The Investing Starter Guide pot

The Investing Starter Guide Robin R. Speziale *** Published by Robin R. Speziale at Smashwords Copyright 2012 Robin R. Speziale *** Author of Lessons From The Successful Investor: Lessons From The Successful Investor is the new investing classic of our time. With thousands of downloads, this new investing eBook has topped bestseller lists across major digital book stores and has received rave reviews. Now available for only $4.99. The new investing classic contains 85 timeless lessons to help you build a quality portfolio of value stocks that will make you wealthy. Reader Reviews - Lessons From The Successful Investor: “This book is an absolute must for all new and inexperienced investors” “This book has given me the confidence to be able to manage my own portfolio” “I downloaded your book and could not stop reading it until the end” “I have been reading many books on investing in the last while and by far this has provided the most insight” “I have the Ben Graham book but you have made it make sense” “Incredibly informative and really motivated me to drive the inner investor I always knew was inside me” "Finally a book with easy to follow stock principles" Other Titles by Robin R. Speziale: The 85 Investing Lessons A Brief Stock Market History The Investor’s Checklist The TFSA Guide *** Contents INTRODUCTION Chapter 1 - THE IDEAL INVESTMENT Chapter 2 - PORTFOLIO Chapter 3 - THE STARTER PORTFOLIO Chapter 4 - SUCCESSFUL MENTALITY Chapter 5 - COMPOUNDING WEALTH Chapter 6 - RECESSIONARY INVESTING Chapter 7 - FUNDAMENTAL EQUATIONS *** The Investing Starter Guide Based on Lessons From The Successful Investor *** Introduction Lessons from The Successful Investor has been a surprise success. I wrote Lessons From The Successful Investor immediately after graduating from the University of Waterloo, having been constantly asked by friends, family, co-workers and acquaintances to consolidate my value investing knowledge into a neat package for easy consumption. That said, the summer of 2010 consisted of researching, writing, and editing Lessons From The Successful Investor, which finally launched September 1, 2010 across major digital book stores. Initially, downloads of the eBook trickled in. However, my value investing speaking appearance at the University of Toronto, coupled with select media coverage, catapulted Lessons From The Successful Investor to the top of major digital book stores. And at that point, downloads started pouring in followed by wonderful feedback from readers, aspiring value investors, around the world. A reader review that struck me was from a gentleman based in Portland, Oregon, who proudly exclaimed, “I have the Ben Graham book but you have made it make sense”. You see, Ben Graham is the father of value investing, author of The Intelligent Investor, and my investing idol. That was a turning point for me. I started touring Canadian Universities, spreading the value investing lessons from Lessons From The Successful Investor. I compiled brand new investing eBooks in 2012. And I started consulting individuals on value investing principles. At the end of the day, what makes me happy is when readers like you benefit from my value investing lessons. Indeed, Lessons From The Successful Investor is the investing classic of our time, containing 85 timeless lessons to help you build a quality portfolio of value stocks that will make you wealthy. Once you finish reading this eBook, I hope you download the original Lessons From The Successful Investor and find out for yourself what aspiring value investors around the world are raving about and profiting from. *** Chapter 1 THE IDEAL INVESTMENT “Simplicity is the ultimate sophistication.” Leonardo da Vinci 1: Finding the Ideal Investment The successful investor would compile a scorecard for his ideal business such as the one compiled for Company A above. Before compiling such a comprehensive scorecard, however, the successful investor filters stocks based on initial value benchmarks, such as P/E, P/S, and M/B. Once qualified stocks are returned, the successful investor scours this list for businesses with ideal underlying fundamentals and clear competitive advantages. For example, from the 340 businesses returned from the filter, the successful investor only developed a scorecard for five. Company A’s scorecard above then is his most ideal business from his top five. Moreover, the fundamentals contained in Company A’s scorecard paint a comprehensive picture of its underlying business. On the income statement, its revenues are growing, its profit margin is consistently high, and its earnings per share are growing consistently. On the balance sheet, its cash holdings are healthy, its