Transcript Value Investing

Value Investing
Buying Good Companies that
Are out of favor with the market.
…CHEAP!
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Value Investors
To name only two of many:
Warren Buffet
David Dreman
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Making Market Panics Profitable
Be fearful when most others are investing
aggressively.
Invest aggressively when most others are
fearful.
– But invest selectively
Warren Buffet, approximate quotation
Think: Panic, time to make $$$ !
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Tell ‘em what y’ur
goin’ a tell em
I hope you read Dreman’s book.
This evening we’ll define Value & Growth
Investing
Show you how to find Value companies
Given examples of “out-of-favor” companies
– And how to use CF, Book Value and the SSG to
evaluate them
Talk about dealing with the psychological
barriers
Discuss when to sell them
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Handouts, etc
GE Cash Flow Statement from Sept. 2009
JP Morgan Cash Flow Statement
TEVA Income and CF Statement, latest
quarterly, (6-K)
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Value vs. Growth
Value: Any company (growth or mature) that has
come upon bad times and whose price has
dropped.
Growth: A company whose sales and earnings
are growing well above the market averages or
GDP
Growth in normal times if the stock is at a
bargain price
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Value vs. Growth
Value dominates opportunities when
economy is in crisis
– But also a few value opportunities in normal
times
Again: Growth in normal times when the
stock is at a bargain price.
– Longer time horizon
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Possible Value Companies
We’ll check out a few of these
GE
FRE, FMA, SMA
AIG
WFC, BOC, JPM, GS, C,
GM, F
Some of these will go out of business
– Like Bear Stearns, Lehman Brothers
– Don’t just buy them!!
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Finding Value Companies
The press dramatizes these and helps
drive the price down
– Take advantage of it
Screen for them, maybe
– Sales growth up, p/e down, cfo up, future
market opportunity = TEVA
– Then the SSG screen and more analysis
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Using SSG for Value Co.s
Look for RR Tracks
– Acceptable in prior years 2 through 5
– Okay if broken in current years IF
You can find evidence the
company will recover.
Run SSG
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Go to SSG’s of
GE
FRE
JPM
TEVA
General Electric
Freddie Mac
JP Morgan Chase
Teva Pharmaceuticals
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Consider Buying Companies
that …
Had reasonable RR tracks in normal times
Are still financially sound with good
management.
Were slammed by events beyond their control
Can come back… gorillas,
Are way under valued
Are not necessarily “growth companies”
Then, if a mature company, sell when the p/e
and earnings reach historical levels.
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Have an Exit Strategy
If a mature company
Price growth may flatten when normal
times return
This is a shorter term situation
Thus, sell when price growth flattens; buy
a growth company
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Financial Crisis Strategies
Set aside cash reserve to last several
years. Buckets of Money approach, (Ray
Lucia).
Put aside additional cash early to invest
“at the bottom”
Get out early. But there is a danger of not
having a real crisis
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Consider the Business Cycle
…an econometric model
Just a taste… Consider doing
more research on this if
interested.
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Qinsight’s Insight
High at about
14,200 Oct. ‘07
Ease
Off
Early
Revival
Ease off
Close to
Plunge
Dow
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Plunge
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Financial Crisis Strategies
Leading indicators: Wait for the “plunge” to end
and start value investing in sound undervalued
companies in early revival phase.
After “plunge”,Continue to buy regularly to dollar
cost average back into the market.
Sell the mature companies you bought when
their valuation reaches fair value
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Qinsight’s Insight
High at about
14,200 Oct. ‘07
Ease
Off
Early
Revival
Ease off
Close to
Plunge
Dow
05
06
07
Plunge
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09
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Leading Indicators
Raise cash before “plunge”
Begin re-investing in “early revival”
Go to www.qinsight.com/
Read the free weekly advisory
Subscribe if you find the weekly advisory
helpful and you want more.
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Risks of Buying Value Stocks
Bankruptcy
Breakup of Company
Sale of Company
Sale of Assets or Chunks of Company
while the company survives.
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Bankruptcy
General Motors Investors
– Common Shareholders are the last to eat at
the carcass. GM Common Stock went to zero
– Bond holders are among the first to eat at the
carcass. GM Bond holders recovered some
or all of their investment.
NO More on GM… Now for
GE
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Breakup or Sale of Company
Generally sells at “premium to the market
price”
Generally the shareholders get a piece (s)
of the buying company.
Risk is buying above the buy out price
Reward is buying below the “premium
price”
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Company Sells Assets
to Raise Cash
For example Kodak and GE
Companies are in weak bargaining
position
Companies often hold on for years at a
low price.
See “Comcast Advances in Deal For NBC”
Why is GE selling NBC?
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GE selling NBC
About half of GE’s business comes from
GE Capital Services (commercial real
estate)
– Big downtown office towers, etc.
