I picked this book up immediately after seeing Phil Town’s appearance in NBC’s Millionaire show. He’s got a pretty good story of how he turned rich from being a river guide, taught by this guy “Wolf.” Basically, his approach is of the value investing but he made it simpler for lay persons and an experienced investor like me. I definitely would love to spend no more than a few minutes watching over stocks. Of course, Rule #1 is “Don’t lose money” or invest with certainty – buying a wonderful business at an attractive price. In essence, be a good shopper.
The author did a comparison against other types of investments to arrive at the advantage of having 15% return with stocks. I believe the author overlooked the benefits of real estate w.r.t. the tax treatments and tax-free cash flow. But I agreed with him that liquidity of stocks with 15% compounded growth rate are pretty good. The trick is to keep it at 15% or more. That’s the tough part. Another lesson learned from the book is the important of the ROIC growth, not the nominal equity value. “The equity growth rate for any business is defined by growing surpluses, and surpluses are what a business makes that’s valuable… Surpluses gives a business the cash to grow, which is why businesses typically growth at about the rate that their surplus grows, i.e. the equity growth rate.”
I think this book beats all the MBA business classes I have taken. Well worth the time. A quick summary below:
Four simple steps:
1. Find a wonderful business.
2. Know what it’s worth as a business.
3. Buy it at 50 percent off.
4. Repeat until very rich.
The definition of a “wonderful” business: 4 M’s
1. Meaning to you. Buy it only if you’d be willing to make this business the sole financial support of your family for the next 100 years. Become a business owner, not just a stock investor. Employ 10-10 Rule. “I won’t own this business for ten minutes unless I’m willing to own it for ten years.” Start with the intersections of the three circles of your Passion, Talent, and Money.
2. Moat (wider the better and sustainable): “durable competitive advantage that protects it from attached, like a moat protects a castle.” Five types of moats: a. Brand: a product you’re willing to pay more for because you trust it. b. Secret: a business that has a patent or trade secret that makes direct competition illegal or very difficult. c. Toll: a business with exclusive control of a market – giving it the ability to collect a “toll” from anyone needing that service or product. d. Switching: a business that’s so much a part of your life that switching isn’t worth the trouble. e: Price: a business that can price products so low no one can compete. The Big Five (must be >= 10%/year for 10 years): 1. ROIC (return on invested capital). 2. Sales growth rate. 3. Earning per share (EPS) growth rate. 4. Equity, or book value per share (BVPS), growth rate, 5. Free cash flow (FCF) growth rate. Rule on debt: if it can pay off debt within 3 years by dividing total long-term debt by current free cash flow.
3. Management (great ones)
Look for CEO’s of the following qualities: 1. Owner-oriented and 2. Drive: look for BAG (big audacious goals), check insider trading, look at CEO compensation,
4. Margin of safety (MOS).
Get a dollar of value for only 50 cents.
Calculate the sticker price with the following 4 numbers: 1. current EPS (TTM EPS: trailing twelve-month EPS), 2. Estimated (future) EPS growth rate (using past equity growth rate), 3. Estimated future PE (2x growth rate, worst of default & historical), and 4. Minimum acceptable rate of return from this investment: 15% of Rule #1 investors.
Future PE * Future EPS = Future sticker price. divide by 4 (15% return for 10 years) to get to today’s price.
Divide by 2 again to get to the MOS price. In other words, divide the future sticker price by 8 to get to a reasonable purchase price.
1. MACD (Moving Average Convergence Divergence): Consisting of slow EMA (exponential moving average: 26-day), fast EMA (12-day), and a trigger/signal EMA (9-day). Use a more responsive model (8-17-9) MACD.
2. Stochastics: Based on Dr. Lane’s research (how the current closing price sit between the high/low range over 14 trading days). Used to identify overbought (above 80%) and oversold condition (below 20%). MSN link here. Buy line crosses up, buy. Buy line crosses down, sell. The author recommends using 14-trading-day for the first number and 5-day for the trigger point. Crosses up through the 20th percentile, it’s a positive signal and when it crossed down through the 80th percentile it’s a negative signal.
3. Moving averages: Author recommends 10-day moving averages for earlier signal. When the price line crosses above the moving average line, buy. When the price line crosses below the moving average line, sell.
When all three signals are saying “buy,” it’s time to get in. When all three are saying “sell,” it’s time to get out.
On “Eliminating the Barriers” chapter:
Advise on debts: don’t take on debt unless the interest rate of the debt is less the 1/3 of the your expected rate of return. And the debt can be paid off within a year.