I rarely see books that break down step by step how to calculate an approximate intrinsic value of a company. Rule #1 by Phil Town does exactly that, for profitable companies at least. By only looking for companies that have grown 5 qualities at least 10% per year for the last 10 years, that ends up in finding high quality companies to be able to invest in for our savings and future retirement.
-people definitely get older, but not necessarily wiser
It is possible to fail in many and different ways, but it is possible to succeed only in one way – Aristotle
-The actions we continue to pursue become less challenging, not because the task itself has become simpler, but because our capability to execute it has grown- Ralph Waldo Emerson
-get a list of companies interested in
-4 M’s: meaning, moat, management, margin of safety
-easy to enter industries like commodities have no moat
-“learning is not compulsory, neither is survival” Edwards Deming
-Companies with moats are usually number one or two in its industry (whether out of brand, secret, toll, switching or price)
-if a company has a moat, it meets all of the five below criteria (all equal to or above 10% annual growth for each of the last 10 years, with exceptions that are for the benefit of the company long term then that would still be fine)
1. Return on invested capital (ROIC) or return on capital
2. Sales growth rate
3. EPS growth rate
4. Equity, or book value per share growth rate
5. Free cash flow (or cash) growth rate
-look at ROIC for 1 year (most recent year), 5 years, and 10 years averages. Rule of 72 doesn’t work for ROIC
-equity or book value, labelled as intrinsic value by Buffett and sticker price by Phil town
-free cash flow; cash leftover built up (hopefully) after use for replacing capital items such as machinery. Free cash can be used for dividends or for working capital to spend to grow business
-debt rule: if a company cannot pay off long term debt within 3 years using free cash flow generated, that debt is too much. I like to see if debt is worth more than the company itself as a first obvious rule.
Whether a company pays a dividend is irrelevant to whether it is a good investment
Order of importance for moat big five: ROIC, equity growth, EPS growth, sales or gross profit growth, cash flow growth
-Management
Owner-oriented: tells it like it is in annual letters, CEO acts as if he is also an owner and has there interests aligned with shareholders
Driven: is the CEO driven to go to work everyday, for a clear and transparent purpose?
Insider trading – is management buying or selling their own stock? If they are all selling, what does that say? It’s nice to have someone like Buffet with all their net worth in their own stock and not sell own company stock for invalid reasons
-CEO compensation: if very high, red flag. CEO’s should love what they are doing for fun. Consistent same, stable management is preferred, not a constant change or “hired mercenaries”, too many stock options also negative.
Find these in annual report; compensation. Bad annual letters: all hype, no substance
“Don’t hire a person who does your work for money, but hire him who does it for the love of it” Henry David Thoreau
-“A cynic is an individual who is aware of the cost of everything but lacks an understanding of the worth behind it” Oscar Wilde
-markets are NOT efficient, and is bipolar
-finding sticker price or intrinsic value:
1. Current EPS
2. Estimated future EPS growth rate
3. Estimated future PE
4. Minimum acceptable rate of return from this investment (rule #1 uses 15%)
-we never buy a business for 10 minutes unless we want to hold for 10 years. Not 5 (too short) or 20 (too unpredictable)
-the best indicator of future EPS growth rate is actually the past equity growth rate (actual equity gained)
-we can use lower of professional analysts estimated future growth rate (5 yr available on msn money) and the past equity growth rate to be conservative
-estimated future P/E: also consider historical trailing P/E
-default PE general guideline metric: double the estimated future earnings per share growth rate (based on conservative equity growth rate). E.g. if 8% estimated EPS growth rate, expect PE of 16. Again use lower of default PE and historical PE
-minimum acceptable rate of return: use 15%. With EPS growth rate estimate, find out how many years it takes for the current EPS to double (rule of 72)
-with future EPS, use conservative of two PE (historical vs analyst) to find future market price per share in 10 years
-if we want 15% return, we want to double in five years, or quadruple in ten years. Thus, the future market price/4 for current market share price. With 50% margin of safety, another divide by 2. So, if future price is 320, it’s worth 80 today, but want to buy at only $40.
-using his example for Harley it got a decent return and avoided mistake of GM
-“the best time to sell is never” Warren Buffett
-sell business if business is no longer wonderful or if market price is above sticker price (I.e. when market is overvalued)
-we can use rule #1 to go after small cap businesses that are in the process of becoming large caps
-if outside forces such as amazon comes, that takes out retail, or Netflix streaming over blockbuster DVD
-inside traitor: CEO excessive pay, spending, or overpriced acquisitions
-one can use a lower margin of safety (say 30%) and repeatedly buy and sell if they really understand and have made profit (so the profit is the margin of safety)
-“Fortune consistently favors the wise and cautious” Euripides
-big money accounts on average 80% of value of a business; when they sell or buy, they move slow and we can track them using free online tools. It takes 6 to 12 weeks due to amount of money going in or out (which subsequently moves prices in that direction)
The three tools
-1. MACD; moving average convergence divergence. Uses moving day averages, slow, fast and trigger EMA. Slow for 26 days, fast for 12 days, trigger when they crossed (buy or sell). Can be found on free sites such as msn and yahoo. Beginning of a mountain, time to buy. Beginning of a valley, time to sell. The technical indicator; first MA period, second MA period, and signal MA period. Less sensitive 12-26-9, more sensitive can use 8-17-9
-2. Stochastic technical indicator; buy or sell momentum. If buy line is above sell line, buy. If buy line is below sell line, sell (14, 5)
-3. Moving average; 10 day, 50 day, 200 day. If stock price below moving average, sell. If stock price above moving average line, buy.
-another good one: RSI, relative strength indicator. If over 70, being bought massively (and price moving up a lot). If under 30, being massively sold (and price moving down a lot).
-technical tools alone won’t make money however; the fundamentals are required first
-free cash flow, want operating cash flow to be growing (investing and financing is not as important)
-once found a good fundamental company, use technical tools and can move in and out of the company constantly (example was 11 times in two years)
-“Formulate a clear strategy for accomplishing your aspiration and initiate the process without delay, whether you feel prepared or not, in order to set this plan in motion.” Napoleon Hill
-want to have businesses trading over 500,000 shares a day. And, amount of stock owned is less than 1% of average trading volume of one day (to get in and out easy)
-around $10,000 per business for first few, max around 5 companies. Top company 50% of money in
-commodity businesses by definition are businesses without a moat and don’t meet criteria for 4M’s already
Disclaimer
This is not Financial Advice. This article is meant only for educational and perhaps entertainment purposes.