current ratio is ideal, its long term debt is low, its book value is growing consistently, and its return on equity is consistently high. Regarding stock valuation, its market capitalization is growing, its P/E valuation is ideal, and both its dividend payout and yield are consistently growing. Clearly, the successful investor would have wanted to invest in Company A during 2008 while its P/E was at a low of 10.5. However, because of Company A’s consistent growth, quality fundamentals, and clear competitive advantage, the successful investor would invest in Company A with its current P/E of 16.48. Company A is deserved of its slight P/E premium. Visit the Value Line site http://www3.valueline.com/dow30/index.aspx for free scorecard reports of the 30 businesses contained on the Dow. Study these scorecards carefully and you will surely become a better business and stock evaluator. 2: Advantageous Businesses with Valuable Stocks The following are the successful investor’s most ideal stocks as of July 1, 2010. These 25 stocks were filtered from the thousands of stocks found on the Dow, S&P 500, and S&P/TSX. Further, these 25 stocks trade with extremely attractive valuations given historical levels. Also, each possesses quality underlying fundamentals with clear competitive advantages. However, upon reading this list, although these businesses may not possess the same ideal stock valuations, they will undoubtedly possess superb underlying fundamentals and clear competitive advantages, five, twenty, or fifty years from now. Case Study: Ideal Business Today, But Not Tomorrow. Before moving on, a business was intentionally slipped into the list above that perhaps should not be there. That business is Microsoft. Microsoft was added to offer a valuable lesson that an ideal business today may not be an ideal business tomorrow. Today, Microsoft’s profit margin is 25%, its return on equity is 38%, and its competitive advantage, Windows, is impenetrable. Indeed, Microsoft Windows has long been, without question, the leading operating system globally in both the consumer and office space. However, it is very possible that Microsoft may lose its competitive advantage – Windows - in the future. This dilemma underscores the most challenging facet of investing; projecting a business’s success into the future. Many wonderful businesses fade. In Microsoft’s case, its operating system monopoly could very well be eroded by a business such as Apple, RIM or Google. For instance, Apple is now donating in large supply its computers to schools, Universities and Colleges. As more use Apple’s operating system, more will become accustomed and, in turn, loyal to its operating system. As well, as business becomes more global, mobile computing will increasingly attract the business person. RIM fills this void. Lastly, Google is leading the charge to cloud computing, where its Chrome operating system operates on massive servers in “the cloud”. In all, with competitors at its door, it is much too difficult to predict Microsoft’s future. 3: The Technological Factor Blockbuster long had stable investment returns. However, Blockbuster’s demise was eventually brought about by rapid changes in technology. With streaming movies and downloadable bit torrent online, one can now watch a movie for free at home. Also, unlike VHS tapes, DVD’s and Blu-ray’s can be copied multiple times at rapid pace. Further, pay-per-view, such as Astral Media’s TMN channel, is now more prominent, where viewers can order movies with the touch of a button, without a DVD or Blu-Ray system. What needs to hit home then is that an investor who believes an investment is ideal today needs ask himself whether that same investment will be ideal tomorrow. A business that possesses stellar fundamentals today may not tomorrow if its competitive advantage is threatened by technological advances. The quality business must evolve with advances in technology in order to deliver long term investment return. 4: Some Great Stocks are Terrible Businesses; Some Great Businesses are Terrible Stocks “Some great stocks are terrible businesses” is true when one finds a stock, trading with low P/E, P/S, and M/B multiples but its underlying business is shoddy, with no growth potential or clear competitive advantage. “Some great businesses are terrible stocks” is true when one finds a great business, chalk with growth potential, solid fundamentals and clear competitive advantage, but is trading at terribly high P/E, P/S, and M/B multiples. Further, the successful investor never invests in low P/E, P/S, and M/B stocks that are terrible businesses but will occasionally invest in great businesses with fair P/E, P/S, and M/B valuations. For instance, the successful