Showing posts with label quality of decision. Show all posts
Showing posts with label quality of decision. Show all posts

Saturday 21 September 2019

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.

Wednesday 9 May 2018

A Framework for Improving Decisions

Smart organizations can improve decision making in four steps:

1.  Identification
2.  Inventory
3.  Intervention
4.  Institutionalization



The four steps to improving decision making.

1.  Identification

Managers should begin by listing the decisions that must be made and deciding which are most important.

For example,

  • "the top 10 decisions required to execute our strategy: or 
  • "the top 10 decisions that have to go well if we are to meet our financial goals."


Some decisions will be rare and highly strategic. 

  • "What acquisitions will allow us to gain the necessary market share?"


Others will be frequent and on the front lines. 

  • "How should we decide how much to pay on claims?"


Without some prioritization, all decisions will be treated as equal - which probably means that the important ones won't be analyzed with sufficient care.



2.  Inventory

In addition to identifying the key decisions in 1 above, you should assess the factors that go into each of them.

  • Who plays what role in the decision?
  • How often does it occur?
  • What information is available to support it?
  • How well is the decision typically made?


Such an examination helps an organization understand which decisions need improvement and what processes might make them more effective, while establishing a common language for discussing decision making.


3.  Intervention

Having narrowed down your list of decisions and examined what's involved in making each, you can design the roles, processes, systems, and behaviours your organization should be using to make them.

The key to effective decision interventions is a broad, inclusive approach that considers all methods of improvement and addresses all aspects of the decision process - including execution of the decision, which is often overlooked.


4.  Institutionalization

Organizations need to give managers the tools and assistance to "decide how to decide" on an ongoing basis.

For example, the managers can be trained to determine whether a particular decision should be made

  • unilaterally by one manager, 
  • unilaterally after consultation with a group, 
  • by a group through a majority vote, or 
  • by group consensus.  
In addition, they can also determine

  • who will be responsible for making the decision, 
  • who will be held accountable for the results and 
  • who needs to be consulted or informed.


Companies that are serious about institutionalizing better decision making can often enlist decision experts to work with executives on improving the process.

For example, the members of a decision analysis group can

  • facilitate framing workshops; 
  • coordinate data gathering for analysis; 
  • build and refine economic and analytical modes; 
  • help project managers and decision makers interpret analysis; 
  • point out when additional information and analysis would improve a decision; 
  • conduct an assessment of decision quality; 
  • and coach decision makers.





Regularly assess and review to improve the quality of your decision making.

An organization that has adopted these four steps should also assess the quality of decisions after the fact.  The assessment should address not only actual business results - which can involve both politics and luck - but also the decision-making process and whatever information the manager relied on. 

The organization should regularly performs "look-backs" on major decisions, and assesses not only outcomes but also how the decision might have employed a better process or addressed uncertainty better.



The Hidden Traps in Decision Making

Making decisions is one of the most important things we do in our daily living.  It is also the toughest and riskiest in some situations.  Bad decisions can damage your career, business and finances, sometimes irreparably.



So where do bad decisions come from? 

In many cases, they can be traced back to the way the decisions were made:
  • the alternatives were not clearly defined,
  • the right information was not collected,
  • the costs and benefits were not accurately weighed.
But sometimes the fault lies not in the decision-making process but rather in the mind of the decision maker.  The way the human brain works can sabotage our decisions.



Psychological traps

There are a number of well-documented psychological traps that are particularly likely to undermine decision making.  These include:
  • heuristics#, 
  • biases and 
  • other irrational anomalies in our thinking.  


Your best defense is AWARENESS

There are specific ways you can guard against them.  However, the best defense is always awareness.  

By familiarizing yourself with these traps and the diverse forms they take, you will be better able to ensure that the decisions you make are sound and that the recommendations proposed by others (your subordinates or associates) are reliable.





