287- Investing Q&A: Stock Splits and Company Valuations
b"A stock split is when a company decides to exchange more shares at a lower price for stockholders' existing shares. They happen from time to time, so it's important for us as investors to understand what that means.\\n\\nStock splits make stocks more accessible to individual shareholders, make selling put options cheaper, and typically tends to increase share prices in the short run. So does a stock split impact your investment if you already own the stock? It shouldn\\u2019t, because your investment should be the value of the entire business no matter how many pieces it is split into.\\xa0\\n\\xa0\\nThere's another kind of stock split which is called a reverse stock split, where you end up with less shares than you previously started with. For instance, let's say you had 100 shares and they reverse split it 10 to 1, you suddenly have 10 shares. Does it increase the value or decrease the value? Not at all.\\xa0\\n\\xa0\\nRule #1 investors look at the company not per share. They look at it as a whole company the way an owner does. This is why the company evaluation process is a critical step in investing\\u2014if not the most important.\\xa0\\n\\xa0\\nThe company evaluation process includes confirming that the business has a margin of safety. Margin of Safety is the discount rate you can buy a wonderful business, which is generally 50% off the Sticker Price. Because the Margin of Safety is just 50% of the Sticker Price, it allows you the ability to purchase into the business with lower risk. Setting this limitation on the price of a business before you buy it helps protect you by providing an extra 50% cushion off the value of the company. Since you must do a lot of research before buying a business, it should always be something you\\u2019re confident in purchasing. However, anything can happen in the stock market, and it makes sense to allot yourself an extra measure of protection. Buying at 50% off does just that.\\n\\nAnother way to evaluate a company is by evaluating the business\\u2019s moat. Moat is the durable competitive advantage that a company has that protects it from being attacked by competitors.\\n\\nMoat is what makes a company predictable and allows us to put a value on the business.\\xa0Charlie Munger said that \\u201cCoca-Cola is the perfect business because it has this gigantic durable competitive advantage, or moat, which gives it predictable cash flow.\\u201d This allows us to figure out what the future cash flow will be and value the company today, so we know whether we can buy it on sale or not.\\n\\nToday, Phil answers fan questions regarding stock splits, company valuation, and explains why it\\u2019s important to do your research and due diligence before committing to any companies on your watchlist.\\xa0\\n\\nIf you want to learn more about how to find excellent companies at attractive prices, download Phil\\u2019s Four Ms for Successful Investing Checklist: https://bit.ly/3jV5QAn\\n\\nLearn more about your ad choices. Visit megaphone.fm/adchoices"