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Wealth creation is not complicated. But doing those simple things – over and over again – with discipline and commitment – is what will get them there.
this process of finding the intrinsic or true value of one share of a company is also popularly known as ‘value analysis’.”
am just teaching them to make money. After this session, they will get aware of the process that can make them rich, but then how many can resist temptations of greed and fear, and stick to the process is all what it comes down to.
Stock homecoming is the understanding of the fact that for the majority of time, the stock’s market price would hover above or below its true intrinsic value, oscillating between irrational exuberance to unjustifiable pessimism. But while oscillating between these periods, there will always be a time when the stock comes close to or crosses its true intrinsic value, always. The long-term value of the company always has a way of rectifying the situation, no matter in which direction.”
“Generally, an investor can think of entering the market when the market price of a stock is more than 20 percent below the intrinsic value, because this is the money you would definitely want to make from the market. And you can think of exiting when the market price of a stock has crossed the intrinsic value or even earlier if you have met your goal. But again, this 20 percent can vary hugely for different investors. You must formulate your own strategy depending on your risk profile.”
“OK, but tell us if this intrinsic value always remains the same?”
Companies will make an attempt to grow in value, their performance may keep changing, economy may undergo change, industry laws may change or, if nothing else, the price of raw materials may change with inflation. Therefore, intrinsic value needs to be revisited at least once a year, if not before.
“A stock ‘X’ may have a market price of INR 120 while its intrinsic value as per your calculation is INR 150. This is a good enough bargain to get into the stock. However, even after two years, the stock is yet to hit the intrinsic value and is still hovering at close to INR 100. You have been waiting patiently for it to boom, but your revised calculation of intrinsic value after two years shows that the new intrinsic value of this stock is only worth INR 110 now. This is a ‘sell’ situation where your intrinsic value is quite close to the current market price of the stock. It is very unlikely
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There are no guarantees, there are only probabilities.
Therefore, if your CMP-Intrinsic Value calculation guides you to sell, then sell even if it means making losses.
“So, what you are saying is that we purchase the stock with a market price of say INR 100, which is 20 percent below its intrinsic value of INR 120. If the stock price goes up and crosses its intrinsic value of INR 120, we make a neat 20 percent profit and we sell. Understandable, but you are saying that if the stock price remains stagnant around INR 100, and intrinsic value drops close to INR 100, we still sell?”
a company has a dividend payout ratio of 60 percent, it means that the company is distributing 60 percent of the earnings back to its shareholders and may be investing the remaining 40 percent to fuel future growth or settling some of its debts. Such companies with a dividend payout ratio of 50 percent or more are generally said to be distributing the dividend ‘generously’.”
“So, here are the four rules to shortlist a stock. Make a note of it: Invest in sectors and industries that you understand. Find companies that have a long-term competitive advantage. Look for companies with good management, and last but not the least Buying when the stocks are available much below their intrinsic value.
“Definitely never more than 20, but 10-15 would be ideal. You see, it is quite logical. Owning and monitoring more than 20 businesses is going to be a challenge in itself. You ought to keep a watch on their businesses frequently.” “What if we find a truly astonishing deal but we already have 20?” “Sell one of the existing ones.” “Even if they have not yet given us the intended yield?” “Yes.”
Media, financial analysts and your well-wishers will talk complex financial jargons, which you may or may not understand. They will present you with data that you do not need. Data will be found everywhere, knowledge nowhere. People are getting drowned in this data. They know the price of everything and the value of nothing. On the contrary, the only financial skills that you need to be a great investor are addition, subtraction, multiplication, division, percentage, and probability calculation. That is the only intellectual framework you need, and of course, the ability to keep emotions from
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First rule:
I am not going to take decisions for you.
second rule:
You will become very powerful post these live sessions with me. With this power, you ought to take responsibility too.”
creating a pipeline.”
“Remember that I give enough opportunities to select more stocks, even if you lose an opportunity in one of them. You will never be short of opportunities. Never ever. So, relax. One hurried investment can ruin your 10 good investments.”
“You need stability in your mind. You need an unbiased judgment. For all that to happen, your mind must slow down first. Excitement and hurry will only lead you to biased judgments. It pays to be active, interested and open-minded, but it rarely pays to be in a rush. And you thought stock investing was only technical?”
Time is a key factor in every human being’s life. They think they are here for a ‘defined’ time period and that they will die after that. I know what happens actually. We all have limitless time, and so do humans. They never die. But this false sense of
‘limited’ time makes them take decisions in a hurry, compete with each other, and as a result, make everyone’s life miserable.
strong foundation for stock selection.” “OK, how do we proceed then?” “That’s the right question. We will go by multiple rounds of elimination. You just completed the initial filtering, and came up with a list of two most probable stocks being recommended by reliable financial analysts. We will call that as Round-0.”