Additional notes:

#heuristics:  
These are unconscious routines we use to cope with the complexity inherent in most decisions.  These routines serve us well in most situations.  These simple mental shortcuts help us to make the continuous stream of judgments required to navigate the world.  But, not all heuristics are foolproof.  The resulting decisions often pose few dangers for most of us, and can be safely ignore.  At times, the decisions arising from these heuristics can be catastrophic.  What make all these traps so dangerous is their invisibility.  Because they are hardwired into our thinking process, we fail to recognize them - even as we fall right into them.

Sunday 7 April 2013

Investment Decisions and Fundamentals of Value



@ 6.47 min
Managers should invest in real assets and should not be involved in investing in financial assets which the shareholders can do on their own.


What is a Valuable Investment Opportunity?

  1. An investment worth more than it costs.
  2. An investment with a return greater than its opportunity cost of capital.

Why does an asset have value?
  1. An asset provides a return on investment in the form of future cash payments.
  2. When we make an investment, we are buying a cash flow stream.
  3. When we assess the value of an asset, we assess the value of its cash flow stream.

Asset valuation is the answer to the following question:
What is the PRESENT VALUE of a Future Cash Flow Stream?


@ 13 min
What determines the present value of a cash flow stream?
  1. Magnitude
  2. Timing
  3. Risk

@ 15 min
Risk of the cash flow stream
Consider 2 cash flows streams A and B
A pays $100 for certain.
B may pay as much as $100 but may pay as little as $60.

Choice:  Choose A
We are risk adverse.  A SAFE dollar is worth more than a RISKY dollar.

@ 17 min
Time Value of Money
Time value of money is the rate of exchange between present dollars and future dollars established in the financial market.
Time value of money is reflected in the rates of return available to all investors in the financial markets.


@ 18.30
Risk and Return Relationship
Safe dollars are more valuable than risky dollars
Risk averse investors prefer safe investments.
How do you induce risk averse investors to take a risky investment?
Risky investments must promise higher returns to induce investors to undertake them.
In the financial markets, investments are priced so that the higher the risk, the higher the expected return.
Risky investment's rate of return reflects a risk premium that rewards investors for taking on the investment's risk.
Investment's opportunity cost of capital is the return forgone on an investment in the financial market of comparable risk.
Riskier investments have higher opportunity costs of capital.

Rate of Return = Time Value of Money + Risk Premium
Rate of Return = Risk Free Rate + Risk Premium


@ 21.30
Value of an asset:
1.  Forecast the magnitude and timing of the cash flow stream over its economic life.
2.  Assess the risk of the cash flow stream.
3.  Value the cash flow stream given its magnitude, timing, and risk at its opportunity cost of capital.




Market Value and Rate of Return


@ 23 min
The cash flow stream's value is determined by the amount of money needed today to recreate its magnitude, timing, and risk in the financial market at its opportunity cost of capital.

@ 24.50
What is the investment's opportunity cost of capital?

PV = FV / (1+r)
The value of an investment asset is the money needed today to recreate its future cash flow stream in the financial market at its opportunity cost of capital (r).
The value of an investment asset is the present value of its future cash flow stream.


How much is the asset worth, and how much does it cost?
  • What is the value of the asset's future cash flow stream today, and how much does it cost?
  • What is its PRESENT VALUE, and how much does it cost?
  • What is the prevent value net of cost?
  • What is its NET PRESENT VALUE?
NPV = PV of Investment - Cost
A valuable investment opportunity is worth more than it costs.

@ 31 min
If 
NPV > 0, investment is worth more than it costs
NPV < 0, investment costs more than it is worth.
NPV =0, investment costs as much as it is worth.

NPV is the absolute dollar change in wealth from the acceptance of an investment opportunity.
Look for investment opportunities in those with positive NPV projects.


What is a valuable investment opportunity?
  1. An investment with a net present value greater than zero.
  2. An investment with a return greater than its opportunity cost of capital.

Investment Decision Rules
  1. Accept all investments with Net Present Values greater than Zero.
  2. Accept all investments with rates of return greater than their opportunity costs of capital.
@ 34 min
Example using the Net Present Value Rule
NPV = PV - Cost 
> 0, therefore we accept the project.