investor first measures a business’s underlying fundamentals, and if he is then convicted in its long term growth and competitive advantage, he invests in its slightly inflated stock but never invests if its P/E is over 20, its P/S is over 4, or its M/B is over 5. Case Study: Some Great Stocks are Terrible Businesses Bell Canada, or BCE, is a great stock. As of July 21, 2010, its P/E was 13 while its dividend yield was 5.54%. However, the successful investor knows well that Bell is a terrible business. For example, his cell phone plan was once will Bell, and their customer service was deplorable. Further, Bell Canada stands to lose considerable market share into the near future. Firstly, Canadians are increasingly discarding their landline phones, instead adopting mobile phones as their primary phone. Secondly, the recent Canadian wireless spectrum auction helped many new players enter the wireless industry. Currently, Bell is a great stock, but a terrible business. Case Study: Some Great Businesses are Terrible Stocks Amazon is a great business. It possesses an immense network across North America, sells virtually every book, prides itself on its customer service, and is a rich resource for book reviews. To top off, Amazon is riding the e-book wave with its popular Kindle e-book reader. As well, Amazon’s revenues, net income, and return on equity have grown consistently while it holds very little long term debt. However, Amazon is a terrible stock. As of July 21, 2010, its P/E is 51 while its M/B is 10. Indeed, Amazon’s stock has been inflicted with unsustainable investor euphoria. Currently, Amazon is a great business, but a terrible stock. 5: Cola Stock Wars: Coca Cola vs. PepsiCo The Cola Wars have raged for decades. Sure, Coca Cola is winning with greater market share, but both Coca Cola and PepsiCo have been relatively comfortable sharing the global market. However, there seems to be a discrepancy between the two stocks; investors place a premium on Coca Cola’s stock. Thus, the successful investor is convicted that PepsiCo’s stock is undervalued while Coca Cola’s stock is overvalued. Let us conduct an analysis to show why. As shown from the data above, PepsiCo is clearly undervalued compared to Coca Cola. To explain, PepsiCo’s P/E and P/S ratios are lower, its revenue greater, its earnings per share higher, and its current ratio healthier. Also, PepsiCo’s 37.50% return on equity is higher than Coca Cola’s 27.20%. Coca Cola’s only advantage is from its profit margin, a high 22% compared to PepsiCo’s 14%. Coca-Cola’s profit margin may be the sole reason for its $18 billion market capitalization premium over PepsiCo. However, while lower than Coca Cola’s, PepsiCo’s profit returns from a larger revenue base, and only falls short Coca Cola’s net income by $800 million. Also, the successful investor owns more earnings per share in PepsiCo than in Coca Cola: $3.94 EPS versus $3.04 EPS. In all, the common investor is applying undue premium to Coca Cola’s stock, and subsequently, ignoring PepsiCo’s undervalued stock. *** Chapter 2 PORTFOLIO “Concentrate your energies, your thoughts and your capital. The wise man puts all his eggs in one basket and watches the basket.” Andrew Carnegie 6: Diversification vs. Focus Philip Fisher, author of Common Stocks and Uncommon Profits, proposed the best portfolio theory; focusing ones holdings. The successful investor follows Phillip’s approach and focuses his stock holdings by investing in a few core stocks – 7 to 30 – to then holds those stocks for the long term. The common investor who diversifies into hundreds of stocks inevitably incurs low returns. It is as if the common investor concedes in himself that he cannot pick quality stocks so he simply picks many stocks hoping some work out. Portfolio diversification runs rampant because financial institutions profit from diversification and thus promote it. Diversification into “safe investments” equates more brokerage fees and fewer lawsuits. Further, so called experts compare market risk to individual risk in order to support their argument for diversification. They will tout that by investing in many stocks, the common investor eliminates the individual risk of each. For example, if in 2010 DragonWave generates negative stock return because of corporate malfunction, whereas Starbucks provides positive stock return, the portfolio does not suffer. DragonWave’s individual risk is effectively mitigated by Starbucks. With many stocks, the experts lavish that only market risk threatens the common investor. Market risk is general panic that would in theory negatively affect all stocks in ones portfolio. However, if the investor’s goal is to eliminate individual risk by blatantly