Before you can conquer the markets and lie back to count your millions, you must have a clear picture of where your finances stand right now. Once you've taken that crucial first step toward your eventual wealth, you'll be ready to set your goals, analyze your style, and put together a real plan — one that will get you exactly where you want to go. The path to wealth comes with countless setbacks, many roadblocks, and dozens of disappointments. A solid plan will help you get through those impediments.

Planning for Success

• Top 10 Things to Do Before You Invest $1
• Laying the Foundation
• Taking Financial Inventory
• Building a Budget

• Do-It-Yourself Filing System
• Knock Out Your Debt
• Easy Ways to Cut Spending
• Set Your Investing Goals

Top 10 Things to Do Before You Invest

Top 10 Things to Do Before You Invest
by Michele Cagan, CPA

1. Pay off every penny of credit card debt. You'll earn sky-high (18 to 22 percent!) returns just by paying your credit card balance in full rather than making the minimum monthly interest-laden payments.

2. Build yourself an emergency fund. Start a separate bank account for this purpose alone. It should have enough money to cover at least three to six months of living expenses.

3. Set up and follow a household budget. Keep track of where your money comes from and (even more important) where it's going.

4. Set clear financial goals. Whether you want to save for a new car this year or retirement twenty years from now, you need to know why you're investing.

5. Determine your time frame. How long your money will be working for you plays a key role in designing the best portfolio.

6. Know your risk tolerance. Investing can bring about as many downs as ups, and you have to know just how much uncertainty you can comfortably stand.

7. Figure out your asset allocation mix. Before you start investing, know what proportion of your portfolio will be dedicated to each asset class (like stocks, bonds, and cash, for example).

8. Improve your understanding of the markets. That includes learning about the big picture, such as the global political and economic forces that drive the markets and affect asset prices.

9. Set up your brokerage account. Whether you decide to start out with a financial advisor or take a more do-it-yourself approach, you'll need to have an open brokerage account before you can make your first trade.

10. Analyze every investment before you buy it. Buy only investments that you have researched and fully understand; never risk your money on an unknown.

http://www.netplaces.com/investing/planning-for-success/top-ten-things-to-do-before-you-invest-1.htm

Learn Accounting

Accounting Sections

• Accounting Is More Than Numbers
• The Basic Accounts
• Keeping Track of Transactions
• Setting Up a System
• The Accounting Equation
• Recording Your Revenues
• The Inventory-Cost Connection
• Standard Operating Expenses
• Managing the Payroll
• Always Know Your Cash
• Handling Customer Credit
• Controlling Purchase Costs
• The End of Period Cleanup
• Preparing Financial Statements
• Different Entities Mean Different Equity
• The Income Tax Impact
• The Best Use of Your Financial Statements
• More Ways Accounting Helps Your Business
• Unique Issues for Specific Businesses
• Retirement Plans
• Common Small-Business Tax Snafus
• Accounting Glossary
• Small-Business Resources on the Internet

Graham's Valuation Formula

Investing is a multidimensional activity.

To cope with this complexity, investors have resorted to increasingly powerful computers that purport to capture the inter-relatedness of many variables.  But this approach tends to lose the most valuable input of all:  human intuition.

A far better solution for the investment process would be to "freeze" some variables so that analyses could focus on a reasonable number of factors.

Benjamin Graham's valuation formula provided all stock market investors with a critically important tool that freezes one of the key variables of the investment process to simplify the purchase decision.  By using Graham's formula, investors are freed to consider other important factors when evaluating a public company.


GRAHAM'S SIMPLE FORMULA
To calculate intrinsic value, multiply the earnings growth rate by 2 and add 8.5 to the total, then multiply that by the current earnings per share.

[8.5 + (2 x growth) ] x EPS = Intrinsic Value per share

1.  A no-growth company.   The company would have a P/E ratio of 8.5 (and an earnings yield of 12%), which is a fairly typical P/E for a mature company.