“Those stocks which get eliminated in Round-0 do not move to Round-1. The ones that get eliminated in Round-1 do not come to us for Round-2, and so on. It is only on the stock that passes all rounds that we are going to bet our hard earned money on. Does that sound reasonable to you?”
“A stability check round?”
A stable earning pattern denotes many things like uniqueness of business, competitive advantage, ongoing demand and so on. The most important reason to look for stability of earnings is that a stable earning allows us to have more accurate future predictions.
First, we are not trying to check for stability of the brand of a company. We understand the brand. It has been there long. We are talking about the stability or regularity or consistency in earnings of a company. A company may be a huge brand, but may be in a tough business scenario, which could result in fluctuating earnings. Such fluctuating earnings make it difficult for all of us to accurately predict its future, and if we cannot predict the future growth of a company with some reasonable accuracy, then it is difficult to visualize where that stock would be, say after five years.
Even the bluest of blue chip can turn turtle.
And we know of brands like Nokia, Kodak etc. They went from being market leaders to extinction in less than 5-6 years timespan. So, forget the brand, focus on earning stability.”
meaning of ‘earnings’,
“Earnings growth like 10 percent in one year, 5 percent in the next year, 7 percent in the third year, 12 percent the year after and 8 percent in the year after that, represents a stable earnings cycle. Although the growth rate may still be different each year.”
“EBITDA essentially are the gross earnings or topline earnings. It is an acronym for Earnings before Interest, Taxes, Depreciation and Amortization.”
“Right, so we will keep it simple. It is just enough to know that outstanding shares can change because of things like stock splits, buyback of shares, reverse buybacks and many other factors.
“Every registered company is mandatorily required to publicly share their annual reports on their website. It is typically available in the 'Investor Relations’ section of a company’s website. You can easily download it from there.”
Gobind was looking at a company’s annual report for the first time, and it is quite a document. The key is always to stay focused and keep things simple. I kept reminding him what our purpose was while going through the report.
“No. We cannot let emotions or confirmation biases rule us. As human beings, you must learn the art of being logical.
We are looking at companies doing stable earnings and available at the right price, so that we have reasonably accurate predictions. We must drop this name from our list and move on. Come on, Gobind, we need to move.”
first thing, the last 5 years are always more important than the last 10 years. They have been inconsistent, badly inconsistent in the last five years in terms of EPS growth: -9.8 percent, 41.6 percent, 13.9 percent and -22.06 percent.
And picking me involves a much larger rejection set than the selection set. He had to learn the art of rejection and failure.
Trailing twelve months (TTM) EPS is preferred over a full year EPS. Profits, by most companies, are declared on a quarterly basis. Even, the number of outstanding shares may undergo a change during the year. Thus, in the middle of the year, it is always advisable to look at the last four quarters rather than the last year’s EPS to get a more accurate value.
“Do not get confused between the company growth rate and the rate at which your invested money will grow. These are two significantly different things. A company’s growth rate helps us establish the most likely future price of the stock while the growth of your investment is determined by two factors – one of course being the above, and the other being the price at which you buy the stock. The latter of the two plays a much more dominant role many a times. That is why the intrinsic value calculation is so important.”
Now, remember that life is not an ‘either-or’ situation. A combination of two extremes works just fine. So, you may want to start 15 minutes early and also catch a vehicle that offers some speed advantage – a combination of both allows you to reach 30 minutes early to your office.
this price-earnings ratio indicates the amount an investor can expect to invest in a company in order to receive one unit of that company’s earnings. This is why the P/E is also sometimes referred to as the ‘multiple’ because it shows how much investors are willing to pay per unit of earnings a year. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay INR 20 to buy a business (or a part of the business) which will fetch him or her with INR 1 of earnings this year and may be more in later years.”
why should I pay more price in one industry when I can get a similar investment opportunity at a lower price in another industry?”
because the future growth prospects for each industry could be different. And the future growth prospects impact the current price of the stocks, and therefore an investor may be willing to pay a high price because he sees a better future for a specific industry.”
aren’t we placing too much importance on the industry?”
Investors typically forget that they are not buying a piece of paper when they buy a stock. They are buying a real, live and kicking business, and they would rather be aware of the industry to which their business belongs and what is happening to their peers in the same industry. You would not buy even potatoes without a decent comparison, but you are ready to buy a business.
then what is the role of the CEO and board of directors of the company whose shares we are buying?