diversifying into stocks, many of which he can do without, he does not trust his ability to invest in quality businesses. The successful investor simply invests in a few core quality businesses and owns those businesses for the long term. 7: Asset Allocation vs. Capital Allocation The majority of investing professionals claim that investing strategically into asset classes maximizes returns. Asset classes are represented by stocks, bonds, and real estate, among others. Apparently, 50% of one’s capital should be invested in stocks while the other 50% in bonds. Those allocated assets should then be re-balanced to compliment ones risk adverse profile in old age, such that at age 70, for instance, stocks should only represent 30% of one’s portfolio while bonds 70%. To stress, the successful investor does not invest based on asset allocation. Only average returns are got by blindly investing in a framework that necessitates constant rebalancing. Instead of allocating assets, the successful investor allocates capital. The successful investor is knowledgeable in stocks, bonds and real estate. Adhering to the rules of asset allocation, the successful investor allocates his capital to the asset class at that moment in time which will most likely generate greatest return. For instance, in 2008, house prices declined. If the successful investor found cheap real estate more valuable than cheap stocks, he allocated his capital to real estate. However, the successful investor generally strays from real estate investing, allocating his capital instead to the stocks that represent greatest opportunity for return, for he finds real estate returns are too low and investing returns too easily got. Case Study: Stock Balancing Act The successful investor does not balance his stock holdings, so that in a portfolio of ten stocks, each stock represents 10% of total invested capital. Along the lines of capital allocation, the successful investor invests in a stock that he believes will garnish greatest returns at that time. Therefore, if RIM represents 20% of his portfolio, that just shows his conviction for RIM’s opportunity for return. 8: 80/20 Rule The 80/ 20 rule applied to investing predicates that 80% of one’s investments will trail the S&P 500’s total return, while 20% will provide significant return above the S&P 500’s 10.59%. The successful investor, in constructing his portfolio, understands the 80/20 rule well. His top stocks will outstrip his average stocks and will increase the value of his portfolio. 9: Portfolio Management One can learn modern portfolio theory, and still not be able to invest like the successful investor. Modern portfolio theory is the culmination of ideas that in no way correlate to investing success. Instead of modern portfolio theory, the successful investor practises good old portfolio management. For instance, the successful investor holds only quality businesses in his portfolio. He does not diversify by industry, sector, or country. And he certainly does not rebalance asset classes. He manages quality businesses in his portfolio, in the form of equity. Bonds, gold, and GIC’s are not quality investments. The successful investor manages his portfolio like he would a holding company. He creates a consolidated report annually, consisting of his portfolio’s average revenue, net income, profit margin, and return on equity. His main focus is on both profit margin and return on equity, for he knows those two metrics determine the core growth of his portfolio. Annually, the successful investor plots his portfolio’s capital appreciation, or price advance, against the S&P 500. He makes sure to beat the S&P 500’s total return by 5%, but is not devastated if he misses that mark. Also, he averages the dividend yield on his portfolio and calculates the dividend income he receives from his portfolio each year, while noting its annual growth. Annually, the successful investor reinvests his dividends in new holdings or shores up current holdings if valuations are attractive. And, if cash is available that was not deployed throughout the year for stock purchases, the successful investor conducts a stock screen on the S&P 500 and S&P/TSX to filter attractive stocks of quality businesses. If attractive stocks are found, he will purchase those stocks, if not, he will reinvest in current holdings. The successful investor does not succumb to investing in hundreds of businesses. He manages a focused portfolio of about 7 to 30 businesses with clear competitive advantages, and only adds businesses that will maintain his portfolio’s average profit margin and return on equity. Logically then, he does not erode his portfolio’s value. The successful investor does not check his portfolio