Let us talk about a strategy used by Warren Buffet to create a $45 billion net worth today. Warren Buffet is a long term investor and he only invests into companies that he feels are worth it. In this post, we shall learn one of the strategies he used to calculate if it is worth investing into a certain company.

1. Pick a good company

First he shall pick a good company in any sector of his choice. He will only pick a company he thinks is going to do good in the long run and not the companies that will out perform in short term and later die.

2. Calculating Market Capital

The next thing he is going to do is to calculate the market capital of the company. Market capital is calculated by multiplying the number of outstanding shares with the share price of that company at any given time. The market capital suggests the amount of money that is required to completely buy out that company.

3. Finding Net Profit

After market capital calculation, he is going to find out the net profit the company makes in the given year. The net profit will give an exact idea of how the company has been performing compared to it’s market capital. The profit will be used to compare to the market capital to calculate the ratio.

4. Net Profit to Market Capital Ratio

In this step, we are going to divide the net profit by market capital and multiply it with 100 to know what kind of percentage return is the company offering in a year. Treat market capital as the investment amount and the profit as your return on that investment. And ask yourself if the return is good enough? Whatever be the case, the return must be bigger than the fixed deposits the banks are offering you otherwise what is the point of investing into stocks?

5. Worth It?

Now that we have all the figures, if the percentage return is decent, only then will Warren Buffet buy a share of that company. If the return is not at all good, then he will not invest in that company. He feels that if it is not worth buying out the entire company, then it is not worth buying a single share of that company.

Now this is a good strategy to implement if you are a long term investor. If a company is performing good, it will give you good returns and dividends, but a company in distress will hardly give you anything. Like I say, if the company does not earn anything good itself, what will the company give you?

An Example – Tata Steel

Tata Steel has a market capital of almost 60,000 crores and the net profit company is generating is 5000 crores.  The percentage return comes up to 8.33% which is slightly more than the return you would get if you put that much money in a bank FD. So I would say that this company is worth putting your money into.

Other Factors To Notice

There are a lot of other factors one should keep in mind. When it comes to doing such kind of calculations, you should keep in mind the fact that the company is in the growing phase and so the company has a lot of debts which are being used to expand and grow the business. In such a case, quite a bit of money is being wasted in paying interest to the bank which once stops can increase the profits.

I’m sure the companies will try to drop the debt to decrease the interests in the future years, of course once the debt increases a lot and expansion plans kind of stops. Like in case of Tata Steel, they paid an interest of 1800 crores, suppose it was not there, the return would be 6800 crores, a 11.33% return over the investment. Those are pretty decent figures if you ask me.

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