Showing posts with label buying good companies. Show all posts
Showing posts with label buying good companies. Show all posts

Thursday 14 March 2019

Checklist for Buying Good Companies at Reasonable Prices


Here is a summary of the questions an investor should ask for investing in good companies at fair prices.


Questions 1 - 19:  Focus on the areas of the business.

Business Nature
1.  Do I understand the business?
2.  What is the economic moat that protects the company so it can sell the same or a similar product five or ten years from today?
3.  Is this a fast-changing industry?
4.  Does the company have a diversified customer base?
5.  Is this an asset-light business?
6.  Is it a cyclical business?
7.  Does the company still have room to grow?

Business Performance
8.  Has the company been consistently profitable over the past ten years, through good times and bad?
9.  Does the company have a stable double-digit operating margin?
10. Does the company have a higher margin than competitors?
11. Does the company have a return on investment capital of 15% or higher over the past decade?
12. Has the company been consistently growing its revenue and earnings at double digits?

Business Financial Strength
13. Does the company have a strong balance sheet?

Business Management
14. Do company executives own decent shares of stock of the company?
15. How are the executives paid compared with other similarly sized companies?
16. Are insiders buying?

Business Valuation
17. Is the stock valuation reasonable as measured by intrinsic value, or P/E ratio?
18. How is the current valuation relative to historical range?
19. How did the company's stock price fare during the previous recessions?


Question 20:  Confidence in Your Business Analysis or Research

20. How much confidence do I have in my research?




The final question centers on how you feel about your research.  Though it is not directly related to the company, your own analysis is a vital consideration.  It determines your action once the stock suddenly drops 50% after you buy.

That same 50% drop can trigger opposing actions depending on your level of confidence.

  • If you are assured in your research, the 50% drop in price is a great opportunity to buy more of the stock at half the price.  
  • If you don't have confidence, you will likely be scared into selling at a 50% loss.

It will happen after you buy the stock and, paradoxically, it happens only after you buy.  So, get prepared!


The checkup questions are based on the company's financial data.  None of them should replace your work of understanding the business and learning about its products, its customers, its suppliers, its competitors, and the people who work in the company.  The warning signs serve as reminders of where you are.  They are not meant to substitute for understanding.  If we paid attention only to the numbers and signs and ignore the business itself, understanding of the company business is incomplete.

If we gain a solid understanding of the business, these numbers and signs will help us to appreciate where we are and where we are probably going.  If business understanding is qualitative and the numbers are quantitative, both are needed to gain the confidence we need for our research.

The checklist is a useful tool for investors to maintain discipline in their stock picking.

Wednesday 13 March 2019

Deep Value Investing has its Inherent Problems.

Buffett said it best:

Unless you are a liquidator, that kind of approach to buying businesses is foolish.

  • First, the original 'bargain' price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces - never is there just one cockroach in the kitchen. 
  • Second, any initial advantage you secure will be quickly eroded by the low return that the business earns ...

There are better ways to make money (see below).


Warren Buffett, Berkshire Hathaway shareholder letter, 1989.
http://www.berkshirehathaway.com/letters/1989.html





When the overall market valuation is high, and everything else is rising, those dropping and appearing in the deep-bargain screener probably deserved to be traded by low valuations.

  • Their stock prices were likely low for the right reasons, and buying these would likely have resulted in deep losses.
  • Therefore, when it comes to deep-value investing, investors need to be cautious and aware of this approach's inherent problems.




The inherent problems with deep value investing

"Cigar-butt investing"

This was coined by Buffett for the strategy of buying mediocre businesses at prices that are much lower than the companies' net asset values.

He said the approach is like "a cigar butt found on the street that has only one puff left in it and may not offer much of a smoke, but the "bargain purchase" will make that puff all profit."




There are several problems with this approach.

1. Erosion of value over time.

Mediocre businesses do not create value for their shareholders; instead, they destroy business value over time.

The value of the business can decline and the initial margin of safety may gradually shrink, even if the stock price doesn't go up.

Investors need to be lucky enough to have the stock prices rise in time and sell before prices drop again following the intrinsic value of the business.

"Time is the friend of the wonderful business, the enemy of the mediocre." Buffett wrote in his 1989 shareholder letter.


2. Timing and Pain

Buy these bargain portfolios when you can find plenty of them, but if the broad market is in quick decline, like in 2008, the bargain portfolio will be very likely to lose much more than the general market.

  • If the decline lasts longer, many of the companies in the portfolio may suffer steeper operating losses and may even go out of business.
  • It is much more painful to hold such a portfolio in bad times, as anyone who owns these stocks during bear markets or recessions will attest - and lose much sleep over.

Because of the quick erosion of business value, selling the deep-asset bargains quickly is key, even if stock prices do not appreciate. The biggest profits are usually achieved within the first 12 months.

"If you buy something because it is undervalued, then you have to think about selling it when it approaches your calculation of its intrinsic value. That's hard." (Charlie Munger.)

Buffett likens buying mediocre businesses at deep bargain prices for a quick profit to dating without the intent of getting married. In that situation, it is essential to end the courtship at the right time and before the relationship turns sour.


3. Not Enough Stocks Qualify

To avoid errors and disasters caused by single stocks in the deep-bargain portfolio, it is important to have a diversified group of them.

But when the market valuation is high, it is just not possible to find enough stocks to satisfy the diversification requirement. They simply dried up as the market continued to tick higher.

This situation may last a long time, as the close-to-zero interest rate has lifted the valuations of all assets.


4. Tax Inefficiency

Because of the short holding time, any gain from the portfolio is subject to the same tax rate as the investor's income tax (for U.S. investors, unless it is in a retirement account.)

This drastically reduces the overall return over the long term.




If buying mediocre businesses at deep bargain prices for a quick profit is like a date without the intent of getting married, buying them and getting involved long term is like a marriage without love. A lot of other things need to be right to work things out, and it will never be a happy marriage.




Important Notes on Deep-Asset Bargains strategy


Though buying deep-asset bargains can be very profitable, this strategy comes with its inherent problems.

- This strategy comes with a much higher mental cost to investors.

- More importantly, business deterioration and the erosion of value put investors in a riskier position.

- As a result, they need to strictly follow the rules of maintaining a diversified portfolio and selling within 12 months whether investments worked out or not.




