Rule #1 Investing Frequently Asked Questions

What are the best online sites for free financial data?

MSN Money and Yahoo! Finance. MSN is best for individual stock information while Yahoo! is better at industry information.

I'm looking at the 3 Tools, and nothing's crossing the Buy Line. Everything's floating slightly above or slightly below. Now what?

Stock prices definitely respond to human foibles. When someone is making money, we all want to make money. When someone is losing we all want to avoid the pain.

People in general, including money managers, tend to not want to be leaders. Leaders tend to get shot. So we hang out and wait to see what others think. This is your stock price wobbling along until everyone sort of psychologically agrees that this price isn't going to go down. Then it forms a kind of base or support and can start to build to a new high. Meanwhile, the signals in that sort of phase can wobble into three greens and sideways red red and nothing is really happening.

There is a Rule #1 secret weapon if you don't want to make the buys and sells. You can watch for a sudden upsurge of volume.

Watch the last twenty days of volume. On the chart (on most any charting site) you'll see that the average volume height is, let's say, 1 million shares trading that day. And for twenty days it hangs right at 1 million shares.

Then suddenly BAM! the volume doubles to 2 million shares and the price moves up slightly.

If you've got three greens, it's time to get in there. The volume spike is one of the best indicators of the stock price readying itself to take off (or drop like a brick if we're in the red zone.)

How do I set up your Excel formulas?

Rule #1 investors can use Excel formulas for figuring out three things:

   1. The future EPS
   2. The future value per share
   3. The present value per share (or what I call the Sticker Price)

Start by collecting three ingredients (just like baking a cake):

1. Current twelve month EPS - On Investools it's automatically on the valuation page. On MSN Money go to Company Report and find it on the Fundamental Data list. It's also available on the first page you see after searching for a stock symbol, to the right of the intraday chart.
2. 10 year average PE (or 5 year if 10 years aren't available) - On Investools it's automatically on the valuation page. On MSN Money go to Financial Results, Key Ratios, Price Ratios.
3. Estimated EPS growth rate - On Investools the analyst estimate is automatically on the valuation page. Change it if you think it's too high. On MSN go to earnings estimates, earnings growth rates and you'll see the analysts' average estimate. Use a lower one if it's too high.

To figure out Future EPS:

Using the Excel =FV formula -- which you get by selecting a cell and typing =FV( -- you are asked by Excel for these things:

=fv(rate, nper, pmt, [pv], [type]}

• For rate, put in the estimated growth rate as a percentage, like 20%.
• For nper, put in 9 (Representing a 9-year span between year 1 and year 10 of data; if you only have 5 years of data, you'd put in a 4.)
• For pmt put in nothing but leave the comma.
• For [pv] put in the current TTM EPS with a minus sign in front and no dollar sign, like this: -1.04
• Hit enter and it will calculate the future EPS out ten years.

Next, you have to calculate the Future Stock Price out ten years using the future EPS and the PE you decided on.

1. Use whichever is lower, the historical PE you got, or 2 times the growth rate you used above.
   
   
2. Multiply the future EPS by the PE and you get the future stock price out ten years.
   
   
3. Now calculate the present value or Sticker Price (retail, intrinsic value, "what it's worth", etc.)

For this calculation you need the future stock price and the Minimum Acceptable Rate of Return (which for me is always 15%).

Using the Excel formula =PV() you'll need to plug in the following:

    * rate - Minimum acceptable rate of return - 15%
    * nper - 10 (to bring the future back to today, since we went ten years out)
    * pmt - skip but leave the comma
    * [fv] - the future stock price we got as a negative, like this: -88.43
    * [type] - skip
    * Hit enter and you'll get the Sticker Price.

Since I use 15% and 15% always compounds with two doubles in ten years, I can do this Excel step in my head. I just divide the future stock price by 4.

So for me, if the future stock price is 88, I immediately see the Sticker is $22. Try it with the formula and you'll see what I mean. The answer will be the same either way.

Final step:

Divide the Sticker by half and you get the MOS. Margin of Safety.

And you're done.

For more information including a visual Tutorial, register here and visit the Excel Formulas guide in the Resources section. 

How do I calculate a growth rate using negative numbers?

Phil Town describes the four choices for dealing with negative numbers and growth rates:

1. Use my Rule #1 calculators.  (Membership and Login required.)

They've been upgraded to allow calculations using negative raw data.  They will also provide negative growth rates when applicable.

However, keep in mind when using the calculators that a Rule #1 wonderful company does not have several consecutive years of zero or negative Big Five Numbers.  If you find you are entering a lot of negative numbers or crunching negative growth rates, you should look over the rest of the items on this list.

2. If a company got "less negative" over time, then went positive, do this:

If the oldest raw numbers you have for a company are negative but get less negative in time, and then go positive and continue to grow consistently more positive, this just indicates either a start up or a turnaround point years ago.

If the first positive year was 6 years ago or more, then go ahead and calculate the growth rate starting with the first positive year.  If it was more recent than that, this is a Risky Biz. Treat it as such.

3. If a company had a single negative year amidst a bunch of positive years, do this:

If a single negative year happens to fall on the 5 or the 3 yr calculation, shift to a positive year. For example, if the EPS number was negative in year 5, then go to year 6 and calculate from there instead. If 3, then go to 4.

Don't forget to change the number of years in the calculator/Excel sheet to reflect the fact that you're starting on a different year.

4. Bail!  This company isn't wonderful.  If there are negative numbers scattered through the 10 years of the company's history, bail. This is an inconsistent business.