@ 35 min
Example using the Rates of Return greater than their Opportunity Cost of Capital
Rate of Return = 20%.
Opportunity cost of capital = 12%.
Therefore, accept the project.

@ 36.50
You are considering an investment opportunity that costs $100,000 and promises to return 10%.
A comparable investment in the financial market returns 15%.
A bank offers to lend you $100,000 at 8% with no conditions.

Do you invest $100,000 in the investment opportunity?  NO.

Financing cost = 8%.
What is the investment's cost of capital? 15%.
The cost of capital is the return on comparable investments in the financial market, that is 15%.
The cost of capital is not the cost of raising the money to finance the investment.  That is a financing decision and not an investment decision.  
That return in the financial market is the standard against which other investment opportunities are evaluated.
The financing by the bank loan is irrelevant to the investment decision.

Investment decision and financing decision are separate and independent decisions.
First make the investment decision, after that, then make the financing decision.


Thanks for pointing this video out to me.
<  I found these very helpful : https://www.youtube.com/watch?v=ZtQKrPBz3XA https://www.youtube.com/watch?v=4q2Xcbrazhw on Financial Ratio Tutorial Anonymous on 4/7/13 >

Tuesday 18 May 2010

Big returns come from small caps

Big returns come from small caps


John Collett asks the experts for their top investment tips among our smaller companies.

The accounts of our biggest listed companies are pored over endlessly by an army of analysts, which makes it unlikely that investors are going to come across hidden value among these giants.

Smaller medium-sized companies, on the other hand, are usually less visible so they provide potential to uncover hidden value and big capital gains. For investors who are patient and prepared to invest over the long term, smaller companies can add some zing to share portfolios.

Money asked leading small-cap fund managers and analysts for their tips from among those market minnows with well-established track records and a history of paying reliable dividends. Like any sharemarket investments, there are always risks. And smaller companies come with more risks than large companies. Their earnings tend to be the most responsive to economic conditions - both good and bad.

Shares should never be held in isolation but in a diversified portfolio. Many investors may find a better way to get exposure to smaller companies is to invest with a specialist smaller companies fund manager. Professional fund managers run portfolios holding dozens of smaller companies, providing small investors with instant diversification.

The stocks nominated by fund managers and analysts cover the spectrum of the Australian economy - retailers, financial services, technology - but there are no resources stocks. Smaller resources stocks may be terrific investments but are too speculative for novice investors.

TURNAROUND STORY

The managing director of Perennial Value Management, John Murray, nominates OrotonGroup, which designs and makes luxury handbags, leather goods and accessories. Murray is a fan of the managing director, Sally Macdonald, who since her appointment in 2006 has turned the struggling retailer around. The company has expanded product lines and refocused on key brands including Polo Ralph Lauren and Oroton. Murray still has the Oroton briefcase he bought in 1991 and says the brand is "classic value fashion" - quality fashion that is not too expensive.

"We are believers in Oroton and growth will be driven by new stores and product lines like lingerie and menswear," Murray says. Perennial first bought Oroton shares for $3 each in 2007. The shares are now trading at about $7. As a luxury fashion retailer, the company's sales are vulnerable to down-turns in the economy. A little over a year ago, towards the tail-end of the GFC, Oroton shares dipped to $2.80 and in the year since, Oroton's share price has increased 250 per cent.

Before it will invest, Perennial has to be convinced of the strength of a company's balance sheet. And Oroton has good financial strength with low debt, Murray says. On a share price-to-earnings multiple of 11 times, Oroton shares are not cheap but they are still reasonable value, he says.

PIPING HOT

Reece Australia, a plumbing supplier, has many of the attributes the small companies fund manager and chief investment officer of Celeste Funds Management, Frank Villante, likes to see. House prices are rising and spending on renovation is healthy, which means Reece is "fantastically positioned" to take advantage of the trend.

