Maths of Crisis Investing. Aim for extraordinary wealth building. Must be prepared.

How to deploy your cash during a crisis?

One mistake I've seen investors make is going all in too early.  They see prices fall 20% and think they've found the bottom. They deploy all their cash. Then prices fall another 30% and they have nothing left to buy at the truly bargain levels. 

The solution is to scale into positions gradually. Don't try to call the exact bottom. Nobody can do that consistently. 

Instead, plan to deploy cash in trenches as prices fall. For example, 

• you might deploy 10% of your cash when prices fall 20% from the peak. 
• another 15% when prices fall, 30%, 
• another 20% when prices fall, 40%, and so on. 

This approach ensures that you're buying more at lower prices. 

If prices keep falling, you have cash left to take advantage. If prices reverse, you've already established positions that will benefit from the recovery.

I followed this approach in 2008 and 2009. I started buying when the crisis began, but reserved most of my capital for later. As prices fell further, I deployed more. By the time we reached the bottom, I had made significant investments but still had powder left for opportunities that emerged in the following months. 

What to buy first?

Another consideration is what to buy first. During a crisis, almost everything goes on sale. Stocks, bonds, real estate, private businesses. You can't buy everything. You have to prioritize. 

My priority is always quality first. I'd rather buy a great business at a good price than a mediocre business at a great price. The great business will recover and compound for decades. The mediocre business might never recover or might recover slowly and then stagnate. 

So I start by looking at the best businesses, the ones with the strongest competitive positions, the most capable managements, the most resilient business models. If those businesses are available at attractive prices, that's where I deploy capital first. 

Only after I've invested in the highest quality opportunities do I consider lower quality businesses that might offer higher potential returns, but also higher risk. These can work out spectacularly. But they can also fail entirely. I size these positions smaller and only pursue them after the core portfolio is established.

https://www.youtube.com/watch?v=Xv9TV-dI7z4

Warren Buffett: Why 2026 Will Be the Best Buying Opportunity Since 2009

Summary of Investment Strategy During a Crisis

The article outlines a disciplined approach to deploying cash during a market downturn, emphasizing patience, gradual investment, and a focus on quality. Key points include:

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1. Avoid Going “All In” Too Early

• Common Mistake: Investors often use all their cash after an initial market drop (e.g., 20%), leaving them unable to capitalize on deeper declines.

• Solution: Scale into positions gradually as prices fall, rather than trying to time the exact bottom. This ensures capital is preserved for true bargain levels.

2. Deploy Cash in Trenches

• Example Strategy:

  • 10% of cash deployed after a 20% decline from peak.

  • 15% more after a 30% decline.

  • 20% more after a 40% decline, etc.

• Benefits:

  • Buys more at lower prices if the downturn continues.

  • Maintains “dry powder” for future opportunities.

  • If markets recover early, positions are already established to benefit.

3. Prioritize Quality Investments

• Focus on Quality First: Invest in high-quality businesses with strong competitive positions, capable management, and resilient models, even if the price is only “good” rather than “great.”

• Rationale: Quality businesses are more likely to recover and compound value over decades.

• Higher-Risk Opportunities: Consider lower-quality, higher-potential investments only after building a core portfolio of quality assets, and size these positions smaller.

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Discussion

The article provides a pragmatic, risk-managed framework for crisis investing. Its core principles—gradual deployment and quality-first selection—reflect lessons from historical crises like 2008–2009. By avoiding impulsive, all-in bets, investors can reduce regret and remain agile. The emphasis on business fundamentals over sheer cheapness aligns with long-term value investing philosophy, where durability matters more than short-term price movements. This approach balances opportunity capture with psychological discipline, making it suitable for investors seeking to navigate volatility systematically.

The most important determinants of your success in investing

 The most important determinants of your success in investing are QMV:

QUALITY - the quality of the company you own,

MANAGEMENT - the integrity of its management, and

VALUE - the price you paid for your stock.

This QMV framework is a powerful and timeless distillation of what truly matters in investing. It moves beyond the noise of daily price movements and macroeconomic forecasts to focus on the few variables an investor can actually control and assess.

