Durable Competitive Advantage >>Equity Bond Theory >> Evaluations of stock in some perspectives

1. DURABLE COMPETITIVE ADVANTAGE

A company with a Durable Competitive Advantage has the following characteristics: Is in an industry with very little competition. Sell a unique product that doesn't change much. Provides a unique service that's difficult to replicate. The low-cost buyer and seller of products the public constantly needs. Spends very little or none at all on research and development. According to Warren Buffett a company with a Durable Competitive Advantage is a cash cow. Meaning its earnings power and business model is so great that its stock is an investment with very little risk. It is stable, just like bonds. A company's Durable Competitive Advantage will show in its financial statements. When doing research for a potential investment an analysis of the company's financial statements needs to be made. Examples of Companies with a Durable Competitive Advantage The Coca-Cola Company o The taste of Coke is unique. o Coke hasn't changed much in decades. It is still the same beverage as it was 100 years ago. o It doesn't spend anything on research and development. H&R Block o Tax Preparation hasn't changed much. Everyone has to pay taxes year after year since middle ages. o They have many locations all over the United States. A feature their competitor doesnt have. o They are the largest Tax Preparation service in the country. Wal-Mart o It is the low-cost buyer and seller of many products the public constantly needs. Examples of Companies without a Durable Competitive Advantage Yahoo o They have plenty of competition in the Internet Ad business. o Their product isn't unique. o It needs to spend plenty of money on research and development to come out with the next big thing. Otherwise, they could become extinct. Ford Motors o They are in an industry with plenty of competitors. o Car models change every 4 to 5 years. They have to spend money on equipment every time they come out with a new model. Best Buy o They are in an industry with plenty of competitors. o Electronics are expensive items that people don't buy every month.

2. WHAT IS EQUITY BOND THEORY

Equity Bond Theory is the embodiment of value and growth investing. It is Warren Buffet's theory that assumes the stock of a company with a Durable Competitive Advantage is equivalent to bonds. It compares the Rate of Return of a company to the Rate of Return of bonds. Bonds are divided into 2 categories: Taxable Bonds Tax Free Municipal Bonds

When compared to Taxable Bonds, the Rate of Return of a company is the ratio Before Tax Income to Market Capitalization. When compared to Tax Free Municipal Bonds, the Rate of Return is the ratio After Tax Income to Market Capitalization. As for bonds, the Rate of Return is the interest payments. The stock of a company with a Durable Competitive Advantage is just as stable as bonds. And their Rates of Return may be compared to each other. What Warren Buffet's Equity Bond Theory does is determine which investment will give the larger Rate of Return - Stocks? Or Bonds? Equations Warren Buffet's Equity Bond Theory compared to a Taxable Bond:

Warren Buffet's Equity Bond Theory compared to a Tax Free Municipal Bond:

While the interest rate on a bond is fixed year after year, the Income of a company with a Durable Competitive Advantage grows year after year. Therefore, the value of the company's stock also grows. Value and growth are not separate. They are related to each other. There are economic conditions when the Rate of Return of a company with a Durable Competitive Advantage is greater than the Rate of Return of bonds. When that happens, it may be a wise to buy stock in that company. And what you would get is a growth stock purchased at a value price. In general: If the Rate of Return of a stock is greater than the Rate of Return of a bond, buy the stock. If the Rate of Return of a bond is greater than the Rate of Return of a stock, buy the bond. Any investment with a Rate of Return greater than 10% is fantastic. Example On March 21, 2011, the Coca-Cola Company's price per share was around $61.50. It has 2.3 Billion shares outstanding which places it at a Market Capitalization of $141.45 Billion. Its Income Before Tax is $14.243 Billion for the year 2010. Date: March 21, 2011 Company: Coca-Cola Price/Share: $61.50 Shares: 2.3 Billion Market Capitalization: $141.45 Billion Income Before Tax (2010): $14.243 Billion

As of March 2011, the Corporate Bond Weighted Average Interest Rate (CB Wtd Avg) is 6.08%. Coca-Cola's Rate of Return: 10.07% CB Wtd Avg: 6.08% At $61.50 per share, the Rate of Return of the Coca-Cola Company is 10.07%, greater than the average Rate of Return of a Corporate Bond at 6.08%. Thus, according to Warren Buffet's Equity Bond Theory, Coca-Cola is the better investment.

3. QUICK ANALYSIS USING GET

GET stands for Gross Profit Margin, Equity Bond Theory, and Total Long-Term Debt. When looking for a potential investment, check these 3 ratios in the company's financial statements to see if it could be a company with a Durable Competitive Advantage.

