Investment Research and Inside Information

How far is it reasonable to go in pursuit of information

The investment research process is complicated by the blurred line between publicly available and inside, or privileged, information. 

Although trading based on inside information is illegal, the term has never been clearly defined. 

As investors seek to analyze investments and value securities, they bump into the unresolved question of how far they may reasonably go in the pursuit of information. 

• For example, can an investor presume that information provided by a corporate executive is public knowledge (assuming, of course, that suitcases of money do not change hands)? 
• Similarly, is information that emanates from a stockbroker in the public domain? 
• How about information from investment bankers? 
• If not the latter, then why do investors risk talking to them, and why are the investment bankers willing to speak? 

How far may investors go in conducting fundamental research? 

• How deep may they dig? 
• May they hire private investigators, and may those investigators comb through a company’s garbage?
• What, if any, are the limits? 

Do different rules apply to equities than to other securities? 

Debt market

The troubled debt market, for example, is event driven. 

Takeovers, exchange offers, and open-market bond repurchases are fairly routine. 

What is public knowledge, and what is not? 

• If you sell bonds back to a company, which then retires them, is knowledge of that trade inside information? 
• Does it matter how many bonds were sold or when the trade occurred? 
• If this constitutes inside information, in what way does it restrict you? 
• If you are a large bondholder and the issuer contacts you to discuss an exchange offer, in what way can that be construed as inside information? 

When does inside information become sufficiently old to no longer be protected? 

• When do internal financial projections become outdated? 
• When do aborted merger plans cease to be secret? 

There are no firm answers to these questions. 

Stay within the law, err on the side of ignorance or seek advice

Investors must bend over backward to stay within the law, of course, but it would be far easier if the law were more clearly enunciated. 

Since it is not, law abiding investors must err on the side of ignorance, investing with less information than those who are not so ethical. 

When investors are unsure whether they have crossed the line, they would be well advised to ask their sources and perhaps their attorneys as well before making any trades. 

Conclusion 

Investment research is the process of reducing large piles of information to manageable ones, distilling the investment wheat from the chaff. 

There is, needless to say, a lot of chaff and very little wheat. 

The research process itself, like the factory of a manufacturing company, produces no profits. 

The profits materialize later, often much later, when the undervaluation identified during the research process is first translated into portfolio decisions and then eventually recognized by the market. 

In fact, often there is no immediate buying opportunity; today’s research may be advance preparation for tomorrow’s opportunities. 

In any event, just as a superior sales force cannot succeed if the factory does not produce quality goods, an investment program will not long succeed if high-quality research is not performed on a continuing basis.

Performance management systems.

These systems align decisions with short- and long-term objectives and the overall strategy.

Such systems typically include:

• long-term strategic plans,
• short-term budgets,
• capital budgeting systems,
• performance reporting and reviews, and 
• compensation frameworks.

The rigor and honesty of implementing the system is at least as important as the system itself.

Implementing the system includes

• choosing the metrics, 
• composing the scorecard, and 
• setting the meeting calendars.

1.  Choosing the right metrics

Choosing the right metrics means identifying the value drivers.

Typically the ultimate drivers are

• long-term growth,
• ROIC, and
• the cost of capital.

Short- , medium-, and long-term value drivers determine growth, ROIC and the cost of capital.


Short-term value drivers

Short-term value drivers are usually the easiest to quantify, and examples include

• sales productivity,
• operating cost productivity, and 
• capital productivity.

Medium-term value drivers

Medium-term value drivers consist of

• measures of commercial health, 
• cost structure health, and 
• asset health.

Long-term value drivers

Long-term value drivers address strategic issues such as

• ways to exploit new growth areas and 
• the existence of potential market threats.

Understanding the value drivers allows the managers to have a common language for their goals and to make better choices of trade-offs between critical and less critical drivers.


2.  Composing the Scorecard


Balanced scorecard approach

This was introduced by Robert S. Kaplan and David P. Norton in "The Balanced Scorecard:  Measures That Drive Performance" (Harvard Business Review, February 1992).

This approach can reflect many aspects of the firm and its goals.

The choice of critical drivers should be tailored to the firm's businesses.