Commercial real estate is undergoing
financial problems as small businesses
collapse
GE needs the cash
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Things to Consider
Cash Position of the Company
Does the company have liquid saleable
assets?
Is it “Financially Strong Enough to
Weather the Crisis?”
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Things to Think About
Get a higher return for more risk.
Is the company cheap because of the
general economy?
What controls the company’s destiny?
– The market?
– The government?
– International events?
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Key Questions
Are they still the gorilla in their market?
Has their stock price hit the bottom and
bounced at all.
What would be your sell strategy if you
bought this company? If they get back to
their high price, will they continue to grow,
or will they flat line?
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David Dreman’s Rules
From: CONTRARIAN INVESTMENT
STRATEGIES, The Next Generation
Rule 29: … Buy during a panic
Rule 30: … Analyze reason for lower
prices
– Were they the company’s own doing?
– Is the management still in place?
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Plan for the Next Panic
Condition yourself
– Emotional response
– Over reacting
Plan ahead
– Have dollars to invest
– Understand how to identify value situations
– Allow situations to lead you to value stocks
Think: A panic… Great! Time to make $
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Psychological Barriers to
Thoughtful Investing
Or
How to Avoid Going off the
Deep End
Adapted from Contrarian Investment Strategies
By David Dreman
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Common Reasons
for Bad Decisions
Over Reaction
Pressure of ‘social reality’
– The consensus of the group
Group peer behavior
Psychological pressures
– Powerful under conditions of uncertainty
Unrecognized cognitive bias
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Understand Them!
Understanding these pressures is the best
protection against stampeding with the
crowd, but easier said than done.
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Cognitive Bias
Limitations of Information-Processing
Capabilities
Systemic Bias of Information-Processing
‘Shortcuts’
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Shortcuts
Shortcuts highly efficient and timesaving
– Swamped with information
– Can react only to part of it
– We use rules of thumb to simplify handling avalanche
of data
Shortcuts work systemically against us in the
marketplace.
– Reach different conclusions than what we should.
– Produce distortions about true odds
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Cognitive Bias:
Representativeness
Draw analogies and see identical
situations where none exist
Give too much emphasis to the similarities
of events or samples
Give too little emphasis to the probability
they will occur
May reduce the importance of variables
that are critical in determining the event’s
probability
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Overcome trap of
Representativeness
Dreman’s Rule to
Look beyond obvious similarities between
a current investment situation and one that
appears equivalent in the past.
Consider other important factors that may
result in a markedly different outcome
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Cognitive Bias
Law of Small Numbers
The smaller the sample used (or the
shorter the record), the more likely the
findings are chance rather than meaningful
We over-generalize the meaning of a
small number of supporting facts
Limited statistical evidence seems to
satisfy our intuition no matter how
inadequate the depiction of reality
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Dreman’s Rules to Overcome the Law of
Small Numbers
Don’t be influenced by the short-term
record of a money manager, broker,
advisor or pundit
Don’t accept cursory economic or
investment news without significant
substantiation
Don’t rely solely on the detail of the
present situation: take into account the
known prior probabilities of profit and loss
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Cognitive Bias:
Ignoring the Regression to the Mean
Over the long run, things trend back to the
average instead of becoming more
extreme
Prevalent belief is that extreme returns,
both good and bad, will persist. Actually,
they are outliers
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Dreman’s Rule to Overcome Trap
Don’t be seduced by recent rates of return
for individual stocks or the market when
they deviate sharply from past norms.
Long-term returns of stocks are far more
likely to be established again. If returns
are particularly high or low, they are likely
to be abnormal
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Cognitive Bias:
Inputs and Outputs
should be Closely Related
Demanding immediate success invariably
leads to playing fads or fashions currently
performing well
Actually, the value (input) is often not
recognized in the price (output) for quite
some time
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Dreman’s Rule to
Overcome the Trap
Don’t expect a good strategy to prove a
quick success in the market; give it a
reasonable time to work out
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Cognitive Bias
Availability
A mental rule of thumb by which people assess
the frequency or the probability of an event by
the ease with which instances of occurrences
can be brought to mind.
Usually recall events more easily that have
occurred frequently
Recall can be distorted by
– Recency
– Emotional charge
– Extremely good or bad characteristic
These distortions move judgment away from
long-term probabilities
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Summary
Cognitive biases are locked more firmly
into place by group pressures
When our own biases are reinforced by
the powerful influence of experts and peer
groups we respect (and who interpret
information in the same way we do), the
pressure to follow becomes compelling.
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Summary
We are too apt to look at insufficient
information in order to confirm a course of
action
We are too inclined to put great emphasis
on recent or emotionally compelling events
We expect our decisions to be met with
quick market confirmation
We need protective rules against the tug
of prevailing fashion
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Will the
Company Survive?
