Thursday, 31 December 2015

Cost leadership

Companies with large fixed costs and able to deliver their products most efficiently have a strong advantage and can achieve superior financial performance.

Firms don't usually advertise their cost structures per se.

To get an idea about how efficiently a company operates, look at its fixed asset turnover, operating margins, and ROIC - and compare its numbers to industry peers.

Unique assets

When limited assets are required to fullfill the delivery of a particular service, ownership of those assets is key.

Companies with well-located landfill assets represent a significant competitive advantage and barrier to entry in the waste management market because it is unlikely that enough new landfill locations will get government approval to diminish its share of this business.

Prudent financing

Having a load of debt is not itself a bad thing.

Having a loa of debt that cannot be easily financed by the cash flow of the business is a recipe for disaster.

When analysing companies with high debt, always be sure that the debt can be serviced from free cash flow, even under a downside scenario.

Examine growth expectations

Understand what kind of growth rates are incorporated into the share price.

If the rates of growth are unrealistic, avoid the stock.

Size the market opportunity

Industries with big, untapped market opportunities provide an attractive environment for high growth.

In addition, companies chasing markets perceived to be big enough to accommodate growth for all industry participants are less likely to compete on price alone.

Focus on cash flow

Investors timely earn returns based on a company's cash-generating ability.

Avoid investments that are not expected to generate adequate cash flow.

Look for recurring revenue

Long term customer contracts can guarantee certain levels of revenue for years into the future.  This can provide a degree of stability in financial results.

Look for scale and operating leverage.

Economies of scale and operating leverage are characteristics that can provide significant barriers to entry and lead to impressive financial performance.

Know the business. Understand the business model.

Understand the business model is important as this will provide insight as to the kind of financial results the company may produce.

Tell tale signs of good cash generation: Dividends, Share Buybacks and Accumulation of Cash on the Balance Sheet

Economies of scale refers to a company's ability to leverage its fixed cost infrastructure across more and more clients.

The result of scale economies should be operating leverage, whereby profits are able to grow faster than sales.

The combination of operating leverage and low ongoing capital requirements suggest that the firms should have plenty of free cash to throw around.

Tell tale signs of good cash generation are dividends, share buybacks, and an accumulation of cash on the balance sheet.

Another characteristic to look for when evaluating investments is predictable sales and profits. That makes financial results more stable and predictable.

Should there be high barriers to entry into this business, the firms in this business tend to have wide, defensible moats.

When they are trading at cheap prices, they are usually worth a good look.

Wednesday, 30 December 2015

Whole life insurance versus Renewable term insurance. The problems with whole life insurance.

Term insurance:

With term insurance all you pay for and get is protection.  If you die, they pay.

Term insurance rates start very low but go up every year.

Whole life insurance:  

With whole life you are buying a tax-sheltered savings plan as well.  Your policy accumulates "cash values."

Whole life rates start high but remain constant.

Insurance salesmen are eager to sell whole-life policies because their commissions are so much higher.

But you would be wiser to buy renewable term insurance and do your saving separately.  (With renewable policy you are assured of continuing coverage even if your health deteriorates.)

The problems with whole life:

  • Many policies pay low interest.
  • It is impossible for a non-expert to tell a good policy from a bad one.
  • There is tremendous penalty for dropping the policy, as many people do, after just a few years.
  • Most young families cannot afford the protection they need if they buy whole life.  The same dollars will buy five or six times term insurance.
  • In later years, and particularly beyond the age of 50 or 55, term insurance premiums rise rapidly.  But by then you may have a less urgent need for life insurance.  The kids may be grown, the mortgage paid off, the pension benefits vested.  You will still need to build substantial assets for retirement, and to protect your spouse; but there are better ways to save for old age than whole life.   

Ref:  The Only Investment Guide you'll Ever Need  by Andrew Tobias

Read also:

Term Life Insurance is Value for Money

Tuesday, 29 December 2015

It is easier to make money in some industries than in others.

It is easier to make money in some industries than in others.

Some industries lend themselves to the creation of economic moats more so than others.

These are the industries where you will want ot spend most of your time.

The economics of some industries are superior to others.

You should spend more time learning about attractive industries than unattractive ones.

Every industry has its own unique dynamics and set of jargon.

Some industries (such as financial services ) even have financial statements that look very different from others.

Wade through the different economics of each industry and understand how companies in each industry can create economic moats - which strategies work and how you can identify companies pursuing those strategies.

Here are some areas of the market that are definitely worth more of your time exploring.

  • Banks and Financial Services
  • Business Services
  • Health Care
  • Media

These are not the four areas of the market with worthwhile investments.

They are highlighted because they contain so many wide-moat companies.

There are great firms in even the least likely areas of the stock market.

The goal is to help answer a few essential questions:
  • How do companies in this industry make money?
  • How can they create economic moats:
  • What quirks does this industry have that an investor should know about?
  • How can you separate successful from unsuccessful firms in each industry?
  • What pitfalls should you watch out for?

Over the long haul, a big part of successful investing is building a mental database of companies and industries on which you can draw as the need arises.

That will make you a better investor.

Super-profitable companies with too much cash pile up on the balance sheet. Be proactive.

Company ABC

It has no long-term debt.

Its current ratio is around 4; rather high for a company with no debt to worry about.

It has consistently kept around 15% of total assets in cash.

Tuesday, 22 December 2015

You must be able to value the business better than Mr. Market to be in this game

In describing the irrationality of the market, Graham uses the metaphor of Mr. Market.

An investor is free to take advantage of Mr. Market, but on no account should the investor fall under his influence.

If someone is not certain that he can value his business far better than Mr. Market can, then he doesn't belong in the game.

As they say in poker, "If you have been in the game 30 minutes and you don't know who the patsy is, you are the patsy."  (Buffett)


Benjamin Graham's Mr. Market, a stubborn business partner who sometimes offer great deals or very expensive prices.

Businesses with challenging fundamentals - commodity type businesses

Producers of relatively undifferentiated goods in capital intensive businesses must earn inadequate returns except under conditions of tight supply or real shortage.

As long as excess productive capacity exits, prices tend to reflect direct operating costs rather than capital employed. (Buffett)

This means that the prices of finished goods are lower than the full production cost, which should include amortization.

The capital employed not only does not earn a return, but also does not reinstate itself.

After Berkshire Hathaway's textile business closed in 1985, Buffett commented that over the years, there had always been the possibility of making a large capital investment in the textile business that would have resulted in a reduction of variable costs.

Those investment opportunities, if viewed throught the prism of standard return on investment tests, would have brought greater economic gains than if similar investments had been made in other Berkshire businesses (candy and newspapers).

