Rule #1 Blog: Phil Town on Investing

YUMMMMY BECOMES MMMM (4M)

A Rule #1 business is a business that has Meaning to us. It also has Moat, Management we admire and a Margin of Safety, meaning we can buy it at a discount. 4 M's.

My publisher, Random House/Crown Publishing, has convinced me to change the YUMMMMY acronym to MMMM, or 4M, to simplify things. I think the changes clarify what we're seeking so I'm into it.

So, from now on YUMMMMY = MMMM. This is how it'll be in the book too. I'll go in and change it on the blog ASAP. You'll notice this change the most in Categories.

Here is the definition of each "M" in the 4M's:

HEADS UP ON PANERA (PNRA)

I'm putting this one up quick because I need some feedback from readers.

My daughter called me from Oxford today.  She's a Rule #1 investor.  She wanted to go over Panera Bread: PNRA.  See what I think.  So we took ten minutes on the phone and looked at it together.   Until 2000 the business was trying to figure itself out.  Then it got it together and has been on a rocket ride ever since.  For a Rule #1 investor the first question is "Do you want to own the whole thing?" and her answer is...

A LITTLE EXCEL HELP: CALCULATING MARGIN OF SAFETY

Garrett, who recently did a YUMMMMY analysis of St. Joe's, was having a little trouble with the Excel formulas outlined here on the site.  Here's our exchange below. Hopefully my answer will help others figure out the numbers they need to be using in their own valuations.

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From: Garrett Smyth
Date: Jun 24, 2005
Subject: Valuation problems
To: Phil Town

Phil,

I know it's not your job to necessarily teach me how to value a company.  I have gone back into your blog and I believe that I have set up my spreadsheet using the formulas that you recommend.  But I keep getting different values than other folks that write into your blog. 

Will you either look real briefly at my spreadsheet or direct me to a reference that you like to use to find the value of a company?

YOUR HOMEWORK: MOAT AND MORE ON ST. JOE'S

Here's the rest of Garrett's analysis of St. Joe's, the paper products company that made a switch to the real estate biz a few years back. I'd asked him to get back to me with his results for Moat, as well as the rest of YUMMMMY. I'll post my comments later.

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In a message dated 6/20/2005, Garrett Smyth writes:

Phil,

To bring you up to date with our conversations, the question you posed to me was “Do they have a moat?”

My answer is this.  St. Joe Company doesn’t own all the land in Florida but they do own a significant portion.

HOW STOCK SPLITS WORK

Last week, Jonathan Welsh -- who's doing his Homework on Toll Brothers, the luxury home builders -- contacted me with the following question about a 2-for-1 split. I figured a lot of people would have the same question:  with 2-for-1, do you really get more for your money -- double the shares? Here's his question and my response.

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On 6/14/05, jonathan welsh wrote:

The current sticker price you calculated for Toll was 105/share. It is currently selling at 96/share, which is not even close to the 50% requirement. Toll is having a 2-for-1 split on the 21st of June 2005. With a 2-for-1 wouldn't that get me the same result?  I am kind of new to the concept of getting one additional share to each share held, but doesn't that count as doubling your money?

God  bless!

Jon Welsh

Date: Jun 16, 2005
Subject: Re: toll 2 for 1
To: jonathan welsh

Good question, Jonathan.  The short answer is no.

Here's the why not: 

YOUR HOMEWORK: EVALUATING A COMPANY IN TRANSITION

Here's another piece of homework, submitted by Garrett Smyth of Chattanooga, TN, who was a professional golfer for 15 years before making a career change to sales.

Garrett wanted to know if the YUMMMMY analysis works in determining the value of transitioning companies that are moving into new and different sectors. Below is his question and my response. I'll post more about his progress once he calculates the Moat for the company in question.

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On 6/9/05, Garrett Smyth wrote:

Phil,

Question:  What is your feeling about a company that has changed directions from what they used to be to something new?  My example is St. Joe Company in Florida.

St. Joe Company was originally a paper company in Northwest Florida who in 1997 shifted its emphasis away from paper products into real estate development.

YOUR HOMEWORK: TOLL BROTHERS, INC.

