1996 vulcan 800 classic value investing
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1996 vulcan 800 classic value investing binary options strategy two stochastics

1996 vulcan 800 classic value investing

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The Vulcan was discontinued in after a 20 year production run, so you could pick up one of these bikes for relatively cheap. Share Tweet. Kawasaki Motorcycle Reviews Motorcycles. By Motorcycle Guy. Great first bike if you want a cruiser. Doesn't look like a cc motorcycle looks much more powerful! Riding 2-up can slow down the bike quite a bit. Warm Blooded Fun The Vulcan is powered is powered by a parallel twin, 4-stroke, liquid-cooled engine with a cc displacement.

Aftermarket shiny bits Because this motorcycle is a member of the prestigious Vulcan family, there are quite a few aftermarket parts to add more style and power to it. Conclusion This would be a great first motorcycle, especially if you are into cruisers. Seat Height: Most investors prefer to use a year discounted cash flow model in determining the true value of a business. Generally, I agree with this approach, but sometimes I am reluctant to rely on numbers beyond 5 years from today.

A lot can happen to a business over 10 years; specific operating or general economic conditions can skew results for a year or two. The result is that you would have to reassess your assumptions anyway, so I find that a 5-year model is a good starting point.

Again, the important thing is to consider the business. A company like Coca-Cola generally can be counted on to sell its product in all environments. For years, it seemed as if financial institutions could continue to deliver solid, consistent results, but the financial funk that began in and has thus far not let up in late proves otherwise.

Notice the meaningful gap between the current price of Mohawk shares and the intrinsic value derived from my assump- tions. This gap is meaningful because it offers a strong cushion for any errors or overtly wrong assumptions in my analysis. In value investing circles, this safety net is known as the margin of safety, a concept developed by Ben Graham in Chapter 20 of The Intelligent Investor.

Two investors will never arrive at the same value for a busi- ness, because no two investors will have the identical set of assump- tions. For this reason, any intrinsic value figure for a business always will be an approximation, never a precise number. Requiring a mar- gin of safety is a necessity if an investor demands preservation of capital.

No set rule of thumb defines how wide a gap should exist between market price and the true value of a business. Some investors look for a margin of safety equal to twice the current market price. A superior business with a dominant competitive position should not require as high a mar- gin of safety as a smaller, less dominant business.

It is much easier to accurately forecast the cash flows of businesses such as Mohawk, Kroger, or Home Depot than it would be for businesses such as Pacific Sunwear or Bare Escentuals. While no cash flow forecasts will be spot-on accurate, your probability for a wide margin of error is smaller when looking at stronger, well-established businesses.

As you can see, the scenario in this case is very favorable, even if your assumptions turn out to be slightly off. A common thread is the businesslike orientation of their invest- ment selections. Your goal is to determine whether that business is undervalued, fairly valued, or overvalued. Contrary to the view of modern portfolio theorists that increased returns can only be achieved by taking greater levels of risk, value investing is predicated on the notion that increased returns are associated with a greater margin of safety, i.

How many would you buy? The process behind this purchase is completely rational. Seeing the tremendous discount between market price and fair price, you would seize the opportunity to make a substantial investment. But you would also want to seize the opportunity in a sensible manner. This is your margin of safety in this investment.

This is Hawaii, where everyone dreams of owning beachfront property and it is a matter of when, and not if, the values rise back to normal. You should have a similar mindset when investing in businesses via the stock market. The instant you make slam-dunk investments using proceeds from your broker, the rules of the game have changed.

You give up any margin of safety the minute you expose yourself to redemption calls from your broker. These are some of the most highly regarded and recognized value investors due to their superior long-term performance. All Investing Is Value Investing During the early days of stock market activity, investing was com- monly perceived as a speculative activity practiced only by the rich or by those with wild dreams of striking it rich. Many of the pub- licly traded companies at the time were oil companies with noth- ing more than land and hopes of striking oil and all the riches that came with it.

This plus-page work provided a blueprint for fundamental analysis of both stocks and bonds. Graham often took a pair of common stocks in alphabetical order from the stock tables and ana- lyzed them based on earnings multiples, growth rates, and balance sheet composition.

Then he would illustrate why one business was a more sensible investment than the other. It was Security Analysis for a more general audience, although the book became much more than that. The core theme of The Intelligent Investor hinged on the distinction between invest- ment and speculation that was provided in Security Analysis: An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.

Operat- ions not meeting these requirements are speculative. I think most investors would agree that satisfying these three condit- ions is the cornerstone of all investing activity, regardless of what you invest in. In Chapter 11, I will discuss why growth investing and value investing are merely two sides of the same coin. Part of the value in any investment is the growth potential of the business.

Ben Graham came along and taught us how to value this future growth and use those principles in paying sensible prices for the stock today. As you will read throughout this book, a major determinant between a successful investment and an unsuccessful investment is the price you pay.

Klarman is founder of the hedge fund Baupost Group. Since , Klarman has aver- aged annual returns of approximately 20 percent. Widely regarded as a student of Graham and Buffett and the value approach, Klarman has done exceedingly well during both bull and bear markets. Lampert started a hedge fund in his 20s after a successful career at Goldman Sachs. His earliest inves- tors included Michael Dell and David Geffen.

