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HEY! DID YOU KNOW…

 

  • The median age in the U.S. is 36.8
  • The median income in the U.S. is $51,939
  • The average 401k match is $1 for $1 up to 6%

A 36.8 year old investing 10% of their $51,939 income with a $3,116.34 match:
With just average stock market returns of 10% would have $1,114,479.31 by retirement.

Join 7,200+ other readers who have learned how anyone, even beginners, can easily make this desire a reality. Download the free ebook: 7 Steps to Understanding the Stock Market.

IFB12: The Validity of Scuttlebutt Investing and Qualitative Analysis

scuttlebutt investing

In today’s session, we are going to talk about quantitative versus qualitative analysis of stocks, this should be an interesting go around. I know how I feel about this, but I am not sure how Andrew feels about this, but I have an idea, but I think this could be interesting. Phil Fisher was the creator of the term scuttlebutt investing, it was a method he used to gather qualitative information to help him in his investment process. He used it to great effect and it was integral to his success. This process is a little more difficult for the individual investor but some of the aspects of scuttlebutt investing can be added to anyone’s arsenal.

  • Definition of quantitative versus qualitative
  • What it means to be strongly quantitative
  • The pros of quantitative analysis
  • The advantage of utilizing both quantitative and qualitative analysis
  • How biases can affect your thinking and investing

Andrew: Yeah, the guy who formulated the Value Trap Indicator, a quant-based system, obviously I might lean one way or the other. The way that I kind of look at and I think it is a little bit contrarian to what a lot of value investor that there is a lot of belief that you have to have a balance of quantitative and qualitative.

If we define that real quickly, for the beginners. Qualitative is talking about the aspects of the business that are more intuitive things like how skilled is management, where you perceive a trend as far as supply and demand. It is things that you can’t put a hard number on, but it still can have an effect on the business. So that’s qualitative and quantitative is everything that is strictly about the numbers, tangible data like assets, earnings, cash flow stuff like that.

So, I kind of want to hear your take on it, Dave, because I am all about the quant, I know there are guys like Phil Fisher, who wrote “Common Stocks and Uncommon Profits”, which was one of the first books I read about the stock market. He talks about a thing called “scuttlebutt” which is his way of using and doing qualitative analysis. He would go and talk to different executives at different companies that he was interested in, and try to get some information based on those kinds of conversations.

I think that Buffett tries to do the same as well. And I know guys like Jae Jun at Old School Value, I’ve interviewed him before and he talks about how there’s an art to value investing and you need to balance qualitative and quantitative. I don’t think there is a right or wrong answer and that is why we are having this discussion and having this episode, it is going to be interesting to see what the positives and negatives are of both methods and which one is better. Or should you try to merge the two?

Dave: That is a very good point. My thoughts on the battle of quantitative versus qualitative. I am going to say that I am a little more like Jae Jun, where I think I don’t know that I could necessarily put hard and fast rule number wise, 75 to 25 or 50/50 anything in nature. I know that Ben Graham, who we both admire quite a bit was definitely a quant, he was definitely all about the numbers. Warren Buffett who is one of our idols, he started off as a quant and he has merged through his life into a little bit more of both. And I think I probably fall a little bit more into that as well. [click to continue…]

IFB11: A Complete Guide to to the Most Useful Stock Valuation Methods

valuation metrics

Today we are going to talk about stock valuation methods. Andrew has a great ebook that he wrote a while back that talks a lot about how to value a stock. These are methods that I use personally every day .

  • A breakdown of the 7 valuation metrics that we use
  • P/E ratio and its importance
  • P/B ratio and the relevance to value investing
  • Debt to Equity is probably the most important ratio

 

Andrew: There are a lot of different ways you can evaluate a stock, there are a lot of different models. I want to talk about some of the simplest ones that you’ll approach, you can always take the subject a bit further. You can talk to experts, they like to talk about things like EV or EV/EBITDA, that is enterprise value to earnings before interest, taxes, depreciation and amortization. You could do a discounted cash flow valuation you can do free cash flow valuations.