daily; for he knows his businesses are running smoothly and are constantly building shareholder value. Quarterly, however, the successful investor checks his portfolio for dividend income earned from the businesses he owns. This makes him happy and proud owner of these successful businesses. Moreover, the successful investor dislikes very much selling his quality businesses. If a quality business generates consistently growing income, why should he sell that business? However, the successful investor does sell a business when its underlying fundamentals deteriorate considerably, pulling down his portfolio’s profit margin and return on equity to historical lows. However, the successful investor is o.k with holding good quality businesses, for he knows his great quality businesses maintain his portfolio’s high returns. If he were to sell every great quality business that turned good quality, he would incur significant brokerage costs. Only quality businesses that are deteriorating significantly are sold. In all, the successful investor invests in quality businesses with clear competitive advantages, reports on their performance, builds his stake in those quality businesses and invests in new quality businesses annually, watches his dividend income, not stock prices, and in turn, becomes wealthy. 10: Portfolio Insider If you would like to know what stocks Warren Buffett’s Berkshire Hathaway invests in, you can, by obtaining its 13f filing. You can obtain Berkshire Hathaway’s 13f, for instance, by visiting secinfo.com, signing up for free, and searching for Berkshire Hathaway in its database. For your reading pleasure, included below are Berkshire Hathaway’s current holdings as of May 17, 2010. The successful investor would study each holding below and assess for himself whether each business Buffett invested in is a quality business. For even investor giants make mistakes. Berkshire Hathaway Equity Holdings (May 17, 2010) Further, some investors ride the coattails of investor giants, such as Warren Buffett, meaning they would frequently invest in the stocks Buffett invested in. However, this strategy is not a very good one because Buffett can negotiate better deals on stocks than the common investor can, such as what he negotiated with GE – guaranteed 10% annuity and the right to purchase more shares for a dirt low price in the future. And plus, it is no fun riding on the coattails of other investors. The successful investor paves his own path to investing success. *** Chapter 3 THE STARTER PORTFOLIO “Take time to deliberate; but when the time for action arrives, stop thinking and go in.” Andrew Jackson 11: Developing a Portfolio The successful investor began his foray into investing at a young age. However, today his starter portfolio is the wealthy portfolio. The following is an example starter portfolio, revealing to the reader the steps involved in its construction. Firstly, let us assume in year one the investor starts with $5,000 in capital. That $5,000 in capital will be invested in stocks. The investor wants to build a focused portfolio with quality businesses. He reasons that he will invest in the stocks of three quality businesses: Wal-Mart, Johnson and Johnson, and PepsiCo. Based on his analysis, Wal-Mart is the most undervalued of all three. Thus, he will allocate more capital to Wal-Mart. He will allocate 40% of his capital to Wal-Mart, 30% to Johnson and Johnson, and 30% to PepsiCo. However, before investing in these stocks, the investor must open an investing account with a bank. For example, RBC offers a direct investing account for those older than eighteen. The investor simply applies online and within a week is able to access his new account. He then transfers $5,000 capital from his savings account to his investment account. However, that $5,000 capital is diluted by trading costs. Trading costs per share at this threshold are $28 per trade. So for each of his three stock purchases, a $28 trading fee will be applied, totalling $84 in fees. Total trading fees are subtracted from the $5,000 capital, leaving $4916 to invest. Finally, using the successful investor’s capital allocation model, the investor invests $1966.40 in Wal-Mart, $1474.80 in Johnson and Johnson, and $1474.80 in PepsiCo. Next, the investor calculates the number of shares he can buy in each business with the capital allocated. The following stock prices are current as of July 10, 2010. Wal-Mart. $49.43. $1966.40/$49.43 = 39.78 shares Johnson and Johnson. $60.54. $1474.80/$60.54 = 24.36 shares PepsiCo. $63.50. $1474.80/$63.50 = 23.23 shares Pertaining to the calculations above, the investor cannot purchase partial shares so he must round off the number of shares of each stock. Thus, Wal-Mart’s 39.78 shares become 40, Johnson and Johnson’s become 24 and PepsiCo’s become 23. The investor will place a buy order for each stock, inputting number of shares desired. After confirming all three stock purchases, the investor now possesses a starter portfolio. He will immediately create an initial portfolio report, as shown below: [...]