Ask yourself:

Why would you, as an investor, want to get involved in this mess (a deep-asset-bargain) and witness things deteriorating, hoping the situation will improve?

Even if it works out eventually, which is very unlikely (in the majority), the mental and psychological drain is simply not worth it.



There are better ways to make money.

Buy Only Good Companies!


"Bargain-purchase folly."


Instead of buying companies with deteriorating values on the cheap and hoping things will improve, why not buy companies that grow value over time?

Warren Buffett summarized in a single sentence the priceless lessons he learned from his personal "bargain-purchase folly".

"It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price."




Monday 3 March 2014

Charlie Munger: I have seen so many idiots getting rich on easy businesses. Don't buy cheap bargains, but look for very good companies.



Don't buy cheap bargains, but look for very good companies.
I have observed what would work and what would not.
I have seen so many idiots getting rich on easy businesses.
Surely, I am interested in the easy businesses.


Saturday 9 June 2012

The real world of investing


There are 10,000 publicly traded companies in the US markets.  There are 1,000 publicly traded companies in the KLSE.  With so many companies out there to pick from, only a small minority will be suitable as LONG-TERM INVESTMENTS.

This means the great majority of companies you investigate will be unsuitable.  You should take some pains to screen for companies that meet your requirements.

If you don't realize this up front, and accept discouragement as a normal part of the process, you may tire of discarding company after company and give up.  Worse yet, you may relax your requirements and accept companies that don't come up to snuff. Either way, you'll lose.  

Remember:  You need to own only about 10 to 20 good stocks - that's all!  And there are plenty of companies to choose from to populate your portfolio.  So be patient and disciplined.  

Assemble a list of companies based on your quality criteria.  You will usually find that even if performance on your quality criteria has persisted - and this is usually the case for most - you'll find the price for many of these stocks unattractive.  When you first assemble this list, make no effort to assess the price, just the quality.

Some of these companies have been around a long time and are familiar to you: others are not so well known.  All have been publicly traded for at least 5 years on the major exchanges and all have revenues of more than $100 million.

The moral of the story here is that you should keep the faith.  There are plenty of fish in the sea for you, even though the sea is enormous and there are many more losers than winners.

Friday 8 June 2012

Evaluating Company Quality

To buy a good stock, you only need to know if the company is a good-quality company and if the price you have to pay for its stock is reasonable.

A good-quality company is one whose growth, upon which you rely to increase the value of your investment, is strong and stable, and one in which management's efficeincy will enable it to continue that satisfactory growth. 

The first assessment of a company's quality is the analysis of its sales and earnings growth.

As a company passes through its life cycle, its success and its potential as an investment can be sized up at a glance.

Companies that are good candidates are easy to spot.

More important, companies that are not good candidates are even easier to spot.

As you become more experienced, you'll be able to gain more insight into what is in store for a company and why.

Wednesday 30 May 2012

Better Investing Philosophy




Fundamentals of Investing

 

Explaining the BetterInvesting Philosophy

 


Our February issue traditionally includes an invitation for you to bring a visitor to your investment club meeting so that they can discover how clubs can help them build wealth and can learn about BetterInvesting’s philosophy. Two years ago we published an article explaining our approach to investing that proved popular with readers. This month we’ll tackle the subject again. If you’re bringing a guest to a meeting or want to introduce someone to the BetterInvesting approach, you might consider giving them this issue.

Brad Perry, in his classic book Winning the Investment Marathon, wrote that investing “is pursued most successfully in a simple, straightforward way.” This is the Golden Rule for most investors who employ fundamental analysis and have a long-term perspective. Buy stocks of high-quality companies at good prices and continue holding them as long as the companies’ performance merits doing so.


Sales drives earnings; earnings drives the stock price. That’s what it comes down to for fundamental investors. You might hear of different ways to buy and sell stocks, and countless books have touted systems that promise great returns. But over the long term fundamental analysis is what works in building wealth.
   
Fundamental analysis comes down to studying a company’s financial performance. Broadly, there are those who look for growth stocks and those who look for value equities, but the line between value and growth investing is gray: As Warren Buffett says, value and growth “are joined at the hip.”
   
Value investing, as practiced by Buffett and his mentor Benjamin Graham, is a time-tested method involving fundamental analysis that has served many investors well. But for the typical person who has a job and family and who is managing his own portfolio while following Perry’s admonition to keep it simple, fundamental analysis focused on growth stocks might be more appropriate.
   
This is because individual investors can spot a good growth company quickly. BetterInvesting’s Stock Selection Guide arranges the fundamental data in a way that allows users to see a company’s growth and management performance as well as the stock’s investment possibilities in just a few minutes; see the Stock to Study SSG on pages 29 and 30 for an example. Meanwhile, the work required to spot a good value stock is a little more complex. But as we’ll discuss later, value should be a vital consideration as well.

The Three Most Important Ideas:
Management, Management, Management
The individual investors who belong to BetterInvesting ask two questions when studying a stock:

  Is this a well-managed company?
•  Is its stock reasonably priced?

   
We seek great management because talented, capable executives know how to ensure their company thrives over the long term amid competitive battles and periodic downturns. These are the people, in other words, who are responsible for driving the sales and growth increases that fuel stock prices.
   
In assessing management, we don’t know everything about a company’s day-to-day operations and boardroom discussions. But as laid out in a methodology promoted by association co-founder George Nicholson, we do have a lot of the information we need. A first step in finding a well-managed company is to look at the history of sales and earnings growth. An important indicator of strong management is its ability to grow the business in good times and bad.
   
We also seek companies that are growing sales and earnings over the long term at a rate that’s high relative to their size. Smaller companies generally should be growing earnings by at least 15 percent a year; mid-size companies, by 10 percent to 15 percent a year; and large companies, by at least 7 percent annually.
   
We want smaller companies to have higher growth rates partly because they generally are riskier investments than large companies. The higher growth rate compensates us for this additional risk, and if we do a good job of assessing these companies, we’ll see handsome returns. As you’ll see in this issue in “Repair Shop” and “Watch List,” finding small companies can be challenging but also quite rewarding.
   
