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The Little Book that Beats the Stock Market

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The Little Book that Beats the Stock Market Should you buy individual Stocks and When ? Should you buy a lottery ticket ? When ? Your going to do it. – PowerPoint PPT presentation

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Title: The Little Book that Beats the Stock Market


1
The Little Book that Beats the Stock Market
2
Chapter 1
3
Bubblegum sales business Earns 500 for next 6
years What would you pay ? Write down a number.
Concept Time Value of Money or Net Present Value
4
A) Competition B) Not as good at Selling C)
New Technology- Kids prefer something else
What are the Risks to Buying this Business ?
5
A) Can you sell more ? B) Can you cut costs ?
Sams C) Expand Market ? D) New Products ?
What are Opportunities to Buying this business
Buying Stock is like Buying a Business !
6
Chapter 2
7
A) Mattress Pros / Cons ?
Options to Invest 1,000 ?
B) Savings Account Bank-Pros/Cons?
C) Corporate Bond What is a corporate Bond ?
Pros/Cons ?
D) US Treasury Bond- What is a US Bond
Pros/Cons ?
And of course Equities/Stock !
8
US Treasury Bond
  • Called Risk Free or No Risk Why ?
  • Almost 100 Guaranteed
  • Every Investment Option you chose should exceed
    this

Question If Teddy starts Gilman Investment Co
and guarantees a return, what should the return
at minimum be ?
9
Chapter 3
10
Jasons Gum Business Has Grown !
JASON's GUM SELLING BUSINESS JASON's GUM SELLING BUSINESS


Sales 10,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 4,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 2,000,000
Taxes (40) (800,000)
Net Income 1,200,000
  • Decides to Do an IPO (Initial Public Offering),
    What is the value ? What would you pay ?

11
Corporations / Stock
2012 685B 90
  • Why form a corporation ?
  • IPO
  • Initial Public Offering
  • Need to be something in Demand-What
  • do you think will be in 2013 ?
  • c) Need Underwriter
  • d) Go on road show-Generate Buzz
  • e) Extremely Stressful
  • f) Can make a lot of money-
  • GM 23.1B, Facebook 104B

12
IPO Initial Public Offering-Facebook
  • In 2006 Offered 750,000 from Viacomm ?
  • In 2007 Microsoft buys 1.6 for 240 Million
    beating Google (Valuation 15B)
  • May 18th, 2012 goes public at 38/share worth
    104 Billion
  • Today what is stock price ?
  • 40 Lawsuits after the IPO, Botched IPO

13
2013/14 IPOs
Twitter
Dropbox
Priced at 20 11/4/2011 Closed at 26 first
day Gone down to 5.73
14
Would you want to work for a start-up ? What are
Pros / Cons to you ? Stopped 2/25/13
PROS To see business ideas develop. To
contribute to those ideas and chart a course of
action. Collaboration with creative,
enthusiastic professionals. Changing demands and
a flexible, changing schedule. Greater autonomy
and authority. A quick education in how a
business works. The potential for large
financial rewards.
Cons Lower Salary / Benefits No Job
Description/Unsure how to get things
done Limited Resources Can be Long Hours Risk
of Losing Job Quickly
15
2013/14 IPOs-Forbes Magazine
Twitter
Dropbox
http//www.forbes.com/pictures/eihm45mdmf/spotify-
2/
Priced at 20 11/4/2011 Closed at 26 first
day Gone down to 5.73
16
Jasons Gum Business Has Grown !
JASON's GUM SELLING BUSINESS JASON's GUM SELLING BUSINESS


Sales 10,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 4,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 2,000,000
Taxes (40) (800,000)
Net Income 1,200,000
  • Sell 1,000,000 Shares at 12/share.
  • What is Earnings per Share ?
  • What is Rate of Return on Buying 1 share ? Called
    ?Earnings Yield.

1.20 1.2/12 10
17
Jasons Gum Business Has Grown !
JASON's GUM SELLING BUSINESS JASON's GUM SELLING BUSINESS


Sales 10,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 4,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 2,000,000
Taxes (40) (800,000)
Net Income 1,200,000
  • Is 10 Acceptable ? Why
  • What would you like to know to make this decision
    ?

