The Five Rules for Successful Stock Investing 4

Economic Moats

Investors often judge companies by looking at which ones have increased profits the most and assuming the trend will persist in the future. But more often than not, the firms that look great in the rearview mirror wind up performing poorly in the future, simply because success attracts competition as surely as night follows day. And the bigger the profits, the stronger the competition. That's the basic nature of any (reasonably) free market – capital always seeks the areas of highest expected return. Therefore, most highly profitable firms tend to become less profitable over time as competitors chip away at their franchises.

To analyze a company's economic moat, follow these four steps:

• Evaluate the firm's historical profitability. Has the firm been able to generate a solid return on its assets and on shareholders' equity? This is the true litmus test of whether a firm has built an economic moat around itself.
• If the firm has solid returns on capital and consistent profitability, assess the sources of the firm's profits. Why is the company able to keep competitors at bay? What keeps competitors from stealing its profits?
• Estimate how long a firm will be able to hold off competitors, which is the company's competitive advantage period. Some firms can fend off competitors for just a few years, and some firms may be able to do it for decades.
• Analyze the industry's competitive structure. How do firms in this industry compete with one another? Is it an attractive industry with many profitable firms or a hypercompetitive one in which participants struggle just to stay afloat?

Firms that generate free cash flow essentially have money left over after reinvesting whatever they need to keep their businesses humming along. In a sense, free cash flow is money that could be extracted from the firm every year without damaging the core business.

If a firm's free cash flow as a percentage of sales is around 5 percent or better, you've found a cash machine [...]. Strong free cash flow is an excellent sign that a firm has an economic moat.

Net margin is simply net income as a percentage of sales, and it tells you how much profit the firm generates per dollar of sales. In general, firms that can post net margins above 15 percent are doing something right.

Return on equity (ROE) is net income as a percentage of shareholders' equity, and it measures profits per dollar of the capital shareholders have invested in a company. [...] As a rule of thumb, firms that are able to consistently post ROEs above 15 percent are generating solid returns on shareholders' money, which means they're likely to have economic moats.

Return on assets (ROA) is net income as a percentage of a firm's assets, and it measures how efficient a firm is translating its assets into profits. Use 6 percent to 7 percent as a rough benchmark – if a firm is able to consistently post ROAs above these rates, it may have some competitive advantage over its peers.

Consistency is important when evaluating companies, because it's the ability to keep competitors at bay for an extended period of time – not just for a year or two – that really makes a firm valuable. Five years is the absolute minimum time period for evaluation, and I'd strongly encourage you to go back 10 years if you can.

When you're examining the sources of a firm's economic moat, the key thing is to never stop asking, "Why?" Why aren't competitors stealing the firm's customers? Why can't a competitor charge a lower price for a similar product or service? Why do customers accept annual price increases? When possible, look at the situation from the customer's perspective. What values does the product or service bring to the customer? How does it help them run their own business better? Why do they use one firm's product or service instead of a competitor's?

In general, there are five ways that an individual firm can build sustainable competitive advantage:

1. Creating real product differentiation through superior technology or features
2. Creating perceived product differentiation through a trusted brand or reputation
3. Driving costs down and offering a similar product or service at a lower price
4. Locking in customers by creating high switching costs
5. Locking out competitors by creating high barriers to entry or high barriers to success

[...] although firms can occasionally generate enormous excess profits – and enormous stock returns – by staying one step ahead of the technological curve, these profits are usually short-lived. Unless you are familiar enough with the inner workings of an industry to know when a firm's products are being supplanted by better ones, be wary of firms that rely solely on innovation to sustain their competitive advantage.

[...] a strong brand can constitute a very wide economic moat. The wonderful thing about a brand is that as long as customers perceive your product or service as better than everyone else's, it makes relatively little difference whether it actually is different.

In general, firms can create cost advantages by either inventing a better process or achieving a larger scale.

If you can make it difficult – in terms of either money or time – for a customer to switch to a competing product, you can charge your customers more and make more money – simple in theory, but difficult in practice.