As I mentioned earlier in the How to Get Mentored post, I'm asking students of investing to do their homework and research YUMMMMY companies on their own... then submit their work to me for evaluation. Every so often I'll post a good example under Your Homework. Be sure to check these out -- they're the best way to learn.

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This is a post from Jon Welsh.  He is a former Marine Corps Sgt.  He was part of a small team that did SWAT actions in Fallujah and he's carrying some scars.  The man is one of our young heros.  I'm hoping he doesn't go through what a lot of Vietnam vets went through when they came home to an uncaring country so I'm working tight with Jon.  And he's getting on this Rule #1 stuff.  These are emails from yesterday back and forth between us.   

On 6/12/05, jonathan welsh wrote:

Hello! This is my homework. Well at least half of it.

Y - Yes I would like to own "the nation's leading builder of luxury homes." (Toll website). Toll Brothers builds quality luxury homes in some great areas in the U.S., and they win some prestigious home building awards.

U - They build it in 20+ states, and people buy it. In Phoenix, New York, and California, people are buying plenty of homes for investment reasons. Demand for homes is rising faster than Toll...

DO YOUR HOMEWORK / HOW TO GET MENTORED BY ME

When I'm out doing speaking engagements, I encourage people to keep in touch with me and shoot their questions over so I can help get them on track with Rule #1. But the thing to remember with investing -- which has a learning curve -- is to actively instruct and not lecture. This is how my mentor did it with me, and it worked. Somehow the work you do yourself has more staying power than something you read off a piece of paper (or web site) from someone else.

This is why I always insist people do their homework and put the companies they want to buy through the YUMMMMY analysis as I've laid it out here on the site (see the Google, Whole Foods and Garmin analyses for detailed examples). Then I have them email me their work so I can give them my opinion.

Some people who write to me don't even know where to start -- what business to analyze. I usually tell them to do this:

GETTING OUT OF WFMI: KNOWING WHEN TO SELL A STOCK

I'm not going to post every time I move in and out of a stock, but I'll post this one so you can see why I sell.

WFMI (Whole Foods Market, Inc.) is a wonderful company at an attractive price. Nonetheless, like any company in this market, it could go down if the institutions start to sell off. Which they do on a regular basis for many reasons - a negative analyst report, bad press, interest rates go up, interest rates go down, sector bad news, or just taking profits ... who knows. Could be anything or nothing at all that starts the selling and then, like lemmings off the cliff, the other institutional guys start selling, too.

WHEN DO YOU SELL YOUR SHARES?

First, everything I say from now on is predicated on owning a YUMMMMY stock.

A business that I own as a business that will, over time, provide me with an earnings yield that will exceed 100% per year.

A business that is highly predictable based on its past consistently high 5 numbers: ROIC and the 4 growth numbers: Gross Profit, Earnings Per Share, Equity and Free Cash Flow. The GEEC numbers. Oh, and it has a big moat - best of its class- and great management. Our YUMMMMY stock has gone up and up. How do we know when it has gone too far and it's time to sell it?

IS GARMIN YUMMMMY? (PART II)

My look at Garmin started with whether I wanted to own it, whether I understood it and whether it had moat.  So far so good.  Next I want to look at management, Value and Yield:

M: Management. Which means Dr. Min Kao, Founder, Chairman and CEO.  Here's the summary I got from articles about him that I got when I googled "Min Kao" Garmin.

1. Dr. Min Kao's BAG:  (I want to hook up with guys who want to change the world and have really committed themselves to it.  I call that a Big Audacious Goal - BAG):  “To bring GPS to the masses”.  Nice.
2. How does he intend to do that BAG?  He says he intends to make the best product, at the lowest cost to build,  and to do that he is going to go for vertical integration. 
3. What kind of guy is Dr. Kao?  He seems like he’s all about this company.  No indication otherwise.

I like the sound of this guy.  He seems like a guy I'd like working for me.  Management gets an A.

IS GARMIN YUMMMMY?

Hi Phil,

I saw you write back to Christine on the blog about practicing and sending you the results to see if we are getting it or not.  Well, here’s one.