However, the potential benefits from investing in the textile industry were imaginary.

Berkshire's competitors were implementing the same types of capital expenditures, and once a certain proportion of the industry participants had made these investments, the reduced cost base in the industry would have resulted in a reduction in prices.

Considered individually, each company's investments appears to be justified, but viewed collectively, these decisions affected every company and did not benefit the individual players ("just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes").

After each cycle of capital investment, all the companies had more money tied up in the bsiness, but their returns did not improve.

As Buffett's parade revelers rising on tiptoes demonstrate, the managerial decisions of individual participants in uniform industries are intertwined.

Poor judgment by a single manager may lead to future losses for all involved.

"In a business selling a commodity-type product, it is impossible to be a lot smarter than your dumbest competitor."  (Buffett)

If your competitors set prices at a level that is lower than your production costs, then you also must set prices at that level and suffer the losses if you are to remain in business.

"The trick is to have no competitors.  That means having something that distinguishes itself." (Buffett)

While the degree to which it is possible to introduce product differentiation within an industry may change because of technology developments or the evolution of consumer preferences, in many industries differentiation among products may be simply impossible to implement.

A few producers in such industries may consistently do well if they have a wide sustainable cost advantage, but such exceptions are rare or, in many industries, nonexistent.

For the great majority of companies selling "commodity-type" products, persistent overcapacaity without regulated prices (or costs) results in poor profitability.

Overcapacity may eventually self-correct as capacity shrinks or demand expands, but such corrections are often long delyaed, and "when they finally occur, the rebound to prosperity frequently produces a pervasive enthusiasm for expansion that, within a few years, again creates ovecapacity and a new profitless environment."  (Buffett)

The best type of business to own

Businesses with Good Fundamentals - the best type of business to own

The best type of business to own is "one that over an extended period can employ large amounts of incremental capital at very high rates of return."  (Buffett)

In practice, most high-return businesses need relatively little capital.  (Buffett)

While the highest return attainable as a criterion is understandable, how capital intensive is a business is a very important consideration.

Buffett opines that between two "wonderful" busineesss one should choose the least capital intensive.  He admits that it took Charlie Munger and him 25 years to figure this out.  (Buffett).

Warnings for calling your investment long term when they were meant to be short-term

Buffett warns against calling long-term those investments that were meant to be short-term but became long-term because the investors could not achieve the desired results quickly.

Buffett recommends being suspicious of those managers who fail to deliver in the short term and blame it on their long-term focus.

Arguing against market timing

1.  While waiting for the market to fall, it is possible to miss out on growth in companies with good prospects (some ten-baggers made their biggest moves during bad markets).

2.  Following the fashionable trend may lead to serious mistakes in the choice of investment targets.

The market is overvalued when there are no suitable investments at suitable prices.

There is no reason to worry about an overvalued market.

The way you will know when the market is overvalued is when you cannot find a single company that is reasonably priced or that meets your other criteria for investment.  (Lynch and Rothchild, 2000)

Peter Lynch holds the same view as Buffett on market timing.

Lynch doesn't believe in predicting markets, but believes in buying great companies - "especially companies that are undervalued, and/or under-appreciated."

"Things inside humans make them terrible stock market timers.  The unwary investor continually passes in and out of three emotional states:  concern, complacency, and capitulation."

Both investors prefer falling markets.

A good 300 point drop creates some bargains that are the "holy grail of the true stock picker."

The loss of 10 to 30% of  net worth in a market sell-off is of little importance.

Peter Lynch views a correction not as a disaster, but as an opportunity to add to a portfolio at low prices:  

"This is how great fortunes are made over time."

Walter Schloss remarked on Warren Buffett

Walter Schloss observed that Buffett's advantage is in that he is not afraid of the downside.  (Schloss, 1998)

Monday, 21 December 2015

The Lessons a CEO wish he knew when he was 21.


It was more years ago than I’d care to admit, but I vividly remember being 21 years of age.

Beneath a headstrong facade hid a perplexed kid, riddled with nerves about succeeding on the professional road that lay ahead. I concealed these feelings of uncertainty because I thought that’s what would impress an employer: an uber-confident young talent with an unmistakable hunger to get ahead. Surely they would respond well to someone who was outspoken, bold and unmistakably ambitious.

Upon entering the full-time workforce I applied this attitude in droves. While I thought I was doing the right thing, unbeknown to me I was damaging my reputation. It started to become apparent that my colleagues perceived me as somewhat arrogant, closed minded, and difficult to work with.

My career advancement was limping rather than sprinting. I’d watch peers receive promotions while I hovered in the same position, brimming with resentment.

Rationalising it was just a simple case of not finding the right job, an environment that would finally let me shine, I propelled myself down a path of short-term stints in various organisations, becoming increasingly disillusioned every time I job-hopped; where was this professional utopia? It took me a few years to realise that utopia doesn’t exist. It wasn’t the particular organisation, culture or people that were clamping my progress; it was my misguided attitude. My professional disappointments were no one else’s fault but my own. Coming to terms with that wasn’t easy, but ultimately, and thankfully, I did.

Today, I am a CEO. My many missteps as a young professional are a chief reason why I spend a significant amount of my time mentoring young people throughout Australia and abroad. I want to help them avoid making the same mistakes that I did.

During these mentoring sessions I am always reminded of my fledgling missteps, and what I wish I’d known as a young professional. If I were to have a mentoring session with my 21 year old self, here’s what I would I tell that bull-headed young person:


Self-awareness in business is paramount. Not identifying or understanding the impact your behaviour has on others is a professional pitfall and will limit your progress. Observe how people respond to you. What is their body language like when you speak or enter a room? If it’s noticeably negative, is there anything you should be doing differently?

This is not about changing who you are as a person: it’s about finding better ways to relate and work with your colleagues. Taking the time to listen, observe, see things from someone else’s point of view is essential to knowing your impact and building solid relationships.


Ambition is great. Blind ambition is not. Constantly focusing on reaching the next level of your career will detract from your responsibilities and relationships at hand. One of the biggest annoyances for any manager is an employee who expects more responsibility before they’ve mastered in their current role. Master your current role and you will be invited to the next level much quicker.


When people are promoted ahead of you don’t let it unsettle you. Jealousy is never, ever, a good look. Believe me, managers are always observing how their employees respond to unfavourable situations. Remaining positive in these situations, using them as motivation to work harder, will be recognised and respected by your superiors.


Employers know you’re inexperienced. They know you’re likely anxious about your first foray into professional life. And they know that you want to impress. Their expectations of you won’t be that high for those very reasons, so avoid trying to look like you know all the answers, because they know you don’t.

