Price Determines Value

The key to unlocking the puzzle to successful long term investing, is to focus on the price you pay — buy at bargain prices (attractive valuations).

In 1999, Microsoft was a great company.  In 2017, Microsoft was still a great company.  However, if you bought Microsoft in 1999, it would take 18 years for you to break even.  Valuation, the price you pay matters even for a great company.

Cash is King

In deciding what an attractive price is to pay for a security, we prefer using an operating company's free cash flow (FCF) to determine valuations.  While price-to-earnings (P/E) is widely used in determining valuation multiples — P/E ratios can easily be manipulated via accounting techniques.  Through financial engineering, valuations based on P/E ratios could be masking the actual truth.  FCF is more difficult to manipulate via accounting.

FCF is the cash generated after all expenses and cash reinvested in a company to continue operating, have been paid.  FCF tells us how profitable a company really is — and provides investors with an important perspective on the cash available to service debt obligations, make strategic acquisitions and investments, and pay dividends or repurchase shares.

Buying a security at an attractive price (valuation) provides you with an extra margin of safety.  And, knowing that you didn't pay too much, helps you sleep better at night and ignore all the market noise.

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