Quality companies turn most of their profits into free cash flow on a regular basis

We can use free cash flow as a tool for checking the quality of a company's profits.

The stock market has been littered with companies that seemed to be very profitable but turned out to be anything but.

Investors can save themselves a lot of heartache and some painful losses by taking a few minutes to study how effectively a company converts profits into free cash flow.

One of the simplest and best ways to test the quality of a company's profits and whether you think they are believable or not is to compare a company's underlying or normalised earnings with its free cash flow.   

The free cash flow will show you how much surplus cash the company has left over to pay shareholders.  It can often be very different from EPS, even though it is supposed to tell you the same thing.  For most years, you want to see the free cash flow has been close to earnings.

Calculating free cash flow

Example:  Company Z ($ m)

Net cash flow from operations  69.0

Capex -6.8

FCF to the firm (FCFF) 62.7

Minority or preference dividend paid 0.0

Interest paid -0.3

Interest received 0.0

FCF for shareholders (FCF)  62.4

Weighted average number of shares in issue  504.6m

FCF per share 12.37 sen

Underlying EPS  11.9 sen

Quality companies turn most of their profits into free cash flow on a regular basis

Can quality be more important than price?

Paying too much for a share can result in disappointing returns. No company, no matter how good, is a buy at any price.

Share valuation is not an exact science.  Your valuation will never be exactly right, but by setting yourself some limits, you can reduce the risks that come from overpaying for shares.

However, there is some evidence to suggest that paying what might seem to be a moderately expensive price (slightly more than the suggested maximum) for a quality business can still pay off in the long run.   The caveat here is that you have to be prepared to own shares for a very long time.  Perhaps forever.

The way people invest is changing. 

Many people are not building a portfolio of shares during their working lives to cash in when they retire.  An increasing number will have a portfolio that may remain invested for the rest of their lives.  For them, a portfolio of high-quality shares of durable companies may help provide them with a comfortable standard of living, with the initial price paid for the shares not being too big a consideration.

Shares of high-quality businesses are scarce

We have to remember that the shares of high-quality businesses are scarce.  This scarcity has a value and might mean that investors undervalue the long-term value of them.

The ability of high-quality companies to earn high returns on capital for a long time can create fabulous wealth for their shareholders.  This is essentially how investors such as Warren Buffett have built their fortune.

Can quality be more important than price?  YES!

High-quality companies with high and stable returns on capital have created substantial wealth over the decades.  

Few if any of the shares could have been bought for really cheap prices.   

In many of the cases, the enduring quality and continued growth of the company could be seen to have been more important than the initial price paid for them.

Investing in high quality stocks for the Long Term

Investing in high-quality stocks and holding them for the correct period is the only way to create wealth. This statement is easier to say than to execute. Here come the obvious questions –

1. What do you mean by “high-quality stocks”?
2. How to select high-quality stocks?
3. How to separate quality business from others?
4. What is the correct holding period?
5. When to buy and when to sell a stock?
6. How to construct my portfolio?

Forget about intraday; short term trading, Futures & Options. Remember, there is no shortcut to earning quickly. Every quick-money makings tricks are eventually money-losing tricks.

How can you begin to own a portfolio of quality companies?

Settling on Quality

There is no scientific way of finding the perfect combination off price and quality.

• Should we pay dearly for high quality?
• And anything for moderate quality?
• Obviously, paying little for quality would be ideal, but practically impossible.  

Uncovering real gems at an attractive price.  Over time, you will find the right balance.



A good set of businesses at an attractive price.

For example, your portfolio may have

• an average ROCE (the companies forming the portfolio) of over 40%, 
• with a free cash flow yield of over 10%  

How can you reach this point of owning a portfolio of quality companies?

You have to progressively sell off stocks that did not meet the new philosophy and to only buy those meeting the quality requirements.

It will be slow work, requiring you to sell off cheap companies (gruesome companies) and to fight against your attachment to them.

You have to be convinced that this is the right way to go and you go all in.




Searching for quality is not about blindly following formulas.

While these are a good starting point, they remove the essential human element which is of such importance to some investors.

It is not enough to find a high ROCE and low P/E ratio.

You have to understand where the profits are coming from and above all, where they are headed. This is essential and you need to spend most of your time doing this.

The possible purchase price can be readily found in the daily newspaper or in real time online, but analysing a specific sector and the company's competitive position is what enables you to determine the intrinsic value, which is neither as obvious nor as easy to identify.

