Investing Ideas—Phil Town—Rule #1



Investing Ideas—Phil Town—Rule #1



“You don’t have to be smart to make money—you just have to do what the best investors have.” Phil Town

I. Three Myths of Investing

A. You have to be an expert to manage money.

B. You cannot beat the market.

C. The best way to minimize risk is diversify and hold (for the long term).

II. Dollar Cost Averaging

III. Rule # 1 and the Four M’s

A. Don’t lose money—“buying a wonderful business at an attractive price.”

B. What does wonderful business mean?

1. That the business has Meaning to you.

2. That the business meets certain criteria in terms of financial strength and predictability.

3. That a business has good management.

C. By ‘attractive” Town means we can buy the business with a Margin of Safety

(MOS). To Town a nice MOS is buying a dollar value for fifty cents (in other

Words you get the company share for ½ off).

D. Four Steps to investing:

1. Find a wonderful business.

2. Know what (the company) it is worth as a business.

3. Buy it at 50 percent off.

4. Repeat.

E. In essence, Rule #1 is just being a good shopper.

F. The Four M’s

1. Does the business having “Meaning” to you?

2. Does the business have a “Moat”?

3. Does the business have great “management”?

4. Does the business have a big “Margin of Safety”?

IV. Buy a Business Not a Stock

A. Does the business have meaning to you?

1. Do you want to own the whole business?

2. Do you understand it well enough to own all of it?

B. 10-10 Rule

1. I will not own the business for ten minutes unless I am willing to own it for ten

years. Passion Talent

Money

C. Ask your self these three questions:

1. What do you love to do, professionally, and as recreation?

2. What things are you good at?

3. What do you do to make money or what do you spend money on?

D. Buying a business (according to Phil Town) has taught him two things:

1 Businesses that lack the history to make a prediction of the future

is inherently risky.

2. Don’t touch a business you do not understand.

V. Identifying a Moat

A. A definition by Warren Buffett (the second richest man in the world) on Moat:

“A durable competitive advantage that protects it (the company he means) from

attack like a moat protects a castle.”

B. If an industry looks as if it might be very easy to get into (no barriers to entry),

there probably is not a Moat. Examples of easy to enter businesses are: farming,

pharmacy, deli, gas stations, or T-shirt shop.

C. Moats keep up with inflation.

D. The Five Moats are:

|Type |Definition |Examples |

|Brand |a product you are willing to pay more for |Coke, Gillette, Disney, McDonalds, Pepsi, |

| |because you trust it. |Nike, Budweiser, Harley-Davidson. |

|Secret |a business that has a patent or trade |Pfizer, 3-M, and Intel |

| |secret that makes direct competition | |

| |illegal or difficult. | |

|Toll |a business with exclusive control of |media companies, utilities, and ad |

| |market-giving it the ability to collect a |agencies. |

| |“toll” from anyone needing that service or | |

| |product. | |

|Switching |a business that is so much a part of your |ADP, Paychex, H&R Block, Microsoft. |

| |life that switching is not worth the | |

| |trouble. | |

|Price |a business that can price products so low |Wal-mart, Costco, Bed, Bath, and Beyond, |

| |no one can compete |Home Depot, and Target. |

E. If you are a company committed to protecting itself from potential invaders, your Moat must also be sustainable. It must be able to sustain (itself—the company) more than twenty (20) years or more.

F. The Big Five:

1. Return on Investment Capital (ROIC, or ROC, or ROI) > 10% per year for 10 years.

2. Sales Growth (Revenue) Rate > 10% per year for 10 years.

3. Earnings per share (EPS) growth rate > 10% per year for 10 years.

4. Equity (or Book Value or BVPS) growth rate > 10 % per year for 10 years.

5. Free Cash Flow (FCF) growth rate > 10 % per year for 10 years.

G. ROIC

1. Check the ten-year average, the past five years’ average, and last year’s average.

2. You must also check ROIC and these four growth rates:

a. Sales growth rate

b. Earnings per share growth rate

c. Equity growth rate

d. Free Cash Flow

3. Sales-are the total dollars the business took in from selling (sales).

4. EPS (Earnings per Share), tells us how much the money business is profiting per

share of ownership.

5. Equity-is what you have if a company sold off everything, paid off debt, Book

Value Per Share—after everything is sold and money divided per # of shares =

BVPS. Equity = the total money made by selling everything (another name is

liquidation value). Equity is also known as intrinsic value ( Warren Buffett calls

Equity this) or what Phil Town calls Sticker Price.

6. Cash = the amount left over at the end of each quarter.

7. Consistency is important to keep track of.

8. ROIC is always given as a percentage, while values for sales, equity, and cash

are in millions of dollars.

9. A business that can grow its earnings at 15 % a year indefinitely has a higher value

placed on every dollar of current earnings.

10. If you are not sure you understand (the business) then this is not an industry for you to

be investing in (look @ Pages 84-85 for more info).

