Craig Martin: My journal entries as student of financial analysis. Week One
The format of these articles was selected in the interests of investor education, so I ask you to please come along with my fictional student as he attends his lectures on the very real topic of financial analysis. Depending on the reception to this idea, my hopes are that this will be the first instalment of many journal entries and lectures to come.
By Craig Martin
Wednesday, 17th of September 2014
When we arrived at class, there were two different size cans of tuna and a tin of crab meat on the lecturer's desk. He introduced himself as Michael and proceeded to use the tins to parallel the experience of grocery shopping to selecting which company to invest in.
The larger tin of tuna and crab meat both weighed 350g, however, the tuna cost R20 and the crab meat was priced at R30. Michael asked us which tin was more expensive. I reluctantly raised my hand to attempt an answer that seemed obvious to me. It wasn't the tuna. He corrected my hasty response, by saying that he wasn't asking which was "priced" higher, but he wanted to know which showed better "value". Initially, I didn't understand what he meant. It was only when he mentioned that crab meat normally sells for three times the price of tuna, that I did some mental calculations and reached the correct conclusion.
We then broke into groups to determine which was cheaper to buy, the smaller tin of tuna for R10 or the larger R20 tin. Once again, my instinctive response would have been to answer that the R20 tin was cheaper as it was 350g and the smaller tin was just 170g. However, my experience earlier had taught me not to respond in haste. I was thankful for that and I would have been wrong. Someone in the group drained all of the water from the tune and used a scale to compare the drained costs per kilogram in each tin. It turned out that the larger tin's weight of 350g was its gross mass, and it contained a lot more water than the smaller tin.
The class concluded with an auction of the crab meat and we were told that there could be something extra for the winner. Carlos won with a R65 bid, but the only "extra" he received, was advice to never pay more than its worth. We all laughed at the look on Carlos face as he reluctantly paid his R65 for a tin that we learnt had cost much less.
Michael, our lecturer, asked each of us to share how we arrived at our maximum bid. I stopped bidding at R40 as that was all I had in my wallet. Carlos planned to pay much less, but got caught-up in his desire to win.
Michael said that if we don't want to get emotional like Carlos and overpay, then we must memorise the words that Warren Buffett uttered in a speech to the Columbia Business School[i]; "The common intellectual theme of investors is: they search for discrepancies between the value of a business and the price of small pieces of that business in the market." I am looking forward to learning how to value the business as a whole, so that I can know what the value of the share of the business is worth.
I decided to pack a tuna salad for lunch tomorrow. I must admit that armed with the knowledge I gained in class today, I began looking at the gross and net weight of the contents of each tin and not just the price tags. I think I got the best value.