Value-based Investment: Wonderful Businesses


 

This is the heart of our value-investing discussion. If you haven’t already, I suggest you go back and read the previous articles in this series.

A Wonderful business is one that delivers value to its customers, shareholders, and employees. The role of the management of such business is to balance those interests, yet satisfy them to a reasonable degree.

This leads us to a key element in spotting a wonderful business: Its management. Who is calling the shots? How does the management maintain a positive balance sheet? What are their pay packages? Are those in line with the financial temperature of the business? We could spend hours asking such questions. The bottom line is to investigate the managing team, meet some of them if possible, ask the tough questions. You should be satisfied with their management style and their track record, before you give them your hard-earned money.

Next, or parallel to that, you need to roll up your sleeves for few hours, or maybe days, to research the financial health of the company. The first station your research train will stop at is the annual report. Reading and understanding annual reports gives you a tremendous edge, yet it’s not easy at all. Studying the financial history of the company gives you a good idea concerning its future. The most important annual report to dig through is the last one. But you should have a look at the annual reports of at least the last five years.

Questions you may want to ask, and find solid answers to, are:

  • Have the earnings been growing quarter over quarter, during the last five years?
  • Has the compensation of employees, especially the executives, been in line with the growth of the business?
  • What is the market capitalization? Is it a small cap or a large cap, or something in between?
  • Does the business pay dividends to the shareholders? What’s the dividend percentage of the share price? Look for something above 2%
  • Are their strategies in place to reduce the cost of production without affecting the quality?
  • How much debt does the company carry from quarter to quarter?
  • What is the net Earning/share (EPS) for the last four quarters, the last five years, and maybe 10 years?
  • Has the EPS been growing or declining?
  • What is the current Price / Earning (P/E) ratio? You need that to be as low as possible. Be careful of any P/E above 20
  • Are there any legal issues facing the business?
  • How does the business compare to its competitors in terms of market share?
  • How much does the business spend on research and development? A retail chain must have a different figure here than a pharmaceutical company, provided everything else is the same
  • Simplicity is another factor. Although it’s not very easy to find out, but it’s worth the research. The more complex the business is, the more prone it is to problems down the road. The reward of simplicity is a low-maintenance business. As an intelligent Investor, you should not fall in love with the business. Even if you love technology, for example, this is not enough reason to buy technology shares, unless they prove to be wonderful businesses!

What you’re looking for is a stable business, which has been growing nicely for quite some time, and which has good, honest, and capable management. A management team that has been successful in making that business a vehicle to delivering real value.

The key words here are: Stability, sustainable growth, ethics, value, and it won’t harm to have some fun along the way!

To be continued…

The Wealth Maker

Value-based Investment: The Rules


 

The rules here are simple. They follow common, yet clear, sense.

Warren Buffett [1], the great investor of all times says: Rule number One: Never lose money! And rule number Two: Never forget Rule number One.

Sounds easy? Not always. But keeping those tow rules in mind helps you say no to a bad investment, while cheering a big yes to a wonderful investment. The first opportunity has the potential to make you lose money. The second has the potential to make you profit.

The intelligent investor buys wonderful businesses at attractive prices, that’s how he/she adheres to the two rules above.

After the IV discussion few days ago, we can guess what an attractive price is. It’s buying a dollar worth of the stock IV for 50 cents! weird? difficult? Not really.

Everyday, stock markets all over the world, list businesses selling at such discounts. Remember, Mr. Market is not logical, it doesn’t care what the IV is. It follows its fluctuating mood. A wonderful business may go down to an attractive price. But we need to be patient and ready. We must be sure that this is the business we want to add to our portfolios.