His fund, ESL Investments, produced annualized returns of over 30 percent since His investment approach is best char- acterized as concentrated value, as Lampert typically makes a handful of big investment bets. Lampert is currently the chairman of Sears Holding, the product of a merger between Sears and Kmart that Lampert orchestrated earlier this decade.

While no longer actively managing money, Lynch is widely considered one of the greatest mutual fund managers of all time. Hawkins founded Southeastern Asset Manag- ement, which runs the Longleaf mutual funds, in All employees have their money invested in the Longleaf funds and nowhere else. Berkowitz is portfolio manager of Fairholme Capital Management, which he founded in He is an avid disciple of Warren Buffett and the value-inspired approach. His investment philosophy, which has proven very successful, is to invest in businesses with talented managers or jockeys, as he likes to call them and in businesses that spin off a ton of cash.

Since , the Fairholme funds have handily outper- formed the markets, and Berkowitz is widely considered as one of the most talented money managers around today. We do need to understand that successful value investing hinges on activities that you are trained not to pursue and often requires that you do the exact opposite of what the major- ity is doing. For example, we are taught that a highly diversified portfolio is the soundest approach.

The wealthiest people on the planet have derived their wealth from a single business: Warren Buffett from Berkshire Hathaway; Bill Gates from Microsoft; Lakshmi Mittal from ArcelorMittal; and on it goes. As Buffett suggests, it is bet- ter to have a few eggs in your basket and watch them closely than to have many and risk some breaking.

At first, the framework looks obvious; all of the individual pieces have been discussed and dissected in other investing literature. This is not a checklist that you go through every time you want to pick an investment but rather six essential elements that should truly exist if you are a value-seeking investor. Investing in this manner is not easy to do. It requires discipline and no emotional attachments.

Maintaining discipline minimizes the severity of mistakes. The key to successful investing is not to eliminate mistakes, which are inevitable, but to minimize their impact on the overall investment portfolio. Investors should not take this viewpoint to mean that invest- ing is a rigid science. On the contrary, investment is part art and part science with a little luck thrown in on the side. The framework to be outlined hardly suggests that investing is a rigid discipline.

Rather these elements are essential fundamentals that enable each unique investor to succeed in his or her own way. All golf swings are different, but attention to the essential elements of a pure golf swing—keeping your head still, a good shoulder turn, and main- taining plane—all serve to keep the ball flying accurately. Similar to golf, the essential elements in investments all work together to produce a consistent and effective selection strategy.

True value investing often requires that you look stupid in the short run. Often you will own shares in businesses that are hated by the majority. With each passing month that goes by without any- thing positive happening, the criticisms will get louder. You must have complete faith in your decisions or else you will be guided by the crowd. And most important, value investing requires total and complete independence of thought.

As Ben Graham states in The Intelligent Investor: You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. Reporter after reporter was quick to criticize Buffett for not having participated in the Internet boom. Shares in Berkshire were set to decline for the first time since Thankfully for Berkshire investors, Buffett spends no time paying attention to what the media thinks about his investments.

This is a very important lesson and one Buffett has alluded to over and over. Just as Tiger Woods adheres to a concise and disciplined set of steps for each and every golf swing, so does the value investor in selecting stocks. In order, these six essential elements are: 1. Commit to a sound investment philosophy. Find a good search strategy. Effectively value a business. Be patient. Be willing to make a significant bet at the point of maximum pessimism. All investors make mistakes, but the most successful investors are those who are best able to avoid the unnecessary mistakes and to avoid making the same mis- takes twice.

Also, when investors apply and commit to pursuing invest- ing based on the six elements, they are conditioning their minds to be more disciplined in making investment decisions, and a disciplined approach is a much more focused approach. A Mental Latticework As I mentioned earlier, many value investors have come across the individual components of this process. The key to this framework is viewing it as a series of building blocks, or—to borrow a term from Charlie Munger—a latticework within investing.

Successful investing is not a rigid science defined by one exact formula; it is a continu- ous, evolving process of constant learning. Warren Buffett has been developing a sound investment philosophy his entire life. But this goal rarely happens in an orderly fashion, and if your mental approach is not defined by a sound investment philosophy, the odds of costly mistakes are greatly enhanced.

The path between buying low and selling high is often littered with bumps, and a patient, businesslike approach to invest- ing makes a huge difference. Overview of the Six Elements The next six chapters dig deeper into this fundamental framework beginning with the foundation of any investing approach: a sound investment philosophy Chapter 4.

There can be no dispute that after nearly a century of practice, which began with Ben Graham in the s and has been carried on by Buffett and many other value investors, a sound investment philosophy centers around the princi- ples of value investing: thorough analysis, margin of safety, and sat- isfactory returns. With a sound investment philosophy, an effective and produc- tive search strategy can begin Chapter 5.

Finding investment opportu- nities will require work and there are no shortcuts, but knowing what to look for will make your search much more effective and productive. Next, you need to take the raw data from the search results and turn them into meaningful facts and figures through the proc- ess of valuation.

