An Example of the Analyst Course

It is 2006, and you want to know the true sustainable free cash flow of Mohawk because you love sleepy, mundane industries that are slowly growing. Why? Because people love to buy lottery tickets and glamour so you “go where they ain’t.”

So what is the difference between Mohawk’s GAAP earnings per share and your estimate of FREE CASH FLOW per share?    Use cash flow from operations and maintenance capex (which you need to roughly estimate). Be roughly right, not precisely wrong.

Can you explain the difference?   What is going on with Mohawk and the industry?   Note the ten-bagger or 25% CAGR for almost ten years (move over Buffett) from the 2009 lows.  Surprising or not?    MHK-2006 AR FCF Analysis.   Can you use this as a way to find other ten-baggers?

Of course, the above question is not hard for you since you have already read this 412 page book several times: Wiley Creative Cash Flow Reporting.  You do not have needed to read that book to answer the question. Use common sense and a small bit of accounting knowledge like (amortization of goodwill-hint!)

This an example of how the analyst course would teach. You have to do many case studies to practice learning concepts like free cash flow.  Like flying and sex, you have to practice.

Good luck.    Those who do not provide the correct answer will have to spend time with my ex-wife:

Analyst Course


  1. Prior mentions of an analyst course with readers’ suggestions were posted:

http://csinvesting.org/2017/03/10/a-strategy-for-resource-stocks-investing-course/

http://csinvesting.org/2017/03/15/update-on-analyst-course-part-1/

http://csinvesting.org/2017/03/17/update-on-analyst-course-part-2-readersuggestions/

There are plenty of other investing courses ranging from free to $20,000.

http://www.tradingacademy.com/ Here you can learn technical analysis and trading techniques for $5,000 to $20,000.  I won’t say this is a scam, but you won’t learn anything than you could find in a $20 book on technical analysis.  Then ask yourself if and how technical analysis has ANY value?

https://www.udemy.com/value-investing-bootcamp-how-to-invest-wisely/  A typical $200 course for beginners.

http://www8.gsb.columbia.edu/execed/program-pages/details/61/VI ONLY $7,200 for three days.  Learn from the famous Prof. Greenwald.  How can you be a value investor and then pay that amount?

https://www.quora.com/What-are-the-best-online-value-investing-courses Look for yourself.

Stamford online value investing course

Columbia_VI_Executive_Summary

Columbia_VI_Sample_Agenda

http://pages.stern.nyu.edu/~adamodar/ FREE. But even an “expert” like Prof. Damodaran can make critical mistakes as pointed out here: http://csinvesting.org/tag/vale/  You must understand economics, banking, and credit cycles!

https://youtu.be/_uQjGz6jp2E?list=PLF1wHLfTCGUQ85w90LIg-1YXZdnUKOGtO 91 short lectures on Buffett.   Not bad.   A good supplement to your readings of Buffett.

https://youtu.be/Jo1XgDJCkh4   M. Pabrai opines about value investing. How to invest in 100-baggers.  I think Mr. Pabrai will beat the averages, but he has had 80% declines in his portfolios (2008/09).  Learn the proper lessons and NEVER cease thinking for yourself.

What Can I Contribute?

Based on my research, I still believe there is a place for a serious, rigorous, and a comprehensive course and resource center to help investors be better independent thinkers and analysts of businesses.  Over twenty-five years, I have collected a huge array of investment writings, case studies, lectures, etc. that would help serious investors–the equivalent of four graduate level courses on investing.  Why pay $60,000 per year to go to graduate school to learn value investing.   Well, students pay the $60,000 for the name brand, the certificate and the relationships with other students. Not a apples-to apples comparison–to be fair.

The issue now is organizing and reformatting the material so both beginner and expert can improve.  My bias is to learn from great investors from theory to case study.   There is nothing new investing that hasn’t been said  before by Buffett, Graham, Klarman, and Jesse Livermore. Why not learn from them instead of from a flatulent, tenured business professor (ironic?!).

While at college, I worked as a pilot. Learning to fly used the theory of flight that the student applied in good, day-light weather with a flight instructor, then progressing to independent flight.  Even Munger says the process of flight training is efficient.

A Craft

Investing is a craft or both an art and science. You need the expertise and experience to place facts, information into perspective.   An investor must understand how capital is allocated by management (Corporate Finance). Take dividends.   There are many perspectives to view dividends, but dividends are paid out of FREE CASH FLOW.   So what is free cash flow and how can we know if it is sustainable?  To understand that you must convert accounting information into underlying reality.  An entire 412 page book is devoted to all the issues surrounding sustainable free cash flow, http://160592857366.free.fr/joe/ebooks/tech/Wiley%20Creative%20Cash%20Flow%20Reporting.pdf

You understand the details but you should not get lost in minutiae because you must focus on what is important and applicable to the opportunity.

