10 Important Takeaways From “The Little Book That Builds Wealth”

I like reading books, especially books written by some of the top investors in the world. My latest book was The Little Book That Builds Wealth by Pat Dorsey. As a quick introduction, Pat Dorsey is the founder of Dorsey Asset Management. He was also the director of research for the investment research outfit Morningstar from 1998 to 2011.

The Little Book That Builds Wealth is simple, yet full of good ideas. Below are 10 important takeaways I have from the book:

1. Buying a share means you own a small piece of a business.

2. The value of a company is equal to all the cash that it will generate in its lifetime.

3. The presence of an economic moat can protect a company from competition, thus allowing it to generate more money for a long time. Therefore, companies with economic moats are more valuable.

4. Economic moats can be categorised into four groups: Intangible assets; switching costs; network effects; and cost advantage.

5. Great products, a big business, and great management do not necessarily result in the presence of an economic moat. They are nice to have, but they are not enough.

6. Do not overpay, even for a company with an economic moat. Valuation matters.

7. What type of valuation methods to use? Some useful ones are the price-to-sales, price-to-book, price-to-earnings, and price-to-free cash flow ratios.

8. How to find companies that are likely to have a moat through a quantitative approach (a quantitative approach means to look at the business numbers)? Look at a company’s historical returns on capital. There are three common ratios in that category: The return on asset; return on equity; and return on invested capital.

9. Watch your investments. Economic moats can and will erode over time.

10. Be patient. Only buy companies with economic moats when valuations are reasonable.

Whether you are a value investor who looks only for companies with low price-to-book ratios, a growth investor who focuses on companies with huge growth potential, or a dividend investor who likes companies with high dividend yields, I hope the 10 points listed above can make you a better investor.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.