Regardless, you have to understand the business to value it appro- priately. One chapter can- not teach you everything you need to know about valuing a busi- ness. Businesses are evolving creatures, and all valuations hinge on numerous assumptions. Understanding the limitations of those assumptions is a vital component of evaluating the worth of a busi- ness. The focus of Chapter 6 is not only on how to value a business but why the process of valuation is critical.

The discipline to say no is as important as any quantitative skill that you may possess. Success in investing rests on more than simply a high IQ or razor-sharp mathematical skills. Without discipline to hold you back and resist the short-term temptation of market gyrations, the best analytical work still can lead to poor results.

Maintaining the discipline to say no requires two abilities. You have to separate any emotional attachment to stocks. You have to always have a clear distinction between value and price. One of my favorite businesses is Chipotle, a fast-casual gourmet Mexican food restaurant chain. The quality of the food is excel- lent, and I eat at Chipotle any chance I get. As of this writing, Chipotle has yet to open up shop in my hometown of Athens, Georgia.

Steve Ells, if you are reading this, please look at the Athens market! Every time I visit a Chipotle, the lines are deep, the restaurants are clean, the service is friendly, and the food is always tops. Without a doubt, Chipotle is a wonderful business with a fantastic future. For now I will have to continue enjoy- ing the food and wait for a compelling opportunity. All businesses are undervalued at one price, fairly valued at another price, and overvalued at yet another price.

Patience Chapter 8 is arguably the hardest quality for many investors to develop. Wall Street, with its fixation on quarterly per- formance numbers, has defined patience as a period of months. Hedge funds, with their rapid-fire trading programs, have made monthly returns the standard reporting metric.

Stock prices, in the short term, typically behave in a way that may not resemble the underlying value of the business. As an investor in a business, your buy-and-sell decisions should also not hinge on monthly or quarterly expectations. A great business is not a great investment if the price is too high. Once you have found a compelling investment opportunity, act on it Chapter 9.

Market hates bad news and uncertainty. An intelligent investor should use this knowledge to the maximum advantage. Many of the best bargains occur when businesses are experiencing a period of uncertainty or difficult operating environ- ment. The underlying business remains sound, but the stock price continues to go down, causing the gap between market price and business value to widen.

Having the conviction to make a big invest- ment during the point of maximum pessimism requires the highest degree of independent thought and analysis. Emphasize the Process, Not the Outcome If you carefully observe the best investing minds today, you can see this mental model applied over and over. The best investors are much more concerned with developing a sound, effective process and letting the outcome follow as a result.

Successful businesses usually are identified by a handful of meaningful variables or data points; everything else is secondary to the success or failure of the business. Warren Buffett has often remarked that he never uses a spreadsheet or calculator when making investment decisions. It is also true that Buffett has a gifted mind for numbers and remembering data.

The point is not against the use of spreadsheets or a calculator. Spreadsheets and calculators are tools that can add value to any analysis. After the first several major pieces of data, any additional variables offer very little signifi- cant value to the analysis.

An often cited example by value investors, the invest- ment illustrates the elegance of a straightforward, businesslike approach to investing. I discussed in Chapter 1 why approaching any particu- lar investment as if purchasing an actual piece of a business as opposed to a share of stock leads to a more intelligent invest- ment process.

Attempting to invest in stocks or any other security without first defining and understanding the reasoning behind your investment considerations is like jumping into the ocean without first having learned to swim in a pool. Likely you will suc- cumb to emotion and fear at the slightest sign of troubles, and your chances of long-term survival are slim.

Most, if not all, of your market activities would be speculative but mistaken for an investment operation because no fundamental intellectual frame- work exists behind the decision-making process. This chapter lays out the foundation of value investing, which is to have a sound investment philosophy. The philosophies of the value investing approach either will take hold with an investor or they will not. And the philosophies underlying value investing are straight- forward.

Value investors focus on capital preservation first and capital appreciation second. The main focus of value investing is avoiding permanent losses of capital. Value investors distinguish between risk—the proba- bility of a permanent capital loss—and volatility—the mere move- ment in stock price.

They also understand that the price paid for an investment ultimately determines the future investment results. Also, value investors seek to elimi- nate as much risk as possible from investing by seeking out only those investments selling at valuations that create a very comfort- able margin of safety.

The value investing approach is an all-or-none proposition. Without the foundation of a sound investment philosophy, an attempt at investing based on the risk-averse tenants of value investing is lost. Preservation of Capital Is the Name of the Game Value investing, by its nature, is a highly contrarian approach. However, value investors have one aim that comes before realizing a capital gain.

First and foremost, value investing focuses on avoiding losses. Although loss aversion may indeed be the goal of every market participant, it seems absent in the decisions of many market bets. By investing at undervalued prices, value investors avoid losses. Often undervalued securities are found in areas unloved by the overall market, thus requiring value investors to zig when most zag. Before making any invest- ment, value investors consider and analyze not how much money can be made but how much money can be lost.