A tree based on profit-and-loss structure approach

This is often the most natural and easiest to complete.

The targets need to be challenging and realistic, however, and should not consist of only a single point.

One recommendation is the use of base and stretch targets, where achieving the latter reaps a reward for the manager and not a penalty.



3.  Organizational Health

In addition to determining the drivers and targets, managers should assess organizational health, which is determined by

• the people, 
• skills and 
• culture of the company.

Managers should help set the targets to better understand these issues.

Fact-based reviews with appropriate rewards should depend on:

• stock performance where macroeconomic and industry trends have been removed,
• long-term assessments that might mean deferring rewards, and 
• measures of performance against both quantitative and qualitative drivers.

The firm should harness the power of nonfinancial incentives, such as creating a culture that attracts and motivates quality employees.

Qualitative and Quantitative factors in Valuation of Stocks or Companies.

Both qualitative and quantitative factors are used in the valuation of stocks or companies.

From an extreme perspective:

1.  Qualitative analysis method:  "Buy the right company, do not consider the price."

2.  Quantitative analysis method:  "Buy when the price is right and do not consider the qualitative factors of the company."


Of course, in reality, both factors are considered when valuing and buying a stock or company.

A great company can be a bad investment if you overpay to own it.

Also, a lousy company can be a value trap though you paid a very low price to own it.

My personal approach.

1.  The company has to always satisfy the qualitative criteria first, namely, the right company of the highest quality.

2.  Having passed the qualitative hurdle, then it has also to satisfy the quantitative criteria, namely, the right price.

That is Quality first, then Price!

The Five Rules for Successful Stock Investing 10

Valuation – The Basics

Even the most wonderful business is a poor investment if purchased for too high a price. To invest successfully means you need to buy great companies at attractive prices.

Investors purchase an asset for less than their estimate of its value and receive a return more or less in line with the financial performance of that asset. Speculators, by contrast, purchase an asset not because they believe it's actually worth more, but because they think another investor will pay more for it at some point. The return that investors receive on assets depends largely on the accuracy of their analysis, whereas a speculator's return depends on the gullibility of others.

Over time, the stock market's returns come from two key components: investment return and speculative return. [...] the investment return is the appreciation of a stock because of its dividend yield and subsequent earnings growth, whereas the speculative return comes from the impact of changes in the price-to-earnings (P/E) ratio. [...] over a long time span, the impact of investment returns trump the impact of speculative returns.

By paying close attention to the price you pay for a stock, you minimize your speculative risk, which helps maximize your total return.

The most basic ratio of all is the P/S ratio, which is the current price of the stock divided by sales per share. The nice thing about the P/S ratio is that sales are typically cleaner than reported earnings because companies that use accounting tricks usually seek to boost earnings.

The P/S ratio has one big flaw: Sales may be worth a little or a lot, depending on a company's profitability.

Although the P/S ratio might be useful if you're looking at a firm with highly variable earnings – because you can compare today's P/S with a historical P/S ratio – it's not something you want to rely on very much. In particular, don't compare companies in different industries on a price-to-sales basis, unless the two industries have very similar levels of profitability.

Another common valuation measure is price-to-book (P/B), which compares a stock's market value with the book value (also known as shareholder's equity or net worth) on the company's most recent balance sheet. The idea here is that future earnings or cash flows are ephemeral, and all we can really count on is the net value of a firm's tangible assets in the here-and-now.

When the market was dominated by capital-intensive firms that owned factories, land, rail track, and inventory – all of which had some objective tangible worth – it made sense to value firms based on their accounting book value. After all, not only would those hard assets have value in a liquidation, but also they were the source of many firms' cash flow. But now, many companies are creating wealth through intangible assets such as processes, brand names, and databases, most of which are not directly included in book value.

Another item to be wary of when using P/B to value stocks is goodwill, which can inflate book value to the point that even the most expensive firm looks like a value. When one company buys another, the difference between the target firm's tangible book value and the purchase price is called goodwill, and it's supposed to represent the value of all the intangible assets – smart employees, strong customer relationships, efficient internal processes – that made the target firm worth buying. Unfortunately, goodwill often represents little else but the desperation of the acquiring firm to buy the target before someone else did, because acquiring firms often overpay for target companies. Be highly skeptical of firms for which goodwill makes up a sizable portion of their book value.