Let's elaborate and comment on each component.

1. QUALITY - The Foundation of the Enterprise

Elaboration:
"Quality" refers to the fundamental strength and durability of the business itself. It's not about a hot stock tip or a trending sector, but about the company's inherent characteristics. A high-quality company typically possesses:

• A Durable Competitive Advantage (Moat): This is the key. It's what protects the company from competitors and allows it to earn high returns on capital over the long term. This moat can come from:

  • Brand Power (e.g., Coca-Cola): The ability to charge a premium.

  • Intellectual Property (e.g., Pfizer): Patents that block competition.

  • Network Effects (e.g., Visa): The service becomes more valuable as more people use it.

  • Cost Advantages (e.g., Amazon): Scale that allows for lower prices that competitors can't match.

  • High Switching Costs (e.g., Adobe): It's too difficult or expensive for customers to leave.

• Strong Financials: Consistent and growing revenue, high profit margins, high returns on invested capital (ROIC), and a strong balance sheet (low debt).

• Resilient Business Model: The company's products or services are in constant or growing demand, making it resistant to economic downturns (recession-resistant).

Commentary:
Investing in a quality company is like building a house on solid bedrock. Even if you overpay slightly (a Value misstep), the company's ability to grow earnings over time can bail you out. A low-quality company, however, is like building on sand. Even if you buy it at a seemingly cheap price, it can be eroded by competition, debt, or obsolescence. Quality is your first and most important line of defense.

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2. MANAGEMENT - The Stewards of Your Capital

Elaboration:
When you buy a stock, you are entrusting your capital to the company's leadership. Their integrity and talent are paramount. Key traits of excellent management include:

• Capital Allocation Skills: This is arguably their most important job. How do they reinvest the company's profits? Do they make smart acquisitions, invest in R&D, pay down debt, or return cash to shareholders via dividends and buybacks? Poor capital allocation can destroy value even in a good business.

• Skin in the Game: Do the CEO and executives own a significant amount of stock? Ownership aligns their interests with shareholders. They benefit when you benefit.

• Transparency and Candor: Do they communicate clearly and honestly with shareholders, admitting mistakes and laying out a clear strategy? Or do they hide bad news and use corporate jargon to obscure the truth?

• A Long-Term Orientation: Do they resist the pressure to manage for quarterly earnings at the expense of the company's long-term health?

Commentary:
You can find the highest-quality company in the world, but if management is incompetent, self-serving, or fraudulent, the investment is likely to fail. A great management team can often improve a good business, while a poor one can run a great business into the ground. Management is the human engine that either multiplies or squanders the value of the quality asset.

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3. VALUE - The Price You Pay Determines Your Return

Elaboration:
This is the discipline of investing. Value is not about the absolute stock price, but the price you pay relative to the intrinsic value of the business. Paying a fair or, better yet, a discounted price for a wonderful business is the goal. Assessing value involves:

• Valuation Metrics: Using tools like the Price-to-Earnings (P/E) ratio, Price-to-Free-Cash-Flow, and Discounted Cash Flow (DCF) analysis to estimate what the business is truly worth.

• Margin of Safety: A concept popularized by Benjamin Graham. This is the practice of buying a stock at a significant discount to its calculated intrinsic value. This buffer protects you if your analysis is slightly wrong or if unforeseen problems arise.

• Patience: Waiting for the right price often means doing nothing for long periods. The market periodically offers opportunities to buy great companies at good prices during periods of panic, sector-wide sell-offs, or temporary company-specific issues.

Commentary:
Paying too high a price for even the best company can lead to years of poor returns. The dot-com bubble is a classic example of investors ignoring value altogether. A great company bought at a euphoric price can stagnate for a decade as its earnings slowly "grow into" its inflated valuation. Value is the discipline that provides the payoff; it transforms a good business into a great investment.

The Synergy of QMV: The Three-Legged Stool

The true power of QMV is that the three elements are not independent; they are deeply interconnected and form a synergistic whole. Think of it as a three-legged stool—if one leg is broken, the stool collapses.