Reece is a conservatively managed company, owned by the same family since the 1930s, and family interests own about 70 per cent of Reece shares. Australian corporate history is littered with examples of majority owners treating minority shareholders shabbily. However Villante says the Reece family has a long history of treating such investors well.

The company has a market capitalisation of about $2.5 billion, which puts it just inside top-100 companies. The company owns about $250 million of land and buildings and Reece's management takes the view that property in the right areas can be an attractive long-term investment. Reece is No.1 in terms of revenue, number of stores and on just about every measure Villante can find. Reece has no debt on its balance sheet; it is carrying about $60 million in cash. Villante is expecting earnings to grow at more than 15 per cent a year between 2011 and 2014.

WEB WONDER

The co-founder of Smallco Investment Manager, Rob Hopkins, is excited about the prospects of the internet sector.

Hopkins particularly likes the well-established internet employment website, Seek, which he says has a "very impressive" management team led by the Bassat brothers who, together with Matthew Rockman, founded Seek in 1997. Rockman left the company in 2006.

Seek expanded into New Zealand and has investments in employment websites in China, Brazil and Malaysia. It owns more than 40 per cent in Zhaopin, one of China's three leading online employment sites.

Seek shares have had a big run. A couple of years ago the stock was $2; it is now $8 and is on a price-to-earnings multiple of 23 times, which is expensive, Hopkins says. With a market capitalisation of $2.8 billion, it is not a market minnow and is just inside the top-100 companies but still has plenty of growth potential. "We expect earnings-per-share growth of more than 40 per cent over the next year," Hopkins says. In internet commerce there is not much room for No.2 and No.3 players. "People looking for a job go to a site where they know all of the jobs are advertised," Hopkins says, adding that the internet sector has plenty of examples where the No.1 player makes very good returns, while the No.2 player is just profitable and the third-placed player loses money.

GRIM REAPER

Fortune favours the grave with InvoCare Limited, which provides funeral homes, burial services, cemeteries and crematoria around Australia and in Singapore. Invocare operates two national brands, White Lady Funerals and Simplicity, and is the only funeral services provider that has a national reach.

InvoCare listed in 2003, having been built up during the 1990s under the ownership of a US funeral services operator and private equity investors that have since sold their shares in the company.

"It's amazing, what we call the death-care industry," says Brian Eley, co-founder of Eley Griffiths Group.

"The number of deaths is rising as the population increases and ages. You have that demographic trend, which is positive for the stock."

InvoCare has been a very good performer, Eley says: The stock is not "super cheap" and it never will be because people know that it's such as good business. The fragmented nature of the market presents plenty of opportunities for the company to grow through acquisitions, he says.

As people become wealthier they tend to spend more on their relatives' funerals, Eley says, and a growing part of the business is pre-paid funerals. He also says the funeral care industry has a lot of pricing power, which means the industry can increase prices by a bit more than inflation with little resistance from customers.

InvoCare has prices that are in the mid-range, which benefits the company as the mid-range is where most of the market is, Eley says.

TICKET CLIPPER

Funds management is a wonderful business because it is so scalable. Taking a percentage of funds under management - clipping the ticket, as it is known - has been the source of riches for banks and insurances.

IOOF, a funds management and investment platform administrator, is a very well-managed company, says Steve Black, a fund manager at Pengana Capital. It has a market capitalisation of about $1.3 billion, which puts it at the larger end of the small-cap companies. It pays out about 80 per cent of its profits as dividends and is yielding about 5.5 per cent, fully franked. "It has done very well but we still see very strong upside in it," Black says. "It is a stock that has not been well understood by analysts, which is why it is starting to perform now as more analysts start to recognise that these guys are delivering really good results."

IOOF, led by managing director Chris Kelaher, is one of the big-five platform providers. These are the administration platforms used by financial planners, which provide their clients with consolidated reports on portfolio performances and taxes and enable easy switching between investments. The platform owner levies a fee that is a percentage based on the assets. IOOF has been acquiring platforms and has its own financial planning network. IOOF is considered a possible takeover target by one of the big banks or insurers.