A company that's trading at a lower P/E than its industry peers could be a good value, but remember that even firms in the same industry can have very different capital structures, risk levels, and growth rates, all of which affect the P/E ratio. All else equal, it makes sense to pay a higher P/E for a firm that's growing faster, has less debt, and has lower capital reinvestment needs.

In general, comparing a company's P/E with industry peers or with the market has some value, but these aren't approaches that you should rely on to make a final buy or sell decision. However, comparing a stock's current P/E with its historical P/E ratios can be useful, especially for stable firms that haven't undergone major shifts in their business. If you see a solid company that's growing at roughly the same rate with roughly the same business prospects as in the past, but it's trading at a lower P/E than its long-term average, you should start getting interested.

Because risk, growth, and capital needs are all fundamental determinants of a stock's P/E ratio, higher growth firms should have higher P/E ratios, higher risk firms should have lower P/E ratios, and firms with higher capital needs should have lower P/E ratios.

When you're looking at a P/E ratio, you must be sure that the E makes sense. If a firm has recently sold off a business or perhaps a stake in another firm, it's going to have an artificially inflated E, and thus a lower P/E. Because you don't want to value the firm based on one-time gains such as this, you need to strip out the proceeds from the sale before calculating the P/E.

Don't rely on any single valuation metric because no individual ratio tells the whole story. Apply a number of different valuation tools when you're assessing a stock.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

The Five Rules for Successful Stock Investing 8

Analyzing a Company – Management

Excellent management can make the difference between a mediocre business and an outstanding one, and poor management can run even a great business into the ground. Your goal is to find management teams that think like shareholders – executives that treat the business as if they owned a piece of it, rather than as hired hands.

Executives' pay should rise and fall based on the performance of the company. [...] Firms with good corporate governance standards won't hesitate to pay managers less in bad times and more in good times, and that's the kind of pattern you want to see as a shareholder.

http://books.danielhofstetter.com/the-five-rules-for-successful-stock-investing/

The FOUR filters of Buffett

The FOUR filters of Buffett:

1.  You must understand the business of the company.
2.  The business must have a durable competitive advantage.
3.  The management must have talent and integrity.
4.  The price must be reasonable with a margin of safety.

Some may focus just on Filter 4 and still make money in their investing.

However, by incorporating Filters 1, 2 & 3 into their investing, they are less likely to encounter losses.  

Filters 1, 2 & 3 are there to prevent losses in your investing.  


[Nothing new, I have been following these for umpteen years.  My QMV method! ]      

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

Warren Buffett's 4 Tenets:

1.  Know the business you wish to own (Circle of Competence Tenet)
2.  Business must have economic moat (Durable Competitive Advantage Tenet)
3.  Management must be hardworking, intelligent and above all, honest (Integrity Tenet)
4.  Buy at fair price (Quantitative Margin of Safety Tenet)

Qualitative Margin of Safety Tenets = 1 + 2 + 3

Qualitative Margin of Safety first, then Quantitative Margin of Safety.

• A Wonderful Company to Invest for the Long Term (Screen 10)...
• A Wonderful Company to Invest for the Long Term (Screen 9)...
• A Wonderful Company to Invest for the Long Term (Screen 8)...
• The Growth has slowed in this company (Screen 7)
• A Wonderful Company to Invest for the Long Term (Screen 6)...
• A Wonderful Company to Invest for the Long Term (Screen 5)...
• A Wonderful Company to Invest for the Long Term (Screeen 4)...
• A Wonderful Company to Invest for the Long Term (Screen 3)...
• A Wonderful Company to Invest for the Long Term (Screen 2)...
• A Wonderful Company to Invest for the Long Term (Screen 1)...
• 
  

Over the last 12 years, the prices of these stocks have shown the following gains:

Screen 1: 200% (3 bagger)
Screen 2: 200% (3 bagger)
Screen 3: 100% (2 bagger)
Screen 4: 900% (10 bagger)
Screen 5: 100% (2 bagger)
Screen 6: 200% (3 bagger)
Screen 7: 900% (10 bagger)
Screen 8: 200% (3 bagger)
Screen 9: 900% (10 bagger)
Screen 10: 500% (6 bagger)


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

When do you sell a wonderful company?  Almost never.

