Here's a recap for those of you just discovering Rule # 1.
The key to Rule #1 investing is certainty. You are certain to
make money if you buy a wonderful business at an attractive price. To
know that all we need are 4 M's:
MEANING
Every business is about something. Make sure you know
what that something is. What does this business mean? What does it
do? And does it match your values? This M is about understanding the
business enough to know you like it for the long haul. [Reading:
Annual reports and 10K on the business website.]
MOAT
We want a durable business that we can be assured is going
to last a long time. We want that because we need to be able to
predict the future in order to know the value of the business today.
The future is notoriously unpredictable so we need all the help we can
get. We get that help from some kind of monopoly, called Moat.
Identify the
monopoly as one of these: Brand (like Coke), Secret (like Phizer
pharmaceutical), Toll Bridge (like PG&E utility: if you don't pay, you can't play), Switch (like ADP
back office accounting; once you start using it, it may cost you too much to switch to another company) and Price (like Walmart low prices).
Once
identified, confirm the Big Five Numbers are all over 10% and not going
down: ROIC, Equity Growth Rate, EPS Growth Rate, Sales Growth Rate,
Cash Growth Rate. [Gather or calculate from stock data research site
like Investools or MSN Money.]
MANAGEMENT
The CEO is responsible for investing the surplus
capital of the business in a way that makes a great rate of return.
Evaluate the CEO as owner-oriented, honest and driven. What's the Big
Audacious Goal? Do you trust this person to invest your money well?
[Google the CEO. Read the articles.]
MARGIN OF SAFETY
Determine your minimum acceptable rate of
return. Mine is 15%.
Determine the growth rate of the business either
by the historical rate or what the analysts say. Determine the
multiple of earnings that is historically accurate (the PE). Determine
the current trailing twelve months EPS. Grow the EPS at that growth
rate for ten years. Multiply that future EPS by the PE to get the
Future Price.
If your minimum acceptable rate of return is 15% you can
now just divide the Future Price by 4 to get the current value or what
I call the Sticker Price. That's retail. We never buy retail. We buy
at 50% below retail. Divide the Sticker by 2. That's the Margin of
Safety price. [Your research site has the analyst estimated EPS growth
rate, the historical PE and the TTM EPS. Use either Excel, Investools
or the Rule of 72 to grow the EPS.]
The 4 M's get us to a wonderful business at an attractive price. From that point, I refer to technical tools like Group signals, Insider Trading, MACD, Stochastics and Moving Averages to help me decide when to get in and out.
Now go play!