This is the great enigma of investment and you have to begin deciphering it.

Shift to Quality

Graham was too focused on price at the expense of quality.  Of course, this is an oversimplification.   Graham also took account of other factors, such as growth or stable results, although he didn't put as much emphasis on them.  

Most investors today pay attention to other drivers, such as growth or business quality, assigning increasing weight to them over time.



Philip Fisher

Philip Fisher played a pivotal role in the transformation undergone by many investors.  It was under the influence of his partner, Charlie Munger, that Buffett first became attracted to Fisher's philosophy.

Fisher put his money on investing in long-term growth stocks, with very robust competitive advantages that were capable of being sustained and increased over time.  The price paid for them was not as important, since if the company performed well it would be able to sustain a high multiple.  

This idea is less intuitive and therefore harder to digest than simply buying something cheap; it means paying seemingly expensive prices for something that will only yield results after a period of time.

This is ultimately the road that Buffett has gone down.  Thus, most value investors are also indirectly indebted to Fisher to some degree or another.

For those who have maintained a certain unshakeable bias towards investing in cheap assets, whose quality was not always proven, it can be a challenge to change their ways, especially when this mix had produced good results.

Every investor develops at their own pace.  



Joel Greenblatt

Joel Greenblatt's short book, The Little Book That Beats the Market, gives empirical proof that quality shares bought at a good price will always outperform other stocks.  

To do so, he classifies each stock according to two criteria: 

• quality, measured by ROCE (return on capital employed) and 
• price, measured by the inverse P/E ratio (price to earnings, the price that we pay for each unit of earnings).  [You can also use FCF yield, that is, FCF/price, instead of inverse P/E].

Greenblatt uses a numerical classification for both return and price:  1, 2, 3,4,...., with 1 being the stock with the highest ROCE under the return criteria and 1 being the highest free cash flow under the price criteria.   He then adds the points obtained by each share in both rankings to produce a definitive classification, which he calls the 'magic formula'.  

• The companies with the lowest sum of both factors deliver the best long-term returns.  
• Furthermore, the same is true throughout the ranking; companies situated in the lowest 10% post a better return than the second 10%, the second decile outperforms the third, and so on until the last 10%.

The exceptional results obtained by Greenblatt is surprising, but logical:  good companies bought at reasonable prices should obtain better returns on the markets.

The problem with applying this approach is that the formulas deliver over the long term, but they can also underperform for relatively long periods, for example, three years  this makes it though for both professional and enthusiast investors to keep faith when things are not working.

The Quality of Companies: Practically all the value investors have gone down the same path of Buffett.

Graham was too focused on price at the expense of quality.  

However, in hindsight, it was clear that the portfolio of quality companies is the best approach to stand up to any market situations.

Indeed, past financial crises confirmed that high-quality companies at reasonable prices perform better over the long term than companies which are straight cheap.

Buffett invested in very underpriced real assets in the beginning of his investing career.   After partnering Charlie Munger, he focused on higher-quality stock, proxied by the degree of competitive advantage they enjoy.

Many investors have gone down this same path of Buffett, practically all the value investors.  The main reason is that it delivers better results over the long term, although there aren't many studies to back up this assertion, making it initially a far from obvious conclusion.



Why have practically all value investors followed Buffett, preferring quality companies?

Maybe, when they are young and start out investing, they have an excessive desire to do well and make their mark.  They tend to favour the cheapest companies, which on face value offer the greatest potential upside.

With experience and maturity, and after having stepped on a few booby and / or value traps (cheap companies in bad businesses, which languish for years, failing to create value) and their economic situation improves, their tastes tend to shift towards quality, even if they have to pay a bit more for it.

Quality first, then Value.

Over the long term, investment return is more a function of business performance than valuation, unless the valuation goes extreme.

More effort should be put into identifying good businesses and buying them at reasonable valuations.

Investors should not be obsessed with the valuation calculations. All calculations involve assumptions. They are valid only if the underlying businesses perform as expected.

Quality has outperformed the market by 40% over 50 years!

QUALITY HAS OUTPERFORMED

Quality companies are defined as those with high profitability, low profit volatility and minimal use of leverage.

Quality has outperformed the market by 40% over 50 years!

Amazingly, this out-performance is not because of an unwinding of some sort of specific risk.

It came from management teams of wonderful businesses simply reinvesting in their competitive advantages and generating more cash which they reinvested to generate further cash – an autocatalytic process that is the hall mark of intrinsic value.