Finally, we favor consistent growth over the long term. In the graph on this page, for example, note the railroad-track-like growth of the company’s sales and earnings. Consistent performance reassures us about the capability of management. And although the past is no guarantee of future performance (as they say in the mutual fund world), history informs our decisions regarding future growth.
   
Two other tests help us assess the company’s management. First, we check the company’s profitability before taxes and other charges outside of management’s control. We like to see stable or growing profit margins. The other ratio is return on equity — how well management is using the equity invested in the company. Again, stable or growing ROE is preferred. Comparing the company’s growth rates, profitability and ROE with those of its peers helps determine whether this is a company built for a long voyage or is simply benefiting from the rising tide for its industry.



Evaluating the Investment Potential

Once we’ve determined the company in question is likely a high-quality one worth studying further, we next project sales and earnings growth. As fundamental investors, we know that in the short term, the market may not reward the company for its excellence. But over the long term, we trust that it will. So it’s the long-term projections — five years, very roughly enough for the company to go through a business cycle — we care about.
   
We start by forecasting sales growth because we need this for building our earnings projection. With the caveat that making long-term predictions can be a humbling experience, we have a number of data points at our disposal, including:

•  The company’s historical growth rate.
•  Company statements regarding growth goals.
•  Wall Street estimates of both short- and long-term growth. Long-term sales growth estimates can be difficult to find but are sometimes buried in analyst reports.
•  The industry’s historical growth rate and estimates of future expansion.

   
More experienced investors might consider such factors as the percentage of recurring revenues, the value of projects under contract but not yet completed and historical organic growth and growth by acquisition. For retailers, they might look at projections for store and square footage expansion as well as same-store sales growth. But history is a powerful teacher for beginning and experienced investors alike.
   
We then estimate earnings growth in light of the sales projection. We’ll consider the company’s history of earnings growth and any goals it has stated. We can also access analyst reports and analysts’ consensus estimates, but these forecasts are usually overly optimistic.
   
Studying past and potential future profit margins and tax rates can help us understand the path revenues will take to earnings. We also want to think about what will happen to the firm’s number of common shares outstanding. For example, if a company regularly buys back shares to reduce the number of shares outstanding and is expected to continue this practice, we would expect future earnings to be spread among fewer shares.
   
When we’re finished, we use the earnings growth rate to arrive at an estimate of earnings per share five years from now. If we have forecast growth of 15 percent a year, and the EPS at our starting point is $1, five years from now EPS will be $2. Two things to keep in mind regarding projections:

•  It’s prudent to be conservative.
A firm might have increased earnings 25 percent annually over the past 10 years, but such performance is extremely difficult to maintain. Gravity will eventually take hold as a company moves from small to mid-size to large.
•  Earnings advances can outpace sales growth for only so long. Over the long term, they usually settle in at the rate of revenue growth. If you’re going to project EPS increases that are higher than sales growth, understand where the additional percentage points are coming from: Increased margins? Lower taxes? Fewer shares outstanding?

Checking Valuation

Once we’ve predicted the EPS five years from now, we’re ready to answer our second question: whether the stock is reasonably priced. Investors are good at discovering high-quality stocks but experience more challenges in determining the proper price to pay for the stock. Our first step is to study the stock’s price-earnings ratios over the past several years and forecast the likely high and low P/Es over the next five years. The P/E, the stock’s current price divided by a company’s EPS, is how much the market is willing to pay for $1 of a firm’s earnings; it’s the most common way to measure how expensive a company’s stock is.
   
Historical valuations can help us in this process, but P/Es often go through unpredictable periods of expansion and contraction as industries go in and out of favor on Wall Street. Another idea to keep in mind is that a stock can trade at extremely high P/Es for a while but eventually will drop — severely so when a high-growth company stumbles. P/Es also tend to contract in times of inflation.
   
After we have predicted what the high P/E for a stock will be, we’re ready to estimate a potential high price for our stock. It’s a matter of simple math: The high point of EPS — what we forecast the EPS to be five years from now — is multiplied by the high P/E to come up with a potential high price. For example, if we predict EPS will be $2 in five years and the high P/E will be 30, our predicted high price will be $60.
   
After projecting the low P/E, we can multiply it by the expected low EPS to come up with a potential low price. Since we’ve determined this is a growth company, we usually can use the most recent 12 months’ EPS as the low point for earnings. I can use other criteria for projecting a low, but this is a common method for determining this figure.

Return Expectations

Now that we have the stock’s potential range from low to high, we’re ready to see whether this stock will provide a suitable return. Our SSG divides the range into three zones: Buy, Maybe (or Hold) and Sell. The lowest 25 percent of the range is the Buy zone, and the upper-most 25 percent is the Sell zone.
   
We include the stock’s dividends — the cash payments of earnings to shareholders — in our return calculations. This gives us three ways to achieve a return on a stock


  • through dividends,
  • through the market increasing the stock’s price in concert with the earnings growth and 
  • through the stock’s price rising because the market believes the P/E should be higher.
   
We aim for our stock holdings to return 15 percent annually on average over the next five years, or a doubling of return. That’s an aggressive target, but the idea isn’t to be disappointed if we fail to meet it. It’s to maintain our focus on seeking high-quality growth stocks. Achieving returns of, say, 10 percent yearly is pretty commendable.
Managing Risk

Investors can manage their risk in picking individual stocks by following some simple rules:

•  Require that the company have at least five years of financial history. Younger firms haven’t developed enough of a track record for assessing management performance.
•  Study only companies that have proven they can make money. Someone who invests in a company that has never reported earnings is speculating, not investing.
•  Understand the possible risk and reward of owning a stock.
•  Diversify your portfolio. Even if you’ve done your homework on every holding using all the information you need to make an informed decision, you’ll still make mistakes. If you have a good-size basket of stocks, however, you’ll also have some stocks that perform much better than expected.
   
Besides investing in high-quality growth stocks and diversifying your portfolio, two other simple principles can help you build wealth over the long term. 


  • First, reinvest all your dividends and earnings. 
  • Second, invest regularly in both good markets and bad; this is often called dollar-cost averaging.
   
The type of analysis I’ve outlined provides a lot of the information fundamental investors need to determine whether a stock is a suitable investment. But not everything. Reading annual reports, listening to conference calls and viewing company presentations will help you form a fuller picture of the company.
   