• Quality + Value: Buying a wonderful company at a fair price (Warren Buffett's classic approach). This is the sweet spot for long-term wealth creation.

• Quality + Management: A great business with a stellar management team is a gem. You might be willing to pay a slightly higher price for this combination because you trust the stewards to increase the intrinsic value over time.

• Value without Quality or Management: This is the "value trap"—a seemingly cheap company that is cheap for a reason (dying industry, bad management). The price never recovers because the business itself is eroding.

Conclusion:

The QMV framework is a robust antidote to the speculation and short-termism that often dominate financial media. It forces the investor to focus on what is knowable and important: the nature of the business, the people running it, and the price paid.

By rigorously searching for high-quality businesses run by capable and honest management that you can buy at a discount to their intrinsic value, you dramatically increase your odds of achieving lasting success in the market. It is a philosophy of business ownership, not just stock trading.

Two major schools of investing: Quality Investing and Value Investing.

 Quality versus Net asset value bargains

Quality: Price today $12. Price in 5 years? Net asset value bargains: price today is $12 and its intrinsic value should be $18. Is it always better to buy compounders? Is it always better to buy growth? If you are buying an asset because it is cheap, is your upside limited? Is buying cheap assets the name of the game? Must you always focus on cheap assets? You should look for both: good and cheap. The greater the margin of safety the higher the potential return. Always demand a huge margin of safety.

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This is an excellent set of statements that gets to the very heart of the debate between two major schools of investing: Quality Investing and Value Investing.

Let's break down, analyze, and expand on each point, culminating in a critical opinion.

Analysis & Expansion of the Statements

1. "Quality versus Net asset value bargains"

• Quality (The Compounder): The statement "Price today $12. Price in 5 years?" is the essence of investing in quality compounders. The focus is not on a static intrinsic value, but on the company's ability to grow its intrinsic value over time. You are betting on the company's durable competitive advantages (moat), excellent management, high returns on capital, and its ability to reinvest earnings at high rates of return. The future price is a function of this growth. If earnings per share double, the share price is likely to follow.

• Net Asset Value (NAV) Bargains (The Cigar Butt): This is classic Ben Graham-style deep value investing. The company may be mediocre, but it's selling for significantly less than its liquidation value or a conservative estimate of its current assets. The premise is that the market is irrationally pessimistic, and eventually, the price will converge to its intrinsic value. The upside is the gap between $12 and $18. This strategy often involves assets that are "one puff" stocks—you buy them cheap, they revert to mean, and you sell.

2. "Is it always better to buy compounders? Is it always better to buy growth?"

• The Allure: It seems obvious. Who wouldn't want to own a business that becomes more valuable every year? In theory, yes, it's better.

• The Critical Reality:

  • The Price Problem: The biggest risk with compounders and growth stocks is overpaying. A wonderful company bought at a ridiculous price becomes a bad investment. If you overpay for growth, you can experience years of poor returns even as the company executes perfectly (see many tech stocks in the early 2000s).

  • The Prediction Problem: Identifying a true long-term compounder in advance is incredibly difficult. Industries change, moats erode, and today's superstar can be tomorrow's dinosaur. The "growth" you see might be cyclical, not secular.

  • The Impatience Problem: The market can be irrational in the short term. Even a genuine compounder can stagnate for years before its value is recognized, testing an investor's conviction.

3. "If you are buying an asset because it is cheap, is your upside limited? Is buying cheap assets the name of the game? Must you always focus on cheap assets?"

• The "Cigar Butt" Limitation: Yes, the upside in a pure net asset value bargain is theoretically capped. Once the price reaches intrinsic value ($18 in the example), the reason for holding the stock disappears. You've captured the margin of safety. This is what Charlie Munger called the "cigar butt" approach—one or two puffs of profit, and then you have to find another.

• Is it the "Name of the Game"? For pure deep-value investors, yes. Their entire philosophy is built on buying dollars for fifty cents, repeatedly.