When you're looking for evidence of high customer switching costs, these questions should help:

• Does the firm's product require a significant amount of client training? If so, customers will be reluctant to switch and incur lost productivity during the training period.
• Is the firm's product or service tightly integrated into customers' businesses? Firms don't change vendors of mission-critical products often because the costs of a botched switch may far outweigh the benefits of using the new product or service.
• Is the firm's product or service an industry standard? Customers may feel pressure from their own clients – or their peers – to continue using a well-known and well-respected product or service.
• Is the benefit to be gained from switching small relative to the cost of switching?
• Does the firm tend to sign long-term contracts with clients? This is often a sign that the client does not want to frequently switch vendors.

Although patents and licenses can do a great job of keeping competitors at bay and maintaining high profit margins, they can also be ephemeral. If you're investigating a firm whose economic moat depends solely on a single patent or other regulatory approval, don't forget to investigate the likelihood of that approval disappearing unexpectedly.

Think about an economic moat in two dimensions. There's depth – how much money the firm can make – and there's width – how long the firm can sustain above-average profits.

Although the attractiveness of an industry doesn't tell the whole story, it's important to get a feel for the competitive landscape. Some industries are just easier to make money in than others.

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

The Five Rules for Successful Stock Investing 3

Seven Mistakes to Avoid

Unless you know how to avoid the most common mistakes of investing, your portfolio's returns won't be anything to get excited about. You'll find that it takes many great stock picks to make up for just a few big errors.

Loading up your portfolio with risky, all-or-nothing stocks – in other words, swinging for the fences on every pitch – is a sure route to investment disaster. For one thing, the insidious math of investing means that making up large losses is a very difficult proposition – a stock that drops 50 percent needs to double just to break even. For another, finding the next Microsoft when it's still a tiny start-up is really, really difficult. You're much more likely to wind up with a company that fizzles than a truly world-changing company, because it's extremely difficult to discern which is which when the firm is just starting out.

You have to be a student of the market's history to understand its future. Any time you hear someone say, "It really is different this time", turn off the TV and go for a walk.

It seems entirely logical, but the reality is that great products do not necessarily translate into great profits.

It's very tempting to look for validation – or other people doing the same thing – when you're investing, but history has shown repeatedly that assets are cheap when everyone else is avoiding them.

You'll do better as an investor if you think for yourself and seek out bargains in parts of the market that everyone else has forsaken, rather than buying the flavor of the month in the financial press.

Market timing is one of the all-time great myths of investing. There is no strategy that consistently tells you when to be in the market and when to be out of it, and anyone who says otherwise usually has a market-timing service to sell you.

The only reason you should ever buy a stock is that you think the business is worth more than it's selling for – not because you think a greater fool will pay more for the shares a few months down the road.

Cash flow is the true measure of a company's financial performance, not reported earnings per share.

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

The Five Rules for Successful Stock Investing 2

The Five Rules for Successful Stock Investing

Here are the five rules that we recommend:

1. Do your homework.
2. Find economic moats.
3. Have a margin of safety.
4. Hold for the long haul.
5. Know when to sell.

[...] perhaps the most common mistake that investors make is failing to thoroughly investigate the stocks they purchase. Unless you know the business inside and out, you shouldn't buy the stock. This means that you need to develop an understanding of accounting so that you can decide for yourself what kind of financial shape a company is in.

What separates a bad company from a good one? Or a good company from a great one? In large part, it's the size of the economic moat a company builds around itself. The term economic moat is used to describe a firm's competitive advantage.

The key to identifying wide economic moats can be found in the answer to a deceptively simple question: How does a company manage to keep competitors at bay and earn consistently fat profits? If you can answer this, you've found the source of the firm's economic moat.

Finding great companies is only half of the investment process – the other half is assessing what the company is worth. You can't just go out and pay whatever the market is asking for the stock because the market might be demanding too high a price. And if the price you pay is too high, your investment returns will likely be disappointing.

Always include a margin of safety into the price you're willing to pay for a stock. If you later realize you overestimated the company's prospects, you'll have a built-in cushion that will mitigate your investment losses. The size of your margin of safety should be larger for shakier firms with uncertain futures and smaller for solid firms with reasonably predictable earnings.