Such excess return, combined with less fundamental risk, is called a “free lunch”.



BEATING THE MARKET

The Efficient Market Hypothesis refutes the existence of “$100 bills lying on the side walk waiting to be picked up by investors”.

The theory hypothesizes that these opportunities will be immediately arbitraged away, thus preventing anyone from getting rich on them.

Yet this is what Warren Buffett has been doing.

"Investing in wonderful businesses) is like having a Triple A Bond outperforming the B+ bond in the long term by 1% a year, when in a reasonable world, it “should” yield, say, 1% less. "

Now would be a good time to circle back to Keynes and validate his reasons for concentrating his portfolio in “well managed industrial companies that compound value by re-investing part of their profits.”

“Quality” has outperformed the market forever: The S&P had a High Grade Index that started in 1925 and handsomely outperformed the S&P 500 to the end of 1965'.


http://www.firstavenue.co.za/sites/default/files/downloads/the_evolution_of_valuation_22112011.pdf

"Cheap" classic value companies versus Quality (growing intrinsic value) companies

Classic value metrics such as P/B, P/E or DY do not represent intrinsic value. 

To illustrate this, Grantham says when he poses the following question to investment audiences

• “I give you Coca Cola at 1.2x book or General Motors 1.0x. 
• Which would you have?” he gets no takers for GM. 

That is the clearest difference between P/B as a corner stone of classic value, and not intrinsic value.

The extra qualities represented by Coca Cola are worth a premium. The only question is, “how much?’ 


OUTPERFORMANCE OF INTRINSIC VALUE (QUALITY) VS. OF LOW P/B.

What this means is that

• any outperformance of intrinsic value (quality) is pure alpha, 
• where outperformance of low P/B (as it is for many small caps) is compensation for a high risk premium. 

To support this point, Grantham points out that had the US government not bailed out the behemoths of the US financial system in the crises of 2008, many companies trading at low price to book ratios would have gone bankrupt (not just in the US, but across the world due to the interconnectedness of the global financial system).

What we learn from Buffett’s review of the first 25 years of his investment experience is that this risk premium sometimes comes back to bite you. 

It should not be surprising that in times of deep economic crises, more of these “cheap,” classic value companies go bust than is the case for the “expensive” intrinsic value companies.

Further studies found that classic value investment opportunities tend to coincide with other characteristics such as

• small capitalization, 
• illiquidity, 
• high leverage, or 
• dissipating fundamentals due to severe cyclical conditions.  

 “The pure administration of classic value investment style really needs a long term lock-up, like Warren Buffet (Partnership) has or it will have occasional quite dreadful client problems.” 

Investment history is replete with examples of such dreadful client problems – Gary Brinson of UBS in the late 90s, Tony Dye who ran a value based contrarian portfolio for Phillips and Drew, and low PE value manager David Dreman in 2008, all lost the majority of their clients due to severe underperformance. 

The big lesson to learn here is not that classic value investing doesn’t work. 

It is the fact that it works far less frequently in recent times than it used to, enough to produce dreadful client problems.  

How to find Quality Companies? (Checklist)

Here is a useful checklist you can use when you are searching for quality companies:

1.   Company's sales record.

• You want to see high and growing sales, year after year.
• A ten-year period of increasing sales and profits is a good sign.

2.  Company's profits.

• You want to see high and growing profits, as measured by normalised EBIT, year after year.
• A ten-year period of increasing sales and profits is a good sign.

3. EBIT and normalised EBIT 

• Check that these are roughly the same in most of the last ten years.

4.  EBIT margin.  

• The EBIT margin must be of at least 10% almost every year for the last ten years.

5,  ROCE

• The company must have a ROCE that is consistently above 15% over the last ten years.
• ROCE = (EBIT / average capital employed ) x 100%

6.  DuPont analysis

• Carry out a DuPont analysis to find out what is driving a company's ROCE.
• ROCE = EBIT/Capital Employed = (EBIT/Sales) x (Sales/Capital Employed)
• ROCE = {Profit margin x Capital turnover)

7.  Annual report

• Read a company's annual report to provide context for the numbers.

8.  FCFF and FCF

• Look for a growing free cash flow to the firm (FCFF) and free cash flow for shareholders (FCF), over a period of ten years.
• FCFF and FCF should also be roughly the same in most years.
• That is, little debt.

