When and If

If there is one thing I have never relied on is market timing. For one, I straight out suck at it. Every “guru” out there claims he or she could figure out when to jump in or out of the market, but very few, if any, individuals have done so in the past, and very few if any will do so in the future. So, knowing that I’m no good at market timing, I do my best to buy a company’s stock at a discount.

I’d rather be approximately right than precisely wrong.” Warren Buffet

The next obvious question will be, how do I know what a stock is worth so I know I am getting a discount?  The most common way of valuing a company is by doing a discounted cash flow analysis or DCF.  Over the years individuals and corporations have developed complex discounted cash flow spreadsheet’s that try to pinpoint exactly what a company is worth. In my opinion, this is baloney. For one, you are trying to predict the future and something will go wrong and that’s why I rarely rely on a DCF. If I do, a pen and paper will do the trick.

• Sidenote: Google “Free Discounted Cash Flow Calculator” and you will find some good ones

Ok  dummy, what do you use? Free Cash Flow Yield and Earnings Yield (Magic Formula Investing)

Formulas:

Free Cash Flow Yield: FCF/ Price

Earnings Yield: EBITDA/ EV

Are we overvalued?

I primarily uses the following tool gauge whether the market it undervalued. One, (image below), tells me its still a great time to purchase stocks despite the recent rally. This is a great way to know where we are in the long term scheme of things.

Take It On A Case By Case Basis

Due to higher priorities, I have narrowed down the stock screens I use every weekend. I still continue to screen for the magic formula every week. I am now getting a handful of companies to analyze and the best “Tip” I can give you is take it slowly and more importantly be patient. Some stocks have doubled/tripled off their lows and thus might be fully valued. At the same time, just because a stock has doubled, doesn’t mean it cannot be a bargain. Take company ‘Blue Widgets” which you figure could be worth somewhere between $30-$42. In March, it could have been trading at $10 and currently trades at $20. Would you purchase it? What are the alternatives?  Why is it going to be wroth $30? What if it goes down, will I buy more?  Are other companies in the sector equally undervalued?

The Good Ol’ Value Traps

If one thing is certain during market run-ups , is that bargains become scarce and we are left with value traps. There 1001 ways to define a value trap, but my definition is “there is no catalyst”. For example, newspapers currently do not have a catalyst that will overcome free online readership.Or, there is no reason for me to purchase a CD when digital music is available. Two value traps: UNTD and ELNK, which both appeared on the magic formula screen this week.

United Online is an Internet service provider (ISP). You might be familiar with Classmates.com or Netzero. The stock has not gone anywhere in the past 3-5 years. Quite frankly, with the company not having any broadband strategy , I see no reason why its stock will go up. And here’s the deal, DSL is quickly becoming a thing of the past with internet providers such as Verizon / Time Warner Cable offering faster and faster speeds at lower and lower prices.

The same could be said for ELNK”

ELNK) has reassessed its strategic direction and eschewed investment in its municipal Wi-Fi network and wireless phone business. The progression from dialup Internet access to broadband has inherently rendered the dialup segment a declining industry with no growth prospects.”- Morningstar

Value Investing Fund

I’m starting a Value Investing Fund from scratch. I’m hoping to create some kind of track record as graduation is in the near future. I’m in no financial position to be purchasing stocks, so I’m hoping this gives me an extra pinch of help when applying for a job. It’s going to be fun, and I hope someone learns one thing.

Paul Sonkin Video

The fact that Bruce Greenwald is a professor at the Robert Heilbrunn Professorship of Finance and Asset Management at Columbia Business School is a must read. I stumbled across this book about four years ago when I was buying everything that was related to value investing. Even though I re-sold most of the value investing books, I kept the must reads like The Intelligent Investor, All of the David Dreman books, Joel Greenblatt’s Little Book, and a few others. I kept this book because it has its own little niche in the value investing arena, its truly a modern approach to Ben Graham and Warren Buffett. Bruce Greenwald’s 3-Step approach to valuing a company is one that a) makes sense and b) does not put too much emphasis on future growth. For those individuals that have not had a chance to read the book, Greenwald advocates a 3 step approach to valuing a company.

1. Value the assets
2. Find the company’s Earnings Power Value (EPV = Adjusted Earnings x 1/R, where R is the current cost of capital or rate of return
3. Only when the company displays a franchise can we incorporate growth into the equation

Especially during the dot-com boom, #1 (Assets) was highly ignored. Companies that had little to no assets were valued greater than a stalwart like Proctor and Gamble (PG). The beauty about investing in companies with hard assets is, if the company disappoints on in the earnings front, one can sleep conferable at night knowing the assets are there (like a safety net). Dot-com companies never had this safety net and the stock price experienced catastrophic declines when earnings disappointed. #2 can be applied to just about any company but I highly suggest looking at companies who have a history of consistency. Third on the list is factoring growth where a franchise is in place. Greenwald defines a franchise as when the firms EPV exceed the company’s Asset Value (43). Another way to think about this is what Warren Buffett calls a moat. Companies with a moat tend not to require additional investment, but can still increase its earnings (think See’s Candies, Burlington Northern). Now, Greenwald and Co. do a tremendous job in walking the reader on how to analyze a company and valuing the company using his 3 step approach ( he values WD-40 Co (WDFC) and Intel (INTC)) but the second half of the book is devoted to value investors and some of the techniques they employ.

The second half of the book profiles value investors that have outperformed the market. Greenwald devotes the most attention to Warren Buffett 9bug surprise there right?) and highlights some of Warren Buffett’s shareholder letters. Below are the value investors highlighted and the chapter title

• Warren Buffett :Investing Is Allocating Capital
• Mario Gabelli : Discovering and Unlocking the Private Market Value
• Glenn Greenberg : Investigate, Concentrate and -Watch that Basket
• Robert H. Heilbrunn : Investing In Investors
• Seth Klarman: Distressed Sellers, Absent Buyers
• Michael Price: Discipline, Patience, Focus, and Power
• Walter and Edwin Schloss: Keep It Simple, and Cheap
• Paul D. Sonkin: Small Is Beautiful, Especially When It’s Ugly

I have read this book twice, and each time I re-read the book I pick up a nugget or two. I have taken this book out of my library and have set it aside to re-read. Finally, the book is selling for 8.99 on Amazon.com and I highly reccommend it. As stated above, its definately not the easiest read, but its definately not the hardest either.