[...] not making money is a lot less painful than losing money you already have.

[...] if you don't use discipline and conservatism in figuring out the prices you're willing to pay for stocks, you'll regret it eventually. Valuation is a crucial part of the investment process.

Investing should be a long-term commitment because short-term trading means that you're playing a loser's game. The costs really begin to add up – both the taxes and the brokerage costs – and create an almost insurmountable hurdle to good performance.

Knowing when it's appropriate to bail out of a stock is at least as important as knowing when to buy one, yet we often sell our winners too early and hang on to our losers for too long.

Even the greatest companies should be sold when their shares sell at egregious values.

As an investor, you should always be seeking to allocate your money to the assets that are likely to generate the highest return relative to their risk. There's no shame in selling a somewhat undervalued investment – even one on which you've lost money – to free up funds to buy a stock with better prospects.

Don't sell just because the price has gone up or down, but give it some serious thought if one of the following things has happened: You made a mistake buying it in the first place, the fundamentals have deteriorated, the stock has risen well above its intrinsic value, you can find better opportunities, or it takes up too much space in your portfolio.

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

The Five Rules for Successful Stock Investing 1

Introduction: Picking Great Stocks Is Tough

Successful investing is simple, but it's not easy.

Picking individual stocks requires hard work, discipline, and an investment of time (as well as money). Expecting to make a large amount of money with only a little effort is like expecting to shoot a great round of golf the first time you pick up a set of clubs. There's no magic formula, and there's no guarantee of success.

The basic investment process is simple: Analyze the company and value the stock. If you avoid the mistake of confusing a great company with a great investment – and the two can be very different – you'll already be ahead of many of your investing peers.

Your goal as an investor should be to find wonderful businesses and purchase them at reasonable prices. Great companies create wealth, and as the value of the business grows, so should the stock price in time. In the short term, the market can be a capricious thing – wonderful businesses can sell at fire-sale prices, while money-losing ventures can be valued as if they had the rosiest of futures – but over the long haul, stock prices tend to track the value of the business.

You have to [...] understand the businesses of the stocks you own if you hope to be a successful long-term investor. When firms do well, so do their shares, and when business suffers, the stock will as well.

Company fundamentals have a direct effect on share prices. This principle applies only over a long time period – in the short term, stock prices can (and do) move around for a whole host of reasons that have nothing whatsoever to do with the underlying value of the company. We firmly advocate focusing on the long-term performance of businesses because the short-term price movement of a stock is completely unpredictable.

Successful stock-picking means having the courage to take a stance that's different from the crowd. There will always be conflicting opinions about the merits of any company, and it's often the companies with the most conflict surrounding them that make the best investments. Thus, as an investor, you have to be able to develop your own opinion about the value of a stock, and you should change that value only if the facts warrant doing so – not because you read a negative news article or because some pundit mouths off on TV. Investment success depends on personal discipline, not on whether the crowd agrees or disagrees with you.

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

Technical Analysis - A Beginner's Guide

Past performance is no guarantee of future results.

Charts do not predict the future from the past.

They seek to find current buying and selling patterns in the past and plan their own course of action once those patterns end.

It is based on probabilities, not forecasting.




Why does it work?

Chart patterns are formed by the buying and selling actions of people, and people tend to act in a similar manner when faced with similar situations.

Some blame this on a self-fulfilling prophecy.

If enough investors believe in the significance of a chart pattern ending then they will act, and thus their actions will assure that the assumed result will occur.

But investors may not act the same way this time and the charts will tell us when that is the case quickly, before losses begin to mount.




Note that technical analysis expects to have losses.

It is in minimising those losses and recognizing when a winner has more room to go that there is success - read consistent profits - in a portfolio.

No other method of analysis includes as a standard feature the possibility that things will not work out as planned.  




Charts need not be adversarial with other forms of analysis.

Charts can be used as tools to help with the other forms of analysis.

Whether it is a sanity check on the fundamentals, or something that tips us off on changing fundamentals in a sector, charts will enhance investing results.

Charts are tools, not crystal balls.

They help investors find good investments and just as importantly avoid bad ones.