Therefore, the course will need to cover the basics like:

  • Does value investing work?
  • Important concepts: How to read, how to think. How to learn.
  • Studying great investors as they apply value investing principles.
  • How to value businesses.
  • Analyzing competitive advantage or disadvantage.
  • When to concentrate and bet heavily/using options, stubs.
  • Subsets of value investing: Growth, special situations, and distressed.
  • And many other skills

You must know:  (1) how to value a business and (2) how to think about prices.  The devil is in YOU and the details.

You either buy an undervalued asset/non-franchise business that is subject to reversion to the mean (growth doesn’t add value)  or

You buy a franchise that depending upon its moat has slower reversion to the mean.  Growth is valuable within a franchise.

The course will take students through those two types of investments with case studies. Students then can refer to Buffett, Graham and others who applied value investing.

One goal would be to help students develop their OWN investment philosophy.

How to SEARCH, VALUE, MANANGE A PORTFOLIO, and IMPROVE THE YOU are involved in having a comprehensive investment philosophy. You will have a library of investors’ different approaches and philosophies.

I probably need four to six months to put the course together.  Several of you have kindly offered to help. I appreciate your interest, and I will reach out at the appropriate time.

The goal will be to have a resource for students to build a strong foundation of skills and knowledge with an area to communicate with one another.

All for now.

Fundamentals vs. Technicals, Templeton, Ackman, Analysis of Valeant

Fundamental vs. Technical Analysis

https://monetary-metals.com/technical-vs-fundamental-report-19-mar-2017/

Technical analysis, in all of its forms, uses the past price movements to predict the future price movements. In some cases (e.g. momentum analysis) it calculates an intermediate signal from the price signal (momentum is the first derivative of price). But no matter the style, one analyzes price history to guess the next price move.

This is necessarily probabilistic. There is no way to know that a particular price move will follow the chart pattern you see on the screen. There is no certainty. And when it does work, it is often because of self-fulfilling expectations. Since all traders have access to the same charts, and the same chart-reading theories, they can buy or sell en masse when the chart signals them to do so.

Fundamentals or Arbitrage:

Arbitrage works just like a spring. If the price in the futures market is greater than the price in the spot market, then there is a profit to carry gold—to buy metal in the spot market and sell a futures contract. If the price of spot is higher, then the profit is to be made by decarrying—to sell metal and buy a future.

There are two keys to understanding this. One, when leveraged speculators push up the price of gold futures contracts, then that increases the basis spread. A greater basis is a greater incentive to the arbitrageur to take the trade. Two, when the arbitrageur buys spot and sells a future, the very act of putting on this trade compresses the spread.

If someone were to come along and sell enough futures contracts to push down the price of gold by $50 or $150 or whatever amount is alleged, then this selling would be on futures only. It would push the price of futures below the price of spot, a condition called backwardation.

Backwardation just has not happened at the times when the stories of the big “smash downs” have claimed. Monetary Metals has published intraday basis charts during these events many times.

The above does not describe technical analysis. It describes physics—how the market functions at a mechanical level.

There are other ways to check this. If there was a large naked short position in a contract that was headed into expiry, how would the basis behave? The arbitrage theory predicts the opposite basis move. We will leave the answer out as an exercise for the interested reader, as thinking this through is really good work to understand the dynamics of the gold and silver markets (and you can Google our past articles, where we discuss it).

This check can be observed every month, as either gold or silver has a contract expiring (right now it’s gold, as the April contract is close to First Notice Day).

Templeton

Ackman and Valeant

Ackman and his disasterous investment in Valeant The are many psychological lessons in this article.  What can you learn?

Ironically, one of the best research on Valeant was done by Allergan: Allergan analysis of Valeant 2014.   Did Ackman’s analysts even read it?   At least you have an example of solid research.

Compare to Ira-Sohn-2015-Presentation on Valeant and Other Platform Companies   Studying the two different presentations provides a FREE course on valuation and presenting a research idea.  But not 1 person in 10,000 would be willing to sweat the details like studying the two documents linked above.

Oh well, opportunity for those who work.

Update on Analyst Course, Part 2, Readers’uggestions

An excellent HBO 90-minute special on Buffett. Even if you are sick of hearing about Buffett, this is an excellent video.  Susan Buffett, wife of Warren, “He was reading ALL THE TIME.”