9.  Operating cash conversion ratio 

• Look for companies that turn all of their operating profits (EBIT) into operating cash flow, as represented by an operating cash conversion ratio of 100% or higher.
• Operating cash conversion ratio = (operating cash flow / operating profit) x 100%
• That is, high quality earnings

10.  Capex ratio

• Look for capex ratio less than 30% almost every year over the last ten years.
• That is, low capex requirements.
• Capex ratio = Capex / Operating Cash Fow

11.  Compare Capex to its depreciation and amortisation expenses.

• If the company is spending more on capex than its depreciation and amortisation expenses, it is a sign that it is spending enough but you need to be sure it isn't spending too much.

12.  FCFF/Capital Employed or CROCI

• Check for free cash flow to firm return on capital invested that is higher than 10% almost every year over the last ten years.
• This is also known as cash-flow return on capital invested (CROCI)
• CROCI = adjusted free cash flow tot he firm (FCFF)/average capitl employed

13.  Compare FCFps to EPS

• Look for free cash flow per share to be close to earnings per share in most of the last ten years.
• That is, high quality earnings.

14.  Free cash flow dividend cover

• Free cash flow per share should be a larger number than dividend per share in most years.
• That is, the free cash flow dividend cover should be greater than 1.
• Free cash flow dividend cover = FCFps / DPS
• Occasional years when this is not the case are fine.

15.  Consistent Growth

• Prefer more consistent growth in turnover and profit to more volatile growth.

Comments:


Don't worry if you cannot find a company that meets ALL of the criteria above.

There are some exceptional companies that do.

Typically you will not find hundreds of them.

Companies can improve and the ones that might not have been good ten years ago can be good companies now.

If you can find companies that have a high and improving ROCE and have been good at converting profits into free cash flow over the last five years, you should consider them as well.

Can quality be more important than price?

"It is better to pay a little too much for something that is a very good business than it is to buy some bargain but really a company without much of a future."  
- Warren Buffett, chairman and CEO of Berkshire Hathaway.


Paying too much for a share can result in disappointing returns.

No company, no matter how good, is a buy at any price.

Share valuation is not an exact science.

Your valuation will never be exactly right.

By setting yourself some limits, you can reduce the risks that come from overpaying for shares.



Paying for a quality business can still pay off in the long run.

There is some evidence to suggest that paying what might seem to be a moderately expensive price (slightly more than the suggested maximum) for a quality business can still pay off in the long run.

The caveat here is that you have to be prepared to own shares for a very long time.  Perhaps, forever.



The way people invest is changing.

Many people are not building a portfolio of shares during their working lives to cash in when they retire.

An increasing number will have a portfolio that may remain invested for the rest of their lives.

• For them a portfolio of high-quality shares of durable companies may help provide them with a comfortable standard of living, with the initial price paid for the shares not being too big a consideration.

Are investors under-valuing the long term value of high quality businesses?

Remember, the shares of high quality businesses are scarce.

This scarcity has a value and might mean that investors undervalue the long term value of them.

The ability of high-quality companies to earn high returns on capital for a long time can create fabulous wealth for their shareholders.

This is essentially how investors have built their fortune (such as Warren Buffett).



Challenge your thinking by answering these questions

1.   Can you list some examples of high-quality companies with high and stable returns on capital that have created substantial wealth over the last decade?

2.   Look at them carefully.  Do you agree that few, if any, of these shares could have been bought for really cheap prices?

3.   In many of these cases, do you concur that the enduring quality and continued growth of the companies could be seen to have been more important than the initial price paid for them?

Charlie Munger's opinion of Benjamin Graham's deep Value Investing

Why Charlie Munger Hates Value Investing

When Charlie Munger ( Trades , Portfolio ) came to Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) in the late '60s, Warren Buffett (Trades, Portfolio) was still running the business and investing how his teacher, Benjamin Graham, had taught him to - by buying a selection of cigar butt type companies and holding for many years.

Unlike Buffett, who had essentially grown up under Graham's wing, Munger had no such attachment to the godfather of value investing. Instead, Munger seems actually to dislike deep value investing:

"I don't love Ben Graham and his ideas the way Warren does. You have to understand, to Warren - who discovered him at such a young age and then went to work for him - Ben Graham's insights changed his whole life, and he spent much of his early years worshiping the master at close range. But I have to say, Ben Graham had a lot to learn as an investor. 