 Gross Profit Margin The Gross Profit Margin is the ratio Gross Profit to Revenue in percent. It must be greater than 40% or greater than 30% for undiscovered companies. More is better. o Company with a Durable Competitive Advantage:

Undiscovered Company:

Equity Bond Theory Check if Warren Buffet's Equity Bond Theory is significantly greater than the Rate of Return of a bond. As a rule of thumb, a Rate of Return greater than 10% is fantastic. o Equity Bond Theory for a Taxable Bond:

Equity Bond Theory for a Tax-Free Municipal Bond:

Total Long-Term Debt A company in good fiscal shape should be able to pay their debt in approximately less than 4 years. The less debt the company has, the better. Use this ratio as a guide. After analysis of GET do a further check of the company's financial statements to determine the company's Durable Competitive Advantage.

4. SOME EXAMPLES FROM WARREN BUFFET

Margin of safety Margin of safety is a concept used in many areas of life, not just finance. For example, consider engineers building a bridge that must support 100 tons of traffic. Would the bridge be built to handle exactly 100 tons? Probably not. It would be much more prudent to build the bridge to handle, say, 130 tons, to ensure that the bridge will not collapse under a heavy load. The same can be done with securities. If you feel that a stock is worth $10, buying it at $7.50 will give you a margin of safety in case your analysis turns out to be incorrect and the stock is really only worth $9. There is no universal standard to determine how wide the "margin" in margin of safety should be. Each investor must come up with his or her own methodology. A principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value. In other words, when market price is significantly below your estimation of the intrinsic value, the difference is the margin of safety. This difference allows an investment to be made with minimal downside risk. The term was popularized by Benjamin Graham (known as "the father of value investing") and his followers, most notably Warren Buffett. Margin of safety doesn't guarantee a successful investment, but it does provide room for error in an analyst's judgment. Determining a company's "true" worth (its intrinsic value) is highly subjective. Each investor has a different way of calculating intrinsic value which may or may not be correct. Plus, it's notoriously difficult to predict a company's earnings. Margin of safety provides a cushion against errors in calculation. Equity bond theory Share info o Coca-Cola company o Late 1980s

o Price per share: $6.5 o Earnings per share (E.P.S.): $0.7 before tax o Annual grow rate: approx. 15% o Equity-bond theory give us the figure 10.7% Analysis o Braham-based value investors may say that Coca-Cola is worth $60 and is trading at $40 a share; therefore it is undervalued. They are just interested in the stocks market price and regardless what happens to the business, They have no intention of holding the investment for more than couples of years. o Warren may say that at $6.50 a share, he is being offered a relative risk-free initial pretax rate of return of 10.7%, which he expected to increase over the next 20 years at an annual rate of approximately 15%. Then he may ask himself if that was an attractive investment given the rate of risk and return on other investments (opportunity cost). If this is exactly what Warren evaluates, this is a real dream investment. Because with each year that passes, his return on his initial investment actually increases, and in the later years the numbers really start to pyramid. What really makes Warren Buffet superrich? Phn ny bn gip tui lc s ra nha. o Consider this: Warrens initial investment in The Washington Post Company cost him $6.36 a share. Thirtyfour years later, in 2007, the media company has pretax earnings of $54 a share, which equates to an after-tax return of $34 a share. That gives Warrens Washington Post equity bonds a current pretax yield of 849%, which equates to an after-tax yield of 534%. For Coca-Cola equity bonds, by 2007, its pretax earnings had grown at an annual rate of approximately 9.35% to $3.96 a share, which equates to an after-tax $2.57 a share. This means that Warren can argue that his Coke equity bonds are now paying him a pretax return of $3.96 a share on his original investment of $6.50 a share, which equates to a current pretax yield of 60% and a current after-tax yield of 40%. o Stock markets revaluation Then the stock market, seeing this return, overtime, will eventually revaluate Warrens equity bonds to reflect this increase in value. With long-term corporate interest rates at approx. 6.5% in 2007, Warrens Washington Post equity bonds/shares, with a pretax $54 earnings/interest payment, were worth approx. $830 per equity bonds that year ($54 : .065 = $830). During 2007, trading range of WPO is between $726 and $885! The same for Coca-Cola, pretax $3.96 earnings by 2007 revaluates its worth with a trading range between $45 and $64!

5. REFERENCES
Warren Buffet and the interpretation of financial statements Investopedia