In the 1880s, a merchant named Patterson converted his small company’s cash box into the world’s first cash register. He did it to reduce employee pilferage. Had he left it at that, it would have been of modest value to him. Instead, the moment he realized he had a machine that would work for other retailers too, he went into the cash register business. In 1884, National Cash Register (NCR) was born.
In a now-famous speech on “worldly wisdom,” Berkshire Hathaway vice chairman Charlie Munger said, “A well-educated orangutan could see that buying into partnership with Patterson in those early days… was a total, 100 percent cinch.”
It’s not surprising that Patterson’s cash register business became a big success. It was the right idea at the right time – a useful tool for an industry that was exploding, like information publishing is exploding on the Internet today.
And that’s the secret of successful investing, Christopher Mayer says in his new book, Invest like a Dealmaker: finding companies that have many things working in their favor, not just the fundamentals of the company itself.
“When many forces are working in your favor,” Mayer says, “amplifying and reinforcing each other, you get what Munger calls a ‘lollapalooza effect.'” It’s like critical mass in physics. Create enough concentration of mass and you’ll set off a nuclear explosion.
The average investor has the wrong idea about how the stock market works, Mayer says. “He thinks about the price of his stock in terms of its quoted stock price. But even then… he often misunderstands what that price represents.”
Mayer explains that a stock’s quoted price represents only part of the stock’s underlying value: the company’s equity.
You can determine the total equity of a company by taking the quoted stock price and multiplying it by the total number of shares that are trading on the stock exchange (the shares outstanding, to use the trader’s term). But then you need to add to that the company’s total debt. The combination of debt and equity gives you the total worth of the company – its enterprise value, as stock experts like to call it.
Most investors focus on a company’s P/E ratio – the relationship between the stock’s market price and its earnings per share. That gives you an idea of how enthusiastic the market is about the company’s growth potential. (In general, faster-growing and less-risky companies have higher P/E ratios.)
But a better way to make investment decisions is to invest like a professional trader, Mayer says. And a dealmaker will always want to compare earnings to enterprise value, because this gives him the bigger picture – the kind of picture you’d have if you were investing personally in a company.
That’s just the first of several important investment concepts that Mayer teaches in his new book: Invest like a Dealmaker. I read it. I liked it. I recommend you read it too.[Christopher Mayer isn’t the only one who can help you become a better, more prosperous investor. ETR’s Rick Pendergraft has created a trading service based on investing principles that are super-simple to understand.] [Ed. Note: Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]