2.  An average-growing company.  Most analysts use a P/E range of 15 to 20 times earnings for the S&P 500.  This would translate into the average growth stock in the S&P 500 growing between the ranges of 3.25% to 5.75% (mean 4.5%).


3.  A faster-growing company.  A faster-growing stock growing at 10% will have a P/E ratio of 28.5.  This is fairly typical for the faster-growing companies in the S&P 500.


Two flaws in the valuation models.  All valuation models have flaws.

1.  Models such as Graham's value a company based solely on its earnings.  This leaves out the possible positive effects of non-operating assets or negative effects of non-operating liabilities..  That's why investors need to look beyond earnings and examine company balance sheets prior to purchase to look for non-operating assets and liabilities.

2.  A second flaw has to do with the potential competition from high interest rates.  Should the P/E ratio of stocks be immune to high interest rates?  Of course not.  Graham himself addressed this issue when he suggested that P/E ratios should be adjusted downward if long-term interest rates on AAA corporate bonds
exceeded 4.4%.  The revised Graham formula factors in the current yield to maturity on AAA corporate bonds in the calculation of a company's intrinsic value:

REVISED GRAHAM FORMULA
Intrinsic value per share = EPS x (8.5 + 2g) x 4.4 / y

where,
g = growth rate
y = yield on AAA corporate bonds


If the yields on AAA corporate bonds were to remain at 4.4%, then the original Graham model would remain intact.

If the yields on AAA corporate bonds increased to 6.6%, the P/E ratios would be reduced by 1/3 (4.4/6.6 = 2/3).

If the yields on AAA corporate bonds increased to 8.8%, the P/E ratios would be cut by 1/2.  Thus, the future value of all companies would be reduced by 50%, all things being equal.

For those who want to use Graham's amended model, some caution is warranted.  The model requires that the user forecast interest rates well into the future.  For an investor to rely on recent interest rates as an input to the model could be misleading.

The Intrinsic Value Formula of Benjamin Graham

Intrinsic Value = E (2r + 8.5 ) x 4.4 / Y

E = Earnings
r =  Expected Earnings Growth rate
Y = Current yield on AAA corporate bonds.
8.5 = Graham believed this to be the correct P/E multiple for a company with no growth.

Therefore, Intrinsic Value will rise proportionately to

• rising earnings, 
• rising earnings growth rate and 
• falling yields of AAA corporate bonds.

P/E ratios have risen in recent years, perhaps making 15 to 20 a more appropriate number for a company with no growth, but a conservative investor will continue to use a low multiplier.

Before accepting this formula too enthusiastically, you might reflect on Warren Buffett's response when asked about it.  "I never use formulas like that.  I never thought Ben was at his best when he worked with formulas either," he said with a chuckle.

Corporate Taxes

Back in the 1940s Graham suggested that to ensure that management is honest about earnings, corporations should make income tax statements available to investors upon request.

• If the company paid taxes on income, then it is genuine income.
• If the company didn't, there must be a logical reason, such as a tax write-off or the use of some type of tax credit.  

Corporate taxes have become progressively complex over the years, and only the most dedicated investors - and ones with a lot of time to kill - would care to pore over corporate tax statements.

Fortunately, many corporations now include summary tax information in their annual reports to shareholders.

Many investor information services also supply simplified income tax information in their stock reports.

Reporting of earnings on an after-tax basis is standard practice and to most people, the "real bottom line" is the profits after tax.


Comment:
When the company reported an effective tax rate that is lower than the normal, you may wish to know the reasons for this.  Perhaps, the company has a tax write-off or tax credit that year.

One simple criterion to base stock purchases - FOCUS ON EARNINGS

Toward the end of his life, Benjamin Graham spent many hours looking for one simple criterion on which to base stock purchases.  His focus turned to EARNINGS.

"My research indicates that the best results come from simple earnings criterions."

His multiple criteria for selecting investment-quality stocks have remained the most reliable.  What makes an "investment-quality stock"?

• Financial condition is conservative and working capital position is strong. (Check the Balance Sheet).
• Earnings are reasonably stable, allowing for business conditions that fluctuate over a 10-year period. (Check the Income Statement).
• Average earnings bear a satisfactory ratio to market price. (Check the Valuation).