In today’s unpredictable, volatile market, fundamental analysis is even more important than usual. But for an investor using a simple, straightforward methodology that focuses on the long term, these are also times of great opportunity.

Sunday 26 February 2012

WHAT WARREN BUFFETT SAYS ABOUT PREDICTING FUTURE CASH FLOWS


DISCOUNTED CASH FLOW (DCF)

This method of valuation is often referred to as the Discounted Cash Flow (DCF) valuation method, but, as Buffett has said in relation to shares, it is not easy to predict future cash flows and this is why he sticks to investment in companies that are consistent, well managed, and simple to understand. 

A company that is hard to understand or that changes frequently does not allow for easy prediction of future earnings and outgoings.

WHAT WARREN BUFFETT SAYS ABOUT PREDICTING FUTURE CASH FLOWS

In 1992, Warren Buffett said that:
‘Leaving question of price aside, the best business to own is one that over an extended period can employ large amounts of capital at very high rates of return. The worst company to own is one that must, or will, do the opposite – that is, consistently employ ever-greater amounts of capital at very low rates of return.
It is well worth reading Buffet’s analogy relating DCF to a university education in his 1994 Letter to Shareholders.

So, it would seem that the intrinsic value of a share in a company relates to the DCF that can be expected from the investment. 

There are formulas for working out discounted cash flows and they can be complex but they give a result.


EXPLANATIONS OF DCF

The best explanation that we have read of DCF is by Lawrence A Cunningham in his outstanding book How to think like Benjamin Graham and invest like Warren Buffett.
A good online explanation is available here.


Saturday 25 February 2012

Warren Buffett and Keynes


WARREN BUFFETT AND KEYNES


In Warren Buffett’s own words, he did not invest in these companies, and many other successful investments, without acquiring as full a knowledge as possible about the company, its business, its management, and its financial position. He has advised individual investors to do the same, as did the great economist and successful investor John Maynard Keynes.

‘As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about …’ - Jim Keynes

What Warren Buffett says about Buying a Business


BUYING THE BUSINESS

Warren Buffett believes, as did Benjamin Graham, that investors should look upon share investment as buying a part of a business. Investors should take the same approach to buying shares as they would if they were buying a business. The only difference is that instead of buying the whole of the business, or a partnership in the business, they are only buying a tiny share.
A prudent investor never buys a business that they do not understand. Similarly, a prudent share investor should never buy shares in a company, whose business they do not understand.

WHAT WARREN BUFFET SAYS ABOUT BUYING A BUSINESS

In 1977, Warren Buffett told shareholders in Berkshire Hathaway that their company would only invest in a business that the directors could understand.. He has repeated this message many times since. In 1992, he expanded on this theme:

‘[W]e try to stick with businesses we believe we understand. That means they must be relatively simple and stable in character. If a business is complex or subject to constant change we’re not smart enough to predict future cash flows. Incidentally that shortcoming doesn’t bother us.’

WHAT WARREN BUFFETT SAYS ABOUT GOOD BUSINESSES



Good businesses with that ‘protective moat’ that Warren Buffett likes have the ability to cope with inflation by raising prices. As he said in 1993:

‘The might of their brand names, the attributes of their products and the strength of their distribution systems gives them an enormous competitive advantage, setting up a protective moat around their economic activities. The average company, in contrast, does battle daily without any means of protection.’



BERKSHIRE HATHAWAY HOLDINGS

Stocks held by Berkshire Hathaway in 2002, as stated by Buffett in his letter to stockholders include:
  • The Coca Cola Company
  • American Express
  • The Gillette Company
  • H and R Block Inc
  • Moody’s Corporation
  • The Washington Post Company
  • Wells Fargo and Company
These are all companies with a unique or special product, or with a company brand name, or in a market domination position. They or their products have a loyalty (voluntary or otherwise) that means customers want or must come back.

Another desirable quality in non-commodity companies is repeat business. Customers drink their Coke, wear out their razor blades, or finish reading their Washington Post, and then, eventually have to replace it.

Tuesday 6 December 2011

The adage is that if you are going to panic, it's best to panic early. When did you last review your investments?


Investments

The stock market's ups and downs have spooked investors. One survey said that the majority of investors hadn't changed their allocations – 72pc had kept their UK investments as they were, while 88pc had left their eurozone allocation untouched.
"Some people seem to be caught in the headlights, "unsure what to do as financial losses bear down on them, said Nicholas Boys Smith of Lloyds TSB International Wealth, which carried out the survey. Experts say avoid making knee-jerk reactions. The adage is that if you are going to panic, it's best to panic early.
But if you can't remember the last time you reviewed your investments, or your financial adviser hasn't been forthcoming, now is the time to give your portfolio an overhaul.
Tip: The bestselling multi-manager team at Jupiter expect markets to be resilient. Not surprisingly, their portfolios are light on European equities. They remain overweight in funds such as Invesco Perpetual Income, Newton Asian Income and First State Asia Pacific.
Algy Smith-Maxwell of Jupiter said: "My advice is to invest in high quality businesses that have a proven track record of paying healthy dividends. A dependable income stream should keep a cautious investor patient while the financial system undergoes a painful period of structural reform."


http://www.telegraph.co.uk/finance/personalfinance/investing/8932939/Eurozone-crisis-surviving-the-second-credit-crunch.html

Saturday 10 September 2011

Long Term Investment Applies to 'Good' 'Business' 'Company'

Over a period of investment, I met with different types of friends. We are all searching for a Low Risk yet High Return investment which is in contrast with the classic 'Modern Portfolio Theory' written by Harry Markowitz.

Some are learning Technical Analysis. A number of theories have been developed in term of the searching of a good stock which has a upward movement or downward movement which they can predict and make use of. However, the cons of this analysis is you are hard to master it and there is still a risk involved which encourage you to 'Cut Lost' if the wind turns another way round.

Some are learning Fundamental Analysis. CFA is a good post graduation course allowing you to learn how to perform fundamental analysis from Global, Sector, and Industry to specific company by annual report. However, there is too many manipulation from the company which hinders you from making a great profit. Instead, some of the companies are trying to cheat the investors by creating a better outlook. So, which one is the best strategy to beat the overall market while enjoying lower risk?