The first job is about listening, observing and fulfilling requests to the best of your ability. You’re laying the foundation for bigger things — don’t be impatient.

Don’t forget:

- Understand the impact your behaviour has on others and respond accordingly.

- Focus on doing your current role well and your manager will take notice.

- Don’t be jealous when a colleague is promoted ahead of you, rather use it as motivation to work harder and improve.

- Employees don’t expect you to know everything – so don’t pretend you do.

This article first ran on

Saturday, 19 December 2015

Patience - the key to successful stock market investment.

The hardest thing to learn is not the complicated technical analysis formulas that one can be found in textbooks. It is the empirical formula called patience. It is the key to successful stock market investment. Without it even one has the sharpest mind of great stock pick will not yield desirable and consistent results.

I have read countless great textbooks, technical and non-technical, throughout my investing life and in the end, I came to realise that the very one thing that many people lack of in stock investment is patience. It took me years to understand and appreciate this. That is why i always stressed one must have patience, persevere, trust and conviction in stock investment. Yes. Each of this word is about human behaviour. Master it and only then talk about fundamental analysis, technical analysis, stock pick and timing. Case in point, how many would have patiently hold on to Presbhd long enough to achieve extreme profit from it ? It doesn't matter if you have held onto a stock for very long time despite making less paper profit, but the patience that you have developed subconsciously within you to keep that stock is already a good start. 

By the way, the worst enemy of patience is distraction. Think about it.

Good luck.

Friday, 18 December 2015

I have learned mainly by reading myself.

Buffett: "I have learned mainly by reading myself. So I don’t think I have any original ideas. Certainly, I talk about reading Graham. I’ve read Phil Fisher. So I’ve gotten a lot of my ideas from reading. You can learn a lot from other people. In fact, I think if you learn basically from other people, you don’t have to get too many new ideas on your own. You can just apply the best of what you see.”

"ORIGINALITY is overrated. I believe in the discipline of mastering the best that other people have figured out. I don’t believe in just sitting down and trying to dream it all up yourself. Nobody’s that smart." Charlie Munger

"What’s really astounding, is how resistant some people are to learning anything … even when it’s in their self-interest to learn. There is just an incredible resistance to thinking or changing. Bertrand Russell once said: ‘Most men would rather die than think. Many have.’ And in a financial sense, that’s very true." Warren Buffett.

Charlie Munger Fan Club

Thursday, 17 December 2015

International Business Machines

International Business Machines

Sector:  Information Technology
Beta Coefficient: 0.63
10 Yr Compound EPS Growth:  13.0%
10 Yr Compound DPS Growth: 19.5%
Dividend raises, past 10 years: 10 times.

Financial Result Year 2014

Revenues (b)     92.8
Net Income (b)   15.7
EPS  15.59
DPS   4.25
Cash flow per share 20.44
Current yield 2.7%

High Price  199.2  P/E 12.8    DY 2.1%
Low Price   150.5  P/E  9.7     DY 2.8%

IBM historically has made a broad range of computers, mainframes, and network servers.  

But the company has morphed over the years into a software and services company.

As a consequence, fewer folks than ever talk about an "IBM computer" anymore; they talk about an "IBM business solution" or some such.

IBM is divided into four principal business units and a financing unit:

  • The Global Technology Services unit:  This is the largest, at 38% of revenues.
  • The Global Business Services unit (18%)
  • The Software unit (32%).
  • The Systems and Technology group (10%)
  • The Financing Unit (2%) helps the company market it all.

Overseas sales make up about 55% of revenues.

The company has kept "strategic" large systems but little else; it is now offering cloud-based and integrated hardware/software/service solutions for diverse needs such as business analytics and data security.

It recently invested $4 billion in "new" core strategic areas in cloud and mobile computing, analytics and information security.

It is buying up its own stock, almost 6% of its float last year.

Its business mix is shifting from less profitable hardware to more profitable services, first came consulting, then outsourcing and now, leading-edge analytics, security and cloud services.

Stock Performance Chart for International Business Machines Corporation

Health Care REIT

Health Care REIT, Inc.

Sector:  Health Care
Beta Coefficient: 0.43
10 Yr Compound EPS Growth:  20.5%
10 Yr Compound DPS Growth: 2.5%
Dividend raises, past 10 years: 10 times.

Financial Result Year 2014

Revenues (m)     3,344
Net Income (m)    505.0
Funds from operations per share  4.13
Real Estate owned per share 69.5
DPS 3.18
Current yield 4.4%

High Price  78.2      DY 4.07%
Low Price   52.9     DY 6.01%

This is a large REIT, paying yield exceeding 5 percent.

It invests primarily in senior living and medical care properties primarily in the U.S.  

The REIT owns and/or operates some 1,328 properties in three countries and operates assisted living, skilled nursing, independent-living and the medical centers.

Health Care REIT operates in three primary business segments:
  • Seniors Housing "triplet-net" segment:  primarily owning senior housing properties.  This segment owns 666 properties, most in the US and contributes 33% of revenues.
  • Seniors Housing Operating segment which operates 202 properties in 34 states, 54 in Canada and 41 in UK and contributes about 43% of revenues.  This is the fastest-growing segment.
  • Medical Facilities which operates office space set in 241 facilities for medical purposes, inpatient and outpatient medical centers and life science laboratories, contributing about 14% to revenues.

Occupancy rates are 87.7% in the Seniors Housing triple-net segment, 90.3% in the Seniors Housing Operating, and 94.4% in the Medical Facilities segment.

In 2014 and early 2015, the company made two medium-sized common stock sales, which hurt the stock price temporarily but also funded the acquisition of $3.7 billion in new real estate investments.

The company added a modest number of shares again in 2015 to fund acquisitions and to approach a goal of 60% equity.

REITS are typically good income producers, as they are required by law to pay a substantial portion of their cash flow to investors.

The accounting rules are different, and REIT investors should focus on Funds From Operations (FFO), which is analogous to operating income.
(Net income figures have depreciation expense deducted, which can vary in timing and not always be realistic.)

FFO support the dividends paid to investors.

Investing in such a REIT, you are investing in real estate and in the health-care industry, and with the property mix owned by Health Care REIT, you are investing in the aging population.


The FED raises interest rate by 0.25%.

After 7 years of near zero interest rate, the Fed raises interest rate by 0.25% from 0.25% to 0.5%.

Reasons given for raising interest rate today are:

  • GDP growing at 2% to 2.5% sustainably for some time.
  • Employment has dropped from 10% to 5%.
  • Inflation is still below the 2% target at 1.3%, but the Fed wants to be ahead of the curve.

To understand the action of the Fed better, watch this very instructive video on the yield curve.