A book on strategy

 

 

 

 

 

 

 

 

The above book is an excellent primer on how to view company presentations on their future plans/strategy.   There are not many good books on strategy, but this is one.  View: http://goodbadstrategy.com/background-materials/. I would trade 100 Good to Great books for one of the above.

readers’ suggestions

I would be extremely interested in analyst course you put together especially with emphasis on lots of case studies from the superinvestors used to teach the principles of valuation. I stumbled upon the course schedules of Mentals models course at Columbia University which could help you in your effort to design the course. Please find attached: mental-models-columbia-gbs-2012-syllabus

As Warren Buffet says there should be just two courses taught in valuation

  1. How to value a Business
  2. How to think about market prices

I think for most of us who are not in the field professionally, we can read all about investing in theory from books and articles but lack the practical experience and applications.  So actively doing the case studies and having the critique and feedback would be great for this course. Otherwise, we are on our own with no one to tell us how to improve or where we went wrong and what was missed.

Sharing and demonstrating how certain things are done/calculated would be great help for myself who is a kinesthetic learner and learn best through doing it practically.

Hey John, I’m very interested in the analyst course. I’ve been reading several books on improving skills i.e Cal Newport’s books, Talent Code etc by looking at various domain i.e chess, music etc where the best does it through deliberate practice and I think in investing domain there has been a lack of these structured learning, although all the case studies you’ve presented here are a great starting point.

Maybe another point which can be included in the course could be method of analysis for some key sectors like banks, insurance, Oi and Gas E&P. It could be helpful if we could get sector special books like Sam Walton for retail etc. helps in understanding key points of the sector

I pick Warren Buffett as the first investment master to imitate. Reading his letter (‘Complete Buffett Partnership Letters 1957 to 1970’ and ‘Berkshire Hathaway Letters to Shareholders’ ) to understand ‘what actually done by him’ and followed by additional reading (sources: ie csinvesting.com / You Tube / Books such as ‘The Intelligent Investor’, ‘Security Analysis’, ‘BUFFETT The Making of an American capitalist’, ‘ Warren Buffett Speaks-Wit and Wisdom from the World Greatest Investor’, ‘Inside the Investments of Warren Buffett’ and etc ) to understand the rational or whatever be discussed about his action. Later put the knowledge into practice and learning from own mistakes.

Thereafter I would adopt the same learning method on other investment master such as Mohnish Pabrai and Howard Marks.

The primary intention is to truly understand the investment philosophy behind them by knowing the gap (or difference), if any, between the saying and the action.

It’s an interesting idea. A few thoughts from my end: – You could organize each section to teach a fundamental skill or lesson and then have a case study that requires you to understand that lesson in-depth. – As part of the course, students should have to create at least one succinct pitch for a stock. – There could be sub-groups that are assigned that work together, offer each other feedback, etc. – Rather than charge for the course, you could have students commit to doing the work with one of the habit-forming/public-contract sites (i.e. stickk, beeminder)

Can we actually look at some current case studies?  Maybe reverse engineer the rationale for buying by some of the greats?

This sounds like an awesome idea. I have been trying to go back and read the Deep Value course this group was supposedly made for. I am going through the stuff slowly but there is some conflicting information. It will be great if we can have some course which puts everything together.

I would put something in there on developing qualitative theories behind investment decisions. How best to vet management, employees, and other stakeholders such as upstream and downstream participants. Most people on this site I would assume wouldn’t have direct access like major investors and sell side analysts do, so developing a theory on how to mimic these interactions through information sources would be a benefit. 

basic quantitative research might be a good value add also. Paying some of these sites multiple thousands of dollars for basic search criteria is frustrating, when basic developed quant and programming skills could replace them. And the ability to automate many processes would be a good point to. I guess this falls into the “improving you” section. 

I never got through the Best Practices of Equity Research Analysts, but there’s probably a structure in there to model off of. 

 —

Definitely a module of one-on-one interviews or presentations major investors have given at events like value investing congress would be good for putting positions in perspective. Also, since not everyone here would be a PM at a 10B hedge fund, investing across asset classes and differently sized capitalizations is very important. If Buffett is correct, then all of us managing less than 5M should be able to return 50% Let’s put that to the test. Let’s build portfolios together and give critique, as we go through the process and the modules. Maybe assigning people committed to doing the modules to working groups would benefit that process too. Applying as we go is probably the best way to reinforce the material, so it’s not just something learned and reviewed, and then forgotten. Studying for the CFA, I learned a tremendous amount of information, however I haven’t had to apply 95% of it to my work, so it’s nearly all forgotten unless I go back to heavily review.