Rule Two: Refer to Rule One. The focus on capital preservation is of paramount importance to the value investor. The goal is to find opportunities where the probability of loss is minimal and there is a probability of a very high upside. Attention to capital preservation requires that you pay attention to the value of the business and ignore stock price fluctuations, unless they pro- vide an opportunity to buy at cheap prices or sell at fully valued prices. Focusing on the underlying business and not the stock price allows you to understand the fine line between preservation of capital and capital at risk of permanent loss.

Establish a Sound Investment Philosophy 51 Assuming you have analyzed the business and determined its oper- ations sound and its management able, the 40 percent decline in the price of the shares is meaningless in the long run relative to the value of the business. The movement in the stock price has not per- manently eroded your capital.

Stock prices tend to overreact in both directions. If a company reports quarterly results that are a few pennies less than the estimates ana- lysts had in place, the price of the stock can go down by double dig- its in no time at all. I preface by adding a little color to the market environment of the time: Until August , the stock market had surged. This surge was followed by a stock market crash in October , when the Dow Jones declined by nearly 23 percent in a single day.

At the time of this writing, the U. This e-mail stood out because of the timing. I am very fearful and thinking about selling it tomorrow. Such fears run rampant during periods of market turmoil. It is very easy to surrender to your emotions and exit in a state of panic. The human brain is not designed to tolerate or ignore pain, and financial loss is arguably one of the most painful experiences a human can face.

Emotional pain can surpass physical pain in terms of severity and longevity. This behavior often is responsible for most capital losses many investors, both individual and professional, real- ize. Selling at a loss is not the problem; as investors, we will all make mistakes and must realize that, at times, the most prudent course of action is to cut our losses and move on.

The key point is to differ- entiate between deterioration in the economics of the business and a drop in share price. Several days of stock price declines usually have nothing to do with the quality of the business but more with the general mood of the market. Usually more than a week is nec- essary to determine if the underlying business has lost some of its economic advantages or earning power. Price Paid Determines Value Received Before investing, it is vital to understand the function the markets play.

Stock markets are important only because they allow you to buy and sell ownership interests in businesses. Everything else is just noise. I like to say that the best investors are pretend investors: those who can pretend that the stock market does not exist.

One of the best advantages of a stock market, liquidity, also hap- pens to be one of the worst. Of course, if you find yourself in a financial bind and need access to capital, the liquidity of the stock market helps you, but I assume that you are investing capital that will not be needed for meaning- ful periods of time. In this case, the liquidity of the stock market is not as beneficial as you might think. Paying constant attention to the daily fluctuation in stock prices can influence you to make very poor investment decisions.

As an investor, your goal is to let the market give you the opportunity to buy and sell at attractive prices, not instruct you on when to buy and sell. It is not uncommon for two investors investing in the same security to have materially different invest- ment results, even to the extreme where one result is gain and the other is a loss. The reason is due to the price paid for the invest- ment.

Value investors approach the market as a proxy for deter- mining whether security prices are undervalued, fairly valued, or overvalued. This distinction between guidance and instruc- tion is very subtle and often is blurred, especially when the market is experiencing periods of wide price fluctuations, or volatility.

He let the market vola- tility instruct him and make him feel that he had made a mistake. Between September 15 and 19, , the Dow Jones experi- enced one of the most volatile trading weeks in history. The mess created by the excessive and irresponsible mortgage and securitiza- tion practices came very close to creating a financial catastrophe. On September 15, the Dow dropped over points, or 4.

On Wednesday, the Dow declined another points, or 4. The final two days of the week, the Dow gained nearly points, or 8 percent, to leave the stock market average basically unchanged over the week. Had you let the price vol- atility instruct your decisions, you were selling during the drops out of fear and buying again at the end of the week when the mood became more optimistic.

Without even realizing it, you were selling low and buying high. In fact, most equity portfolios were worth more at the end of the week as the two-day surge in the market recaptured the declines earlier in the week and then some. Investors would benefit tremendously if they would remember to echo the sentiments of Bill Ruane and Richard Cuniff during moments of great market turmoil.

Before succumbing to your emo- tions and rushing to sell at moments of pessimism or buying at moments of jubilant optimism , step back and ask yourself whether the movement in the stock price reflects the intrinsic or true value of the business.

Absent some discovery of fraud or any other illegal activity, a quick decline in stock price should not persuade you to head for the exit. Instead, you need to look at the business. If your fundamental thesis remains intact, then do nothing or buy more of a good thing for less. The Starting Point Matters Value investors often are credited with espousing the buy-and- hold approach to investing.

Nothing is more valuable or sought after than a wonderful business that can deliver returns year in and year out. These investments allow you to sit back and enjoy the ride. However, the concept of buy and hold is not without its cave- ats. The most crucial one is the starting point of the buy process. Whenever you hear any serious investor advocate the concept of buy and hold, take the phrase a step further to mean buy at the right price and then hold. In value investing, the stock price is of extreme importance when entering and exiting an investment.

When prices indicate that a good business is cheap, use it to your advantage to make a good investment. Conversely, when prices indicate that business values have exceeded intrinsic value, use the opportu- nity to sell the overvalued business and once again buy an under- valued business.