... unfortunately, because the majority lack common sense, they avoid investing altogether, never able to realize success For starters, the majority of persons have no interest in investing They would rather leave investing to mutual fund managers However, those managers do not work for the investor, they work for the bank And so, the majority must simply accept mediocre returns Another reason for there being so... is that they may have been burned in the past Perhaps they invested their hard earned money in Nortel’s stock only to see it all evaporate The majority of people then likely see investing as they do the lottery, a game with many losers but few winners A gentleman in real estate was asked why he chose not to invest in stocks; his reply: “if I were to invest in a stock, it would just go down the next... perplexing then that the wealthy within a capitalistic system are called capitalists? Capitalists acquire capital, appreciating assets Those who are not capitalists own the debt in an economy The poor are the anti-capitalists, or rather, depreciationists 14: Goal of Investing Clearly, the successful investor’s goal is to make money If any investor says different, they are not making money in the stock... age 41 is the tipping point in which the compounding effect gains significant power Now you can amend that age old saying and conclude that the first $532,536 is the hardest” Indeed, up until $532,536, the money in the example portfolio compounded slowly, underscoring the value in patience 19: Patience The value in compounding interest is only realized through patient, disciplined investing The successful... $144.40, 2.9% of the portfolio’s current value Also, the starter portfolio’s average profit margin is 12.67% while its average return on equity is 28% Indeed, the investor’s starter portfolio consists of quality businesses In year two, if the stock valuation of each business is fair or undervalued, the investor will consider investing more capital in each, unless better opportunities are found in the stock... do not care about investing If they did care, they approached investing incorrectly, employing complex theories and equations uncorrelated to investing success As Warren Buffett so eloquently said, the business schools reward difficult complex behaviour more than simple behaviour, but simple behaviour is more effective.” What the successful investor finds most interesting is that these students have... learn all he can Further, once the successful investor spots a positive trend, such as business people retaining their BlackBerry’s instead of trading them in for iPhones, he sees dollar signs The successful investor then invests in RIM because he is sold on what he sees, not what he is told A fourth grade teacher from long ago had an excellent saying: “don’t tell me, show me” The successful investor... how people think during a recession 4 Even if the stock market keeps on tanking after you invest, the dividends from your stocks will make you comfortable RBC sent the successful investor a $1000 dividend cheque per quarter during the recession 5 If you cannot stomach a 50% loss, do not invest in the market At the nadir of the financial crisis – March 2009 – the successful investor’s stock losses amounted... price the next day, week, or year, but would only check its market price when he was ready to sell So why did he worry the stock price would go down the next day? Because stock prices are much more readily available than property prices are Some people are just too active and reactionary, and would sell a stock the minute it declined Another reason why so many people avoid investing is because they... Free Savings Account The TFSA is a tax shelter devised in the 2008 Canadian federal budget and officially launched January 2, 2009 Think of the TFSA as a money shelter, not as an investment product like a mutual fund Moreover, the TFSA allows one to contribute $5,000 - consisting of stocks, bonds, GIC’s, or mutual funds, among other investments - annually into the shelter However, the successful investor . interest in investing. They would rather leave investing to mutual fund managers. However, those managers do not work for the investor, they work for the bank Perhaps they invested their hard earned money in Nortel’s stock only to see it all evaporate. The majority of people then likely see investing as they do the