Lastly, I would do a module on investing in different industries. Since investing in financials is not like investing in medical devices. What are the key metrics, kpi’s to these businesses. What are the nuances of investing in each of these industries since they are unique. 

If you needed any help in construction I would be willing to participate. I’m currently leaving my company, and actively searching and networking for a new career path on the asset management track, so I will have the time and interest.

HAVE A GREAT WEEKEND!

  

 

 

 

 

Update on Analyst Course, Part 1

What We do Not want to learn

We want to learn from professionals who are putting their money on the line: Michael Price, Seth Klarman, etc.

You ONLY need to learn two skills:

  1. How to value a company
  2. How to think about prices.

Unfortunately, the devil is in the details and within YOU.

How to value a company: So What’s it worth?

You must learn how businesses allocate capital.

How to think about prices


and

and

How Wall Street Works

Analyzing Management

If you actually studied the above videos, you would find much wisdom.
The good news about the course is that I have ALOT of material, the bad news is that I have ALOT of material to reformat and organize.

Part two will be your suggestions and comments. Thank you for those who have made the effort so far. So keep them coming.

A Strategy for Resource Stocks; Investing Course

A Strategy for investing in highly volatile, cyclical stocks

Once again, gold, silver and their mining stocks are selling off for whatever reason: risk-on as money floods into the stock market, rising nominal yields, 95% certainty of a (meaningless) 0.25% interest rate hike, momentum–take your excuse. The main point is to know your companies (valuation) and wait for sales like you do at the grocery store.   This week we are having a sale on some miners.

As Sprott’s Rick Rule often says, “If you are not a contrarian in the resource sector, you are a victim.  The above video is provided to show a particular investing strategy when your quality miners are selling off to prices where you estimate a margin of safety.  However, it doesn’t mean you predict THE exact bottom.  If your holding period is three-to-five years, you can occasionally pick up cheaper merchandise. Use prices to your advantage, not disadvantage.  I also wouldn’t be surprised to see the miners sell-off further because of their highly volatile nature–huge operational and asset-based leverage–when gold or silver goes up or down, both the price of their product goes up or down and the value of their reserves.  Never expect exact timing–a fool’s game.  Also, miners are impacted by the cost of their inputs, so a rising gold/oil ratio is a positive, for example.

What about the gold price in my assumptions?   I am assuming gold is money (“All else is credit”–JP Morgan) and thus I can benchmark it against world currencies. Gold has been THE strongest money relative to all other currencies for the past 20 years, 30 years, 40 years, 50 years, 100 years.  Gold is THE only money and store of value that can’t be created out of electronic bits like FIAT MONEY.  The stability of available supple is what makes gold the premier money. Of course, due to LEGAL TENDER LAWS, gold is not a currency in the U.S., except that may be changing in some states like Arizona: http://planetfreewill.com/2017/03/09/Ron-paul-testifies-support-arizona-bill-treat-gold-silver-money-remove-capital-gains-taxes/.

In fact, gold (originally silver) is the only Constitutional money allowed–http://www.heritage.org/constitution/#!/articles/1/essays/42/coinage-clause

You can get a historical overview of gold’s‘ price history below. Notice a trend?


http://www.macrotrends.net/1440/hui-to-gold-ratio Now view the miners in perspective.

P.S. Let me know if anyone wants to see a NPV case study on a miner.

Designing an analyst course

My goal is to organize a comprehensive analyst course using the best investors’ teachings and lectures. For example, Buffett, Munger, Graham, Fisher, Tweedy Browne, Walter Schloss, Klarman, and many others etc.  Why not use original sources of the best practitioners?  This is the course I wish I had twenty years ago.  It will be Buffett and Munger teaching not me.

The course would cover search, valuation, portfolio management, and you (how to improve decision-making).   There would be different modules continuing articles, case studies, videos from Columbia Business School and others. We would go from DEEP VALUE to FRANCHISE INVESTING.   Valuing assets to assessing franchises. Understanding reversion to the mean and slow reversion to the mean.  You need to understand that when a moat is breached-watch out! Note Nokia in cell phones.

I would have to make it a private web-site because of copy-right.   This would be more of like a private study place, library, and discussion area for learning.   There could be a in-person value class in some convenient location depending upon interest once folks have had a chance to go through the modules.