At any other time, the stock price fluctuation is a distraction. To appreciate the significance of why valuation matters in choosing the right starting point, consider the year period from to Had you bought the stocks in the Dow Jones Industrial Average at the beginning of and held until , your returns would have been nonexistent.

During those 17 years, the Dow Jones started and ended at the same point. At the begin- ning of , the Dow stood at about points. Seventeen years later, the Dow was at A buy-and-hold approach over that period would have effectively delivered a zero percent return—a negative return when you factor in decline in purchasing power over that period.

Seventeen years is a significant amount of time. For many inves- tors, it represents the bulk of their investment years and is certainly a long enough buy-and-hold period. Interestingly, the period from to turned into one of the greatest market periods in American history. The starting point matters. While you can never expect to buy at the exact bottom say, in and sell at the peak as in , you can avoid doing the exact opposite, which is what many inves- tors did by buying in the late s at inflated prices.

Excited by the quick and unsustainable rise in stock prices fueled by the Internet boom, investing turned into speculating motivated by greed rather than commonsense business principles. Yet millions of well-educated people were buying shares of companies valued at billions of dollars without a single dollar of profits. It repre- sents how much investors are willing to pay for the future earnings of a business based on future business expectations. In fact, decades of data confirm this logical assumption, as shown in Table 4.

Establish a Sound Investment Philosophy 57 Table 4. Source: Copyright , Crestmont Research www. In business, you make money when you buy an asset, not when you sell it. By that I mean that if you buy low, odds are very strong that you will make money when it is time to sell.

The Internet boom of the late s and the housing bubble that started earlier this century are two examples that come to mind. But blindly participating in peri- ods of excessive speculation ultimately ends up doing more harm than good to most participants. Employing a sound philosophy with regard to stock invest- ing demands that you consider the price paid.

In order to buy intelligently, you must know how to assess the value of the busi- ness. Valuation is explored in greater detail in Chapter 6. Recognize that very rarely will you make your purchase decisions at the very bottom. As such, you will rarely ever buy at the absolute bottom or even sell at the absolute top. If you are fortunate to buy at the bottom and sell at the absolute top, under- stand that doing so involves a big dose of lucky timing. Prudent inves- tors who devote serious time and effort to understanding and valuing a business will be able to buy at an undervalued price and sell at a higher price.

Investors must learn to be at peace with their investment deci- sions. You can do this only if you have truly focused on paying cheap prices for your investments. If you have, any subsequent decline in the stock price will not cause you to make ill-timed sell decisions. Instead, most likely either you will sit still, knowing that the movement in stock price has nothing to do with the value of the business, or you will look to buy more of an even better bargain.

It should come as no surprise that a value-oriented investment approach looks to profit and capitalize during weak markets. Periods of market turmoil and uncertainty increase the likelihood of finding bargain investment opportunities. When the general mood is against equities, the likelihood of finding irrational valuations is greatest. Declining markets tend to create very fertile hunting ground for patient value investors.

The biggest investment opportunities can arise during the direst market environments. Risk versus Volatility As I wrote this book, the U. The substandard lend- ing practices that were fueled by one of the greatest housing booms in history have virtually frozen the global credit markets.

Once-storied financial powerhouses such as Bear Sterns and Lehman Brothers no longer exist as a result of excessive financial leverage and the inability to dispose of toxic assets in a timely fashion. The biggest bank col- lapse in the history of the United States took place when Washington Mutual had to dissolve in September House of Representatives the vote later passed , which sent the Dow Jones down nearly points, or 7 percent, on September 29, This represents the biggest point drop in Dow history and the second largest percentage fall after the October crash.

Stock prices in general have been declining for well over a year, but on September 29, , stock prices went into a free fall. Aside from financial institutions—some of which declined by over 50 percent that day—perfectly sound and often debt-free businesses suffered single-day losses that in some instances exceeded 20 percent.

In such times, markets can experi- ence prolonged periods where valuations simply do not matter. In late , plenty of strong nonfinancial businesses were selling for under 10 times earnings, with little or no debt, and producing gobs of free cash flow. Today some of these same businesses are now trading at two to three times forward earnings. In the short run, the market moves on the votes of participants, not the quality of businesses. Global economic slowdowns will certainly reduce intrinsic values if future earnings are set to decline.

But just as stock prices tend to overshoot during periods of endless optimism, they can also under- shoot during periods of endless pessimism. And these periods can last several months or many years. Nonetheless, even value investors must learn to respect the market and realize that bear markets can put you to the ultimate test of patience. Determining whether the stock price indicates an undervalued or overvalued business is challenging.

Consider a bond, which is relatively straightforward to value. There is certainly more to bond pricing, but the general idea is that relative to stocks, bonds are relatively straightforward to value. And during environ- ments of unprecedented financial turmoil, such as , valuations simply do not seem to matter, so any attempt to value a business seems worthless.

Still, the ultimate driver of value is the amount of cash produced by business after all other needs and bills are paid the free cash flow. A business that continues to generate cash ultimately will become more valuable. But in the short term, stock market prices are affected by the votes of market participants, not by business fundamentals.