"I think Ben Graham wasn't nearly as good an investor as Warren Buffett is or even as good as I am. Buying those cheap, cigar-butt stocks was a snare and a delusion, and it would never work with the kinds of sums of money we have. You can't do it with billions of dollars or even many millions of dollars. But he was a very good writer and a very good teacher and a brilliant man, one of the only intellectuals - probably the only intellectual - in the investing business at the time." - Charlie Munger, The Wall Street Journal September 2014

When he arrived at Berkshire, Munger actively tried to push Buffett away from deep value toward quality at a reasonable price, which he did with much success.

All you need to do is to look at Buffett's acquisition of See's Candies in the late 1960s to realize that without Munger's quality over value influence on Buffett, Berkshire wouldn't have become the American corporate giant it is today.



A love of high quality

Munger always had a fascination with buying high-quality businesses, and in the early days, his style differed greatly from that of Buffett. He always placed a premium on the intangible assets of a company, those assets that had no financial value to other companies but were worth billions in the right hands.

"Munger bought cigar butts, did arbitrage, even acquired small businesses. He said to Ed Anderson, 'I just like the great businesses.' He told Anderson to write up companies like Allergan ( AGN ), the contact-lens-solution maker. Anderson misunderstood and wrote a Grahamian report emphasizing the company's balance sheet. Munger dressed him down for it; he wanted to hear about the intangible qualities of Allergan: the strength of its management, the durability of its brand, what it would take for someone else to compete with it. 

" Munger had invested in a Caterpillar ( CAT ) tractor dealership and saw how it gobbled up money, which sat in the yard in the form of slow-selling tractors. Munger wanted to own a business that did not require continual investment and spat out more cash than it consumed. Munger was always asking people, 'What's the best business you've ever heard of?'" - "The Snowball: Warren Buffett and the Business of Life" by Alice Schroeder

Munger understood that it's these businesses where big money is made as the high returns on capital, and a nonexistent need for capital investment ensures shareholders are well rewarded over the long term.

For example, in his 1995 speech, "A Lesson on Elementary, Worldly Wisdom As It Relates to Investment Management & Business," Munger said:

"We've really made the money out of high-quality businesses. In some cases, we bought the whole business. And in some cases, we just bought a big block of stock. But when you analyze what happened, the big money's been made in the high quality businesses. And most of the other people who've made a lot of money have done so in high quality businesses. 

" Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return -even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you'll end up with a fine result. 

" So the trick is getting into better businesses. And that involves all of these advantages of scale that you could consider momentum effects."

Buffett added some meat to this statement at the 2003 Berkshire Hathaway meeting:

"The ideal business is one that generates very high returns on capital and can invest that capital back into the business at equally high rates. Imagine a $100 million business that earns 20% in one year, reinvests the $20 million profit and in the next year earns 20% of $120 million and so forth. But there are very very few businesses like this. Coke ( KO ) has high returns on capital, but incremental capital doesn't earn anything like its current returns. We love businesses that can earn high rates on even more capital than it earns. Most of our businesses generate lots of money but can't generate high returns on incremental capital - for example, See's and Buffalo News. We look for them [areas to wisely reinvest capital], but they don't exist."

These quotes do a great job of summing up Munger and Buffett's investment strategy. Even though there are thousands of pages of investment commentary from both of these billionaires, their investment style can be summed up with the simple description of quality at a reasonable price, and the above quotes show exactly why they've both decided this style is best.

By: GuruFocus

http://www.nasdaq.com/aspx/stockmarketnewsstoryprint.aspx?storyid=why-charlie-munger-hates-value-investing-cm774232

Do you always avoid all companies with large amounts of debt?

In an ideal world, you will select to invest in companies that produce consistently high returns and have low levels of debt.

This is the essence of quality and safe investing.

Do you always avoid all companies with large amounts of debt?

Not necessarily.



When larger debts are not a problem

There are some companies which can cope with higher levels of debt and still potentially make good investments.

These are companies with very stable and predictable profits and cash flows.

They have consistently high debt to total asset ratio and quite low levels of interest cover, and yet, they have many of the hallmarks of a quality company.

They have

• grown their sales, profits (EBIT) and free cash flows, 
• whilst maintaining high profit margins (EBIT margins) and 
• very good levels of ROCE.

The general point is:  if a company shows it can continue to increase turnover and EBIT - sales and profit - year after year, whilst holding high levels of debt, this can still be regarded as a quality company and potentially a good investment.