• The "Value Trap" Danger: The critical risk of only focusing on cheap assets is the value trap. A stock is cheap for a reason—its business may be in permanent decline. Its assets may be eroding, or its earnings may be disappearing. The "cheap" price can get even cheaper if the intrinsic value falls faster than the price. You have a margin of safety on the balance sheet, but no safety from a deteriorating business.

4. The Synthesis: "You should look for both: good and cheap. The greater the margin of safety the higher the potential return. Always demand a huge margin of safety."

This is the evolved, modern view of value investing, heavily championed by Warren Buffett after his influence from Charlie Munger.

• "Good and Cheap" (The "It's-Fat-Pitch" Investing): This is the holy grail. It means finding a high-quality business with a durable competitive advantage, trading at a price that provides a margin of safety. You are not just buying a cheap asset; you are buying a growing stream of future cash flows at a discounted price.

• Margin of Safety Redefined: For a compounder, the margin of safety isn't just the gap between price and current assets. It's the gap between the price you pay and your conservative estimate of the company's future intrinsic value. A "huge margin of safety" protects you from:

  1. Errors in your analysis (you were wrong about the quality).

  2. Unexpected bad luck (industry disruption, recession).

  3. The inherent unpredictability of the future.

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Critical Opinion

The progression of these statements mirrors the evolution of smart capital from rigid dogma to a more pragmatic, synthesized philosophy.

1. The Duality is False, but the Tension is Real: Pitting "Quality" against "NAV Bargains" as a strict either/or is a false dichotomy. The most successful long-term investors seek to unite them. They want to buy a wonderful business at a fair or bargain price. The real tension is in the trade-offs: How much quality are you willing to sacrifice for a deeper discount? How much of a premium are you willing to pay for superior quality?

2. "Always" is a Dangerous Word in Investing: The statements "Is it always better..." and "Must you always focus..." are traps. The market is a dynamic ecosystem. There are periods when growth stocks are wildly overvalued and deep value is the only rational choice. There are other periods when the economy is so disruptive that the few true compounders are the only assets that can thrive. A rigid strategy that ignores market context is fragile.

3. The Superior Framework: The final synthesis—"look for both good and cheap"—is the most robust framework. It acknowledges that what you buy (the business quality) is ultimately more important than what you pay for it, but it crucially adds that what you pay determines your return. Paying too much for quality can lead to mediocre returns, while buying a poor business because it's cheap can lead to permanent capital loss.

4. Margin of Safety is the Bedrock: The concluding emphasis on a "huge margin of safety" is the non-negotiable element that ties it all together. It is the principle that manages risk and acknowledges the limits of human foresight. Whether you're valuing a stagnant net-asset bargain or a high-flying compounder, demanding a significant discount to your calculated intrinsic value is the single most important discipline an investor can have.

Conclusion:

The initial statements chart a path from a simplistic, binary view of investing to a sophisticated, nuanced one. The optimal strategy is not to choose between Quality and Value, but to seek the intersection of both, guided always by the discipline of a Margin of Safety. This approach avoids the value traps of cheapness-alone and the capital destruction of overpaying for growth. It is the difference between being a mere "trader of cigar butts" and being a "business owner" for the long term.

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.

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.

Understanding Economic Cycles and Market Valuation.

Understanding the economic cycles and market valuation will not help anyone predict the direction of the market in the short term or even in midterms like a year or two.  However,

• it keeps investors from looking in the rear-view mirror, and 
• they will have a clearer view of the future and be able to stay rational when the market gets euphoric or sinks into fear again.

For analyzing individual companies, having a good knowledge of business cycles and the likely future market returns can be useful in evaluating

• management's capital allocation decisions, 
• their aggressiveness in accounting and 
• the quality of earnings related to pension-fund return assumptions.

Buffett is a bottom-up value investor and rarely talks about the general market.  But he has a tremendous understanding of 

• business cycles, 
• the role of interest rates, 
• market valuations and 
• the likely future returns and risks.

Over the long term, investors should always be optimistic.  They should focus their investments on the quality companies that not only can pass the test of bad times, but also can come out stronger.

Now, more than any other time, it is vital to invest only in good companies.

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.

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.