Over time, the stock market becomes a weighing machine where valuations are influenced by business attributes. Unfortunately, when markets are in crisis mode, the mar- ket can vote for a very long time. Avoid Using Margin As a value investor, your goal is to participate in investment oppor- tunities where the probability of a gain exceeds the probability of loss by the widest possible margins. You devote serious time to analyzing the business, assessing the quality of management, and rationalizing what the business will look like into the future.

These efforts require time and painstaking effort. In short, the goal of value investors is to skew the odds very heavily in their favor toward the number-one goal: preservation of capital. This mentality often is referred to as focusing on the downside while letting the upside take care of itself. For that reason, most value investors avoid the use of margin like the plague.

To put it simply, using mar- gin in an investment fund is much like using debt in a business. Although there are important differences, this much is certain: Too much debt can cripple, if not kill, your business. Another criti- cal reason to avoid the use of margin is that it places the destiny of your investment returns in the hands of your broker or banker. And the only time you will ever get a margin call is not when your securities are up in value but when they have declined and your broker demands that you sell your investments to raise cash.

Finally, more people should consider the cost of margin. Once you invest using margin, your returns are now influenced by the interest rate charged on that borrowed amount. It seems rather silly to participate in a transaction where the disadvantages clearly outweigh the advantages. Margin essentially involves you agreeing to sell securities at even lower prices and better valuations. Instead of buying more of a business at a cheaper price, margin can force to you sell perfectly sound businesses at fire-sale prices.

The financial crisis that came to a head in illustrates the destructive nature of an overdose of borrowed money. For every dollar of equity, you have taken on 50 cents of leverage, or debt. Assume your cost of debt is 6 percent a year.

You invest in a collection of perfectly sound businesses at very sensible prices. Table 4. When you have a good year, margin works as it amplifies returns, but it has the same effect on losses when performance is negative or even flat. You have no choice but to sell or to somehow raise additional outside capital. Most often, the only option is to sell investments, thereby risking the chance that you are selling a security that was initially bought at an undervalued price at an even lower and more attractive price.

Making matters worse, should the same security later have a price rebound, your lack of capital prevents you from participating from the upside. All in all, the juiced losses coupled with the loss of control when using margin far outweigh the ben- efits of juiced returns.

Avoiding margin is a big step in avoid- ing a complete wipeout. It should come as no surprise then that the focus for value investors is and should always be absolute returns. An absolute return philosophy is one that has consistent prof- itability as its key objective. While the clear answer is yes, the goal of most investment professionals suggests no.

A relative return approach accepts the notion that markets are risky in the short term but believes that, in the long term, investors will benefit from the general growth in the economy. As a result, the relative return approach focuses its efforts on allocating capital across various asset classes and industries. The ultimate effect is a broad portfolio that comes very close to mirroring the general stock market indexes.

The vast diversification of the relative portfolio will greatly reduce volatility, which has the effect of creating returns that broadly mimic those of the overall stock market. Relative return investors accept these market-matching returns because the major- ity of individuals will be reporting the same or similar returns. The name of the game in investment management is to, first, keep your job and then, second, attract additional amounts of capital.

So why not protect your job simply by using an approach followed by the vast major- ity? Unlike the relative return approach, an absolute return approach aims to profit consistently regardless of market return. Further, and as I mentioned earlier, an absolute return approach is obviously much more valu- able during bear market periods.

Most important, however, is the understanding that investment records start becoming meaningful after a period of years, not just one year. In the short run, a rela- tive return approach can look extremely good during bear mar- kets.

Because value often is found in the most unloved industries, a concentrated value-oriented portfolio could easily find itself vastly underperforming the broad market during a bear market. Value investors are by default oriented toward an absolute return approach.

Rather than looking at the market as whole, they focus attention on individual businesses. And rather than needing to be invested at all times, if the valuations are not attractive, value investors rec- ognize that the best investment option may at times be to make no investment at all. Understand that you are investing in businesses, not stock prices. The volatility of the stock market should not instruct you in valuing a business. Remember in the short run, prices are determined by votes of the market participants.

Focus on buying great businesses at sensible prices. Leverage is the only way that a smart investor can go broke. Searching for stocks is both interesting and daunting. The truth is there are no great stocks, only great investments.

What differenti- ates between the two? The price you pay. And how do you increase the likelihood of paying a sensible price for a share in a company? By making your investment decisions based on business fundamen- tals and nothing else. A great business does not necessarily imply a great stock invest- ment. Google is a fantastic business that generates tremendous profits. The earnings yield is the return you get based on the price you pay. When Google was trading at these valuations, ultra-safe U.

Treasury bills yielded over 3 percent. In other words, investors were willing to take less return by paying more in hope of a con- tinual rise the in share price. You have no margin of safety at such lofty valuations. The slightest hiccups and the share price begins to free fall. Stocks are merely pieces of paper that fluctuate in price every Monday through Friday. Great investments, however, arise when sound business fundamentals dictate the investment decision.