11. Check borrowing based amount on Long-term debt (Total) vs. Free Cash Flow.

If a company can pay off that debt in three (3) years or less you have a good

company.

12. A good dividend is one that is paid out with money the CEO cannot efficiently

allocate to growth.

H. Calculating the Big Five:

1. Four Ways to calculate growth rates:

a. Learn how to use Excel rate calculations.

b. Learn how to use Rule # 1 calculators @ the website

().

c. Learn how to do calculations by hand.

d. Look up the growth rate numbers on the stock data website.

2. Example---( go to --( Financial Results --( Key Results

---( Key Ratios --( Growth Rates

3. Rule of 72 Cheat Sheet:

|Approximate years to double once |Growth Rate |

|2 |36 |

|3 |24 |

|4 |18 |

|5 |15 |

|6 |12 |

|7 |10 |

|8 |9 |

|9 |8 |

|10 |7 |

4. Priority of Growth Rates (which of the growth rates are most important)

a. Equity Growth

b. EPS Growth

c. Sales (or gross profit) Growth

d. Cash Flow Growth

5. ROIC and how to calculate it:

net operating profit after tax = ROIC

equity + debt

or Net operating profit after tax = NOPAT

I. Betting on the Jockey (CEO)

1. Must have (CEO must have) certain qualities

a. owner-oriented

b. driven

2. Owner-oriented-the best way we can do this is to pick a CEO who seems to be

acting as if the company were the only asset their family will own for the next

100 years.

3. Driven—is that he or she is driven to change the world in some small and cool way

or BAG Big Audacious Goal.

4. Look for articles on the CEO that have terms that are “humble” or self effacing.”

5. Also check out as a final test:

a. Insider trading activity

b. CEO compensation

* Check out under the company report check out Insider trading (

Remaining shares. Check out Annual Reports and executive Compensation

Part III of the 10-K --@ Edgar Online or SEC Filings @ .

J. Demand a Margin of Safety

1. It’s what defines our “attractive price.”

a. Efficient Market Theory (EMT) developed by Burton Malkiel of Princeton

University states “that stocks are priced according to their value.”

b. Buy $100 of value for 50cents. This is possible because sometimes the value of

a business we want to buy is not equal to the price it’s selling for. Price is what

the market is getting for the business today. Value is what it is worth.

c. A big part of the secret of getting rich buying businesses is knowing what they

are worth and what they are not worth.

d. Knowing that price is not value and Mr. Market is going to price stocks crazy

from time-to-time.

e. First, we determine the value—the sticker price, then the Margin of Safety price-

the MOS, which is half of the sticker price. If we do not get our MOS price, we do

not buy the stock.

K. Calculate the Sticker Price

1. Sticker price is also know by other names intrinsic value, fair value, and simply

retail value.

2. It’s what the market should be selling it at (but does not always).

3. To find the sticker price, we need four numbers:

a. Current EPS

b. Estimated (future) EPS Growth Rate

c. Estimated Future P/E

d. Minimum acceptable rate of return from investment.

4. Current EPS =

a. Trailing Twelve Months

b. Estimated EPS Growth rate look at “Future EPS Growth rate or Equity Growth

Rate.

c. Estimated Future P/E:

4.1 P/E x EPS = Price or P/E = Price divided by EPS

4.2 The P/E ratio indicates how much we are willing to pay for a dollar’s

worth of a company’s earnings. Pick the lower of either the historical P/E or

or the default P/E.

4.3. Minimum Acceptable Rate of Return is 15% per year.

4.4. From Future EPS to Future Market Price—Divide the Future EPS / Future

P/E. Example: 320/ 4 = 8.

4.5. From Future EPS to Sticker Price—320 / 4 = 80. You would need to be able

to buy the stock for $80.00 or less.

4.6 Sticker Price to MOS—Take 50% of 80 = MOS which is $40.00

L. Know the Right Time to Sell

1. There are two times to sell:

a. When the business has ceased to be wonderful.

b. When the market price is above the sticker price.

2. There are only two (2) reasons a business can change from wonderful to not

wonderful:

a. Due to an outside attack (by another company or i.e. more competition).

b. An Inside Traitor.

3. The market price is above the Sticker Price.

a. If the stock is doing well + technical are keep the stock.

M. The Three Tools (Technical Tools)

1. MACD or Moving Average Convergence/Divergence. Developed by Gerald

Appel.

a. The numbers at 8-17-9 to make it more sensitive. “Beginning of a mountain time to buy. Beginning a valley time to sell.”

2. Stochastics- developed by Dr. George C. Lane. This a momentum toll that tracks

the overbuying and or overselling of a stock.

a. Buy line crosses up indicates a t buy. Buy line crosses down indicates a sell.

3. Moving Average or Market Psychology—this tool tracks an average price during

a specific time period. Moving averages are simply closing prices over a defined

number of days divided by that number of days. Use a ten (10) day moving

average.

a. When the price line crosses above the moving average line buy. When the price

crosses below the moving average, sell.

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