As investors become more familiar with these guidelines, they follow them easily and automatically, or so it seems.

Buffett and his partner, Charlie Munger, say they don't sweat over formal rules or procedures when trying to determine if a stock has growth potential.

For those of us with less talent and experience than Buffett and Munger, however, it is acceptable to work out a portfolio plan and run a checklist tally of a stock's pluses and minuses.


REMEMBER:

• Quantitative data are useful only to the extent that they are supported by a qualitative survey of the enterprise.
• The companies with the best investment potential are consistently profitable.
• The P/E ratio should be low compared with those of other companies in the same industry.
• The P/E ratio establishes the upper share price limit on intrinsic value.
• Earnings and other estimates should err on the side of understatement.  That, in itself, makes for a margin of safety.

Also read:
Ben Graham's checklist for finding undervalued stocks
https://docs.google.com/spreadsheet/ccc?key=0AuRRzs61sKqRdFpHTldITEQyZDJuVGdDY3hTS3lvQ0E&hl=en#gid=0

Be careful with companies in formation - Wait For Earnings

Without Earnings, Nothing To Measure

Graham was suspicious of 'hot' or fast-growth stocks because their promise relies on the prediction of ever-increasing future earnings with little historical evidence that the company can consistently produce ever-rising future earnings.

He warned the growth stock investor to seek two things:

• Assurance that growth will continue
• Assurance that the investor isn't paying too high a price for future growth.

Peter Lynch warns investors to be especially careful with companies in formation.  "Wait for earnings," he cautions.

• Though Lynch has done very well with some initial public offerings in particular (he was an original investor in Federal Express, "I'd say three out of four have been long-term disappointments."

Venture capital operations

Many high-tech, bio-tech or other emerging technology companies operate more like venture capital operations.

Venture capitalists demand guarantees of high returns because the risk is high that earnings will be slow in arriving, or will never materialize at all.

The venture capitalist is betting on a technology and the talent to put that technology into use.

Venture capital investment is best practiced by those who know a particular industry extremely well.

Knowing and Setting the Upper Limits of Share Price

The P/E also can be used to establish a cap on intrinsic value.

While asset values set the lowest level for estimating intrinsic value, the P/E can serve as an upper limit.

The P/E ratio establishes the maximum amount an investor should pay for earnings.

• If the investor decides that the appropriate P/E ratio for a stock is 10, the share price paid should be no more than 10 times most recent yearly earnings.

It is not wrong to pay more, Graham and Dodd noted; it is that doing so enters the realm of speculation.  

• Since young, rapidly expanding companies generally trade at a P/E ratio of 20 to 25 or above, Graham usually avoided them, which was one reason he never invested in some new start up stocks, though he used and was impressed by their products early in his career.

A Subnormal P/E

When a stock is selling at a P/E significantly lower than that of its competitors, an investor will want to know why?

A low P/E does not necessarily mean higher risk, though the company should be studied with that possibility in mind.

• The low P/E stock may be selected anyway if, for example, it is a cyclical stock at a low in its cycle.   Cyclical stocks - automobile manufacturers are the most notorious among them - periodically develop fire-sale P/E ratios.  
• Other out-of-favour stocks also can drop to surprisingly low P/Es.

On the other hand, if a stock is cheap in terms of its multiple for a troubling reason (or permanent deterioration of  business  fundamentals), such as pending depletion of oil or mineral reserves or a patent expiration, the value investor may want to shop elsewhere.




Comment:
Often the low P/E is appropriate for the stock as it is perceived to have poor potential for growth or its earnings are poor, volatile and less stable.

A Pricey P/E

High Pricey P/E

A company may be selling at an exceptionally high P/E because it is considered to have remarkably good prospects for growth.

No matter how high the quality of the car you are looking at, there is a price at which it is no longer worth buying.  No matter how junky a car is, there is a price at which it is a bargain.  Stocks are no different.