In my previous post Margin of Safety, First thing in Investment, I always emphasize the margin of safety. One of the way we can find out the margin of safety is through searching a good company operates in a good industry and invest it in a good time.

While we try not to time the investment as we can reduce the timing risk by 'Dollar Cost Averaging', I always search for a well managed company in a good industry. ROE (a.k.a Returns On Equity) is the most important key performance indicator which I judge a good company compared against its peers. However, we also must look at its optimal corporate finance structure so that we can know the optimal debt levels it can operates at.

If you want to stay investing in long term, try to find out a good industry too. There is different industry performance in different countries. While Singapore is performing excellently in finance industry, Malaysia is good at the Agriculture & plantation and Islamic Finance. Of course, there are some industries which is less reflect during recession period such consumer industry as well as low cost leadership companies.

If you a serious investor, try to do your homework before invest in any company. Try to make the investment like invest in a business which you think it is the best company you can ever invest in. Of course, some diversification will allow you to sleep well without having worry too much in particular stock.

Long term investment does not necessarily means you have to hold the company for more than 10 years. However, this concept will keep you in mind that while investing a longer period of time in a good business company, you will enjoy a better returns as compared to other lower risk investment such as Fix Deposit, as the more homework and steadiness you performs, the better result you will get. In long run.

http://www.jackphanginvestment.com/2011/05/long-term-investment-applies-to-good.html

Treat your investment as your own business

For those who are in business, they typically know that it is very hard to compete with others with exceptional result by doing a normal job. Their business profits will eventually gone down or up depending on the environment.

Hence, please treat your investment as your own business. Before you make any decision of investing, please ask yourself few questions:

1) Is this a good business? 

2) How reliable of the top management? 

3) Can I hold this investment for long term?

4) Can I buy more if the price goes down further?


If the answers for above questions are positive, what you can do is just wait for the opportunites to invest in to it.
And, please remember to hold it for long term. It is not easy to find a good monopoly business in this world. If you are doing a business, you will understand it.




http://www.jackphanginvestment.com/2011/04/treat-your-investment-as-your-own.html

Thursday 29 July 2010

****Desired Characteristics for Potential Investment (Investment Philosophy of Magellan Infrastructure Fund)



Magellan Infrastructure Fund - Investment Philosophy


The Magellan Funds have two principal Investment Objectives:

  • to minimise the risk of permanent capital loss; and
  • to achieve superior risk adjusted investment returns over the medium to long-term.

Our Investment Philosophy is simple to state. We aim to find outstanding companies at attractive prices. We consider outstanding companies to be those that have sustainable competitive advantages which translate into returns on capital materially in excess of their cost of capital for a sustained period of time. While we are extremely focused on fundamental business value, we are not typical value investors. Securities that appear undervalued on the basis of a low price to earnings multiple or a price to book multiple will often prove to be poor investments if the underlying business is fundamentally weak and exhibits poor returns on capital. We will buy companies that have both low and higher price to earnings and price to book multiples provided that the business is outstanding and the shares are trading at an appropriate discount to our assessment of intrinsic value.

An outstanding company will usually have some or (ideally) all of the following characteristics:

WIDE ECONOMIC MOAT
An economic moat refers to the protection around an economic franchise which enables a company to earn returns materially in excess of the cost of capital for a sustained period of time.

Outstanding companies are unusual as capitalism is very efficient at competing away excess returns, in most cases. A company’s economic moat will usually be a function of some form of sustainable competitive advantage.

A strong indicator as to whether a company possesses an economic moat is the historical returns on capital (both including and excluding intangible assets) it has achieved. If a company has earned returns materially above the cost of its capital for a sustained period, it is a good indication that a company may have an economic moat. In some cases, a company may be developing a strong economic moat, but its historical returns on capital are low reflecting the investment in building a business with long-term sustainable competitive advantages. The key lesson is that historical returns on capital do not necessarily indicate whether a business has a wide economic moat and it is critical to fully understand the competitive advantages and threats which protect and threaten a company’s economic franchise.

Identification of companies with wide economic moats involves consideration and assessment of the barriers to entry, the risks of substitutes, the negotiating power of buyers and suppliers to a company and intensity of rivalry amongst competitors.

The following are illustrations of sustained competitive advantages:


  • Where it is very expensive for consumers to shift from the incumbent provider (that is, where there is a low threat of substitutes) because of, for example, cost, inconvenience and/or regulatory restrictions.
  • Where the leading market participant has material economies of scale which gives it a significant cost advantage over competitors or new entrants.
  • Where the business has a strong and unique brand name or is protected by long-term intellectual property rights such as copyright, patents, trademarks and/or regulatory approvals.
  • Where a company has a very strong network (ideally monopoly or proprietary). For example, where it is the vital intermediary between buyers and sellers, a market maker or even a ring road that tolls workers and businesses use as they move people and goods. We are particularly interested in networks where access, pricing and volume are subject to market forces and are not regulated in a materially adverse manner.
  • Where the use of psychological imperatives (such as, safety, exclusivity and quality) drives customer loyalty and enables companies to charge a premium for their products or services.

Each of these sustained competitive advantages is relatively unusual and it is particularly valuable where a strong competitive advantage prevails over a long period of time. Market-based monopolies and proprietary networks can provide the strongest and most sustainable competitive advantages, but are extraordinarily rare.

RE-INVESTMENT POTENTIAL
We seek companies that have a moderate to high potential to continue to re-invest capital into the business at high incremental returns.

We believe that conventional investment analysis fails to properly assess the potential of a business to deploy material amounts of additional capital into the business at attractive rates of return. This is a fundamental driver of value over time.

The most attractive types of companies are either:

  • Companies with wide economic moats which can continue to grow materially with very limited additional capital.
  • These companies will exhibit rising returns on capital employed. These types of businesses are extraordinarily rare and extremely valuable.
  • Companies with wide economic moats which have opportunities to deploy material amounts of capital into the business at high incremental rates of return. Examples include a strong retail franchise with substantial roll-out opportunity, or a retail banking or financial services franchise that can continue to grow its lending activities at attractive margins.

These types of businesses are rare and can be very valuable compounding machines. It is more usual to find businesses with wide economic moats which can only deploy very modest amounts of capital and exhibit modest growth potential. These businesses, while attractive, are less likely to be compounding machines than those with material high return re-investment opportunities.