What is a yield curve?

For those who wish to understand the Fed better, watch this video.

What is the FED?

US economy has improved.  Consumer spending, autocar buying and housing sector activities are up.  Wages have not risen much so far.

Read also this very good post:

Wednesday, 16 December 2015

Johnson & Johnson

Johnson & Johnson

Sector:  Health Care
Beta Coefficient: 0.5
10 Yr Compound EPS Growth:  8.5%
10 Yr Compound DPS Growth: 11.5%
Dividend raises, past 10 years: 10 times.

Financial Result Year 2014

Revenues (m)     74,311
Net Income (m)   17,105
EPS  5.97
DPS 2.76
Cash flow per share 7.90
Current yield 2.8%

High Price  106.5  P/E 17.8    DY 2.59%
Low Price     96.1  P/E 16.1    DY 2.87%

The company has three reporting segments:
Consumer Health Care ($145 billion in FY2014 sales)
Medical Devices and Diagnostics ($27.5 billion), and 
Pharmaceuticals ($32.3 billion).

J&J has more than 250 operating companies in 60 countries, selling some 50,000 products in more than 175 countries.

The company is fairly active with acquisitions, acquiring small niche players to strengthen its overall product offering.

J&J continues to own a dominant and stable franchise in a secure and lucrative industry.

Persistent and moderate share buybacks and dividend increases gave shareholders their fair share of the profitability of its business.

The company expects to resume a mid-single digits growth pace for both revenues and earnings in FY 2016, with corresponding benefits paid to shareholders.

J&J's steady earnings and cash flow combined with a healthy dividend and share repurchases provide gratifying total shareholder returns.

The P/E has expanded from 14 - 15 to the 16 - 17 range, adding a bit of downside risk.

Stock Performance Chart for Johnson & Johnson

Apple Inc.

Apple Inc.


Sector:  Consumer Discretionary
Beta Coefficient: 0.84
10 Yr Compound EPS Growth:  70.5%
10 Yr Compound DPS Growth   NM
Dividend raises, past 10 years: 3 times.

Financial Result Year 2014

Revenues (b)    182.8
Net Income (b)     39.5
EPS  6.45
DPS 1.82
Cash flow per share 8.09
Current yield 1.5%

High Price  119.8  P/E 18.5    DY 1.52%
Low Price     70.5  P/E 10.9   DY 2.58%

The company designs, manufactures and markets personal computers, tablet computers, portable music players, cell phones and related software, peripherals, downloadable content and services.  

It added the digital watch to its portfolio in mid-2015.

It sells these products through its own retail stores, online stores, and third-party and value-added resellers.

The company sells digital content through its iTunes stores.

It has become a big player in the "digital wallet" mobile payment space, with its Apple Pay apps and network.  

The company is rumoured to be considering a move into the automobile business.

The company's products have become household names:  iPhone, iPod, iPad, MacBook, iTunes, QuickTime, OSX and iCloud.  

Steve Job, who passed away in October 2011,  was clearly the driving and leading force in Apple's innovation, style and success.

The current CEO is Tim Cook.

The company recently split its shares a massive seven for one, and has, in part due to shareholder activist pressures, stepped up its cash returns to shareholders.

It is rumoured the company is planning up to a cumulative $200 billion to be delivered in the form of dividends and share buybacks by the end of 2018.

Investors can expect dividend increases and especially share buybacks to continue large, with about 100 million shares retired each year on a 5.8 billion share base.

The company has already retired about 13% of its shares since FY 2012.

Apple's ability to generate income and now, to distribute it to shareholders is admirable.

Stock Performance Chart for Apple Inc.

Tuesday, 15 December 2015

The Coca-Cola Company

The Coca-Cola Company


Sector:  Consumer Staples
Beta Coefficient: 0.49
10 Yr Compound EPS Growth:  8%
10 Yr Compound DPS Growth   9.5%
Dividend raises, last 10 years: 10 times.

Financial Result Year 2014

Revenues (m)   45,998
Net Income (m)   9,091
EPS  2.04
DPS 1.22
Cash flow per share 2.53
Current yield 3.2%

High Price  45.0  P/E 22.1   DY 2.71%
Low Price  36.9  P/E 18.1   DY  3.31%

The Coca-Cola Company is the world's largest beverage company.  

For more than 100 years, the company has mainly produced concentrates and syrups, which it then bottles or cans itself or sells to independent bottlers worldwide.  

It took a big step to own the supply chain in 2010 with the acquisition of bottler Coca-Cola Enterprises" North Amercian operations; CCE still handles distribution for Europe.

Independent bottlers add water ingredients, then bottle and distribute the products to restaurants, retailers and other distributors.  

The company owns the brand and is responsible for consumer brand marketing initiatives, while the distributors handle all downstream merchandising.

The company operates in more than 200 countries and markets nearly 500 brands of concentrate and finished beverages.

In terms of unit case volume, 79% of all sales are overseas - 29% in Latin America, 15% in Eurasia/Africa, 21% in the Pacific and 14% in Europe.

In terms of revenues, the company counts about 57% as overseas sales.

With $18 billion in cash in hand, Coke has made many strategic acquisitions.  Coke has the means.

Cash returns to investors are decent on both the buyback and dividend front, with high single-digit to 10% dividend raises the norm, even with flat performance.

For a company this size, it still make 20% net profit margin.  

Warren Buffett said he'll never sell a single one of the 400 million shares of Coke stock he owns.  "I like to bet on sure things."

Coke has category leadership, especially, in soft drinks, juices and juice drinks, and ready to drink coffees and teas.

They are number two globally in sports drinks and number three in packaged water and energy drinks.  

In Coca Cola, Diet Coke, Sprite and Fanta, they own four of the top five brands of soft drink in the world.

The Coca Cola name is probably the most recognized brand in the world and is almost beyond valuation.

The company have raised dividends in each of the past 53 years, and returned some $8.5 billion out of $10.5 billion in cash generated to shareholders in 2013.
Dividend raises, last 10 years: 10 times.

It is also a pure play on international business as you will find in a US company.

The low beta of 0.49 continues to confirm its low-volatility credentials.

This is a slow, steady growth story, which may be too slow for many, with new risks the company didn't face when Mr. Buffett bought in years ago.

Stock Performance Chart for The Coca-Cola Co

Becton, Dickinson and Company

Becton, Dickinson and Company

Sector:  Health Care
Beta Coefficient: 0.87
10 Yr Compound EPS Growth:  11.5%
10 Yr Compound DPS Growth 16.5%

Financial Result Year 2014

Revenues (m)   8,446
Net Income (m)  1,236
EPS  6.25
DPS 2.18
Cash flow per share 9.37
Current yield 1.7%

High Price  142.6  P/E 22.8   DY 1.53%
Low Price  105.2  P/E 16.8   DY  2.07%

Becton Dickinson is one of the premier medical supply and technology companies on the planet.