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?

"Margin of Safety" as the Central Concept of Investment

The Intelligent Investor by Benjamin Graham

Chapter 20 - “Margin of Safety” as the Central Concept of Investment

A single quote by Graham on page 516 struck me:

Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.
Basically, Graham is saying that most stock investors lose money because they invest in companies that seem good at a particular point in time, but are lacking the fundamentals of a long-lasting stable company.

This seems obvious on the surface, but it’s actually a great argument for thinking more carefully about your individual stock investments. If most of your losses come from buying companies that seem healthy but really aren’t, isn’t that a profound argument for carefully studying any company you might invest in?

MARGIN OF SAFETY CONCEPT: STOCKS SHOULD BE BOUGHT LIKE GROCERIES, NOT LIKE PERFUME

The high CAGR in the early years of the investing period, due to buying at a discount, tended to decline and approach that of the intrinsic EPS GR of the companies over a longer investment time-frame.

Better Investing

A.  Analyse Growth

Step 1: Historical Sales

Historical sales growth is the first of four indicators BetterInvesting uses to identify well managed growth companies.

It is desirable to invest in companies whose sales growth is strong and consistent and generally growing faster than the overall economy and inflation combined. *

Is the company's historical sales growth rate acceptable for a company its size?
Check growth rate % - have sales grown faster than the competition and the economy?
Check growth rate trend - have sales figures changed direction recently? If sales are up or down do you know why? Are the forces that caused growth in the past the same ones that will create growth in the future?
Does the company deserve further study?

Compare your candidate company to:
Others in the same industry
Peer group average
Industry average

* Review background economic and inflation data
Gross Domestic Product Data
Inflation Data


Step 2: Historical Earnings Per Share

Historical earnings per share (EPS) growth is the second indicator BetterInvesting uses to identify well managed growth companies.

It is desirable to invest in companies whose EPS growth rate is strong and consistent and generally growing faster than the overall economy and inflation combined.

Is the company's historical EPS growth rate acceptable for a company its size?
Check growth rate % - have earnings grown faster than the competition and the economy?
Have EPS figures changed direction recently? If so, do you know why?
Does the company deserve further study?

Compare your candidate company to:
Others in the same industry
Peer group average
Industry average


Step 3: Historical Stock Price Review

You've reviewed the company's historical sales and earnings growth. Both should be growing
1. Faster than the economy and inflation combined
2. Faster than competitors
3. Consistently

If these conditions have been met then check that EPS is growing in line with sales.
1. Check that the graph lines of sales and EPS are mostly straight and moving together in parallel toward the upper right-hand portion of the graph.
2. Compare the growth rates of both sales and EPS using the rates given in the data grid.

Next, determine whether the company's stock price has tracked the growth rates of Sales and EPS. A company's stock price will typically follow the earnings growth rate -- price follows earnings. Looking at the graph you can see the relationship of stock price to EPS.

Steady growth in stock price is an indicator of management's ability to grow sales and EPS and that the market has confidence in the company.

It is desirable to invest in companies whose share price increases as its sales and earnings increase. Price bars show how much movement up and down there is in the stock price each year. Skilled management can control the variables in the company so that the high and low prices travel smoothly upward. More up and down movement means more risk.

Check
Are earnings growing in line with sales?
Has the company's stock price moved in line with EPS?
Does this company deserve further study?


B.  Evaluate Management

Step 1:  % Pre-Tax Profit on Sales

% Pre-tax Profit on Sales is the third indicator BetterInvesting uses to identify well managed growth companies. A good percent pre-tax profit margin shows a company is well managed.

It is desirable to invest in companies whose percent pre-tax profit is increasing or at least staying the same. Examining the most recent five year average helps us determine this.

Is the 5 year average percentage of pre-tax profit on sales increasing or at least staying the same?
Is the percentage of profit consistent over time?
Does this company deserve further study?

Compare your candidate company to

Others in the same industry
Peer group average
Industry average

Step 2:  % Earned on Equity

% Earned on Equity (ROE) is the fourth indicator BetterInvesting uses to identify well managed growth companies. It tells how effectively company management is using the shareholders' money to make a profit.