As I alluded to in Chapter 4, you must approach the markets with an emotion- free, fundamentally based approach before beginning your search strategy. If you are a seri- ous investor looking to participate in the investing game for many years, be prepared to roll up your sleeves and look at hundreds of stocks continuously. Unfortunately, investors today have many more resources that also can lead to poor investment decisions.

It is far easier to develop a good search strategy if you first understand where not to look. The death of equities looks like an almost perma- nent condition—reversible someday, but not soon. By the end of the year, the Dow stood at , a decline of approximately 4.

If you thought equities were dead, you might have missed out on what is now arguably one of the best performance dec- ades in market history. Please note: I am by no means singling out BusinessWeek as having made a wrong call. All media outlets were in one way or another disregarding equities as a viable investment class.

BusinessWeek is just known for having the most famous and sensational cover at a time when the markets were preparing to make a historic upward run. One fundamental difference between the markets and the media makes the media a poor guidepost in security selection. The media tends to focus on the current state of affairs while markets are anticipatory creatures. While the media focuses on the current outlook of the economy, it is highly likely that markets begin to turn up just when investors are being told to exit the game.

Over the past years of market activity, the market historically has experienced cycles in which it advanced bull mar- ket or declined bear markets. Table 5. While the media maintains its focus on the current situation, markets—and investors—tend to focus on the future. Bear ???? Copyright , Crestmont Research www. Investors should rely on the media as one source of information. Similar to the analogy regarding the stock markets, let the media inform but not guide you in what to do.

As investors, we need accu- rate and honest journalism. We are fortunate to have many excel- lent sources, including BusinessWeek. But investors must remember the role of the media: to provide news commentary, not investment guidance. The media is staffed by journalists, not market analysts. Investors are rewarded for finding value when everyone else is leaving the party. By the time the media gets hold of investment ideas, the smart money has already been there.

An effec- tive search strategy relies on knowing where not to look just as much as where to look. In fact, seeing what other investors are buying is the greatest and most effective starting point for an effective search strategy. With thousands of publicly traded secu- rities in the United States alone, it is an intelligent move to take that large pool of stocks and shrink it down to those owned by the most experienced and talented investors in the world.

As far as I am concerned, there is no new secret formula waiting to be discov- ered in value investing, only the discovery of bargain investment opportunities. Fortunately, our search is aided by the existence of many highly regarded value investors who have produced the long-term numbers to back up their reputations. These investors have been tried and tested over years and have demonstrated an ability to outperform the markets over mean- ingful periods of time.

So why not begin your search for companies by leaning on the shoulders of great men? Copying the Great One In , two professors published a study that analyzed the invest- ment moves made by Warren Buffett between and This per- formance should come as no surprise. If investors had simply bought the same stocks that Buffett was buying for Berkshire over the same period, they would have earned aver- age returns of 24 percent during the to period. You simply had to wait until his investments became public information and then make the same investments on your own.

An average return of 24 percent versus 11 percent implies that you could have spent some time perform- ing your own due diligence, and odds are you still would have done better than the index. Even more impressive, you would have done better than a vast majority of professional investors. A monkey could have beaten the socks off the market by copying Buffett! Buffett is obviously a unique individual and a brilliant investor without equal. But he is certainly not alone is delivering incredible performance num- bers year in and year out.

Aside from the names just mentioned, do some digging, and you will find some excellent candidates worthy of imitation. Where to Look Fortunately, SEC regulations today make it effortless to find out what other investors are buying and selling. This quar- terly report is referred to as a F filing and is public information. It has to be filed 45 days following the end of each calendar quarter. The four-step process of getting copies of F filings is quick and simple: 1.

Go to the SEC Web site, www. Under the search information, enter the name of the invest- ment fund in the Company Name section. Once there, scroll down and look for the most recent F filing. Typically the dates will be 45 days after each calendar quarter. Many investment firms have various funds or different legal names for the funds and the investment management company. Figure 5. You can use this search process over and over for numerous investors. Sometimes you might see similar investments across vari- ous investment managers.

These common holdings should really grab your attention. For example, many value managers hold siz- able positions in Berkshire Hathaway. Even more so, Buffett still keeps on increasing intrinsic value by an aver- age of 10 percent a year, so even at its current size, Berkshire still represents a solid investment coupled with very little risk. Develop a Search Strategy 75 Figure 5. Aside from Berkshire and Buffett, value investors occasionally jump on the same wagon, whether it is for the same stock or a gen- eral industry that has been battered and offers value.

The filings of several value investors will provide you with at least ideas to research. Basic Search Strategies Researching what the smart money is buying is just the beginning. The next step in developing a good search strategy is to filter out the best resources and rely heavily on them. In no particular order of importance, the next resources offer valuable investment ideas for any value investor.

The site was founded by Joel Greenblatt, an investor, professor, and author. Greenblatt began as a value investor in the mold of Ben Graham and Christopher Dodd. What we do know is that the invest- ment partnership began in and achieved annualized returns exceeding 40 percent until it shut down in Like Buffett, Greenblatt focused on good-quality businesses that were selling for cheap in the market. He looked at the earnings yield of the business.

The earnings yield is simply the stock price divided by the annual earnings per share of the business. Obviously, the higher the yield, the cheaper the stock as long it can continue to grow earnings. The other variable was finding good businesses.