Becton Dickinson is a global health care company .  The company develops, manufactures, and sells medical supplies, devices, laboratory instruments, antibodies, reagents, and diagnostic products through its three segments:

BD Medical  (54% of FY 2014 sales)
BD Diagnostics (14%)
BD Biosciences. (32%)

International sales account for about 59% of the total.

In mid-2014, the company announced the acquisition of CareFusion, a global provider of automated tools and systems designed to reduce patient medication errors and to prevent care-associated infections.

With the acquisition, while accretive, CareFusion may appear to dilute BD;s strong profit margins (NPM for BD is about 15% while CareFusion is about 11%), but it is anticipated synergies and growth to be a net positive.

Its dividend increases are not only steady but large, typically 10% per year, and the company plans to continue that pattern.  Dividend raises, last 10 years: 10 times.

Stock Performance Chart for Becton Dickinson and Co

When to sell? Sell when there is something else better to buy.

When should you sell?

Answer: Sell when there is something else better to buy.

Something else better for future returns.

Something else better for safety.

Something else better for timeliness or fit with today's go-forward worldview; a megatrend.

What is that something else? 

It can be:

- another stock
- an index fund
- a house
- or any kind of investment

It can also be cash. 

Sell that stock when .... when what? When cash is a better investment. Or when you need the money, which is another way of saying that cash is a better investment - at least it is safer for the time being.

Best possible deployment of your capital

If you think of a buy decision as a best possible deployment of capital because there is no better way to invest your money, you will also come out ahead.

It really is not hard, especially if you have done your homework.

And it is also made easier if you avoid rash overcommitments; that is, you avoid buying all at once in case you have made a mistake or in case better prices come later down the road.

Buy and hold quality companies for the long haul, and you will likely be handsomely rewarded for that patience.

Invest regularly.

Monday, 14 December 2015

"20-Slot Rule" - This tip from Warren Buffett will help you be more successful at work and in life



Charlie Munger settled into his seat in front of the crowd at the University of Southern California.

It was 1994 and Munger had spent the last 20 years working alongside Warren Buffett as the two men grew Berkshire Hathaway into a billion-dollar corporation.

Today, Munger was delivering a talk to the USC Business School entitled, “A Lesson on Elementary Worldly Wisdom.”

About halfway through his presentation, hidden among many fantastic lessons, Munger discussed a strategy that Warren Buffett had used with great success throughout his career.

Here it is:

When Warren lectures at business schools, he says, “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches — representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”

He says, “Under those rules, you’d really think carefully about what you did and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”

Again, this is a concept that seems perfectly obvious to me. And to Warren it seems perfectly obvious. But this is one of the very few business classes in the U.S. where anybody will be saying so. It just isn’t the conventional wisdom.

To me, it’s obvious that the winner has to bet very selectively. It’s been obvious to me since very early in life. I don’t know why it’s not obvious to very many other people.

The Underrated Importance of Selective Focus

Warren Buffett’s “20-Slot” Rule isn’t just useful for financial investments, it’s a sound approach for time investments as well. In particular, what struck me about Buffett’s strategy was his idea of “forcing yourself to load up” and go all in on an investment.

The key point is this:

Your odds of success improve when you are forced to direct all of your energy and attention to fewer tasks.

If you want to master a skill — truly master it — you have to be selective with your time. You have to ruthlessly trim away good ideas to make room for great ones. You have to focus on a few essential tasks and ignore the distractions. You have to commit to working through 10 years of silence.

Going All In

If you take a look around, you’ll notice very few people actually go “all in” on a single skill or goal for an extended period of time.

Rather than researching carefully and pouring themselves into a goal for a year or two, most people “dip their toes in the water” and chase a new diet, a new college major, a new exercise routine, a new side business idea, or a new career path for a few weeks or months before jumping onto the next new thing.

In my experience, so few people display the persistence to practice one thing for an extended period of time that you can actually become very good in many areas — maybe even world-class — with just one year of focused work. If you view your life as a 20-slot punchcard and each slot is a period of focused work for a year or two, then you can see how you can enjoy significant returns on your invested time simply by going all in on a few things.

My point here is that everyone is holding a “life punchcard” and, if we are considering how many things we can master in a lifetime, there aren’t many slots on that card. You only get so many punches during your time on this little planet. Unlike financial investments, your 20 “life slots” are going to get punched whether you like it or not. The time will pass either way.

Don’t waste your next slot. Think carefully, make a decision, and go all in. Don’t just kind of go for it. Go all in. Your final results are merely a reflection of your prior commitment.


Richard Branson explains his 4 rules for making difficult decisions


In the summer of 2012, the British government informed Virgin Trains that it had lost the bid to retain the operating rights to the UK’s West Coast rail franchise. Virgin Trains had been running the £7 billion ($10.9 billion) franchise for 15 years, expanding the line and growing its annual passenger numbers from 13 million to 30 million.

Richard Branson, chairman of Virgin Train’s parent company the Virgin Group, writes in his book “The Virgin Way” that he was “stunned and baffled” that he could have lost the bid to the company FirstGroup.

He decided to stay quiet for awhile, meeting with lawyers and advisors to see if Virgin had actually been beaten fairly. Everyone he spoke with seemed to conclude that FirstGroup’s numbers were unsustainable, meaning the British government had made a mistake in calculations. Regardless, many of his senior team told Branson that he’d only be wasting his time and hurting his image with a lawsuit. But, after carefully weighing the facts, he decided to move forward with it.

A week before he was scheduled to meet the Department for Transport in the UK’s high court, Branson got a phone call from the department’s secretary. The secretary told him that on further review, the department had indeed made grave miscalculations and Virgin had offered the better deal.

Branson considers his decision to sue the government, which ultimately saved his rail business, to be one of the best high-stakes decisions he’s ever made. In his book he highlights four rules that he’s used to make tough decisions like this one throughout his business career, and we’ve described them below.

1. Don’t act on an emotional response.

Branson says he was flabbergasted when he first heard that the Virgin Trains deal had not gone through, but he was experienced enough to know that he should take some time to settle down and collect data instead of letting his feelings take control of him.

Had he made a statement to the press out of frustration or demanded to sue the British government solely out of instinct rather than fact, he would have increased the likelihood of having his case dismissed and appearing reckless.

It’s just as bad to act on a positive emotion, he says. Give decisions you’re considering enough time to lose the influence of your first impressions.