Reference:  My Investing Philosophy

Donald Yacktman: "Viewing Stocks as Bonds"

Investment Philosophy

1. Good businesses that dominate their industry
2. Shareholder-oriented management
3. Low purchase price

A good business may contain one or more of the following:

• High market share in principal product and/or service lines
• High cash return on tangible assets
• Relatively low capital requirements allowing a business to generate cash while growing
• Short customer repurchase cycles and long product cycles
• Unique franchise characteristics

   

                                                   High Cyclicality          Low Cyclicality

Low Capital Intensity                  Media                        Consumer Staples

High Capital Intensity                 Capital Goods           Utilities

Secular growth, not cyclical growth preferred.

Published on 30 Jul 2015

Drawing on his four decades of experience, Don Yacktman identifies the three key characteristics of value stocks. In this talk, he shares his investment philosophy along with the lessons he has learned from the markets and from life.

About the speaker:

Don Yacktman is Partner and Portfolio Manager of Yacktman Asset Management. He began his career at Yacktman founding the company as its President, Portfolio Manager, and Chief Investment Officer. Since founding the company Don has been awarded the 1994 “Portfolio Manager of the Year” by Mutual Fund Letter. Don has also been nominated by Morningstar as Fund Manager of the Decade in 2009, and finalist for Morningstar’s Domestic-Stock Manager of the Year award in 2011, and “Portfolio Manager of the Year” in 1991. Don holds an MBA with distinction from Harvard University.

A quality strategy - appreciating the future earning potentials of wonderful companies.

Though Warren Buffett popularized the idea of the moat, he credits partner Charlie Munger for bringing him around to the idea that "it's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

A quality strategy is a bet that the market doesn't appreciate wonderful companies enough, particularly their earnings potential many years out. 

As Charlie Munger said, "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 one hell of a result." 

(Of course, it's not easy to identify in advance firms that can sustain such high rates of return for so long.)




http://news.morningstar.com/articlenet/article.aspx?id=643125&SR=Yahoo

Buffett investment thought process

Answering the following questions will guide you through the Buffett investment thought process.

QUALITY AND MANAGEMENT ANALYSIS

1.  Does the company have an identifiable durable competitive advantage?

2.  Do you understand how the product works?

3.  If the company in question does have a durable competitive advantage and you understand how it works, then what is the chance that it will become obsolete in the next twenty years?

4.  Does the company allocate capital exclusively in the realm of its expertise?

5.  What is the company's per share earnings history and growth rate?

6.  Is the company consistently earning a high return on equity?

7.  Does the company earn a high return on total capital?

8.  Is the company conservatively financed?

9.  Is the company actively buying back its shares?

10.  Is the company free to raise prices with inflation?

11.  Are large capital expenditures required to update plant and equipment?

PRICE ANALYSIS

12.  Is the company's stock price suffering from a market panic, a business recession, or an individual calamity that is curable?

13.  What is the initial rate of return on the investment and how does it compare to the return on risk free Treasury Bonds?

14.  What is the company's projected annual compounding return as an equity/bond?

15.  What is the projected annual compounding return using the historical annual per share earnings growth?

The Powerful Chart That Made Peter Lynch 29% A Year For 13 Years

6/26/2013 

In his excellent book One Up on Wall Street, Peter Lynch, the best mutual fund manager ever, revealed a powerful charting tool that helped him to achieve a gain of 29.2% in his portfolios for 13 years. In this chart, Peter Lynch drew the stock price and the earnings per share together and aligned the value of $1 in earnings per share to $15 in stock price. He wrote in pages 164-165 of the book:

“A quick way to tell if a stock is overpriced is to compare the price line to the earnings line. If you bought familiar growth companies – such as Shoney’s, The Limited, or Marriott – when the stock price fell well below the earnings line, and sold them when the stock price rose dramatically above it, the chances are you’d do pretty well.”

