Wednesday, 24 August 2016

A good video to share on Value Investing (Richard H Lawrence)

The speaker has shared a lot of his experience and knowledge, and has been very generous in answering many questions in this video.


1.  Invest in superior company.
2.  Good management.
3.  Buy when stocks are down.  Be a contrarian.
4.  Invest for long term capital gains.


Surround yourself with the right people who share your philosophy.  (The DNA of the firm).

Discipline, procedure and process.   Set up the tools.  (e.g. monitor the 52 week low levels.  Pricing power.  Score risk.  What would you do when you meet a big bear market?)


Deliver the results to the investors.

Time weighted returns (NAV return in the fund).  Capital weighted returns (Investor's return).

Must learn to manage your partnership in the bear market.  The best opportunity in bear market gives you excess return over the next 7 years.  Control the level of your asset under management to ensure his stocks have the muscle to get through a severe bear market.

Control greed.  Don't allow greed to get into your way.


6 Tenets of his model:

1.   Pricing power:  

How do you calculate this?  Able to price your profit to ensure no erosion of margin irrespective of input cost rising or falling despite facing a lot of competition.   .

Look at Margins -  Gross profit margin.  Cash gross profit margin (EBITDA margin).  Low variability of cash gross profit margin.

2.   Cash flow:

Cash flow from operation:  Net Income + D&A + other non cash items.

Free cash flow = CFO - maintenance Capex  (business in steady state)

Cash flow of the corporate structure.  (e.g. Apple has all its cash in overseas countries and has to borrow in US to pay off dividends and buy backs.domestically)

Working capital cash flow:  Negative working capital cash flows.

Company must know how to manage the FCF.   Give dividends.  Reinvest for growth.

3.   Invest in High profitability company.  

600 out of 1000 companies are probably mediocre profitability companies.  Eliminate them.

Focus on the ones with the highest profitability in the 400s.

Stay with the best of the best, and you should be able to outperform.

(I don't believe in the WACC.  DCF can be difficult to use and garbage in and garbage out.)

What is an acceptable level of profitability?

Above industry average (NOT THE BEST ANSWER).

Better to look at this through the DUPONT MODEL.   Asset turnover.  Net profit margin. Financial leverage.   Can check the reasons why these factors are not high.  Very good model.

Margin gone up.  Asset turnover gone up.  Financial leverage gone down.  VERY GOOD.
Those where ROE is high due to high finanical leverage.  NOT SO GOOD.

EBIT / NET OPERATING ASSET transfer into high ROE,  allows you to look at the quality of the management.

4.   Need to be prepared for a bear market.

Don't like cyclical companies.  Volatility of margins.  Sales slow, interest cost goes up and profit margin drops.  A whole waste of time and pain to get into these stocks.

Better stay with companies with stable earnings that can get through bear markets.  Even when you invested on a wrong day, you will still be alright.

5.  Sustainability of EPS growth.  Don't invest for change of PE.  INVEST FOR EARNINGS GROWTH.


Companies with EPS growth -  look for low cyclicality of business, ability to increase market share, good companies usually grow market share during a bear market or recession, low cost, large number of customers and suppliers.  All these are low risks to your investing.

6.   Valuation (Benchmarking)

His Formula:

(ROE + normalised Earnings growth over next 3 to 4 years) /4 = target PE
e.g. (30 + 14 /4) = target PE of 11. 

Comparing a group of 15 companies and score them 1 to 15, ranking them.

John Neff: (Earnings growth + Dividend yield) / PE.  Discards the stocks with the worse number.

De-emotionalise the process which is incredibly emotional.

These are powerful instruments for rebalancing your portfolio.

Track the key numbers in your portfolio.

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