For example, putting ebitda into perspective might be a mini-module on a sub-set of cash-flow: http://csinvesting.org/placing-ev-and-ebitda-into-perspective-case-studies/   Now, if you scroll down to the last link, you can see that it was taken down.   With a private web-site, you would see this: http://csinvesting.org/wp-content/uploads/2012/09/placing-ebitda-into-perspective.pdf

Let me know your thoughts because this would be a huge project to complete.  What focus do YOU want?   How would YOU design and make the course.

Have a great weekend!

Outperformance without Better Stock-Picking

NERVES OF STEEL

The Little Newsletter That Crushed the Market

The Prudent Speculator has more than tripled the broad stock market since 1980. What’s its secret?


By MARK HULBERT
Feb. 23, 2017 5:48 a.m. ET

Photo
Mike Lawrie/Getty Images

It pays to have nerves of steel.

That’s the most important lesson to emerge from the Prudent Speculator’s position as one of this country’s most successful investment newsletters of the past four decades.

The advisory service, which celebrates its 40th birthday March 10, has pursued a riskier strategy than almost all other newsletters—far riskier than many investors can tolerate. But those who could and did were richly rewarded. Its advice has made more money over the past 40 years than any of the nearly 200 other services monitored by the Hulbert Financial Digest.

CSInvestor: the author defines risk as volatility!

Since mid-1980, when we began monitoring the investment newsletter industry, through the end of January, the Prudent Speculator’s model portfolios on average produced a 16,937% gain, versus 4,952% for buying and holding the broad stock market (as measured by the Wilshire 5000 index).

That’s equivalent to the difference between 15.1% and 11.3%, annualized. (These performance numbers assume all model-portfolio transactions were executed on the day a subscriber would have been able to act on the newsletter’s advice; dividends and transaction costs, but not taxes, were taken into account.) To put this into perspective, consider that the best-performing U.S. equity mutual fund over this same period produced an annualized return of 13.6%, or 1.5 percentage points per year less than the Prudent Speculator. (The fund, according to Thomson Reuters Lipper, was Waddell & Reed Advisors Science & Technology [ticker: UNSCX]).

The Prudent Speculator newsletter, which was founded in March 1977 by Al Frank and is based in Aliso Viejo, Calif., was initially named the Pinchpenny Speculator. Frank had become interested in investing several years earlier while working toward his Ph.D. in educational philosophy at the University of California, Los Angeles. He started the newsletter in part to report on the performance of his personal portfolio. From the start, his strategy was to purchase undervalued stocks and hold them through for the very long term. The newsletter’s current yearly subscription rate is $295.

In the 1990s, Frank—who died in 2002—began handing the newsletter over to an associate, John Buckingham, now 51, who had been with the firm since 1987. The transition to Buckingham has been unusually successful; the norm in the newsletter business is for services to either languish or close down completely upon the death of their founders. Not in this case. On a risk-adjusted basis, the newsletter’s model portfolios have performed even better over the past two decades than in the first two.

What’s the secret to the newsletter’s success?

It’s definitely not market timing, since it has actively argued against market timing throughout its history. Most commentators assume that the newsletter must owe its success to superior stock selection. But though the newsletter’s stock-picking has been commendable, many other advisors favor stocks with similar characteristics.


Not for the Faint of Heart

Perfomance of the Prudential Speculator

Chart

Source: www.HulbertRatings.com

Recent examples of the newsletter’s picks include Zimmer Biomet Holdings (ZBH),Williams-Sonoma (WSM), Nike (NKE), Schlumberger (SLB), and Digital Realty Trust (DLR). In an interview, Buckingham insisted that he pursues value wherever he can find it. But my computer’s statistical software shows that the newsletter’s recommended stocks tilt to the value end of the value-versus-growth spectrum and the quality end of the so-called quality-versus-junk spectrum, and tend to have smaller market values than the components of broad market averages such as the Standard & Poor’s 500 index.

If neither market timing nor stock selection is the key to the Prudent Speculator’s outstanding long-term record, what is? In my opinion, it’s those nerves of steel I referred to above.

Almost all other advisors who recommend smaller-cap, higher-quality value stocks are unwilling to hold them through thick and thin. Though these value-oriented advisers have longer holding periods than most others, their average currently is 18 months. The average holding period of the Prudent Speculator’s currently held stocks, by contrast, is four years. And there have been many times during the newsletter’s history when its average holding period was even longer than four years. Its current holding period is this short because the market’s extraordinary strength has propelled many of its previously recommended stocks above their target prices.