Overall:

One negative year is not a deal killer. We're looking for consistency, and even great businesses can have a bad year. Often that's when we want to be buyers -- because Mr. Market will get very depressed and sell it too cheap.

Cash Flow seems to be where the bouncy numbers are most common. As a reminder, here's how you calculate Free Cash Flow:

Free Cash Flow is defined as the cash the business has to work with to grow new business.

The right way to do Free Cash Flow is to take the Cash Flow from Operations number and subtract only the Capital Expenditures. The balance is Free Cash Flow.

Cash Flow from Operations - Capital Expenditures = Free Cash Flow

For businesses that are buying other businesses, MSN Money doesn't calculate it correctly (in my humble opinion). So if the other three growth numbers are all awesome but Free Cash Flow is bad on MSN, look up the cash flow numbers in the SEC 10K filing to see if the business bought other businesses. This takes a few minutes but it's worth it.

When using The Rule of 72, why do you divide the Future Stock Price by 4 to get the Sticker Price?

Here's why dividing the Future Stock Price by 4 to get the Sticker Price works.

15% is our minimum acceptable rate of return.

15% doubles your money every 5 years.

This means that in 10 years, your money would double twice.

If your money doubles twice, it has quadrupled -- so the Future Price (the stock's value in 10 years) is 4x the Sticker Price, or its value today.

Instead of having to do some fancy calculation, we can just divide our Future Stock Price by 4 to get a price that will give us a 15% annual return.

This is our  Sticker. Take 50% of Sticker and you have your Rule #1 Margin of Safety.

Where do I go to find Free Cash Flow data on MSN?

Let's use WFMI as an example:

Go to MSN.
Enter the stock symbol (WFMI) and hit Return. You get this screen, shown below.  [Click on an image to see it larger in a pop-up window.]

 

Click on Financial Results > Statements (in the side bar).  You will end up here.

Choose the tab marked "Cash Flow".  You'll end up here.

Free Cash Flow is the cash a business has left over AFTER it subtracts what capital items it needs -- things like manufacturing plants and replacing machinery that broke.

To arrive at Free Cash Flow, you need to subtract Capital Expenditures from Cash from Operating Activities. 

(FCF = Cash from Operating Activities - Capital Expenditures)

For the “Cash from Operating Activities” value, use the appropriate number from the line “Cash from Operating Activities”.  See image below to learn where to find this line of information.

For the “Capital Expenditures” value, click on the blue arrow next to “Capital Expenditures” to expand the section. Underneath it, look for the line labeled “Purchase of Fixed Assets”. 

Use this number, "Purchase of Fixed Assets", as your "Capital Expenditures" number.

You may note there are 5 years of numbers here (as mentioned in the book). Unfortunately, free sites like MSN are only offering 5 Year Data for Cash Flow. To go back further you'll have to either subscribe to a paid research tool or look up past years' statements in the Investor Relations section of the company website.

NOTE: On a company balance sheet or document like the one pictured above, numbers "in the red", with minus signs in front of them, should not be treated mathematically like negative numbers.

The red and the minus sign simply signify a debit.  You will never need to subtract a negative (thus converting it to a positive) when calculating free cash flow.

For example: Free Cash Flow from 2006, using the numbers above, would be calculated thus:

$452.66 - $356.53 = $96.13

Why can't I find 10 year Cash Flow data (or other 10 year numbers) on MSN?

MSN doesn't go back very far on Cash Flow numbers and doesn't do much of a job of calculating them either. I used Investools, a professional set of tools, for some of the numbers you'll see in the book. Investools goes back ten years and they have a nice line for Free Cash Flow. They also cost money, but in this case you do get what you pay for.

However, you can still dig up the 10 year numbers from the SEC statements filed by the company you're researching. Go to the company website and click on Investor Relations. You should be able to find annual SEC filings.

You can also check Edgar. In some cases, past years' filings originally submitted on paper need to be requested directly from the company. But you can also get this data for free by going to the library and looking at the Value Line reference books.

If the library is a full subscriber to Value Line (which costs them about $25,000 a year I think) you can look up your company's Cash Flow back ten years.

Whew. Which is why I use a pro site for my research. Sometimes it's just cheaper to pay the money for a toolset!

I am having trouble with the Stochastic chart on MSN. Which line is the buy line and which is the sell?

Phil Town explains: The "buy line" for the Stochastic is the 14-Period %K line -- and it's usually black.

The other line, the 5-Period %K line, is red and is the sell line. When black goes above red, buy. When red goes above black, sell.

(Of course we don't use just one Tool, but that's how we'd read this one.)

I'm an Investools user. How do I find the Big 5 Numbers on this toolset?

It's really easy on Investools.

Select a stock like WFMI. Now look on the left column and you'll see Fundamentals.

Below that is Trends.

Click on Trends and you get the 1 yr., 5 yr and 10 yr ROIC.

You'll also get the same thing for EPS and Sales.

You'll have to look back under Fundamentals and click on Balance Sheet to get the Equity (bvps) info, and then use the Rule of 72 to calculate the Equity Growth Rate.

Same with Cash Flow. Get that by clicking on the Cash Flow button.

Your Rule #1 strategies are markedly different from conventional and accepted investing practice. How do you explain that?

My firm Rule #1 is: Don’t lose money.

That said, the secrets to being successful in investing—and not losing money—are incredibly different than what everybody believes. Everything we’ve been told about investing is wrong. Even Warren Buffet’s been calling them myths for a long time.

First myth: diversify; buy lots of different kinds of stocks so you lower your risk. What if I told you diversification is for the ignorant? What if I told you that the only people who should diversify are people who don’t have a clue about what they’re doing? The best investors in the world don’t diversify.