Today, we will cover Number 8 on our list of the 10 Things To Look For When Buying A Stock series. It can be summed up in the following words, consistency is the key. Warren Buffett is a big believer of investing in companies with consistent operating results. You won’t find Buffett chasing after many startups and new IPO’s. Buffett likes to see 5 years or more of consecutive earnings growth and strong cash flow growth. Let’s take a look at three stats that Buffett finds useful for valuing stocks.
He values stocks based on their book value, price to sales and price to cash flow.
Book Value
Value investors know all about book value. Book Value is the value of an asset on a balance sheet. It is the difference between total assets minus total liabilities, preferred stock, and goodwill. This is a useful statistic because it tells you exactly what a company’s shares are worth. This is the amount of money that you would receive for your stock if the company were sold or liquidated. Buffett never likes to pay more than 1.5 times tangible book value.
Price To Sales Ratio
The price to sales ratio is as simple as it sounds. It is simply a stock’s price divided by its sales. The lower the price to sales ratio is the better for a value investor. Buffett likes to see a price to sales ratio less than 2. This means that an investor is only paying $2 for every $1 dollar of sales. The ideal situation would be to find a company trading at a 1 to 1 basis. This would mean that you are only paying $1 for every dollar of sales.
Price To Cash Flow Ratio
Buffett also relies on the price to cash flow ratio. Price to cash flow is a good gauge for judging the future health of a company. Price to cash flow ratios can differ significantly depending upon the industry that a company operates in. Generally speaking, Buffett looks for a price to cash flow that is under 12. The lower a company’s price to cash flow ratio compared with its competitors, the more likely that the firm may be undervalued.
This may explain why Buffett is such a big buyer of insurance companies. He loves the huge float because it costs him practically nothing and he uses the cash to generate significant investment income.
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