goldman or GE, or both) without the equity options. Also, the BAC pref shares + option deal done in 2011 was at much lower than 10% (6%+ IIRC).

At the risk of appearing silly in front of a financial expert , I believe what Buffett look for (in this sequence) is, (1) he must like the stock and importantly at the exercise price (and hence the options); (2) downside protection via pref shares exposure rather than equity; and lastly (3) sweetener in the form of high pref share dividends.
My view if it doesn't pass screen (1), he probably won't proceed.

Hi Wee I actually dont recall his 6% coupon deal with BAC...only remember Temasek bought ... must be the age but from observation I think he does look at this "magical" 10% as a good gauge for capital preservation. He did also say that if he had US$700b he would absolutely do TARP himself so that shows he would buy America. I look at it as the cashflow is paramount to him, capital appreciation will come by itself as business recovers.

The BAC deal was done post GFC.

http://www.forbes.com/sites/steveschaefe...ng-better/

I agree that Buffett looks for 10% return hurdle but I see it more in the context of of investment in a business or equity (or properties per his latest article). In the case of the farm and property in his article, the assets are returning 10% on cost, and more importantly growing over time, so the return expectation is clearly higher than a plain pref share or bond returning 10%.

[specuvestor]

Yup wee I googled it... Just that my memory failed me

10% cash flow I think is a good rule of thumb MOS. As discussed and practiced by forumer Gautum, the cash flow / dividend is growing if it is a good company. If it is not, your counterparty risk still diminished and capital deploy goes to zero in any case.

Growing cash flow is more important than capital growth. The latter takes care of itself when u focus on the former. That's actually central in how Buffett talks about his investments, and the article itself