To see how this Peter Lynch Chart works, we applied it to the top holdings of Warren Buffett, the most successful investor ever: Wells Fargo (WFC), Coca-Cola (KO), IBM (IBM), American Express (AXP) and Wal-Mart (WMT). The Peter Lynch Chart of Wells Fargo is below, where the green line is the Price Line, and the blue line is the Peter Lynch Earnings Line. When the Price Line is well below the Peter Lynch Earnings Line, the stock is a buy.

Among these top five holdings of Warren Buffett, we found that Wells Fargo is the most undervalued. Wal-Mart and IBM are about fair valued. We then compared this result with the trading activities of Warren Buffett. To our surprise, we found that Warren Buffett was buying Well Fargo heavily and adding to Wal-Mart and IBM.

Is this just a coincidence? Does Warren Buffett only buy the stocks that are undervalued as measured by the Peter Lynch Chart? Is Warren Buffett using this powerful tool, too?

We don’t know the answer to the question. But we know that great minds think alike!

Now this powerful charting tool is available at GuruFocus.com. You can create it in just two clicks for any of the more than 50,000 stocks covered by GuruFocus.com.

We applied this tool to the portfolios of George Soros, Carl Icahn and other investment Gurus tracked at GuruFocus.com. We even developed a screen for this strategy that makes it easy to find stocks that are traded well below Peter Lynch’s Earnings Line.

Certainly buying stocks that are traded well below their Earnings Line is not the only criterion Peter Lynch used to achieve his 29%-a-year results. We also added his other requirements such as strong balance sheet and solid growth into the screener. When I limit my Peter Lynch screen to only the stocks that are owned by Warren Buffett, I found eight other companies that Warren Buffett owns and Peter Lynch would be buying. All of these eight companies have strong balance sheet, solid growth and reasonable valuations. One of them is of course Wells Fargo. Warren Buffett loves it so much that he made it his largest holding.

Now both Warren Buffett and Peter Lynch are working for me! I have added these stocks to my watch list.

http://www.forbes.com/sites/gurufocus/2013/06/26/the-powerful-chart-that-made-peter-lynch-29-a-year-for-13-years/

Historical and Performance F.A.S.T. Graphs™

Channeling Peter Lynch

http://online.barrons.com/article/SB50001424052748704382404578571404089572628.html

What can F.A.S.T. Graphs™ do for you and your investments?

http://www.fastgraphs.com/

www.fastgraphs.com

Prospecting for Good Quality Stocks at the Right Price at any given time.

There are about 16,000 publicly owned companies in the U.S. for you to select from.  There are also about 3 times this number (48,000) of publicly owned companies in the other countries for you to select from too.

With so many companies, of course, some are much better candidates for your consideration than others.

Of these companies, fewer than 2% are likely to make the cut so far as your quality standards are concerned.

And perhaps, only 5% of THOSE might be available at the right price at any given time- and even this could be an overestimate.


Illustration:

1000 stocks

Only 20 are quality stocks (20/1000 = 2%)

Of these 20 quality stocks, only 1 is available at the right price at any given time, if at all. (1/20 = 5%)

How to approach international stocks?

The examination of these stocks for your international investing are the same.  Follow the QMV approach.

1.  Look at the QUALITY of the company (the existence of competitive advantages)
2.  Its MANAGEMENT must be of integrity and smart (and not suspicious management)
3.  The VALUATION of the company (and not an outrageously high valuation)

However, you need to add other risks to your due diligence process too.

1,  Country risk 
What's the political environment?
Is corruption a problem?
How is the country's debt structured?
What are its plans for economic development?

2.  Political risk
This is a subset of country risk.
Is there a real threat of nationalization?
Is there a real threat of rebellion or military action?

3.  Currency risk
This is a risk unique to foreign investing.
Pay attention to the level of exposure a company has to weak currencies.
Be reminded, Zimbabwe's insane inflation rate hit 66,000% in the early months of 2008.

4.  Investability risk
Are you able to buy shares of a company.
Do you have access to one of the exchanges it trades on?


So, to summarise, look for countries with:
1.  Respect for rule of law, strong rights of appeal, and low levels of corruption.
2.  Political stability and a government that doesn't dominate the local economy.
3.  A stable currency
4   Investability

Also, apply the bottom up search for the best companies with the brightest prospects.  