There are all these different metrics that someone can use to really value a stock. some of the most basic ones I actually use. We are going to talk about 7 of them and they’re all part of the seven steps that I wrote about in my ebook. IT is also the same 7 metrics I use for my value trap indicator system. All of these combined are what I use to formulate my approach and it’s the exact same method I use to buy every single stock that I buy.

Now, keep in mind you certainly can use one of these. Some people do, you have the Peter Lynch approach where people just strictly look at a PEG ratio, which can be a combination of two of them that we are going to talk about today. You certainly could use just one, there is the Ben Graham approach, which early one was one that Warren Buffett used which he calls the “net, net” approach. Kind of like, the metaphor they use is picking “cigar butts.”

And they really use a price-to-book, more focused on net tangible assets. This is another variation of a valuation method that we are going to talk about today. My whole point is that you could center on any one of these valuations, I argue that when you value a stock, you don’t want a laser focus on making one ratio that much more important than the others. I think you want to take a complete picture approach, understand that there are three financial statements that every single stock needs to post to the SEC.

The SEC puts it on their website and it’s freely available information to us. A lot of investors will look at one little tiny sliver of the financial statements, completely ignore the other ones and get blindsided when they don’t account for things they aren’t looking for.

We are going to look at the whole picture, all seven of these and not so much that they are all excellent but they are all good enough to where you can feel comfortable that number one we are getting a stock at a good price. And number two, that were are getting a stock that has a great business model, and is likely to continue and gives us gains in the future.

The first method valuation method I want to talk about is probably the most common and every single novice investor knows of this ratio. And that is the Price to Earnings ratio or P/E. What this is going to tell us is, if you think about what a business does, the business will basically spend money and they are going to try to make more than they spend, and that difference is a profit.

[click to continue…]

IFB10: Making a Quant Investing Approach Inspired by Baseball Sabermetrics

Quant Investing

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Baseball and value investing have much more in common than one would think at first. The discipline and analyzation that you find in baseball can correlate to value investing quite easily. Great hitters like Ted Williams, Tony Gwynn, and Barry Bonds were extremely disciplined in their approaches and did an extensive study of the pitchers that they faced. All of this lead directly to their success, as well as their incredible talents. Great value investors like Warren Buffett have taken these ideas and adapted them to their value investing style. Using quantitative investing is the investing version of sabermetrics. Numbers can tell a story and value investors use quant investing to help tell that story.

  • Value Investing and baseball have more in common than you would think.
  • Ted Williams was the first player to take a scientific approach to hitting a baseball
  • Warren Buffett adopted these ideas to his investment philosophy.
  • Patience is key to being a great investor
  • Intrinsic value is found everywhere
  • Keeping your mind open to any possibilities can lead you to unexpected investment ideas.
  • The study of numbers or quant investing is the investing version of sabermetrics used in baseball. 

 

Dave: Welcome to session number 10. In honor of the baseball season starting this coming Sunday we are  going to talk a bit about baseball and investing and how they go together. That may be a strange topic for some people, I am sure we are getting some funny looks from people as they are listening to this.

But you would be surprised there are some very strong correlations and a lot of big value investors are very big baseball fans and they use a lot of analogies about baseball and how they look at their investing. They get a lot of great ideas from baseball and some of the strategies as well as the discipline that baseball players adhere too.

 

I will start and talk a bit about an article that I wrote just recently about Ted Williams and value investing. And for those of you not familiar with Ted Williams. First, of all, he is probably considered, in a lot of baseball circles the finest hitter in the history of baseball. Better than Babe Ruth, Willie Mays, Hank Aaron and he has the numbers to prove it. He played from the late ’40s thru the mid-’60s and he was the last man to hit over .400, and he hit .406 in 1941 and it has not been done since. So that is over 66 years since it was last done.

He was really the first guy to study hitting as a science and he was a huge influence on scores of players who followed him, most notably Tony Gwynn. But Williams was the first guy to take baseball and apply science to it and analyzation.