We are therefore very focused on assessing a company’s ability to continue to re-invest free cash flow at high rates of return. It is factors such as, store roll out potential, global expansion potential, the size of the market and market share potential, and market growth rates, which will drive this re-investment potential.

We judge re-investment potential as low, medium or high depending on the level of re-investment over the medium term as a percentage of net income, and the rate of return expected to be achieved.

LOW BUSINESS RISKS
The purpose of assessing business risk is to determine the predictability of cash flow and earnings projections. Businesses which are difficult to predict or could exhibit large variations in cash flows and earnings have high inherent business risk.

We assess business risk taking into account factors such as cyclicality, operating leverage, operating margin, financial leverage, competitive strength, regulatory and political environment and profitability.

We assign each company a risk assessment: low, medium and high. This is not an attempt to measure the volatility of the shares, but rather the predictability and strength of the underlying business.

LOW AGENCY RISK
We term the risk surrounding the deployment of the free cash flow generated by a business as €˜agency risk’.

A fundamental assumption inherent in a standard discounted cash flow valuation (DCF) is that free cash flows are returned to shareholders or are re-invested at the cost of capital. The reality is that this assumption is often flawed as free cash flow is often not returned to shareholders but, rather, cash is re-invested by companies at returns below the cost of capital. In these cases, businesses can end up being worth substantially less than implied by a DCF analysis. We term the risk surrounding the deployment of the free cash flow generated by a business as agency risk.

A company which can deploy a substantial amount of free cash flow back into the business at attractive returns for a sustained period of time will almost certainly carry lower agency risk than a company which has limited opportunities to re-invest capital at attractive returns, unless the company is explicit about returning excess cash flow to shareholders via dividends and/or share buy-backs.

In assessing agency risk, we look at factors, including the structure and level of incentives offered to senior management, the level of share ownership by senior management and directors, the track record of management in pursuing acquisitions, the desire of management to grow their empire and the track record of management and the Board in acting in a shareholder friendly manner, including returning free cash flow to shareholders via share buy-backs and/or dividends.

The assessment criteria we apply in evaluating potential investments are depicted in the diagram here.



An ideal investment will normally have a number of combined favourable attributes operating together which would illustrate what Charlie Munger of Berkshire Hathaway describes as a Lollapalooza effect (which is a term for factors which will reinforce and greatly amplify each other).

MARGIN OF SAFETY
We will only purchase an investment when there is a sufficient margin of safety. The margin of safety is the discount we require before buying shares of a company. The bigger the assessed discount, the wider is our margin of safety.

The available margin of safety, we believe, is driven, in part, by prevailing market psychology. While not a driver of a company’s quality or intrinsic value, the markets can have a profound, albeit rarely long-term, effect on the pricing of a company’s shares. When short-term issues or concerns are worrying investors or other factors are resulting in excess enthusiasm (that is, irrational exuberance), shares will often be mis-priced relative to intrinsic value. While our process can make us appear to be out of step with trends, investing contrary to consensus thinking has the potential to provide investment opportunities. Understanding where current market sentiment lies and assessing the company within the context of whether the concern or excitement is being appropriately priced, is an important step in investing.

There are some exceptional businesses where the Lollapalooza effect is truly at work and the moat is so wide and the risks are so low that we will invest with a very modest margin of safety. It is more usual to find companies which do not have all the reinforcing factors at play which results in a higher level of risk and requires a higher margin of safety.

Monday 19 July 2010

High-Quality Stocks Could Take Market Lead

July 18, 2010, 9:01PM EST

High-Quality Stocks Could Take Market Lead

Investors have ignored steady profits and predictable sales from companies in consumer staples and health care. Will the market now value them?

By Ben Steverman

Slower economic growth may be good news for stocks renowned for their resilience in tougher economic times.

This, in turn, could boost the performance of stock managers who specialize in these higher-quality, defensive names, especially in sectors such as health-care and consumer staples.

"Maybe we'll have our moment in the sun," says Scott Armiger, portfolio manager at Christiana Bank & Trust Co., who has a high concentration in consumer staples stocks.

As the stock market recovered from its decade low of Mar. 9, 2009, to its 2010 peak on Apr. 23, the Standard & Poor's 500-stock index's financial sector—beaten down by the financial crisis—rose 170 percent. The S&P 500's consumer discretionary sector, including retailers hurt by the slowdown in consumer spending, gained 124 percent.

"At the very beginning of a market upturn, the lowest-quality stocks tend to outperform," says Sean Kraus, chief investment officer at CitizensTrust. "You had a lot of [portfolio managers focused on quality] underperforming last year because they would not go" to lower-quality stocks.

ARE HIGHER-QUALITY STOCKS MOVING UP?
Falling behind was the S&P 500 health-care sector, up 43.5 percent from Mar. 9, 2009 to Apr. 23, and the S&P 500 consumer staples sector, up 44 percent, even as both sectors did a better job at maintaining earnings and sales during the recession.

Worries about the economy may already be helping higher-quality stocks outperform during the last several weeks.

The Morgan Stanley Cyclical Index (which measures economically sensitive stocks in the U.S.) is down 16 percent since Apr. 23, while the Morgan Stanley Consumer Index (a gauge of less economically sensitive companies) has fallen 9.8 percent.

While the S&P 500 has slid 12.5 percent since Apr. 23, the S&P 500 consumer staples sector is down 5.1 percent—and its largest company, Procter & Gamble (PG), is off 2.4 percent.

The S&P health-care sector and its largest stock, Johnson & Johnson (JNJ), are both down 8.6 percent since Apr. 23.

HEALTH-CARE EARNINGS HAVEN'T FALLEN
"Consumer staples and health-care stocks typically have more predictable, less volatile earnings streams," says Michael Sheldon, chief market strategist at RDM Financial Group.

According to Bloomberg data, health care is the only sector of the S&P 500 not to see quarterly earnings drop year-over-year in the past two years. The S&P 500 consumer staples sector's worst quarter, the fourth quarter of 2008, saw earnings fall 7.5 percent—as overall S&P 500 earnings were plunging 47.2 percent.

