Monday, 29 February 2016

My simple dumb way of following Warren Buffet method of investing (With pictures!)

There are 3 main points in valuing a stock

1)Value of the company now

2)Fundamentals of the company

3)future earnings


This is literally the basis of the discounted cash flow method where you

- Predict future cash flow(3)
- Compare it against the value of the company(1)
- Take a discount(margin of safety) based on how well you think the company can achieve these future cash flows (2)


1) is easy, load up any bloomberg terminal and you get the answer



When P/E bands are narrowly trading around 18-20x, you know 16 and below is cheap and vice versa


2) is also easy, grab the company's annual report, do the usually check on its cash flow, D/E ratio, margins, ROE/ROA etc and you get quick a good picture of the company


3) Now this is the hard one, and its also the point that essentially dictates whether you are going to make or lose money on the stock.


So how do I do #3? How do I beat all the super smart people that are being paid $10k a month, to not create anything productive but instead to just guess what the company is going to earn next year?


What i do is to....... Not try to predict the company earnings but just find companies with predictable earnings.


I know myself, I'm a lazy investor that cant be bothered to fight with all the smart people head on, I like to answer questions where the answers are also a dead certain


Warren Buffet quote ' I don't cross over 10 feet poles, I look for 1 foot poles to stepover'

Just take a look at the earnings of raffles medical



With my lazy intellect, I can safely assume that this company is going to get me between 0-10% growth a year


Or even Comfortdelgro



I don't need some analyst to tell me that comfort is going to grow 5-6% next year, I can see that for myself



Barring some unforeseen
-terrorist act
-government order
-recession or the end of capitalism as we know it


I can feel safe with these numbers without you know... putting much effort



Of course this largely depends on the industry

Some people look at Sembcorp (like alot of retail investors do)

see it grow about 10% yoy (like alot of retail investors do)

see its high yield (like alot of retail investors do)

assume it will do so in the future (like alot of retail investors do).


Then you forgot about the part where rigs are tied to oil price, and go thru cycles.



Boom -22%!



However, the downside of this method is you dont get those spectacular returns, unlike when you call for the bottom or turnaround in an industry.

Thats because the market rewards people that do hard work and understand cyclical industries, small caps or those that swing from losses to +100% profit next year.


I on the other hand, am slightly allergic to hard work (even though I'm trying to improve), and I don't feel confident on taking all the 'smart people' who are in the serious business of making money head on.

*Insert sun tzi art of war quote here* (know yourself, fight the battles you can win etc etc)


I'm looking for stocks that is at least

-10% undervalued

-grows 5% a year

-pays 2-3% yield.


In 5 years that results in 10% + 5(3%+5%) = at least a 50% gain which is about 10% a year.


Now, even though it pains me to say this: markets are surprisingly quite efficient (most of the time)

and that its quite hard to find these stocks at even a 10% undervaluation.


But certain events such as

1) General market weakness

2) Slight miss in quarterly earnings

3) 1 time solvable problems


Can give you that window to invest


1) General market weakness




Comfort tanked about 13% due to the so-called China 'meltdown'
I'm sure that would hurt Comfort when it has a great...... 5% revenue exposure in China



2) Slight miss in Quarterly earnings


I don't have an example here, since most of my stocks have a bad, or should I say good track of beating earnings. But the point is, unless there's a huge shock or change in the direction of the company, there is no cause of concern.


If you expect the company to make 5-7% a year and it actually made.... 4%. I mean I'm disappointed but it shouldn't cause panic which is what Mr Market sometimes do


3) 1 time solvable problems



Visa tanked 13% in less than a month when Russia wanted to ban it (Russia contributes to a stunning.... 1% of Visa's revenue). It didn't get banned anyway.



The huge risk

However there is a huge risk in this seemingly safe method which is the structural shift of the company or industry.

This method heavily hinges on the company being in a position/industry so impenetrable (think coke) that it can be counted on to deliver steady earnings and is awarded with a generally high PE level.


But when the company loses it, everything gets thrown out of the window.

Lets start with Warren Buffet stocks (since he is a big user of this strategy)


1. Walmart/Tesco (Position decimated by amazon)





2. American Express (Decimated by supreme court ruling and losing its brand to Visa/MA)




3. IBM (Destroyed by cloud computing giants, though it may be too early to write them of as ibm has continuously reinvented itself)







I'd like to add on another i fell for


4. Sands China (Anti- Corruption Drive)





The good thing is these problems even though well-documented, takes AGES for the market to realize it.


Visa and Amazon didn't come out of nowhere, and neither did cloud computing giants. Xi started his anti-corruption drive back in 2014. So there should be ample time for you to get out when you see the signs


The bad news is that it hurts a lot, you suffer the horrible word called 'de-rating' where instead of having a nice 20x you get sent down to 12-13x, funnily enough same pe as industrials


The other bad news is that theres alot of false challenges. Loads of people tried to displace coke over the years and yet no one is calling for its demise, apple pay is trying to supplement visa (maybe in 10 years), but failing horribly etc etc.


Conclusion

Its not totally a buy-and-hold strategy, you still have to sell out when there is large structural changes, or when the stock gets too pricey (I mean if the stock goes up 20-30% while earnings grow 5%, there is a bit of a problem) its good to take money off the table.

But if you do want a sleep-easy portfolio, something that you won't feel worried about when the markets are tanking, then this may be a good method to start your investing journey

P.S I started investing 4 years ago, and I'm still refining this method instead of trying new ones

P.P.S Look at the performance of the companies I mentioned during this downturn (aka. coke, comfortdelgro, raffles medical, visa), in this period of horrible times they are all trading..... near record highs

P.P.P.S That makes me quite mad because they aren't cheap. I'm in this situation where the markets are tanking and I can't seem to add positions.


2 comments:

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