A picture is worth a thousand words and charts can be put into action to help investors make and keep money.


Ref:  Michael Kahn

The FOUR filters of Buffett

The FOUR filters of Buffett:

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

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

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

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


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

In investing, it is just as important to know which companies to avoid.

In investing, it is just as important to know what are the companies you do not wish to invest in.

This is very important and if you are able to identify these companies that are not going to do well or that are going to do badly in their businesses, you can prevent yourself from a lot of future heart-aches and losses.

Being able to identify these companies that are going to do poorly over the long term, means you have the ability to also:

1.  identify those companies with good long term prospects, which you may choose to dwell in deeper into to prospect for your long term portfolio of stocks.

2.  identify those companies that are fundamentally poor which are presently exhibiting temporarily a period of exceptionally good results, so that you may avoid them.

These assessments are based mainly on the businesses of the companies.  Do not look at the stock prices for guidance, especially in the initial stages of your analysis of the companies prospects.

It is better to assess the quality of the business and the quality and integrity of the management first.

When you like what you analyse, then do a valuation of its intrinsic value.

Then determine at what price you will be willing to buy at with a margin of safety and a promise of satisfactory return.

Then look at the market price.  Looking at the market price to get guidance may bias you in your intrinsic value calculation.

ALL EQUITY SECURITY INVESTMENTS PRESENT A RISK OF LOSS OF CAPITAL

Investment performance is not guaranteed and future returns may differ from past returns. As investment conditions change over time, past returns should not be used to predict future returns. The results of your investing will be affected by a number of factors, including the performance of the investment markets in which you invest.

THE ULTIMATE HOLD-VERSUS-SELL TEST

Here is the overriding primary test, followed by observations on why it is so critically important:

Knowing all that you now know and expect about the company and its stock (not what you originally believed or hoped at time of purchase), and assuming that you had available capital, and assuming that it would not cause a portfolio imbalance to do so, would you buy this stock today, at today's price?

No equivocation. Yes or no?

Answers such as maybe or probably are not acceptable since they are ways of dodging the issue. No investor probably buys a stock; they either place an order or do not.

Here is the implication of your answer to that critical test: if you did not answer with a clear affirmative, you should sell; only if you said a strong yes, are you justified to hold.

SELL THE LOSERS, LET THE WINNERS RUN.

Losers refer NOT to those stocks with the depressed prices but to those whose revenues and earnings aren't capable of growing adequately. Weed out these losers and reinvest the cash into other stocks with better revenues and earnings potential for higher returns.

SOME THOUGHTS ON ANALYSING STOCKS (KISS)

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

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

"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.

MARKET FLUCTUATIONS OF INVESTOR'S PORTFOLIO

Note carefully what Graham is saying here. 

It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% ("equivalent one-third") from their highest price -regardless of which stocks you own or whether the market as a whole goes up or down.

If you can't live with that - or you think your portfolio is somehow magically exempt from it - then you are not yet entitled to call yourself an investor.

KESM 7.6.2016

KESM Charts

Cyclical business

PE has expanded and contracted over the years.

Revenue growth is anaemic.

PBT and EPS have grown fast recently due to margin expansions for various reasons.

Its price was below RM 1 in recent years and has climbed to 6 before dropping to present levels recently.


Best time to be enthusiastic on cyclical stocks:


1.  When their PE is the highest in the cycle

2.  When their profit margins are the lowest in the cycle.

The company has about 50 m debts but is net cash positive.

Large capital expenditure expended last year.  

ROE is improving, was a single digit and now about 12%.

Its dividend is minuscule, DPO is about 15%.

DY at its present high price of 4.90 is about 1.6%.

The key to profitable investing - knowing how to capitalize successes and curtail failures.

An investor who year in and year out procures for himself a final net profit.

An investor who year in and year out who is usually in the red.

What might be the reasons to explain their different outcomes?

Is this entirely a question of superior selection of stocks?  Maybe NOT entirely.

Is this entirely a question of superior timing of buying and selling of stocks?  Maybe NOT entirely.

How good are economists in their forecasts?