It is desirable to invest in companies whose ROE percentage is increasing or at least staying the same. An exception is when a company is paying off debt, which is covered in the next section.

Is the percentage of ROE increasing or at least staying the same?
Is the percentage of ROE consistent over time?
Does this company deserve further study?

Compare your candidate company to
Others in the same industry
Peer group average
Industry average


Step 3:  Total Debt

One indicator of management skill is how debt is employed.

Most companies borrow money to help them reach their goals. Companies go into debt to buy equipment, real estate, and many other things. Some industries use debt more than others. Borrowing some money can be very good because it helps the company do things it could not afford to do on an all cash basis. Borrowing too much money can be very bad because it increases risk in two ways:

1. Debt increases the risk to common shareholders because the company must pay the claims from debt and preferred stockholders before common shareholders receive anything.

2. High levels of debt are risky for a company because it has to pay its debt obligations whether it's doing well or not. If the company runs short of money during a recession, the debt obligations could force the company to go out of business.

Check:

Is the total debt increasing or decreasing?
Review the company web site and official reports to understand the reasons for significant changes in total debt.

Look at Total Debt and % Debt to Capital together to understand how the company is managing debt.

Step 4:  % Debt to Capital

One indicator of management skill is how debt is employed. Look at Total Debt and % Debt to Capital together to understand how the company is managing debt.

The percent of total debt to capital helps you understand whether company management is using debt conservatively or liberally. The ratio enables you to make valuable comparisons between the company you are studying, peer companies and the industry.

Some industries such as banks, financial institutions, and utilities typically operate using higher levels of debt. Some successful companies in other industries have proven that they can carry high debt over many years. Younger companies often have relatively higher levels of debt, but because they are young they don't have a track record that shows they can manage it well over many years. This adds considerable risk as an investment.

Check:

Is percent of Debt to Capital increasing or decreasing markedly?
Review the company web site and official documents to understand the reasons for changes in debt levels (company expansion, acquisitions, divestiture, etc.)
Is the company on a "spending spree" financed by debt?
Is the company borrowing enough to help it stay competitive?

Compare to:
Historical trends
Peer Group
Industry averages


C.  Forecast Sales Earnings

Step 1:  Forecast Sales

If the company you are studying has not met any of the BetterInvesting standards you have studied so far, you should discard the company and begin the study of another.

If all preceding indicators have met the BetterInvesting standards then you have more than likely identified a quality growth company. You now need to consider its potential as an investment for your portfolio.

You must predict how well your investment candidate will perform in the future by estimating sales and earnings.

First, forecast the rate at which you believe sales will continue to grow in the future.

Forecast company sales by considering:

1. Historical results -- consistent strong growth
2. Competition
3. Changes in consumer or market preferences
4. Changes in products or services offered

Is your forecast moderate, meaning it does not rely on extreme conditions or situations?
Is your forecast sustainable, meaning it does not rely on events or circumstances that are not likely to occur regularly?
How does it compare to other companies you may have studied?


Step 2:  Forecast Earnings

Forecast the rate you believe earnings will grow in the future. Your forecasted earnings growth rate will establish an estimate of how much money the company will be earning per share five years from now. This EPS forecast will help you establish an estimated high price the EPS would support.



D.  Assess Risk and Reward

Step 1:  Forecast High Price

How high is the price of the stock likely to go in the next five years?

The answer comes by multiplying the highest likely earnings per share by the average high price earnings ratio.

1. The default high EPS forecast is determined by your entries in the preceding screen.

2. The average high PE forecast is determined by reviewing historical data and current PE primarily, and competitive information as well.

Changing the numbers in the boxes changes the forecast.


Step 2:  Forecast Low Price

How low is the price of the stock likely to go in the next five years?

The answer comes by multiplying the lowest likely earnings per share by the likely average low price earnings ratio.

The default values displayed are based on historical averages.

You need to decide whether or not they reflect the company in the next five years and adjust if necessary.

