The Business of Value Investing: Six Essential Elements to Buying Companies Like Warren Buffett

Chapter 6. Effective Business Valuation: THE THIRD ELEMENT

If you have to go through too much investigation, something is wrong.

—Warren Buffett

I don't think investment is that hard. It's doing the simple things on a regular basis.

—Paul Clitheroe, Australian financial writer

You might find it silly to title a chapter "Effective Business Valuation," implying that one chapter can do what Ben Graham and David Dodd did in 700-plus pages of Security Analysis. Just as there is no one way to value all businesses, no one chapter will ever give you every detail on how to value all businesses. However, if you recall from my example in Chapter 1 about our bicycle shop, the ultimate considerations were based on a few variables: operating history, future cash flow generation, competitive threats, and the price of the business.

Any sensible business valuation hinges on a few critical points. For instance, when looking at oil companies, two variables dominate the analysis: the company's production level and the price of oil over the long run. These two variables alone represent the critical valuation metrics of oil companies. While no two businesses can ever be valued in identical fashion, when it comes to valuing any business, a large portion of the valuation will hinge on a small handful of variables.

Does this suggest that investors should ignore the little details? Absolutely not. Serious investment requires a keen knowledge of all the information. One of the wonderful aspects of investing is ...