Rate of return

Simple way to determine your initial rate of return.

What we should be interested in is what the company we are trying to buy is earning. Pretty obvious, ist't it?.

So let's say that we are trying to by company X for 100 USD and it makes 1 USD a share. That means that, from the moment we buy it, we will be making 1 USD for every share we buy.

Once the company makes money, it has to decide if it wants to pay out the earnings as dividend or keep the profits. It can also do both, keep part of the profits and pay part as dividend.

After a while the money the company makes (if it's well managed) will accumulate and, if wisely reinvested, will cause the market to re-value its price up.

If we have company Y priced at 3,80 USD and it earns 0,46 a share then we can calculate what will be our rate of return if we buy it.

Just divide 0,46 USD by 3,80 USD and you end up with 12,1%.

In other words:

Earnings Per Share / Stock Price = Our Initial Rate of Return

So, basically what Buffet and Graham stressed is that the price you initially pay will determine your rate of return. If you pay more you will get a smaller percentage on your return and if you pay less for a stock your rate of return will be greater. That's why Buffett likes to buy when stocks are cheap Simple as that.