[click to continue…]

IFB09: Myths about Dividend Paying Blue Chip Stocks

 

blue chip stocks

Finding blue chip paying dividend stocks is one of the best ways to grow your wealth over time. These companies that pay a dividend consistently over the years over a great double compounding effect that is hard to beat. We will discuss some of the myths of dividend paying blue chip stocks and why they are in some cases avoided by the investor for flashier, more exciting opportunities.

  • The definition of blue chip dividend paying stocks
  • Accumulating dividends is better than selling shares for income
  • A hot topic is a reinvestment versus dividend payouts
  • Some of the best dividend payers are “boring” companies
  • Blue chip dividend paying stocks are great wealth building machines

Andrew: Yeah, so I want to talk about blue chip stocks tonight. And specifically, dividend paying stocks. Because on the one hand they are very popular and people like to look to them. you have indexes like the Dow that are made up of blue chip stocks and turn on the tv people always talk about the blue chips stocks.

You have these stereotypes about stocks that pay dividends, specifically blue chip stocks that pay dividends. As a big dividend investor trying to buy stocks at a discount to their intrinsic value these myths that I want to address are something that I think is something that I think can turn people off from dividend investing.

And maybe we can figure out if these ideas are really valid. Then we can understand them and feel more confident. And additionally, know what to look for when it comes to picking the right blue chip dividend paying stocks.

Dave: That sounds like a great topic, it would be interesting for me and to learn a little bit about this subject. I think it would also be interesting for our listeners too. Dividends are obviously a very big, important part of investing. And it’s a great way to earn income and that is what we are all here for. As you have mentioned in the past, investing for income is what we are all about. I know that we have some different topics that we want to talk about.

In particular, the myths surrounding dividend paying blue chip stocks. So why don’t we talk about the first one.

 

Selling shares is better for income than dividends?

 

Andrew: so there’s this idea that number one you can buy a stock and if it grows let’s say 20% in one year, this idea is even though this stock didn’t pay a dividend it grew 20% compared to it a typical blue chip that pays a dividend and is yielding 3% or less.

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The Concerning Trend Towards Return on Capital and Away from Graham

Investors have a myriad of options available when it comes to analyzing a business. The return on capital ratio is one fantastic way to do this. It’s an especially strong metric when it comes to identifying companies with a good growth track record or prospects.

return on capital

But I’m concerned there’s a growing popularity with the return on capital ratio and too much reliance among many other fund managers who have been successful thus far. It could lead to lower performance in the coming years, especially in the case of a bear market.

First, let’s define return on capital.

There are many flavors of the actual return on capital formula. Check out the successful value investor and my friend Ken Faulkenberry’s article if you’d like to see 5 variations of this important calculation.

Since I personally come from a very value investor based school of thought, and much of my website teaches value-based principles, I’m going to focus on Joel Greenblatt’s definition of return on capital. This is likely the formula many successful fund managers are using as self-proclaimed value investors themselves.

The Magic Formula (Joel Greenblatt) return on capital equation is:

Return on Capital = EBIT / (Net Fixed Assets + Working Capital)

Instead of examining this with an example, let’s look at this at a higher level. Testing the validity of equations through a logical examination is better than blindly following a widely used process.

EBIT is simply earnings before interest and taxes. It’s basically a measure of a company’s operating earnings, which gives you good insight on how well the core business model is performing.

An obvious advantage of this is it gives a sense of how much demand there is for the company’s products or services and exposes companies that consume a lot of cash in order in relation to their sales—creating smaller profit margins and indicating possible higher risk.

Net Fixed Assets is another way to describe net tangible assets. The “net” portion refers to tangible assets minus liabilities. This number is commonly negative or positive depending on the business model.

For example, a company with a strong brand may have negative net tangible assets because it doesn’t need much capital to create profits, the popularity of its brand name already creates very high demand. In the fundamental analysis camp of the stock market, a company like this would be called a low capital intensive business.

I’ve covered the debate whether tangible or intangible assets should be preferred before. For the sake of brevity, I’m going to assume you’ve read the article and have insight on these implications. [click to continue…]