Is negative free cash flow always bad?

The best companies to buy are ones that have large and growing amounts of free cash flow.

One possible drawback of this approach:  you will ignore companies with small or even negative free cash flows because they are investing heavily in new assets to grow their future sales, profits and operating cash flows.




Should you ignore companies like this?

Ideally, you will try to find companies that don't need to spend a lot of capex to grow.

However, if you come across what appears to be a quality company that is spending a lot of money, then you need to make sure the company is getting a good return on that investment.

You need to look at the trend in ROCE at the same time as you are looking at free cash flow.

If ROCE is high and rising whilst a company is spending heavily then the company could start generating lots of free cash flow when its spending settles down - if it ever does.

The main issue is how much money the company needs to spend to maintain its assets in a steady state.

The point here is that you might be making a mistake by ignoring companies with low or negative free cash flow.

There could be a great cash flow business waiting to blossom.




Four simple rules

Four simple rules when comparing FCF per share with EPS when looking for possible investment candidates:

1.  FCFps is 80% or more of EPS = definite candidate

2.  FCFps is less than 80% of EPS and ROCE is increasing = possible candidate

3.  FCFps is less than 80% of EPS but ROCE is falling = avoid

4.  FCFps is consistently negative = avoid

The free cash flow per share figure is all-revealing:  you want to see quality companies with a consistently similar EPS and FCFps, not companies where these numbers are markedly different.

How to avoid bad investments?

Picking winning shares is something every investor naturally wants to do.

However, success in investing is just as much about avoiding bad investments and minimising the risks that you take with your money.

Investors spend too much time thinking about how much money they can potentially make from owning a share and not enough time thinking about how much money they could lose if things go wrong.

Avoiding bad investments is important because they are hard to recover from.  If you lose 50% of your money invested, you need to find an investment that will double in value just to get the value of your portfolio back to where it started.

The more bad investment you can avoid, the better your long-term investment performance is likely to be.



How do you stay away from bad investments?


1.   The first thing to do is to focus your investments on quality companies with the following characteristics:

• A consistent track record of increasing sales and profits.
• High returns on capital employed (ROCE).
• An ability to turn a high proportion of profits into free cash flow.

2.  Arguably, the biggest danger that shareholders face when investing in a business is the company's debt.  

The investor must learn how to analyse a company's debts and to distinguish between safe and dangerous companies.  

This will help the investor to stay away from risky investments that have the potential to damage his/her wealth.

Paying the right price is just as important as finding a high-quality and safe company. Don't be too mean either lest you miss out on some very good investments.

Most people lose money in the stock market because:

1. they buy stocks that are of poor quality, and,
2. they overpay for these stocks.

Paying the right price is just as important as finding a high-quality and safe company

If you are to be a successful investor in shares, you need to pay particular attention to the price you pay for them.

The biggest risk you face is paying too much.

It is important to remember that no matter how good a company is, its shares are not a buy at any price.

Paying the right price is just as important as finding a high-quality and safe company.  

Overpaying for a share makes your investment less safe and exposes you to the risk of losing money.



Be careful, don't be too mean with the price

Be careful not to be too mean with the price you are prepared to  pay for a share.

Obviously you want to buy a share as cheaply as possible, but bear in mind that you usually have to pay up for quality.

Waiting to buy quality shares for very cheap prices may mean that you end up missing out on some very good investments.

Some shares can take years to become cheap and many never do.



Additional notes:

Can quality be more important than price?

1.  Paying too much for a share can result in disappointing returns.  No company, no matter how good, is a buy at any price.

2.   You need to know how to work out how much to pay for the shares of quality companies.  Bear in mind share valuation is not an exact science.  Your valuation will never be exactly right, but by setting yourself some limits, you can reduce the risks that come from overpaying for shares.

3.  There is some evidence to suggest that paying what might seem to be a moderately expensive price (slightly more than the suggested maximum) for a quality business can still pay off in the long run.  The caveat here is that you have to be prepared to own shares for a very long time.  Perhaps, forever.


 How is the way people invest changing?

1.  Many people are not building a portfolio of shares during their working lives  to cash in when they retire.  An increasing number will have a portfolio that may remain invested for the rest of their lives.

2.  For them, a portfolio of high-quality shares of durable companies may help provide them with a comfortable standard of living, with the initial price paid for the shares not being too big a consideration.