2. Find as many downsides to an idea as possible.

Branson carefully considers everything that could go wrong before he goes forward with a decision.

Regarding the rail case, Branson’s lawyers initially told him he had a 10% chance of winning a case against the government. But after collecting proof that some numbers in his competitor’s deals were off, he was convinced he had truth and customer support on his side.

“Nothing is perfect, so work hard at uncovering whatever hidden warts the thing might have and by removing them you’ll only make it better still,” he writes.

3. Look at the big picture.

Before he makes a decision, Branson takes a look at how it will affect his other projects in both the short and long term.

“This one may be a ‘too good to miss’ opportunity but how will it affect other projects or priorities and, if now is not the best time to do it, what risks if any are there in putting the thing on hold for an agreed period of time?” he writes. “If you cannot manage this project in addition to another that’s waiting in the wings, which one gets the nod and why?”

Branson’s latest project is Virgin Hotels, which he hopes will take advantage of a booming American hotel market.

With every project he undertakes and manages, he considers how the Virgin brand and his own name will be represented.

4. Protect the downside.

In a LinkedIn blog post from 2014, Branson writes that the best lesson his father ever taught him was to protect the downside; that is, limit possible losses before moving forward with a new business venture.

Branson’s father told him that he would allow him, at age 15, to leave high school and start Student magazine only if he sold £4,000 worth of advertising to cover printing and paper costs.

It’s a strategy he repeated in 1984 when he made a huge leap from the music business into the airline business with Virgin Atlantic. He was only able to convince his business partners at Virgin Records to agree to the deal after he got Boeing to agree to take back Virgin’s one 747 jet after a year if the business wasn’t operating as planned.

These four simple guidelines can become habit, whether you’re about to approach a prospective client or sue the British government.



Heuristics are simple rules of thumb, developed by humans, which enable them to efficiently make decisions.

Heuristics are essentials; without them it would be impossible to make the decisions required to get through a normal day.

They allow people to cope with information and computation overload and to deal with risk, uncertainty  and ignorance.

Unfortunately, these heuristics can sometimes result in tendencies to do certain things that are dysfunctional.

Everyone must be careful not to fall prey to certain (often dysfunctional) tendencies.

In the context of human activities that were not a part of most of our evolutionary past as a species, such as investing, heuristics can produce one mistake after another.

"Individuals tend to extrapolate heuristics from situations where they make sense to those where they do not."

Heuristics conserve scarce mental and physical resources, but the same process, which is sometimes beneficial, can lead people to harmful systemic errors.

An approach to risk:  Probability of loss X the amount of possible loss  versus Probability of gain X the amount of possible gain.

If the amount of loss is massive even if the probability was small, rationality should overcome psychological denial, optimism, and other negative decision-making tendencies.

The reality is that we all tell ourselves false stories to avoid the truth.

Even if you spend a lot of time studying behavioural economics, you can only improve your skills on the margin.  You will always make mistakes.

If you understand dysfunctions that are caused by behavioural economics phenomena and the other person does not, then you have a potential edge.

The best Graham value investors spend a lot of time thinking about possible sources of dysfunctional decision-making and emotional errors.

Other people's errors create opportunities for the Graham value investor.

"There is a lot of behavioural finance confirming Ben Graham's original judgment." (Professor Bruce Greenwald of Columbia Business School.)

You will need to deal with heuristics like mental accounting, sunk cost, ambiguity, regret and framing, just to name a few in your investing journey.

Thursday, 10 December 2015

How smart is Warren Buffett?

"We've seen oil magnates, real estate moguls, shippers and robber barons at the top of the money heap, but Buffett is the first person to get there by picking stocks" [Rothchild, 1995]

1982            Buffett first appeared on the first Forbes list

1992            Reached top position in 1993 with a fortune of $8.2 billion.

2001-2007  Buffett was in second place (after Bill Gates).

2008            Buffett was again in first place with a fortune of $62 billion.

2010-2012   Buffett remained in third place (by that time he ha transferred some of his fortune to a charitable fund)

2013             He was in fourth place.

"Stocks are simple.  All you do is buy shares in a great business for less than the business is intrinsically worth, with management of the highest integrity and ability.  Then you own those shares forever". [Buffett]

The data on Buffett's results are reliable and his performance is very well documented.

"Is this a result of Buffett's application of his methodology, or did it happen by chance?"
"Is it possible to replicate this achievement?"
"What is required for replication?"

The question of whether financial success is achieved by chance or through application of a methodology is the central point of discussion on the rationality and efficiency of financial markets.

Buffett would not have achieved his results without the "right" investment process and without his unique abilities as a business analyst.  But icebergs always have much larger submerged parts.  The true "secrets" may hide there.  Supporting the investment process that he developed is the intellectual foundation (intellectual core) beneath his accomplishment.  

Sunday, 6 December 2015

Investment Decisions and Fundamentals of Value

Investment Decision Rules:

Accept all investments with Net Present Value greater than Zero.

Accept all investments with Rates of Return greater than their Opportunity Costs of Capital

@ time 39.00

An example:

You are considering an investment opportunity that costs $100,000 and promises to return 10%.

A comparable investment in the financial market returns 15%.

A bank offers to lend you $100,000 at 8% with no conditions.


1.  Do you invest $100,000 in the investment opportunity?

Answer:  NO

2.  What is the investment's cost of capital?

Answer:  15%.


You should invest the $100,000 in the financial market that returns 15%.

The financial market provides the investing return standards against which other investments are evaluated.

Financing by the bank loan at 8% was irrelevant to the investment decision.

The investment decision and the financing decision are separate and independent decisions.

After you have made the investment decision, thus:
You are considering an investment opportunity that costs $100,000 and promises to return 10%.

A comparable investment in the financial market returns 15%.

Then you make the financing decision, thus:
A bank offers to lend you $100,000 at 8% with no conditions.

Corporate Finance by Aswath Damodaran - Youtube lectures

Wednesday, 2 December 2015

Risk Management

Risk refers to the likelihood that your assets will decrease in value.

Risk is unique in that it applies to the probability of losses occurring, and the potential value of those losses.

In finance, risk is considered a type of cost.

All decisions you make have some degree of inherent risk.

Inaction too often has the greatest amount of risk, so rather than becoming paralysed by attempting to avoid all risk, look at it as a type of cost that allows you to calculate whether a financial decision will reap greater benefits that the potential losses and to compare the available options.

There are a variety of different ways to:

  • avoid risk,
  • reduce risk, or 
  • even share risk.

Each of the above has a price.

By calculating the cost-value of specific risks, it becomes possible to determine whether any of the tools available for managing risk are financially viable and are themselves an appropriate risk.