HEALTHY PERFORMER

Blackmores, the natural health remedies company, has very high returns on equity, which analysts say is a good thing because it shows a company is making good use of shareholder funds.

Whether it's arthritis, joint, bone and muscle pain or "brain health", Blackmores, which was started in 1938 by Maurice Blackmore, has a pill for everything.

Greg Canavan, a sharemarket analyst and editor of Sound Money. Sound Investments, a weekly report on the sharemarket, says Blackmores is a "nice little smaller cap" that is tapping into a growing market for natural remedies. It has a strong business in Australia and has established a presence in Thailand and Malaysia. The company distributes its products mainly through pharmacies and supermarkets.

Canavan says $23 a share is a little expensive and would prefer to buy at $20. "In 10 years' time, I think Blackmores will be a lot bigger company than it is now," he says.

http://www.smh.com.au/news/business/money/investment/big-returns-come-from-small-caps/2010/05/11/1273343328362.html?page=fullpage#contentSwap1

Wednesday 25 November 2009

When things go wrong: Towards better decision making - measuring success

What to use to measure success - quality of decision making or results?

The implications for businesses are profound.  If it is the quality of decision making , rather than results, that are the measure of success, then those who take decisions in the right way should be rewarded, even if they make mistakes.  They should also be given more decisions to make in the future, not fewer.

This doesn't mean automatically promoting people who get bad results.  it means:
  • encouraging better decison making and making it clear that it will be rewarded
  • setting boundaries to limit the impact that mistakes can have; acknowledging and actively managing the risk of mistakes
  • avoiding or limiting exposure to fatal downsides (doctors and airline pilots, for example, need systems to help them avoid errors)
  • when rewarding people, considering the way decisions have been taken as well as the results of decisions
  • questioning the business benefit of punishing those who get bad results
  • weighing the negative impact of mistakes against the learning and development they can bring.

It is important to remember that none of this means ignoring poor results or mistakes.  Financial loss or commercial reverses are bad for business.  But failing to learn can be worse.  The focus of management has to be the future, and what can be learned from the present and past to help shape the future.  By focussing on learning and better decision making, the business is doing everything it can to do to avoid bad result in the future, rather than simply reflecting what has happened in the past.

When things go wrong: Towards better decision making - quality of decision and the role of chance

Business results are the outcome of the interaction between our decisions, our actions and chance. Even if we make no error, there is always the cahnce that a bad outcome will result from a 'good' decision. For example, we might play dice game version A (http://spreadsheets.google.com/pub?key=te9MzyHoIN6EyuoHmfDxMaw&output=html) ten times and lose every time, despite having established that hte risk had a positive expected value. But how would such a decision be regarded in business?

 
If we were rewarded solely on results, with no attention paid to the way we took our decisions, our $10 loss would look pretty bad.  Our performance report might read as follows:  'Despite your poor results, you played this game again and again, throwing good money after bad on the off-chance of things somehow coming right.  You recklessly gambled company money on an uncertain future.  Your poor results are evidence of your bad judgement.  What were you thinking?'

 
But if we were rewarded on the quality of our decision-making process, our actions would appear in a very different light, resulting in a different review:  'Although results have been poor, due to circumstances beyond your control, the quality of your decision making was excellent.  You obtained all the information that you could on possible outcomes, and the probabilities of each, and took a decision on that basis.  The negative results, though disappointing, have not bankrupted the company.  You will be rewarded on the basis of decision-making quality.'

 
The flip side of this is that people might make decisions on impulse, or randomly, and still get good results by chance. 
  • By rewarding or promoting these individuals, the business risks having lucky managers rather than competent ones - fine, until their luck runs out. 
  • Also, although spontaneous decisions may turn out to bring some business benefit, they don't teach us anything.  We can't use them to improve the way we take decisions, or to instruct others.