Warren Buffett 1$ Rule For Investing | Delivery Trading Strategy
Investment in any company or business requires us to understand their evaluation that we are going to own. So this article delight comes up with Warren Buffett 1$ Rule For Investing, that will maximize your long term profit for any delivery trading or investment in any business.
What is Warren Buffett 1$ Rule For Investing ?
Warren Buffett came up with in the 1980s with this simple $1 Test. In his own words,
“We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained.
Unrestricted earnings should be retained only where there is a reasonable prospect – backed preferably by historical evidence or, when appropriate by a thoughtful analysis of the future – that for every dollar retained by the corporation, at least one dollar of market value will be created for owners. This will happen only if the capital retained produces incremental earnings equal to, or above, those generally available to investors.”
In simple words, for Buffett’s view, every dollar of retrained earnings should, over time, generate at least one dollar of market value. Simplifying it further..
Simplifying Warren Buffett 1$ Rule For Investing
Let us take an hypothetical example Of company A. Suppose within a year, it generates a profit of say , 1000 Rs. Now, the company gets two choices in terms of handling its profits. The first option is that our company A gives out dividends. Lets assume the company A gives 400 Rs as dividend payout. So, now they have left with 600 Rs. This 600 Rs is their Retained Earnings, option second. They may utilize this retained earnings as hiring more people, building new factories, launching new products etc. Now what Warren Buffet 1$ Rule For Investing says is that at some stage this Retained earning should come back to the shareholders in terms of stock market price increase.
According to Mr. Warren Buffett’s one dollars rule if the company is retaining $1 of earning then it should translate into increase of $1 in its stock price at a certain stage. If that is not happening, it means that it is a bad company from the valuation perspective of investing. In order to run Warren Buffett’s one dollar test, you have to compute the cumulative EPS. EPS is earning per share, which is the monetary value of earnings per outstanding share of common stock for a company. For example, in the Company A profit is 100 Rs and let’s assume that it had only one share. So what will become the earning per share? It will be 100.
Now applying same methodology to practical stocks we may try to find good stocks . If you consider and run the same analysis for Asian paints for FY 17-21, the number comes out to be 28, which is a fabulous number. Again, if you go to something like Hindustan Unilever, this number comes out to be fairly large. While, if you take a look at Maruti Suzuki, Tata Steel it has delivered negative stock price trend. So this Warren Buffet 1$ Rule For Investing becomes a very important parameter if you are trying to identify good companies.
Limitations of Warren Buffett one dollar’s rule
The first key limitation of $1 rule is applicable to companies like ITC . Such companies will not give run up despite excellent financial performance. Where many analysts reckon the valuations are still undemanding. So from that particular perspective, you might miss out on investing in some good stocks because you will take a look at number zero as cumulative EPS for ITC. And according to 1$ test you will not invest in it. This is the first key limitation.
The second key limitation of this Warren Buffett rule is that you might pick the period that supports a certain type of stock. For example, let us pick the period 2017 to 2021for Nestle. During this time, Nestle stock has been on an up run. From this period onward, it has been on an uptrend like never before. This gives a skewed performance. Therefore, you can see a very high number for a company like Nestle. But this is only for a certain time period
Final Takeaway
Companies small or big must make capital allocation decisions on a frequent basis to maximize returns for shareholders. But only a few companies in the world have excellent capital allocators at their helms. Warren Buffet 1$ Rule For Investing is an excellent formulae in terms of understanding the capital allocation efficiency of a company. So it’s always good to invest in companies where the market believes that the company has the power to allocate capital efficiently.
For further read on Warren Buffett Investment Ideas : Read Warren Buffett: Inside the Ultimate Money Mind https://amzn.to/3CgZVlp
Read also : Direct Stocks vs Mutual Fund : Which is Better Investment ( https://thebrightdelights.com/direct-stocks-vs-mutual-fund-which-is-better-investment/ )