Risk management is a critical part of financial success.

You should explore:

  • the different types of financial risk, 
  • the ways in which risk is measured and 
  • how to effectively manage the amount of risk to which you are exposed.

Additional notes

Ways to avoid risk:  diversification and appropriate use of derivatives
Ways to share risk:  insurance

In the end, the best tool you have available to you in limiting the costs associated with risk is simple due diligence.
  • Do your research, make decisions which make sense to you and keep watching so you know when that decision doesn't make sense anymore.
  • If someone's credibility is in question, risk mitigation can come in forms as simple as asking for a nonrefundable down-payment, just as banks will sometimes ask for collateral before issuing loans.
  • Preparing for losses can be as simple as keeping enough funds available in a liquid form so you can pay your bills until you regain your losses.  
  • The duration of your exposure to losses can be shortened by ensuring you always have an exit strategy - before you commit to a decision, develop a way to undo it in a worst-case scenario.

Like most things, you get out of risk management that you put into it, and as the amount of potential risk increases, so should your intolerance for sloppy risk management.

"No risk, no reward." "Higher risk, higher returns."

Risk:  The probability and value of financial loss.

Specific risk:  Risk that is associated with an individual investment.

Old cliche in finance:  "no risk, no reward".

But there is absolutely no reason to think that accepting risk inherently generates financial returns.  

The reality is the opposite:  all other things being equal, higher risk causes you lower financial gain, since the costs you incur as a result of the elevated risk corrode the value of your assets.

All other things being equal between two distinct investment options, if one option has greater risk, then the organisation selling that investment must offer a higher rate of return in order to attract investors.

It is not that the higher risk causes higher returns - it is that investors demand higher returns in order to accept the higher risk.

Various models are used to understand the relationship between risk and returns:

  1. CAPM
  2. APT
  3. Value at Risk
  4. Expected Shortfall
  5. Ratings by underwriting agencies

Sunday, 29 November 2015

Growth Investing

The Conventional definition:  An investor who buys high price-earnings ratio stocks or high price to book ratio stocks.

The Generic definition:  An investor who buys growth companies where the value of growth potential is being underestimated.   

In other words, both value and growth investors want to buy undervalued stocks.

The difference is mostly in where they think they can find bargains and what they view as undervalued (value of the growth assets versus the value of the assets per se.)

If you are a growth investor, you believe that your capability edge lies in estimating the value of the growth assets better than others in the market.

Friday, 27 November 2015

Cyclical losses from economic cycles, time horizon and retirement planning

The value of assets such as stocks and real estate increases on average over the long run.

It also tends to fluctuate in waves - it will go up for a while, then down a little, then up some more and down again.

If you are not careful these waves can make you seasick, metaphorically speaking, of course.

If you watch these cycles happen but aren't aware of how to manage your response, you could find yourself making poor financial decisions as a result or even attempting to retire shortly after a devastating economic collapse, as happened to many people after the 2008 financial collapse.

What are the ways to prevent this from happening?


The main thing to consider is your time horizon - the number of years you have remaining before your planned retirement date.

When you are young and first begin saving for retirement, it is easy to take a lot of risk without worrying about CYCLICAL LOSSES, because you think you will have more than enough time to regain that value.

This is a mistake a lot of people make, as they sell all their investments when the economy crashes, forgetting that economies eventually recover.

A recession is the worst time to sell your investments because you will get the worst possible price for them, for the reason of a national economic cycle rather than anything inherent to the investments themselves.


It is important, however, that you don't confuse economic cycles with troubled investments.

If your investments are doing poorly in a strong economy, consistently underperform or otherwise give you a reason to believe that the price won't recover, then don't stay on a sinking ship - sell those investments and buy something better.

Losses resulting from economic cycles, such as recessions, will recover; so remain persistent.

After you get some practice and become familiar with these cycles, you can even sell your investments just as they begin and then rebuy them when they lose a lot of their value, maximizing your wealth.

Another approach is then to sell them again slowly as their price recovers.

This reduces some of the risk associated with the economy's uncertain movements - something which so many people struggle to predict, even experts.

If you know how to ride these cyclical waves in the economy, you can actually use them to your advantage, but even if you just hold onto your investments and wait out the recession, you will regain the value eventually.


These cycles only really pose a risk to people who are getting ready to retire in the middle of one.

This is why you should absolutely manage a shift in the types of investment you hold as you get closer to your retirement.

When you are young, more volatile investments like equity index funds will give you the highest growth rates, even though the price roller coaster may make you dizzy.

As you get closer to your retirement date, the timing of these cycles can be very unfortunate, leaving you with little money to fund your retirement; so over the years you should gradually switch from high-risk to low-risk investments.

This means that you should regularly increase the percentage of your total investments that are allocated to things like low-risk bonds, fixed-rate annuities or even high-yield bank accounts.

That way, by the time you are ready to retire, the fluctuations in the economy will have little influence on the value of your investments.

This process of gradual risk reduction will help to give you the highest returns on your investments, while carefully managing the amount of risk to which you are exposed.

Capital Management in Personal Finance

A simple equation in finance describes your approach to capital management:

Assets = Debt + Equity

Everything you own was funded either by incurring debt or by expending your own resources.

Subtracting all your debt from the total value of your assets shows you how much equity (net wealth) you have accumulated.

The BALANCE of debt and equity you have used to fund the value of your assets is a critical portion of your financial management strategy, known as CAPITAL MANAGEMENT.

Cost of capital

Whether you use debt or equity to fund your asset ownership, there are COSTS OF DEBT and EQUITY involved, known collectively as COST OF CAPITAL.

The cost of debt refers to the amount of interest you will pay over the life of your debt.

Most people don't realise that there is also a cost associated with using your own resources to purchase assets, known as the "cost of equity".

"OPPORTUNITY COST" is the value of the next best option; so if you have the choice between purchasing furniture and keeping your money in a bank account, the opportunity cost of buying the furniture is equal to the amount of interest you would have earned by keeping your money in the account.

This makes most purchases far more expensive than people realise, since each purchase you make not only includes spending money, but also losing any earnings on that money if you hadn't spent it.

Effective capital management

Effective capital management requires you to assess the cheapest sources of both debt and equity being used to fund your assets, and also to find the proper balance of equity and debt so that you choose the cheaper of the two at any given point.

As you come to rely on one more than the other, its costs will start to increase; the more debt you have, the more lenders will start to charge you in interest rates as a result of the shift in your credit report.

If you rely more on equity, you will begin to pull assets which are more valuable, making debt cheaper compared to the money you would be losing by selling your investments.