To keep it simple, think of ROIC as how much a business earns pretax for each dollar invested in the business. The concept is simple. If a business gener- ates more than a dollar in pretax income from each dollar invested in the business, then it is creating value.

The company is taking a dollar and earning more than a dollar. Over time, busi- nesses that continue to generate strong returns on invested capital increase the value of the company and, ultimately, the stock price. So Greenblatt took these two valuable pieces of data and cre- ated the Magic Formula list of stocks.

The site is merely a list of stocks based on a minimum company market value that you choose. The list gives you the business name, its stock symbol, the earnings yield, and the return on capital. The intuitive concept behind the Magic Formula is brilliant; value investors should research and ana- lyze its list of stocks. The site is updated daily so it remains a very useful tool for stock searches. Value Line is one of the oldest and most respected investment research firms around.

Most important, it is an independent research company, so its information is unbiased. Value Line covers over 3, securities in its research database. Each week, Value Line publishes an issue that covers a couple hun- dred stocks until the cycle is repeated again each quarter. What I like about Value Line is the loads of data you get on each company. On one page, Value Line gives you 10 years of data on the company. It lists all the necessary fundamentals including sales, profits, margins, and return on capital.

The businesses profiled in Value Line cover all the major industries and sectors; just knowing them will give you an excellent mental model of the market. While the weekly publications are great for general investment ideas, the Value Line Web site offers a powerful search tool.

Based on the category, Value Line screens its own database and lists the 50 to stocks that fall under that classification. So instead of initially going through all the securities in the database, you can look at the areas that would likely contain bargain investment opportunities.

You get the same detailed one-page Value Line report for each business. This is an excellent resource base for initial investment ideas. An annual subscription to the print manuals will set you back several hundred dollars a year. Unless you need the print manuals, however, the online service is the way to go. Purchasing your own subscrip- tion is definitely worth the investment. Again take these lists as wonderful starting points, but also be careful of value traps.

Occasionally you have periods of extreme pessimism, where all rationality ceases to exist. As I write these pages in the fall of , the implosion of the credit cri- sis, steep housing declines, and global economic recession are pro- viding a similar type market environment. You can find lists of stocks hitting new annual lows in various places. The Yahoo! My favorite source is Barchart www. Each day it provides a comprehensive list of week lows, highs, and everything in between.

As a member, you have real-time access to the ideas posted by other members. The membership is capped at , so the emphasis is truly on the quality, not quantity of ideas. Many of the members are widely known in the value invest- ing community. Fortunately, the heads at the Value Investors Club VIC gra- ciously allow guest access to nonmembers to see ideas that are at least 45 days old.

You get the same information as members, except that the ideas have already been up for 45 days. In many cases, a day-old idea is still very current, as many value investment ideas take some time to play out. In any case, each investment idea is usu- ally a two- to four-page write-up on why the investment is a compel- ling one at the time.

A good place to start would be the highest-rated ideas, but with only members contributing two ideas a year, you can easily keep up with them all. Without question, you can find some phenomenal investment ideas on VIC. Nearly all the investment write- ups are owned by the writers themselves, so you get the most com- pelling reasons why the investment should be made. Ultimately, it is up to you to decide whether to pursue the investment idea; some ideas can be so compelling that a mere due diligence of the facts and figures presented is all that is needed.

However, I would urge investors to take the ideas presented on VIC just as any other source: as fertile hunting ground for great investments. Unlike other sources, it is quite easy to get wrapped up in the analysis presented from the contributors; you can see the sub- stantial work that was done to present the idea.

The best write-ups do an excellent job of demonstrating a clear understanding of the business, its history, the industry landscape, and a sound, conserva- tive valuation. In fact, one of my major reasons for recommending VIC is not only because of the ideas but because of the wonderful education you can get simply by reading the write-ups. This is the last thing you want to do. One of the central tenets of successful investing—and a big theme in this book—is to invest in what you understand.

The last thing you want to do is make mistakes that could have been avoided easily with some basic research. As with any of the resources mentioned, use VIC for its insights and recommendations, but do your own work. Your Own Common Sense One of the most underrated and underappreciated sources for good investment ideas is your own common knowledge.

Use your own advantages or those of the people around you to discover new investment ideas. Odds are almost percent that you will be looking at business where the most important factor—understand- ing the business—is virtually guaranteed. In other words, using your interest and lifestyle habits to find those businesses that fit within your lifestyle guarantees that you will always be looking within your circle of competence.

While I admire Warren Buffett a great deal and give him credit for the great bulk of my investment philosophy, one area he and I differ on is our dietary habits. While Buffett usually begins his day with a Cherry Coke, I usually start my day off with a mango smoothie or some other type of fresh-squeezed fruit juice.

I enjoy eating lots of fresh fruits, generally avoid soft drinks herbal tea is my choice for a pick-me-up, although I do enjoy a good root beer or cola , avoid eating meat on a daily basis, and pay close attention to food ingredients. So, it should come as no surprise that I am very fond of and familiar with Whole Foods.

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