Step 3:  Assess Stock Price

Now that you have estimated the high and low prices for the next five years, find the current price and determine where it falls within the high-low range.

The range between the high and low prices is divided into three zones: sell, hold and buy.

1. If the current price is in the top range, the stock is in the sell range.

2. If the current price is in the middle range, the stock is in the hold range.

3. If the current price is in the lower range, the stock is in the buying range.

Step 4:  Determine Potential Gain vs. Loss

Even though well considered, forecasts are not certain.

By comparing the current price to

1. Your forecast high price and
2. Your forecast low price

you determine your potential gain and potential loss.

It is desirable to invest in companies offering a potential gain at least three times the potential loss.


E.  Determine 5 Year Potential

Determine 5 Year Potential

Compounded Return is the projected annual price appreciation plus the projected average annual yield.

The Price Appreciation is the increase in the price of the stock, assuming you sold the stock at its projected high price.

The Yield is the projected average annual return on the price, paid as a dividend. Yield is calculated by dividing the dividend by the purchase price of the stock.

If the company performs as well as you expect, and you sell the stock at the forecast high price, this will be your financial return.





Better Investing - Core SSG
http://www.betterinvesting.org/public/default.htm

http://www.betterinvesting.org/NR/rdonlyres/CB93E207-7341-4225-B609-8197173DFBB9/0/P1JudgmentandtheSSG4pp.pdf

http://www.betterinvesting.org/Public/SingleTabs/Webinars/archives.htm


Stock Research Form

4.0 CONCLUDING DIALOGUE (STOCK SELECTION REPORT)

To complete, make selections from choices presented in each statement below.

1.       The company is (well-established) (new) and operates (internationally) (nationally) (regionally).

2.       The product line or service is (diversified) (limited) and sold to (consumers) (manufacturers) (other companies) (government(s)).

3.       Business cycles affect sales and earnings (minimally) (moderately) (severely).

4.       Interest rates for T-bills are historically (low) (average) (high) and seem to be (trending upward) (steady) (trending downward).

5.       Current inflation rates are (low) (average) (high) and seem to be (trending upward) (steady) (trending downward).

6.       In its industry the company is the (largest player) (in the top tier) (an average or smaller size company).

7.       The company has a (continuous dividend record for ________ years) (an inconsistent dividend record) (no dividend record).

8.       The business cycle seems to be (trending upward) (steady) (trending downward).

9.       The current stage of the business cycle tends to (help) (not effect) (hurt) the profits of the company which suggests (no concern) (caution) (optimism) for the company under review.

4.1 YOUR PROJECTIONS ON THE SSG (SUMMARY)
	Projection	Rationale
Sales Growth Rate (%)
EPS Growth Rate (%)
High P/E
Low P/E
Low Price
% Payout
4.2 YOUR FINAL RECOMMENDATION (BUY, SELL, HOLD)

When to Sell?

Selling “Myths”
• MYTH – Once a stock has doubled our investment it is time to sell.
• MYTH – Wait until a stock is back to even before selling.
• MYTH – Sell if the stock price falls 10% (or some other %) below the
purchase price.
• MYTH – Only sell when your SSG says “Sell.”
• MYTH – If a company is meeting our growth expectations, then do
not sell.
• MYTH – Don’t sell a stock until you have found a good replacement.
• MYTH – Sell everything when we are going into a bear market.
• MYTH – Don’t sell because it’s a “good company.”

Valid Reasons to Sell
• When something is truly wrong with the
business and it won’t likely be fixed within a
year
• When the stock price has risen so much that
future gains are unlikely.
• When you find a better stock. Frequently this is
a back‐door way of exiting a weak holding.

How can you become a better seller?
•Write it down – have written rules for selling just like you do
when buying
•For an investment club – rotate stock assignments so one person
isn’t identified with “her” or “his” stock
•Remember, stocks are a means to an end. The goal is to grow
your wealth. You aren’t being disloyal to a stock if you sell it.

http://www.betterinvesting.org/NR/rdonlyres/12386A1B-284F-4E75-B02C-D9396B363B26/0/StockUpFeb2015Slides4pp.pdf