Be reminded once again.
-  Your top priority is to invest in your best ideas - ignoring country, sector, or number of vowels in the ticker.
-  Your secondary concern should be ensuing that you're not overexposed to any specific geographic region or industry sector.

With the U.S. market moving in lockstep with overseas markets (high correlation) - a trend that certainly doesn't seem to be reversing itself- diversification is no longer the reason to consider foreign equities for your portfolio.  

The reason to look overseas is much simpler:  opportunity.   

Warren Buffett How to Turn 40 into 5 Million

Buy an attractive business.
My biggest mistakes are those of omissions.
Better to learn from other people's mistakes.
Disagree but never argue.
Live life forward.
Important and knowable.
Important but not knowable.
Buffett's buying is not affected by macroeconomic factors.

Charlie Munger Reveals Secrets to Getting Rich

@ 6 min

Best Stocks to Buy & Picking your stock - Two rules of value Investing

Follow these 2 rules and you will find investing in stocks is very profitable and very enjoyable too.

Rule 1: Find a wonderful business to invest in.
Rule 2: Buy its stock at a discount.

Secrets to successful investing

Secrets to successful investing.

1. Know the business well. Do you understand the business?
2. Know the intrinsic value of the business. Is it increasing its intrinsic value consistently?
3. Know the management. Are they with integrity?
4. Know the price. Is the company's price attractive, that is, undervalued?

It is just so simple, everyone can adopt these.

Invest In Quality Not Quantity

June 15, 2012 

Tickers in this Article » HSY, BRKA, BRKB, KO, WDFC, HSY

Strangely enough, most investors commit a very basic mistake when they make investments. They choose quantity over quality. Psychologically, people find it very appealing to own 10,000 shares of a $1 stock versus 100 shares of a $100 stock. All the while, investors fail to forget that the size of pizza hasn't changed - it's merely 100 slices or 10,000 slices. The painful reality is that by choosing quantity over quality, the lack of quality increases the risk assumed, leading investors to sell at the first sign of trouble.

Keep It Simple
Warren Buffett, perhaps the world's most successful investor, has a unique ability to make very sophisticated investments that have created great value for his holding company Berkshire Hathaway (NYSE:BRK.A, BRK.B). Yet as Buffett will tell you, the most successful investments that created the greatest value for Berkshire were those where Buffett chose quality over quantity. Buffett made a huge investment in Coca-Cola (NYSE:KO) in the 1980s. The cost of that investment was roughly $1.3 billion. Today, that stake is worth around $14 billion. What that gain does not reflect are the dividends that Berkshire has received each year from its ownership in Coke. Berkshire owns about 9% of Coke's shares.

In 2011, Coke paid out $4.3 billion in dividends, $360 million of which went to Berkshire. Berkshire's biggest stock investments have been heavy on quality, as Buffett deeply values intangibles like brands, market leadership and durable businesses.

SEE: Think Like Warren Buffett

Boring Is Quality
At the end of the day, stock prices anchor on earnings growth. The highest quality companies are those with consistent records of profitability. Exciting industries can be profitable, but they invite lots of competition, which ultimately serves to erode profitability. Boring businesses don't invite competition and as such, can generally be counted on for generating consistent profits at an acceptable rate of growth. WD-40 (Nasdaq:WDFC) is a great example. The company makes a boring product that has been in use for decades.

However, the profits for WD-40 are anything but boring. Investors can count on around a 2.5% dividend yield each year. Same idea with The Hershey Company (NYSE:HSY). Candy doesn't change much and there is no fear of technology risk in chocolate. And people will always eat a little (maybe a lot) of candy. Therefore, it's no surprise that HSY has a return on equity (ROE) that would excite anyone: an ROE in excess of 70%. In today's zero percent interest rate environment, the 2.3% dividend is oh so sweet.

The Bottom Line
Investing benefits those who are patient and harms those who seek excitement. The passage of time allows for compounding to go to work, which is the greatest value creating force in investing. Investing in quality should be a starting point for all investors. 

http://www.investopedia.com/stock-analysis/2012/invest-in-quality-not-quantity-brk.a-ko-wdfc-hsy0615.aspx

Uncovering the best value stocks****