So, what we do is the following:

  1. Make a list of businesses you like. By that I mean, you’d love to own. You’re interested in their products or services. You know the management, or the owners, and you want to be part of the game. Something in every entry on that list has attracted your attention
  2. One by one, find out the IV of each business
  3. Divide that IV by 2. That is your attractive price. You keep the stock on your radar screen till it hits that price. Why do we discount the price that much? first, it’s very possible that the business would fall to that price. Second, we all like to sleep well at night, don’t we? In order to sleep well, not worrying about your stock picks, Ben Graham introduced another term he referred to as Margin Of Safety (MOS). When you divide the intrinsic value of a stock by two, you introduce the right MOS into the process. Even if Mr. Market becomes so angry at that business and yanks its price way down, you’re still much better off than someone who bought at the IV or even higher!
  4. Decide whether the business is a wonderful business or not. Is it going to grow your money, or is it going to send you to the cleaners? You shouldn’t buy such a loser even at 10% of the IV.

But how would you know that the businesses on your list deserve your money (provided their share prices have already fallen down to 50% of the IV)?

That’s our topic for the next episode…

To be Continued…

 

The Wealth Maker

 

[1] Warren Buffett was one of Ben Graham’s devoted students. He had followed Ben’s methodology for a long time, then introduced some of his own modifications. However, the theme and style of Buffett’s investment approach still resembles that of Graham’s to a great extent. Together, they have had changed the business of value investing for good, and for the better…

Value-based Investment: Emotions


Investing taps into different aspects of the investor’s character and skills. Some experts advise: “Check emotions out at the door”. I’d take that with a grain of salt.

The word “emotion” can be written as follows: e-motion! Without e-motion, we become robots without power. Emotions give taste to life, fuel our existence, make us “feel”, appreciate, and love…

In the context of investing, the key, when it comes to emotions, is to channel them productively. Capitalize on the positive, and let go of the negative. This is easier said than done.

Two major emotions dominate investors’ minds: Fear and greed. Fear of picking the wrong stock, fear of holding a stock too long, or too short, fear of losing, and fear of winning! You might wonder: Does anyone fear winning? Yes. The inner images we hold about ourselves, our self concepts, limit how much profit we “afford” to make, and propel us to sell when we hit that limit. How to change that? Study self esteem. Expand your self concept. Allow yourself to be wealthy. Wealth is an inside job, always. Have the courage to be wealthy! The whole Universe is wealthy, and you are an integral part of that wealthy existence…

Greed, on the other hand, could be fatal. It usually kicks in after the first or second successful transaction. You put all your capital in one share, or even worse, you risk money you don’t own, or money you’ll need in the near future.

So, how should an intelligent investor address his/her emotions? Here’s a quick hint: remember that good businesses will always be there at attractive prices, so there’s no need to rush. Take your time reaching an intelligent decision, then act with confidence.

Emotional intelligence is a skill that can be learned and applied to different human endeavors; investing being one. Carefully read a book on the subject or attend a seminar. The bottom line is to approach the investing adventure with a clear mind, accurate information, and a calm, open heart.

To be continued…

Value-based Investment: Mr. Market


Mr. Market

We’ve been using this term rather casually. Ben had used it in his book: “The Intelligent Investor” at several occasions.

I like to use metaphors. I find them easier to understand and to relate to, by so many people.

Imagine you are in the middle of the ocean, the Pacific for example. Your are the captain of a well-built ship. You’ve mastered the skill and the art of sailing such a vessel. You have a good deal of control over the ins and outs of that ship. However, do you control the weather? No one claims that, even the best of captains!

What you do, as an “Intelligent Captain”, is that you make sure that you understand the physics of the weather, and know the up-to-date weather forecast. Now you sail your ship, so that Mr. Weather is on your side; blowing your sails in the right direction, even during the harshest storms.

Got the idea? No one can control Mr. Market. It’s so moody, no one can even predict its next move for sure, ever. So, what can we do? We select our investments carefully, so that the ups and downs of Mr. Market’s moods do not affect us dramatically. We sometimes use those rather extreme variations to our benefit. We will see how, down the road.

For now, think of Mr. Market as the weather. Be prepared as much as you can. But don’t waste too much time trying to precisely predict its next move. Even worse, trying to time it.