Check the
Financial Statements
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Will the Company Survive?
Necessary Financial Strength
– Can they service their debt?
– With Cash
– Or by selling Marketable Securities
– Saleable Assets
Book Value (ultra conservative)
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Financial Statements
We offer a separate financial statements
workshop.
A GE Financial Analysis will follow. The
conclusions of the GE financial analysis will be
shown, not the whys and hows.
Go to
www.betterinvestingsandiego.org/resources and
look for the article on financial statements
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Why GE
BI Magazine, September, 2009; p 8
Club Accounting #1 most active @ 147
buys and 30 sells
Bivio #2 most active @ 131 buys and 43
sells
SSG looks mature
Big price dip looks value
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Cash Flow Analysis
Having Sales and Earnings does not
equate to having cash.
Always watch Cash Flow from Operating
Activities.
– This is the net amount of cash the company
took in (not necessarily earned) during the
reporting period.
– A business can’t continue to operate without
cash.
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Cash Flow Analysis
A healthy company generates cash from
its operations
Uses cash to make investments
Uses cash to pay shareholders, debt
holders
Has enough cash left to operate the
business for the next period
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Saleable Assets
on Cash Flow Statement
Check Cash Flow from Investing Activities
Example (GE)
GE is selling NBC to Comcast for “around
$30 Billion”
Go to http://sec.gov/edgar to see how long
that might last GE
– Go over detail of GE Cash Flow Statement
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Start with the GE
Cash Flow Statement
9 months ended
Sept. 30, 2009
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Summary of GE so far
Income STATEMENT
– Interest coverage = how many times PTP pays interest
– Interest coverage = $7.7B EBT + $14.3B net interest ÷ $14.3B
net interest = 1.54
– Acceptable interest coverage is > 4
– GE failed the interest coverage test, so dig deeper
Balance Sheet
– $160 B due in “Short Term…” Debt
– $358 B due long term
– Mostly debt of GECS
Cash & Cash Equivalents = $61 B
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Will GE Survive?
Managing Debt
– Cash & Cash Equivalents
– For Sale Securities
– Short Term Borrowings
Saleable Assets, see Business Segments
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For Sale Securities
$53 B
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Short Term Borrowings
Due within
12 Months
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Saleable Assets
Business Segments
$30 B
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Saleable Assets
Business Segments
$65B ?
$75B ?
$90B ?
$20B ?
$30 B
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Let’s Add it up!
GE needs $70B to $160 B to service debt in next
12+ months
Cash Flow Operations Est. > $15 B
Cash & Equivalents = $61 B
$ 76B
Saleable Securities = $53 B
$ 129B
Sale of NBCU = $24 B
$153B
– $6 B to Vivendi for its share of NBCU
Sale of rest of company = $250 B
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How COULD GE Manage its debt?
Assumes $ & debt is all accounted for
Service current debt.
– Pay interest and principle due
Pay off or roll short term borrowings
– Roll means to write a new loan
Reduce “net interest” by managing interest
coverage upward
– Move ratio of PTP to net interest from 1.5
ultimately to 4 or higher
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More Conclusions
Leverage is not a good thing !
Borrowing more money is costly or
impossible when they can’t service their
debt from earnings
– Debt is a terrible thing to have in a financial
crisis.
– Not well positioned to buy good deals
– Won’t have the cash to speed their recovery
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Speculation about the
Financial Analysis
GE will be a smaller company for a while
– May need to sell off more parts of GE
GECS may be monetizing future
commercial real estate receivables.
– “Do I have a deal for you! Pay me now and I’ll
give you a great bargain”
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Homework
Understand the calculation of GE Book Price
Look at JPM and TEVA
– Financial Statements attached to your notes
JPM, a bank that took TARP $
TEVA, an Israili Pharmacuitical Company
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–
–
–
Growing sales
Somewhat flat earnings
Flat stock price
Growing cash flow from operations
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When to Sell Crisis Stocks
When the crisis is over and the economy
has recovered.
When the P/E reaches the average for the
industry.
Rule 21: Sell when P/E reaches that of
the overall market, regardless of outlook.
Rule 19: Buy mid to large cap companies
Rule 15: Buy blue chips
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Tell em what yu told em
We recommended Dreman’s book.
We’ve defined Value & Growth Investing
Showed how to find the companies
Discussed the psychological barriers
Given examples of out of favor companies
– And how to use CF, Book Value and the SSG
to evaluate them
We discussed when to sell them
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Do you have Questions?
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Next BI Event
Mark your Calendars !
February 4th, 2010
Thursday between 6:30 and 9:00 PM
Right here
Club Accounting
Using Took Kit 6, The Stock Selection
Guide
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