By selling out too early, Buckingham told Barron’s, other advisors find themselves with either one or two strikes against them. The first strike applies even if those advisors immediately reinvest the proceeds of their premature sales in other undervalued stocks: They still leave too much money on the table, since

The second strike is when advisors go to cash after selling. These advisors often end up bailing out of stocks near the bottom of bear markets. Because it almost always takes them a long time to get back into equities after the market begins to recover, they enjoy only some of the market’s recovery after suffering the bulk of its decline—and therefore lag the market over the long term.

By not deviating from its commitments to equities, the Prudent Speculator sidesteps both of these strikes.

Consider Frank’s reaction to the 1987 crash—the biggest one-day drop in U.S. stock-market history, during which Frank’s model portfolio lost nearly 60%. Far from cashing in his chips and going home, as most of us would have been tempted to do in the wake of a one-day loss that big, Frank said he saw no reason to alter the basics of his long-term strategy.

Similarly, consider Buckingham’s advice to clients on March 9, 2009, the day that turned out to be the bottom of the 2007-09 bear market—though of course no one at that time could have known that. Buckingham’s average model portfolio was sitting with a loss of more than 60% since the 2007 high, and yet his message to clients that day—as it had been every other day during that bear market—was that “our long-term enthusiasm [for stocks] remains intact.”

Many investors no doubt find it boring to remain fully invested to stocks through thick and thin and to hold stocks for many years. In fact, Buckingham says, one of the most challenging parts of his job as newsletter editor is continually finding new and interesting ways of saying the same thing: Remain focused on the long term with patience and discipline.

Easier said than done–90% of investing is character.

Note: He leans toward smaller (more apt to be mispriced) stocks, value more than growth (so he faces lest risk of overpaying for growth), quality over junk (so less chance of bankruptcy risk), and then allows AT LEAST four years for value to come out or be recognized.   His edge is his patient, long-term perspective.

A Reader’s Question on DCF


 

 

 

QUESTION:  So the intrinsic value of a company is the present value of all future cash flows?

Now everyone has a different required rate of return or discount rate, so does that mean one person’s intrinsic value of a business will be different from another person (not because of different estimates of future cash flows but because of discount rate)?

CSInvesting: Yes, a pension fund may be fine with a discount rate of 8.5% but you require 15%.

I just want to confirm what it means when in articles, famous investors talk about their investments and they would say for example that they found a business which they think is worth $50 but was trading at $15. Is their estimate of $50 the value they came up with after using their own discount rate, or is it more a comparable analysis of using a discount rate of the industry norm and that’s the value that they come up with.

I don’t know what discount rate they are using, but when you see a company trading at $15 and you think it is worth, then probably your valuation is off.   Markets are not ALWAYS inefficient, but they are usually not GROSSLY inefficient.  Say, you value a miner based on today’s gold price of $1,200 and it trades at triple the price in two years but the gold price trades at $1,600 (US) then a speculative element changed your valuation.

 

I ask because some say they will buy only if there is a 50% discount to their intrinsic value and would sell around 90-100% of their intrinsic value.  But say for example that you used a discount rate of 20% to get your intrinsic value and it so happens to be selling at 50% discount and you bought it.  Even if price reached 100% of such intrinsic value, basically what that means is going forward for that price, you will be getting 20% returns for holding that investment, which to me is an excellent investment and would hold on and not sell (assuming that the cashflow is certain for the example).

 

I think you are double counting.   You use 20% discount rate when usually the cost of equity capital is 7% to 11% AND it trades at a 50% discount, then your valuation is probably in fantasy land.

Some go to Prof. Damodaran’s Industry Cost of Capital Spreadsheet

 

http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/wacc.htm  But I wouldn’t use it other than to see what most analysts use.
REMEMBER the iron law of CSInvesting.  If you know or do something that everyone else does in the market, then it is probably useless.

DANGER with USING DCFs

STANDARD THINKING

Better:

Chapter 8 Cost-of-Equity-Capital Credit Model by Hackel 

The analysis of risk represents the single most underexplored factor in security research and the primary reason for investor disappointment in their investment returns.

The cost of equity capital, while known as a measure of investors’ attitudes toward risk, more aptly should represent the uncertainty to the cash flows investors can expect to receive from their investment in the security being considered.  Only through n accurate and reliable cost of equity capital can fair value be established as well as the determination of whether management is creating value for shareholders, as measured by the return on invested capital (ROIC) in comparison with its cost.

Because security analysts are not confronted with the daily barrage of problems and hazards that managers and executives working directly for the entity face a wide swath of hidden risks that tends to be ignored or not calibrated properly. Investors need to think and behave like corporate insiders to truly appreciate this multitude of exposures so as to accurately place a cost of capital that takes into account these uncertainties, of which any one could damper cash flows or even threaten the entity’s survival.  On the other hand, if investors were to overweigh such risks, the entity’s valuation multiple would depress, causing misevaluation.