In a meeting of economists, they agreed if their forecasts were 1/3 correct, that was considered a high mark in their profession.

You cannot invest in securities successfully with odds like that against you if you place dependence solely upon judgement as to the right securities to own and the right time or price to buy them.

It is also a case of knowing how to capitalize successes and curtail failures.

You have to learn by doing.

Total Pageviews crossed the 2,000,000 mark.

TOTAL PAGEVIEWS

 2,115,105

SEARCH THIS BLOG

FOLLOWERS

This blog was started in August 2008 in the midst of the Global Financial Crisis.

It is on developing a sound investing philosophy, strategies and methods to profit from investing in stocks.

It has been an interesting and a rewarding journey blogging on investing.

Thank you for visiting my blog and wishing you a safe and rewarding investing in stocks over your lifetime..

This was the first post in this blog dated 

FRIDAY, 1 AUGUST 2008

INVESTMENT POLICIES (BASED ON BENJAMIN GRAHAM) SUMMARY OF INVESTMENT POLICIES

• ►  2015 (256)

• ►  2014 (208)

• ►  2013 (533)

• ►  2012 (1470)

• ►  2011 (1031)

• ►  2010 (2430)

• ►  2009 (2379)

• ►  2008 (368)

Burton Malkiel - Talks at Google

WHEN TO SELL by Buffett

When To Sell Quotes

Warren Buffett’s advice on when to sell is fairly straightforward. Sell when the business you are invested is performing poorly (and will likely continue to do so).

“Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.”

As an individual investor, you can’t fix a declining business. Your energy is best spent cutting losses and moving on.

“The most important thing to do if you find yourself in a hole is to stop digging.”

Buffett sells infrequently. He is a long-term investor that would rather hold forever than sell as long as a business maintains its competitive advantage. Even Buffett gets it wrong sometimes. When you make a mistake, learn from it and cut your losses.

Selling businesses in decline is a form of risk management. 

http://www.suredividend.com/warren-buffett-quotes/#when to sell

WHEN to Buy by Buffett

Warren Buffett on When To Buy

Warren Buffett’s buying wisdom can be condensed into 2 statements:

1. Buy great businesses when they are trading at fair or better prices.
2. This occurs when short-term traders become pessimistic

The 8 quotes below clarify Warren Buffett’s thinking on when to buy great businesses.

“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

In the quote above, Buffett explains that he acquired his value-focused mindset from his mentor Benjamin Graham. Graham was the father of value investing and a fantastic investor in his own right. It makes sense that his philosophies significantly influence Warren Buffett.

There is a stark difference in investing style between Graham and Buffett. Graham focused on deep value plays – businesses that were trading below liquidation value. These were typically poor businesses that were undervalued because they had such bad future prospects.

Buffett focuses on great businesses trading at fair or better prices, as the quote below clarifies:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

Wonderful companies compound your wealth year-after-year. Poor quality businesses that are exceptionally cheap only grow your wealth once (when you sell them – hopefully for a profit).

Note that Buffett does not say to buy great businesses at any price.

“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”

Overpaying severely limits the growth of your wealth. If you pay for a large part of future growth today, you will not benefit from that growth down the line. Great businesses can be very overvalued…

“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

You don’t need to be a contrarian to do well in investing, but you do need to exhibit emotional control and be realistic.

Just as great businesses can be overvalued, they can also be undervalued.

“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”

It’s not easy to buy great businesses when they are ‘on the operating table’. That’s because the zeitgeist is decidedly against buying – stocks become undervalued because the general consensus is negative. Intelligent investors profit from irrational fears.

“Be fearful when others are greedy and greedy only when others are fearful.”

Fear and market corrections create opportunities for more patient, long-term investors. The two quotes below expand upon this.

“So smile when you read a headline that says ‘Investors lose as market falls.’ Edit it in your mind to ‘Disinvestors lose as market falls—but investors gain.’ Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other.”

&

“The most common cause of low prices is pessimism—some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.”

Paying too high a price is an investing risk that can be avoided (for the most part) by staying disciplined.

Buying is only half of investing. The next section covers when to sell.

http://www.suredividend.com/warren-buffett-quotes/#when to buy