Several stock managers and strategists say that the current environment may give higher-quality sectors an advantage. "As the economic data continues to soften, we should see these better-quality names picking up steam," says Quincy Krosby, Prudential Financial (PRU) market strategist.

Federal Reserve minutes released on July 14 show that central bank officials have lowered their 2010 economic growth forecast from a range in April of 3.2 to 3.7 percent, to a range in June of 3 to 3.5 percent. Other data have supported the belief that the economy is slowing its growth rate, including a drop on July 16 of 9.5 points in the Thomson Reuters/University of Michigan preliminary index of consumer sentiment to 66.5, the lowest level in 11 months.

INVESTMENT FOCUS: LEADING STOCKS?
Still weighing on health-care stocks is the possible impact of federal health-care reform legislation that became law in March. On one hand, the law "wasn't nearly as bad as a lot of industry participants were fearing," says Morningstar (MORN) health-care stock analyst Matthew Coffina. On the other hand, the law is complex and could take years to fully enact. "Investors are on edge," Coffina says, reacting day-by-day to shifting perceptions of how regulators will implement the law.

Wayne Titche, chief investment officer at AMBS Investments, says a slower-growth economy will favor the leading stocks in many different sectors, including consumer discretionary and technology. The key, he says, is finding companies with strong balance sheets and cash flow, good management, and the ability to develop new products and gain market share.

Titche cites retailer Kohl's (KSS), which he owns. "They have the money to invest and take share from weaker players," Titche says.

A stock market that rewards quality is one that is thinking long-term, Titche says. Investors have become very short-sighted, he says. "People have totally lost faith in long-term investing."

In the past year, broad trends—from issues in the U.S. economy to the European debt crisis—have shaped the stock market. Soon, however, investors are going to have to make "stock-specific" distinctions between the strong and weak players in each industry, Krosby says. Despite "a slowdown in the economy, many stocks are going to do very well," she says.

Steverman is a reporter in Bloomberg's Chicago bureau.

http://www.businessweek.com/print/investor/content/jul2010/pi20100716_711583.htm

Monday 24 May 2010

Take a long shot in such choppy markets. Investors tend to forget that equities deliver only in the long term

Take a long shot in such choppy markets
24 May 2010, 0501 hrs
IST,Nikhil Walavalkar & Prashant Mahesh,ET Bureau

Increased volatility in markets has made life difficult for equity investors in India. The risk that some European governments may default has thrown a scare into equity markets globally. Though domestic economic fundamentals are sound, flight of some foreign funds has eroded value of companies on Indian exchanges.

A look at indices’ movement shows that S&P CNX Nifty has lost 5.43% since January 2010 whereas Nifty Mid-cap 50 index lost 2.21%. But this is rather deceptive. If one looks at the fall from the highest point, the indices (the Nifty level of 5374) in the current calendar year, the Nifty lost 7.94% in 30 sessions and Nifty Mid-cap lost 7.32% in 14 sessions, as on May 20, 2010. This has confused retail investors. Now, the million-dollar question that haunts all of them is — “What should I do with my equity investments?”

QUICK ACTIONS

Though often repeated, investors tend to forget that equities deliver only in the long term. So, if you are there with your short-term resources for some quick buck, just follow the classical advice and get out of equities. This applies to even the best of the conviction ideas you have. “Though there is some global uncertainty, there is no crisis. The current correction is a good buying opportunity, as markets have corrected 10-15%, and we are positive on mid-cap stocks as valuations there are at a discount to large caps,” says K Ramanathan, chief investment officer, ING Mutual Fund.

Leverage can be disastrous when equities obey the laws of gravity. In volatile times, futures, too, may emerge as the weapons of mass destruction, as envisaged by legendary investor Warren Buffett. Given the circumstances, it’s better to cut down naked derivative exposures and avoid taking any positions using borrowed money.

If you are not sure of the equity markets’ future in the near term, change all your lump-sum investments in mutual funds and other vehicles into systematic investment plans (SIP) to ensure that you don’t commit the mistake of trying to time the market. If you need some time to think before you act, you can consider buying insurance by way of purchasing index ‘put’ options. Of course, there is a cost attached to it.

THINK BEFORE YOU JUMP

Equity investing is an art as well as science. Especially in cases, where you decide it on your own, it becomes a tight-rope walk. “One should stick to strong conviction ideas with strong fundamentals. Fundamentally, strong companies are last to fall and first to bounce back when the environment changes,” asserts Vinod Ohri, president-equity, Gupta Equities. It makes sense to revisit the portfolio with a single question in mind — If I am given money, will I buy the share I am holding now? If the answer to this question comes positive, your investment deserves a place in your portfolio. If you are not sure if you will buy it at the current price, probably, it’s the time to bid adieu to that stock.

“Retail investors need to at least check business performance of companies in which they have invested, by going to the exchange website,” says Sunil Shah, director-equities, Indsec Securities & Finance. This is even more important in case of small-, and mid-cap companies, where there is no or limited research coverage. “As a broad rule, one can decide to stay with mid-cap stocks, enjoying single-digit price earning multiples and book profits, where the mid-cap stocks quote at price multiple of more than 20,” adds Mr Shah.

If you are not sure as to how the global crisis will unfold, you can choose to convert some of your equities into short-term fixed income instruments to earn decent ‘return on capital’ without compromising on ‘return of capital’.

Strategies

As of now, the domestic economy is in shape. Some experts prefer to restrict their equity exposure to ideas that revolve around domestic themes such as consumption and infrastructure. One can cut his exposure on export-oriented companies.

There is another advice to stick to companies with least leverage. This may come handy if the credit crisis spread beyond European countries. Look at only those companies with no or nominal debt on books. To play safe, one can avoid companies that are still in the capital expenditure mode and are expected to guzzle a good amount of cash.

Looking for price supports is a very much a normal act of savvy equity investors. Some call it special situations-investing. Investing in fundamentally strong companies where due to open offer or some other corporate action there exists a safety net is a good bet in weak markets. Delisting offers also can be considered here.

Ultra-conservative investors looking at equity can resort to a capital protection strategy. If you have, say Rs 5 lakh, to invest with a three-year time-frame, invest Rs 4 lakh in fixed deposits, earning an 8% return and invest the rest in diversified equity funds with a good track record using systematic investment plans. Here, your investments in fixed deposits will ensure that you get Rs 5 lakh back at the end of three years. At the same time, your equity investments will earn superior returns for you.