Garmin Ltd. (GRMN)

This place is a few miles from my home and I love their products.  I’m a gadget geek and GPS is usually involved somewhere.  Garmin makes a variety of GPS related products for the consumer, commercial and government markets.  With GPS devices showing up in cell phones, PDA’s, cars and probably a refrigerator somewhere, I think the market is just getting started. Garmin has a few competitors, but there seems to be enough business to go around.

WHAT NOW FOR WHOLE FOODS?

I popped into Whole Foods last February at 90.  And as a Rule #1 investor getting into WFMI meant that I thought it was YUMMMMY.  Turned out it was!  Since then WFMI ran up to 104 and I bailed at 102.  Then again in at 97 and now its at 120.  That is some serious up.  About 40% in 5 months.  Good.   But here is where it gets real good.  That investment represented about 40% of my portfolio.  That means that my entire portfolio went up 16% in 5 months even if the rest of it was under my mattress.  That is just nuts! And it's all about focus.  If you think you can do that by diversifying, think again.  Remember this:  Diversification is for the ignorant.

THIS BUD'S FOR ME?

Warren Buffett just bought a bunch of Budweiser, so I thought I’d write about how I look at it. So I’ll put BUD through the YUMMMMY hoop and see what we come up with.

Do we want to own it all?  Legendary company and I drink Bud and Corona, which they own half of.  So yes.

Do we understand the business?  They sell beer.  Yeah, I get it.

Buying Google Stock (Part III of III)

To this point we've decided we want to own Google and that its almost a wonderful company (a wonderful company by definition is predictable and therefore possible to put a value on and Google isn't - see below). It is also available at what might turn out to be an attractive price (but I can't be certain). Now we want to buy it as if it is a business and not a stock. To do so, we have to calculate Yield. But first a word about Mr. Market:

6. Mr. Market: Mr. Market is my partner. He's going to sell me all the Google I want, but he names the price. Mr. Market is often quite lucid and rational. He usually prices the companies he is buying and selling at reasonable prices that reflect a reasonable estimation of future value. I say 'usually' because sometimes he gets emotional. Giddy actually.

Buying Google Stock (Part II of III)

Last post, I decided I wanted to own Google and I understand the company. It's got a lot of moat and tested management. But I've got to figure out the value. Here's how I do that.  Its step #5 of the 7 step YUMMMMY analysis:

5. Margin of Safety: No matter how wonderful the company, you gotta get it at a great price to have certainty about your long term position. Even if you are trend trading you want to know the long term general direction of the stock price. So you have to know the value of Google's business. This is where the real risk comes in with a new company in a new industry - no track record means predictions are so full of debatable assumptions that the prediction of future cash is a dubious proposition. But I do dubious in my "Risky Biz" portfolio so here's how I look at Google's value: How fast can it grow it EPS for the next 10 years?

Buying Google Stock (Part I of III)

I bought Google at $200. I wish I bought it at $100 but I really didn't understand the moat these guys have figured out. And I don't buy anything without an identifiable monopoly (Buffett and Morningstar call it Moat, so so do I). Google had enough of the rest of the things I look for (See YUMMMMY post) to buy it long term in my Risky Business account (about 10% of my capital is available for newish ventures that do not have long term history or for some other reason are not very predictable out 20 years). Let's look at it through a Rule #1 investor's glasses:

YUMMMMY

To students that are having problems when paper trading:  I'm so glad you followed Rule #1 and stuck to paper trades.

Remember: Don’t Lose Money!  Now let me see if I can help you find businesses that will go up and make you some bucks.

First, remember that the tools are just tools; it's up to us to make the furniture.  Just like that, research data is just data.  It's up to us to make the key judgments whether to not to invest. 

VALUING WHOLE FOODS

I love owning Whole Foods.  It is a great example of a Rule #1 company.

First, Rule #1 investors don’t buy stock.  We buy businesses.  That means we evaluate the opportunity as if we owned the whole thing and as if there was no stock market for the next ten years. 

Second, Rule #1 investors try to buy $1 of value but only pay $0.50 for it.  When we do this correctly we know we are going to make money at some point.  We also know that our risk is less than if we bought a comparable business but paid the full $1 for it.  We call this a Margin of Safety.  I insist on a MOS because I’m not all that smart and need a cushion that can absorb my mistakes in valuing a business or unexpected problems that the business might have.