Say the standard tech company has a cost of capital of 9%.  Well, Apple’s might have a lower, 7.6% cost of equity capital, because of the lower operational risk of its business as noted by the cost of its credit.

Use a credit model for the cost of equity capital –See ch. 8: Security Valuation and Risk Analysis by Kenneth Hackel. (in Value Vault)

At least you are garnering a different perspective.    Good questions.

Case Studies on Buffett’s Investing: NYU Course This April

 The Fundamentals of Buffett-Style Investing

Learn the investment techniques of Warren Buffett, the world’s most legendary investor. Examine case studies of Buffett’s acquisitions in order to review the real-world principles that the “Oracle of Omaha” uses to pick companies. Topics include both quantitative methods, such as valuation metrics and cash flow analysis, as well as qualitative principles, such as competitive advantage and economic moats. As a final project, partner with a classmate to present a publicly traded company you believe Buffett would buy. At the conclusion, understand what Buffett means by a “great business at a good price.” This course is appropriate for beginners in the industry and for individuals with a broad array of backgrounds. The final session is taught synchronously from the Berkshire Hathaway annual meeting in Omaha.

More details

You’ll Walk Away with

  • An understanding of the investment techniques of Warren Buffett, the world’s most legendary investor
  • The opportunity to present a publicly traded company you believe Warren Buffett would buy

Ideal for

  • Students with little to no knowledge of investing
  • Professionals across the experience spectrum in regard to investing

READ:

CSInvesting Editor: Let me know if you attend.  Several readers took the class last year and enjoyed it.

I received this email:

Dear Mr. Chew,

You were very kind last year to post a notice about our Buffett investing class on your website.  We had several students from your site, all of whom were excellent and dedicated. According to end-of-semester student surveys, the students enjoyed the class quite a bit. You clearly attract a high caliber of investor to your online community. We would be very grateful if you would consider posting a notice of this year’s class, which starts April 1st.
See below:
New York University’s School of Professional Studies is offering an online class focused on the time-honored techniques of value investing, as practiced by the world’s most legendary investor, Warren Buffett.
By examining case studies of Buffett’s acquisitions, students will explore the real-world principles that Buffett uses to pick companies. The class starts online April 1st and is open to the public for registration.
CONTACT INFO:

The instructor, James Berman, is available to answer questions. He can be reached at 212.388.9873 or jgb4@nyu.edu.

The INSTRUCTOR

If it’s about value investing, I’m interested. I run a global equities fund that invests in the United States, Europe and Asia. As the president and founder of JBGlobal.com LLC, a registered investment advisory firm, I manage separate accounts for high-net-worth individuals and trusts. As a faculty member in the Finance Department of the NYU School of Professional Studies, I teach Corporate Finance and the Fundamentals of Buffett-Style Investing. My book, Lessons from the Lemonade Stand: a Common Sense Primer on Investing, winner of the 2013 Next Generation Indie Award for Best Non-Fiction eBook, is a guide for the first-time investor of any age. I received a B.A. from Harvard University and a J.D. from Harvard Law School. My wife, daughter and I live in Greenwich Village where I find the lessons of value investing as useful with life as with money.

An article from the Instructor on Buffett

The One Word Missing from Buffett’s Annual Letter

 These days, can anyone tweet, converse or goose-step–let alone write 28 pages–without using the five letter word: Trump?

Warren Buffett just did.

As a value investing aficionado and Berkshire shareholder, I anticipate the annual missive from the Oracle of Omaha with bated breath. When it popped online today, I knew enough not to expect much commentary on the economic or the political. A secret to Buffett’s success has been an agnostic view on the too-many moving pieces of the macro scene. By avoiding the human obsession with the short-term and fortune telling, Buffett has always concentrated on the only thing that matters: buying wonderful businesses at fair prices. As Peter Lynch says: “If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.” I myself have found no other investing mantra more important.

But really? No mention of the greatest threat to the democratic process and the rule of law since Nixon–or beyond?

Geico is mentioned 22 times, Charlie Munger 17 times, hedge funds 12 times, table tennis once. Trump zero.

In April of 2016, Buffett went on record saying that Berkshire would do fine even with a Trump presidency. But that was at last year’s meeting–well before the election, and well before anyone thought it was a serious concern. And Buffett made some further post-election comments in December about still buying stocks, but this letter was his first major written opportunity to hold forth.