Ultimately, investors will be better off sticking to their asset allocation. Of course, one can take tactical calls of moving from one type of equities (such as mid-caps) to another type (large-cap). One should never forget that all bear markets start with correction. Greed leads to investors throwing good money after bad ideas. It is time to have some conviction in the Indian growth story and buy quality businesses at attractive prices slowly and steadily.

http://economictimes.indiatimes.com/articleshow/5966749.cms

Wednesday 31 March 2010

Buffett (1981): Prefers buying 'easily-identifiable princes at toad-like prices'. These 'princes' are able to preserve margins and generate attractive return on capital year after year.


Warren Buffett wrote in his 1981 letter.

"Our acquisition decisions will be aimed at maximizing real economic benefits, not at maximizing either managerial domain or reported numbers for accounting purposes. (In the long run, managements stressing accounting appearance over economic substance usually achieve little of either.)

Regardless of the impact upon immediately reportable earnings, we would rather buy 10% of Wonderful Business T at X per share than 100% of T at 2X per share. Most corporate managers prefer just the reverse, and have no shortage of stated rationales for their behavior."

By making the above statements, Buffett is trying to highlight the difference between acquisition rationale for Berkshire Hathaway and most of the other corporate managers. While for the latter group of people, the motivation behind high premium acquisitions could range from reasons like penchant for adventure, misplaced compensations and a fair degree of overconfidence in their managerial skills, for Berkshire Hathaway, the maximisation of real economic benefits is the sole aim behind acquisitions.

Infact, the company is even happy to deploy large sums where there is a high probability of long-term economic benefits but an absence of ownership control. In other words, the company is comfortable both with total ownership of businesses and with marketable securities representing small ownership of businesses.

The paragraphs that follow bring to the fore some of the biggest qualities of the man and what makes him an extraordinary investor. Warren Buffett has a knack of knowing his circle of competence better than most and also a rather unmatched ability to learn from past mistakes. These could be gauged from the following comment:

  • "We have tried occasionally to buy toads at bargain prices with results that have been chronicled in past reports. Clearly our kisses fell flat. 
  • We have done well with a couple of princes - but they were princes when purchased. At least our kisses didn't turn them into toads. 
  • And, finally, we have occasionally been quite successful in purchasing fractional interests in easily-identifiable princes at toad-like prices."


In the above paragraph, the master uses a childhood analogy and likens managers to princesses who kiss toads (ordinary businesses) to convert them into princes (attractive businesses). Put differently, there are certain managers who believe that their managerial kiss will do wonders for the profitability of a company and convert them from toads to princes. While the master has gone on to add that there are indeed certain managers that can achieve this feat, his own track record is nothing to write home about and hence, he would rather prefer buying 'easily-identifiable princes at toad-like prices'.

Although the opportunities for finding these types of companies are very rare, the master is willing to commit a large sum once such opportunities surface. According to him, such businesses must have two favored characteristics:

  1. An ability to increase prices rather easily (even when product demand is flat and capacity is not fully utilised) without fear of significant loss of either market share or unit volume, and

  2. An ability to accommodate large dollar volume increases in business (often produced more by inflation than by real growth) with only minor additional investment of capital.
Indeed, an ability to preserve margins and generate attractive return on capital year after year are the qualities that one should seek in a firm that one wants to invest in.

Buffett (1978):"Turnarounds" seldom turn. Be in a good business purchased at a fair price than in a poor business purchased at a bargain price.





Warren Buffett in his 1978 letter to his shareholders places a great deal of importance on the quality of business and also the fact that he had to let go of many attractive investment opportunities just because the price was not right. In the following write up, let us see what the master has to offer in terms of investment wisdom in his 1979 letter:

"The inflation rate plus the percentage of capital that must be paid by the owner to transfer into his own pocket the annual earnings achieved by the business (i.e., ordinary income tax on dividends and capital gains tax on retained earnings) - can be thought of as an "investor's misery index". When this index exceeds the rate of return earned on equity by the business, the investor's purchasing power (real capital) shrinks even though he consumes nothing at all. We have no corporate solution to this problem; high inflation rates will not help us earn higher rates of return on equity."

The above paragraph clearly demonstrates that in order to improve one's purchasing power, one will have to earn after tax returns that are higher than the inflation rate at all times. Imagine a scenario where the inflation rate touches 9%, which means that a commodity that you purchased at Rs 100 per unit last year will now cost you Rs 109. Further, assume that you put Rs 100 last year in a business that earns 10% return on equity and the tax rate that currently prevails is 20%.

Thus, while you earned Rs 10 by virtue of the 10% return on equity, the tax rate ensured that only Rs 8 has flown to your pocket. Not a good situation since your purchasing power has diminished as while your returns were only 8% post tax, you will have to shell out Re 1 extra for buying the commodity as inflation has remained higher than the after tax returns that you have earned. Further, high inflation does not help the business too unless it has some inherent competitive advantages, which enables it to pass on the hike in inflation to the end consumers. Little wonder, investors lay such high emphasis on businesses that earn returns way above inflation so that the purchasing power is enhanced rather than diminished.

"Both our operating and investment experience cause us to conclude that "turnarounds" seldom turn, and that the same energies and talent are much better employed in a good business purchased at a fair price than in a poor business purchased at a bargain price."

In the above paragraph, the master once again extols the virtues of a good quality business and says that he would rather pay a reasonable price for a good quality business than pay a bargain price for a poor business. It would be worthwhile to add that in the early part of his investing career, the master himself was a stock picker who used to rely only on quantitative cheapness rather than qualitative cheapness. However, somewhere down the line, he started gravitating towards good quality businesses and out of this thinking came such quality investments as 'Coca Cola' and 'American Express'. These were the companies that 
  • had virtually indestructible brands (a very good competitive advantage to have), 
  • generated superior returns on their capital and 
  • had ability to grow well into the future.





We prod you to find similar businesses in the Indian context, pick them up at a reasonable price and hold them for as long as you can. For if the master has made millions out of it, we don't see any reason as to why you can't.



http://www.equitymaster.com/detail.asp?date=7/5/2007&story=1