The goal is to maintain the lowest cost of capital possible, using variations on the core equation:

Cost of capital 
= Cost of Equity + Cost of Debt
= [(E/A)*CE] + [(D/A)*CD]

E= The amount of equity you have
D= The amount of debt you have
A= The total value of your assets (D+E)
CE= The average cost of your equity (the money you would earn o the next best option)
CD= The average cost of your debt (the interest payments you will make)

E/A= weight of source of capital from equity
D/A= weight of source of capital from debt

You can assess whether your debt or equity is costing you more money from the above equation, to help you to determine the proper balance.

If these are not about equal, it is likely you could fund your assets more cheaply.

Are your assets generating returns more than the cost of capital?

Adding the cost of equity to the cost of debt gives you the total cost of capital.

The question remaining is whether your assets, on average, are generating MORE value than they are costing.

If yes, good for you.

If not, keep trying, because  right now you are losing money on your assets.

This equation only gives you a rough idea of your cost of capital, though.

The more precise you can be, even to the point of breaking down each source of debt and equity individually, the more accurate your calculation will be.

Thursday, 26 November 2015

Beginner Strategies for Investment

Investment strategies aren't just about picking the best investments you can find, but about picking investments that are more beneficial together than they are on their own.

Here are some basic strategies to build your investments.

The most common strategy is simple diversification of investments.

For bonds, this means staggering your coupon and maturity dates not only to provide consistent income but also so that you can more readily respond to changes in the market, rather than having the entirety of your bond investments tied up at the same time.

For stocks, this means picking high-quality investments which tend to fluctuate in price in opposite directions; as one stock decreases in value in the short run, another should increase, but both should appreciate over the long run.

In the same manner, including global diversification of stock investments can reduce the impact of global trends.

Diversifying into types of investment you have can help you find an appropriate balance of potential gain and risk - maintaining a percentage of your portfolio in stocks or even high-risk investments like speculative stocks or junk bonds and the remainder of your portfolio in low-risk investments.


Many options make use of a combination of stocks and derivatives.

Buying stocks as well as a put option gives you the upside potential of the stock but limits your potential losses by guaranteeing you will be able to resell the stock at the price noted in the option.  So long as your gains exceed the purchase cost of the put option, you will remain "in the black".

If you believe a stock will decrease in price, you can sell it short and then buy a call option, so that if you are wrong you can repurchase the stock at a guaranteed maximum price, putting a limit on the immense risk associated with shorting stock.

Buying both a call and a put option with the same strike price (the price at which you can exercise your option) means that you will make money regardless of which direction the stock moves, so long as the move is large enough that you earn more money than the cost of the options.  This strategy is known as a "straddle".

In a strategy known as a "collar", you buy a stock and sell a call option on the stock , so that if the price of the stock increase, the option buyer will likely exercise their option; this creates limited upside potential, but the money from the sale of the call option can be used to fund a put option, so that you eliminate the cost of the option.  The result is that you create both a "floor" and a "cap" (a maximum amount of loss and gain, respectively), functioning as a collar that limits the amount of movement in the stock price.

The strategies available to you are varied and numerous.  As you get more practice using them, you can expand to develop multi-step strategies.

[Diversification:  The act of investing in several different investments to reduce the potential value of loss if a single investment fails.

Buying a call option gives you the choice to purchase a given volume of something at a specified price, so long as you do so before the maturity date.

Buying a put option gives you the choice to sell a given volume of something at a specified price.

Regardless of what happens to the market price, the seller of the option is obligated to participate in the exchange if the buyer decides to exercise the option.]

Valuation methods

Even the best investing strategies won't help you if you don't understand the value of the investments you are making.

Without assessing the future potential of your investments, you are simply gambling by letting probability take over.

It is in the nature of investment valuation that the calculations of their value are mathematical.

Return on Investment (ROI)

This is the end result of how much money you make or lose on an investment.

ROI = (P - C) / C

P= current market price at which you sold the investment
C = cost of the investment - the price you paid for it.

Present Value

Present value is the value that an investment with known future value has at the present time.

PV = FV / [(1+r)^t]

FV= amount of money you will receive at the end of the investment's life
r= the rate of return you are earning on the investment during that time
t= the amount of time that passes (in years) between now and the end of the investment's life.

This is an extremely common calculation with bonds, since bonds are sold at the discounted rate (the present value), and you must estimate whether the market price of the bond is above or below the present value to determine whether the price is worth it.

Net Present Value (NPV)

Net present value is the sum of present values on an investment that generates multiple cash flows.

When calculating NPV, calculate the present values of each payment you will receive, and then add them together.


The value of fixed-rate investments is easy because you have certainty regarding what you will earn.

The problems come when you start estimating the value of variable-rate investments, like stocks or derivatives.

There are many complicated methods of calculating variable-rate investments, but they fall into three categories:

Relative, and

Absolute models

Liquidation value or intrinsic value

Absolute models are the most popular among investors who look for the intrinsic value of an investment, rather than attempting to benefit by trading on movements in the market.

Such models include calculations of the liquidation value of the company, often adjusted for growth over the next few years.

In other words, you start with what the company would be worth if you simply sold everything it has for the cash, then subtract the debt.

Of course, the value of companies changes over time, and the market price of stocks is often based on the future earning potential of the company, rather than its current earnings.

So, estimates of liquidation value start with the current liquidation value and then increase that value by a percentage consistent with their average past growth, or by some other estimate of their future growth.

Dividend Discount Model  (DDM)

For investors who prefer investments that yield dividends, the DDM is popular.

DDM is calculated by working out the NPV of future dividends.

If you estimate that dividends will grow over that period, simply subtract the growth rate from the rate of return in the NPV calculation.

NPV = Dividend / (R - g)

R= discount rate
g= growth rate

For dividend investors, if the NPV of the dividends is lower than the current market price per share of the stock, the stock is undervalued, making it a great deal.

Relative Models

Relative models are popular among traders, who invest based on short-term movements in the market because they allow them to compare the performance of various options.

Common tools in performing these comparative assessments use the financial statements of a company and include:

Price to earnings ratio (P/E)

This functions as an indicator of the price you are paying for the profits a company will earn for you, either as dividends or through the investment of retained earnings.

Return on equity (ROE) = Net Income / Shareholder Equity

This indicates the amount of money a company makes using the money shareholders have invested in the company.

Operating margin = Operating Income / Net Sales

This indicates how efficiently a company is operating.

These indicators are not calculations of company value, but indicators of the comparative performance of companies in which one might invest.


Absolute and relative models are combined to create hybrids that attempt to estimate the value of a stock by combining the intrinsic value of the company with how well it performs compared to other potential investments.