3.  Despite trying to put a precise value on a share, we have to remember that the shares of high-quality businesses are scarce.  This scarcity has a value and might men that investors undervalue the long-term value of them.

4.  The ability of high-quality companies to earn high returns on capital for a long time can create fabulous wealth for their shareholders.  This is essentially how investors such as Warren Buffett have built their fortune.

SOME THOUGHTS ON ANALYSING STOCKS (KISS)

Ideally a stock you plan to purchase should have all of the following characteristics:

• A rising trend of earnings dividends and book value per share.
• A balance sheet with less debt than other companies in its particular industry.
• A P/E ratio no higher than average.
• A dividend yield that suits your particular needs.
• A below-average dividend pay-out ratio.
• A history of earnings and dividends not pockmarked by erratic ups and downs.
• Companies whose ROE is 15 or better.
• A ratio of price to cash flow (P/CF) that is not too high when compared to other stocks in the same industry.

A Wonderful Company to Invest for the Long Term (Screen 1)

Chart of Revenue, PBT and EPS.over 13 years

Revenue = Red line
PBT = Green line
EPS = Blue line

Chart of EPS, High Price and Low Price over the last 13 years
EPS = Brown line
High Price = Blue line
Low Price = Purple line



























ABC

Take risks (but protect yourself) - Peter Lim

Image Credit: futbolfinanzas.com

Much of Lim’s wealth was the product of an unlikely venture. His single investment of US$10 millionin Wilmar, an Indonesian palm oil startup, seemed far from promising in the late 90s, when Indonesia was facing political and social unrest. At the time, the currency fell from 2,500 to 16,000 rupiah against the US dollar. But against all odds, Wilmar began to pick up the pieces and Lim’s faith in the company paid off — in 2010, he cashed out his shares for US$1.5 billion.

“My Indonesian partner was asking me the other day: ‘How the hell did we make so much money?’

Up to a point after people tell you a story and a vision, don’t write it off. Sometimes it comes true. You just make sure that if it doesn’t come true, you don’t get hurt too much.”

(Source: The Business Times, AsiaOne News)

 https://sg.news.yahoo.com/8-wise-lessons-wealth-singapore-053251357.html

Comments:

1998. US$10 million
2010. US$1,500 million (1.5 billion)
Period 12 years

Compound Annual Growth Rate:
51.82%. (WoW.  )


2015.  US$ 3,000 million (3 billion). His present net worth.
CAGR from 2010 to 2015.  14.87%

CAGR from 1998 to 2015.  39.87%


He bought Wilmar in 1997/1998.
It was at the time of the Asian Financial Crisis.
Prices of stocks were very low.
Indonesian currency and regional currencies were at historical lows compared to US dollars and Singapore dollars.
He made a big investment.  (Fat pitch when the opportunity came.)
He was in the position to make this investment and he took the risk, knowing his downside was protected. (My analysis.) (Luck = preparation + ability to seize opportunity when this presents)
He stayed with the company long term (12 years).
He cashed out in 2010. (Perfect timing or pricing.  How did he do this?)
Since 2010, he has grown his wealth around 15% per year, doubling in 5 years.

There are many lessons one can learn from this investing behaviour of Peter Lim (almost sounds like Peter Lynch).  :-)



For references.
CAGR
61.41%      (Land - short term frenzyl)
8.14%        (Property capital appreciation)
9.75%        (Plantation capital appreciation)
17.79%       (Land - long term)
9.65%         (Property Total Return)
10.61%       (Plantation Total Return)
15%+          (Equity)
Unlimited     (Business)

THE BIG PICTURE. Investing is less about the stock price and more about the value of the business.

The Big Picture

Finding companies you know is only the beginning; the circle of competence is only meant to help you stay within your arena of expertise. 

Once you have generated a list of the companies you understand, the next step should be conducting an analysis of the financials. 

Don’t worry — you don’t have to be a finance whiz to understand the basics of the stock market. 

For example, Berkshire Hathaway’s investment philosophy is surprisingly simple: The company should have 
1.  consistent earning power, 
2.  good return on equity, 
3.  capable management and 
4.  be sensibly priced. 


Investing is less about the stock price and more about the value of the business — is it a good one?

Successful investing is more about learning over time and slowly expanding your circle of competence. For now, stick with what you know and focus on the long term. 

Anyone can find success in the stock market; you just have to keep it simple. 

As Buffett has famously said, “You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ.” And you know what? $60 billion says he’s right.