When your investment strategy is based on solid principles, patience and discipline, Mr. Market’s current mood has little effect on the future of your portfolio.

Happy investing..

To be continued…

Value-based Investment- The Intrinsic Value of a Stock


Last time we concluded by defining the IV of a stock. An Intrinsic Value is not always the same as the sticker price (but sometimes it could be). Rather, It’s the inherent value that this business deserves in today’s market.

Simply put, it’s very similar to the net-worth of an individual. You add up the sources of income and subtract the expenses. What you’re left with is that person’s net-worth. Same thing with businesses. What is the expected income from operation? What would be the value of all assets if they got liquidated? Patents, royalties, etc. Anything that the company owns and can convert into cash, minus whatever loans or liabilities it has in the market.

Next, divide that by the number of shares the business has (or intends to make) available in the market. For example, say the calculation we just made above resulted in ten million dollars. That is the net-worth of the business. The number of shares is one million. This gives rise to an IV of $10. This is what a single share of that business is intrinsically worth!

Armed with this knowledge, your decision-making process becomes a whole lot easier. You now have a baseline to come back to. Now, and only now, you go ahead and check the current sticker price of the business; what Mr. Market “feels” the price of one share of that business should be today! If Mr. Market was in a good mood and wanted to raise the price above $10 per share, then as an “Intelligent Investor”[1], you would hold back and keep the stock symbol on your wishlist. If the sticker price was less than ten, then the next step of investigation would kick in: Is it a business you would own for a 100 years, proudly? In other words, Is it a “wonderful”, growth, and money-making business?

That will be the subject of the next episode of this series. Stay tuned and be well…

To be continued…

 

The Wealth Maker

 

[1] Ben Graham has a book holding the same title. I’m not sure if he was the first to use this term though. The book is one of the best references on value-based investing.

Value-based Investment: A Symbol or a Business?


Ben Graham had come with a paradigm shift, using today’s strategic terminology. Stocks had been seen through their ticker symbols: paper vehicles to make money in the future, relying on some emotional expectations of the price going up, luck, hype, and above all, Mr. Market’s moods.

The paradigm shift was significant. It simply devised that a stock symbol represents a company; a business in other words. For the stock price of that business (its ticker value at Bay Street, Wall Street, or any other “street” for that matter) to go up or down, keeping Mr. Market’s modes aside, something has to happen in that business.

The analysis goes even deeper. Before allocating capital to a “symbol”, an investor must know if the business behind that symbol deserves what it is being sold for. Very simple, just like grocery shopping. One wouldn’t buy a pound of tomato for $100, or a gallon of milk for $50. Yet investors do that, till today, in stock exchanges around the globe.

The reader would wonder: Why? Because they rely on second-hand information, which blows the actual value of a stock out of proportion, and then fuel that with hype that the price would go even higher. We all know too well what happens next.

Ben suggested that before you allow yourself to buy a stock, find out what its “Intrinsic Value” (IV) is. Does that gallon of milk deserve $50? Of course not. Then how much? The IV of a gallon of milk is around $3. That is common knowledge. Finding out the IV of a stock is not common knowledge. It requires deliberate research. However, that work is essential to making informed investing decisions.

To be continued…

Value-based Investment: Introduction


Before Benjamin Graham (1894-1976), investing had been restricted to a special few. People didn’t know that what those ‘special few’ had been doing was merely guess-work!

In order for an individual to invest in the stock market, she or he had to submit to an ‘expert’, who was supposed to know the game of investing: A stock broker, a money manager or a fund manager.

The ‘experts’ had formed an elite circle of influence. What happened within that circle was at best ambiguous to the public. It was not a fair game! Not based on logic and common sense.

What Graham did to stock investing was very similar to what Newton did to physics and astronomy. He’d transformed the practise from one of hype to an activity of research, analysis, logic, decision-making, and of course, risk taking

To be continued..