Some stocks with high multiples work out, but investors who consistently buy high multiple stocks are likely to lose money in the long run.

Often the highest multiples are present in a bull market which increases the risk.  

Graham and Dodd observed, " It is a truism to say that the more impressive the record and the more promising the prospects of stability and growth, the more liberally the per-share earnings should be valued, subject always to our principle that a multiplier higher than 20 (i.e., 'earning basis' of less than 5%) will carry the issue out of the investment range."

It is not wrong to pay more, Graham and Dodd noted; it is simply that doing so enters the realm of speculation.

Super High-Growth Portfolio - Pushing the Limit to achieve Maximum Portfolio Growth

There are investors who can and should invest the time and effort to create a supper high-growth portfolio.

Although it will require greater effort in selection and maintenance, a high-performance portfolio can be achieved while abiding by the commandments of value.

Any appearance of higher risk must be well understood and accounted for in the share price.

Pushing the limit, say Graham and Dodd, is a game for the strong-minded and daring individual.


According to Graham, a growth stock should double its per share earnings in 10 years - that is, increase earnings at a compound annual rate of over 7.1%.  To do so, a growth stock's sales should be continually higher than sales in the early years.

The investor who can successfully identify such "growth companies" when their shares are available at reasonable prices is certain to do superlatively well with his capital.

Have an opinion on future growth - How can the company increase its earnings?

It is only rational to have an opinion on future growth.  Otherwise, how could you ever choose a stock?

When forming that opinion, back up quantitative information with qualitative factors.

For example, ask what management is doing to make a positive impact on earnings.

According to Peter Lynch, there are 5 basic ways a company can increase earnings:

• reduce costs; 
• raise prices; 
• expand into new markets;
• sell more of its products to the old markets; or
• revitalize, close or otherwise dispose of a losing operation.

When management is enacting growth-promoting activities, earnings may be temporarily flat.  They often soon take a giant step up.

Benjamin Graham saw a vulnerability in a high growth rate and in high returns on capital - the two normally go together.

So what's there to worry about in good earnings?  Exceptionally high earnings often attract rough competitors.  

The good part is that high earnings lure enthusiastic new investors, who often bid the share into the stratosphere.


Comment:
Buy good quality growth companies.
Assess the quality of the business and the management.
Then do the valuation.
These are the basics of the QVM or QMV approach to investing.

Charlie Munger - Projections do more harm than good

Reading Tea Leaves

" I have no use whatsoever for projections or forecasts.  They create an illusion of apparent precision. The more meticulous they are, the more concerned you should be.  We never look at projections but we care very much about, and look very deeply, at track records.  If a company has a lousy track record but a very bright future, we will miss the opportunity,"  explained Warren Buffett.

Charlie Munger, added that in his opinion projections do more harm than good.  "They are put together by people who have an interest in a particular outcome, have a subconscious bias, and its apparent precision makes it fallacious.  They remind me of Mark Twain's saying, 'A mine is a hole in the ground owned by a liar.'  Projections in America are often a lie, although not an intentional one, but the worst kind because the forecaster often believes them himself."

Here is how Graham and Dodd looked at projections.  "While a trend shown in the past is a fact, a 'future trend' is only an assumption.  The past, or even careful projections, can be seen as only a 'rough index' to the future."

More than five decades have passed since those words were said, and Buffett still agrees.

How Value Investor identifies Earnings, Sales and Future Growth

The real goal of the value investor is to identify companies with solid financial base that are growing at a faster rate (in terms of sales and earnings) than both their competitors and the economy in general.

All things being equal, share price is likely to increase in value at about the same rate that sales grow.

For dominant companies in major industries, an investor will want a sales growth rate of 5 to 7 percent.  

Within a portfolio, look for an overall sales growth rate of at least 10% annually.

Earnings need not rise every year. Almost all industries operate in cycles, and any company can suffer a temporary setback.

But investors should be wary

• when a company's earnings and sales are erratic without explanation or 
• when sales and earnings are slowly sinking and the company is not taking corrective action.