He even mentions the worthwhile contributions of immigrants but somehow never calls out Trump by name. Perhaps the silence is deafening. Buffett was an ardent supporter of Hillary Clinton in the election and his failure to mention Trump may be the most damning maneuver of all.

Or not.

Because if there’s one thing I wanted as a Buffett follower, it was a reasoned and sober commentary–refracted through the prism of his extraordinary, eminently sensible brain–on what this erratic, errant president means for our country, our markets and our lives.

James Berman teaches The Fundamentals of Buffett-Style Investing, an online class starting April 1 offered by NYU’s School of Professional Studies.

Buffett Warning

Where is he now? http://ericcinnamond.com/buffett-1999-vs-buffett-2017/

Buffett 1999 vs. Buffett 2017

This may sound awful coming from a value investor, but I don’t read Berkshire Hathaway’s annual reports cover to cover. I did earlier in my career. In fact, I’d eagerly await its release, just as many investors do today. However, over the years I’ve gravitated more to what makes sense to me and have relied less on the guidance from investment oracles such as Warren Buffett (see post What’s Important to You?).

While I know significantly less about Warren Buffett than most dedicated value investors, it seems to me that he has changed over the years. I suppose this shouldn’t be surprising as we all have our seasons. And maybe I’m the one who has changed, I really don’t know. But I remember a different tone from Buffett almost twenty years ago when stocks were also breaking record highs. It was during the tech bubble when he went out of his way to warn investors of market risk and overvaluation.

I found an old article from BBC News with several Buffett quotes during that period (link). The article discusses Warren Buffett’s response to a Paine Webber-Gallup survey conducted in December 1999. The survey showed that investors expected stocks to rise 19% annually over the next decade. Clearly investors were extrapolating recent returns far into the future. Fortunately, Warren Buffett was there to save the day and help euphoric investors return to their senses.

The article states, “Mr Buffett warned that the outsized returns experienced by technology investors during 1998 and 1999 had dulled them into complacency.”

“After a heady experience of that kind,” he said, “normally sensible people drift into behaviour akin to that of Cinderella at the ball.

“They know that overstaying the festivities…will eventually bring on pumpkins and mice.”

I really like and can relate to the Warren Buffett of nearly twenty years ago. If I could go back in time and show the 1999 Buffett today’s market, I wonder what he would say. I’d ask him if investor psychology and the current market cycle appears much different than the late 90s.

Similar to 1999, have investors experienced outsized returns this cycle? From its lows in 2009, the S&P 500 has increased 270%, or 17.9% annually. This is very close to the annual returns investors were expecting in the 1999 survey, when Buffett was warning investors.

Have investors been dulled into complacency? Volatility remains near record lows, with every small decline being saved by central banks and dip buyers. Investors show little fear of losing money.

Are today’s investors not Cinderella at the ball overstaying the festivities? It’s the second longest and one of the most expensive bull markets in history!

There are of course differences between 1999 and today’s cycle. While valuation measures are elevated, today’s asset inflation is much broader than in 1999. The tech bubble was extremely overvalued, but narrow. A disciplined investor could not only avoid losses in the 1999 bubble, but due to value in other areas of the market, could make money when it burst. Given the broadness of overvaluation in 2017, I don’t believe that will be possible this cycle. In my opinion, it will be much more challenging to navigate through the current cycle’s ultimate conclusion than the 1999 cycle.

The broadness in overvaluation this cycle makes Buffett’s recommendation to buy a broadly diversified index fund even more difficult for me to understand. Furthermore, given the nosebleed valuations of many high quality businesses, I’m not as confident as Buffett in buying and holding quality stocks at current prices. It again reminds me of the late 90s. At that time, there were many high quality companies that were so overvalued it took years and years for their Es catch up to their Ps. But these are important (and long) topics for another day.

Let’s get back to Buffett 1999. I find it interesting to compare him to Buffett 2017. Surprisingly, Buffett 2017 doesn’t seem nearly as concerned about valuations this cycle. Buffett writes, “American business — and consequently a basket of stocks — is virtually certain to be worth far more in the years ahead [emphasis mine]. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.”

You can include me as a naysayer of current prices and valuations of most risk assets I analyze. Based on the valuations of my opportunity set, I’ll take the advice from another naysayer – the Warren Buffett of 1999. As he recommended, I plan to avoid extrapolating outsized returns and will not ignore signs of investor complacency. I plan to remain committed to my process and discipline. By doing so, when the current market cycle concludes, I hope to achieve two of my favorite Warren Buffett rules of successful investing – avoid losing money and profit from folly.

Recent Munger Wisdom

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