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it's rule number two of investing is see rule number one all right now the reason it matters is down to maths and then we'll talk about how you do it all right why is it so important not to lose money and it sounds ridiculous to have to prove it but it's because the losses are really really hard to recover okay just give you one example if you currently hold an investment and it drops thirty percent in value tomorrow morning mathematically you need it to rise forty-three percent just to get back to where you started from all right that's the maths of losses so buff it was onto something when he said don't lose money but okay good so how do you not lose money when you buy shares and the answer to Warren Buffett was you look for good companies that cheap prices and there are two vital words that go together they're a good company at a cheap price no point in finding a bargain if it's all load of rubbish right you don't just want cheap companies anyone can find cheap stuff that turns out to be jargon or rubbish okay what you want is good companies at a cheap price okay no point in buying a good company it is expensive if everyone else knows about it all right so the key good company the cheap prices question going to focus on right now then is what makes a good company what made those coca-cola Gillette annex investments quite so successful and you can't repeat those investments tomorrow because they've been done in one sense those are much bigger companies now and maybe they're not cheap as they once were maybe they don't have all these qualities when you go rummaging around looking for stocks trying to apply Warren Buffett's principles what is a good company as far as he's concerned well let's have a look at a few key investing lessons investing the Warren Buffett way okay so number one you want companies with a high rocky return on capital employed and low debt now high return on capital employed that means they are generating annually lots of bang per buck okay I'm not going to a lot of detail detail and return on capital employed in this video have a look at my related video what is return on equity but here's the concept okay lots of bang per buck in profit terms combined with low debt alright and high return on capital employed that just means if you take from a profit and loss account profit before interest and tax and put it over debt and equity capital employed that's the capital that's come from shareholders and the capital it's coming from lenders and banks so one year's profit before interest and tax / total capital employed as a percentage you get rocky so in very simple terms if that was a hundred million from the profit and loss account sterling that was 500 million adding up shareholders funds and any interest-bearing debt employed by the business 100 over 500 as a percentage is about twenty percent what so what others are doing high return on capital employed with low debt so you want this to be low so the interest bill on that debt is also low and it's a city right right an awful lot of banks for example of driven up return on equity and return on capital employed by deploying gearing dead not adding any value Warren Buffett was saying it's the value you want it's the ability to generate proper operating profits bang per buck not some kind of financial alchemy based on borrowing lots of money alright so high return on capital low debt now very one thinking that's a bit quick on point one because it's more points to come all right take a look at my return on equity video and also have a look at my how you can make money from gearing videos and then explain those in a bit more detail right that's point number one he didn't get to be the world's richest man by just having one point alright so there are a few more tricks of the Warren Buffett trade if you like so there's point one point two you want to find companies with predictable earnings now Warren Buffett's broken his own rules a few times recently with a litter of his investments but that's beside the point political earnings you don't want any surprises all right you want companies they're going to be there day in day out a feature of his portfolio is a lot of those shares been there at all for long time these are not fly-by-night companies that suddenly gone bus is not dot-com companies for example and Buffett famously avoided the dot-com boom and the share price rises the with it and also the dot-com bust and the pain that went with that okay so steady predictable earnings and you want profits back by cash flow up profits equals cash flow now analysts rather grandly call this cash cover but you want to check for example that operating profits in the profit and loss account are not a kind of accounting mirage you wanna have a look at the cash flow statement and check that the cash from operations is in line with operating profit okay cash cover is your idea there's lots of cash being generated lots of operating profits in other words this and this bears some resemblance to each other and buff it likes that okay he doesn't like firms where there's lots of profit being generated and virtually no cash all right the more on that see why do profitable firms go bust not by Warren Buffett by me alright so there's number three number four and only half dozen of these by the way he liked businesses that uncomplicated now some would say well he didn't he just invest in bablo sacks us fairly complicated some would say uncomplicated to you alright there's no absolute measure here what Buffett was getting at was you must understand the business you invest in because if you don't you just playing the lottery if you have no idea how the durex are doing it what if they stop doing it all right you're stuffed okay so fine businesses that you understand all right a lot of people or this point to make didn't have any clue how calm companies ever going to make profits all right let alone generate cash flow and buffets point was the business doesn't have to be hugely complicated or hugely simple the fact is you've got to understand how it's doing what it does okay if you're an expert in financial derivatives you understand those businesses you can invest in them if you're not you probably don't want to bother all right so uncomplicated as far as you're concerned all right good example no Jill add one of them buffis early investments there's a product everyone understands and as a product everyone's probably seen okay same the coca-cola right um then you want a strong brand coupled with pricing power now i'm going to use gillette razor blades as an example or the ink cartridge i recently bought for my printer at home as another example of what Buffett means lots of things have gone down in price in recent years thanks to the chinese clothing springs to mind cds but anyone who shaves using Gillette razor blades like me you will know somehow they managed to keep pulling off a remarkable trick the price of those razor braids seems to keep going up the little thing you attach them to doesn't that's cheap for the business multiples tever alright the price of those razor blades keeps creeping up on the way they do that partly as they say well you were shaving or two now have three ok so I'll pay more for those all right so they've got their ways or making sure than even in a recession and maintain pricing power same with the people quite often who make replenishment cartridges for printers the printer is cheap try and third up the anything and you end up paying an arm and a leg and you think this is more expensive than was 12 months course going on where's the tech revolution here right those are clever business models those are the sorts of things that Buffett was talking about pricing power you can't suddenly just be undercut and who can suddenly be undercut strong brands but you're more likely not to be suddenly undercut if you've got that of a brand Bauer and wrap it Buffett likes brand names okay you know even the Fletcher investment mark em in Goldman Sachs love them although them has quite a brand name okay now final point there are there are others we could make but management need to be owners of the business not a hundred percent all right it's often not possible when a stocks listed for example I mean if they 100% how would you ever buy into it the point is management's need to have a high stake in the future of the business all right now there's no science to this is a little bit art and science there are two extremes that it comes to paying managers you can pay them all cash Kim a massive salary or you can play them no salary and give them all shares or share options those are the two extremes all right and both have their drawbacks pay managers all in cash with no shares or share options in the business you want to buy into they're just going to do what they need to do to earn their salary and nothing more goes the argument give them all shares and share options and all well do is try and boost the share price very short-term cash in and get out all right so you so those two extremes or from won't work as attractive they might seem superficially so there is obviously a middle ground here but you don't really want is management not prepared to back their own decisions with their own hard cash okay so all companies take a look at the arrangement the directors are they required to put a certain amount a percentage of a year's salary or something into shares by a certain time in what's the management scheme that gets them into buying shares in the company because if they own some shares at least they're likely to be more committed to doing what you want them to do which is raise the share price not just collect their salary go home axilla mean right there's the bond with bonuses as well you know a bonus is fine doesn't help you as a shoulder all right you know a bonus doesn't have to have anything to do with share price increases look at banks recently it can simply be part of the benefits negotiated by up taking director all right so what buffett said make sure that the managers are to some extent owners of the business you're buying into all right so they have it when you're buying shares half a dozen key invest like buffett tips well these half-dozen tips turn you in to warren buffett know there are historical reasons why he's the greatest investor of all the time even he's found it more difficult to make money recently all
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