RULE #1 RECAP POST: 4M AND MORE

A lot of readers have been contacting me with repeat questions about doing a 4M analysis. Because of this I took a cue from the Carnival of the Capitalists and decided to host my own mini-Carnival here on the site, as a recap of useful Rule #1 posts that have all the info you'll need.

I'll link to this post in the sidebar and add all of this to the FAQ as well.

First, here's a basic summary of Rule #1 investing from the FAQ, and the site disclaimer, which explains what Rule #1 is about, and why you have to make your own decisions about what companies to buy. My Watch List post covers the same.

Now, onto the fun stuff...

Doing & Submitting Homework

I like this Refresher Course post as an Intro to the process of finding a Rule #1 company that is 4M for you: one that has Meaning, Moat, a Margin of Safety, and good Management.  Start with the 3 Circles assignment outlined there.

The next step after that is to gather a list of companies in the Industry sector you've chosen, and run them through the 4M's to see if they are potential Rule #1 companies, either using pro tools (like Success/Investools) or free tools (Yahoo Finance, MSN Money).

If you're new to Rule #1, read this FAQ entry on Getting Started, YUMMMMY Becomes 4M (which outlines the 4M process in detail), and my Google Posts #1, #2 & #3. (Which also outlines when to put a Wonderful Company in your Risky Biz folder). 

If you need more examples, read through all the Homeworks on the site.

Once you've tried the 4M's for yourself, send your picks to me for critique.

Now, onto detailed posts related to doing each of the 4M's:

Meaning

Meaning means you understand the business you're thinking of buying. YUMMMMY Becomes 4M covers this well, but the best way to learn is to read all the Homeworks on the site to see how others determined Meaning for themselves.  Also check out How Deep Should Rule #1 Investors Dig? for tips on how far to take your research, and Don't Forget the Meaning Part of 4M, which explains why having great numbers isn't enough.

Moat

The St. Joe posts, #1 & #2, are good examples of doing Moat (durable competitive advantage) research.  This Garmin post is also great for Moat, and supplies a definition of BAG (Big Audacious Goal), which relates to Management.  Determining Brand Moat is pretty straightforward. Reading Between the Lines defines Toll Bridge Moat.  And Netflix is an excellent example of detailed research, including a comparison of the company to its competitors. Be sure to read Shopping for Certainty: Netflix Part II to get the entire picture. (Netflix is another Risky Biz without a lot of historical data.)

The Big Five, Nahmean? lists the Big 5 Numbers we use to quantify whether a company has Moat. It also runs through the 5 Kinds of Moat (Brand, Toll Bridge, Switching, Trade Secrets, Low Price).  The Smithfield Food Company homework post does a good job of pointing you in the right place to find the Big 5 Numbers on free tools sites. It also shows where to find analysts' growth projections. Go here to learn where to find ROIC on Success/Investools. And be sure to read this Bud followup post to learn all about Equity Growth Rate: what it means and why it's important.

Margin of Safety (including Excel formulas & Sticker Price)

I like this post because it explains what Sticker Price is, why it's so important, and how it helps us decide when to get in -- and out -- of a company. Similarly, this Whole Foods post goes over Sticker Price calculations and gives a concrete example of how to determine & use S.P. (Garmin's Up: Now What? is another case study that shows when to get out of a company.) Margin of Safety, as a reminder, is half the Sticker Price.

The TOL and Sticker Price post goes over how to buy $1 for $0.50. It also covers where to find Sticker Price on Success/Investools.

The Whys Behind the Buy explains the reasoning behind the numbers we use in Excel calculations. Generating Excel Numbers further clarifies the formula. The Rule of 72 shows you how to do the math in your head and explains what Equity/Book Value Per Share (BVPS) is and where to find it. More on the Rule of 72 takes this a bit further.

Management

Again: read all the Homework posts for case studies in Management research. Specifically, the Panera posts #1, #2 and #3.

Miscellaneous Questions

This post covers how to use Investools search parameters to help hone in on potential Rule #1 businesses, as does this one and this one.

Go here for an understanding of stock splits. And go here to learn about Good Debt vs. Bad Debt -- when to start investing, and how (including info about investing from an IRA).

I think that's enough information recap for one day... now go play!

Comments

[Kirk]

Phil,

Panera (PNRA) has an estimated target price on Investools of $164.46. This is based on 23.9% growth, which I understand should be investigated. But, if we accept this growth rate, current price of $69 should get our attention. Question? What about the current P/E of 38 and historical P/E of 43.83? How does high P/E effect your evaluation?

[Shane]

Kirk,

I did the analysis on PNRA at the end of October. Everything said buy so I did. It took a little dip, I got scared and sold. I'm just glad it was only paper money. The indicators did not tell me to sell, I just got scared. I guess lesson learned and better to learn with paper than with real money.

Shane

[Phil]

Kirk:

High PE (as long as its under 50) doesn't bother me one bit as long as I know I'm getting a good deal.

Charlie Munger (Buffett's partner and a great Rule #1 investor in his own right) once quipped that it is better to buy a great business at a fair price than a fair business at a great price. I think so, too, and sometimes great businesses carry hefty PE's. As long as it makes sense, ie, its a wonderful business at an attractive price, I don't worry. I'm not a 'value' investor and Rule #1 investing is not Value investing. We're not searching for stocks with low PE's. We're searching for great businesses that are undervalued. Sometimes, like with Google and Whole Foods, those businesses carry high PEs but are still a steal.

[peg jensen]

Phil,
I took my 10 yr old son to hear you speak with Zig Ziglar in Richmond last Fall. He was thrilled. He is currently in the Gifted program at school and they are studying "stocks" in Math. Can you recommend a good book that teaches stock investing at the child's level...does yours???
thanks so much for your gifts of teaching others....

make it a great day!! pj

[Phil]

I hear Warren Buffett is doing a book thing for kids. That would be perfect. Meanwhile, Moms and Dads should learn the Rule and teach it to their kids themselves.