18
Chapter 4
19
Look At Apple Article
  • 52 Week High
  • 52 Weeks Low
  • EPS Changed much ?
  • What is apple worth ?
  • What is Margin of Safety ?
  • What would you like to know to make this decision
    ?

20
Chapter 5
21
Recall Jasons Gum Selling Business

Sales 10,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 4,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 2,000,000
Taxes (40) (800,000)
Net Income 1,200,000
  • Sell 1,000,000 Shares at 12/share.
  • What is Earnings per Share ?
  • What is Earnings Yield on Buying 1 share ?

1.20 1.2/12 10
22
Suppose Net Income Rises to

Sales 12,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 6,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 4,000,000
Taxes (40) (1,600,000)
Net Income 2,400,000
  • Sell 1,000,000 Shares at 12/share.
  • What is Earnings per Share ?
  • What is Earnings Yield on Buying 1 share ?

2.40 2.4/12 20
23
Suppose Net Income Rises to

Sales 12,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 6,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 4,000,000
Taxes (40) (1,600,000)
Net Income 2,400,000
  • So is 2.40 better than 1.2 ? 20 better than 10
    ?
  • Does this mean its a good company that you
    should buy ? Why or Why not ?

24
Look at Blockbuster
  • 1994 Bought by Viacomm for 8.4Billion?
  • 2008 Tries to buy Circuit City

1/10/10 Got two quarters? Congrats, you can now
buy one share of Blockbuster Inc. (NYSEBBI),
today they finished trading at 50 Cents.
Blockbuster's stock fell 31 today, times have
changed for the company that still holds the
crown as the largest U.S. movie-rental business.
Volume and selling was screaming on Blockbuster
shares today 28.5 million BBI shares have traded
hands, that's more than 14X the daily average.
  • As shares were falling its, Earnings Yield was
    doing what ? Was it a good buy ?

25
Suppose Net Income Rises to

Sales 12,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 6,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 4,000,000
Taxes (40) (1,600,000)
Net Income 2,400,000
  • Why do you think Sales grew ?
  • Two Scenarios
  • a) What if you know that each store Jason opens
    costs 400,000 and would earn 200,000 per store.
    Is that good ? What return ?
  • b) If you could invest in another company of
    comparable risk that costs 400,000 and would
    earn 100,000 per store, should you ?
  • Called Return on capital Return / Investment. a)
    50, b) 25

26
2 Main Concepts
  • 1) Buy Good Companies (High Return on Capital)
  • 2) Buy at Bargain Prices (High Earnings Yield)

27
Chapter 6
28
Steps To Take
  • Take 3,500 largest companies
  • Rank 1-3500 on Return on Capital
  • Rank 1-3500 on Earnings Yield
  • Add up Rankings for each company, divide by 2
  • Could a company with a top return on capital be
    ranked lower overall than the 1,500 ranked
    Company ?

17 Year Period Studied Magic Formula30.8,
Market Avg 12.3, SP 12.4
29
Chapter 7
30
Class Agenda / Hope to Accomplish
  1. Quiz 9-10
  2. Max Presentation
  3. Alex Presentation
  4. Little Book Review
  5. Stock Market Game

31
2 Main Concepts
  • 1) Buy Good Companies (High Return on Capital)
  • 2) Buy at Bargain Prices (High Earnings Yield)

32
https//personal.vanguard.com/us/funds/vanguard/al
l?sorttypesortorderasc
The performance data shown represent past
performance, which is not a guarantee of future
results. Investment returns and principal value
will fluctuate, so that investors' shares, when
sold, may be worth more or less than their
original cost. Current performance may be lower
or higher than the performance data cited.
Magic Formula works for large companies with
established Earnings history. Not recommended for
Small/Penny Stocks
33
What is a Penny Stocks ?
  • Small (In US defined as under 5/share)
  • Tend to be Thinly Traded
  • Highly Volatile
  • Can be manipulated easily. Be careful !

34
Chapter 8
35
Issues w/ Magic Formula
  • Faired poorly in 5 out of every 12 months
  • Failed to beat market one out of four years
  • One out of ever six periods did poorly 2 years in
    a row ?
  • What are your thoughts on these statements ?

36
BILL MILLER
  • Questions
  • What happened to Bill Miller in 2007-2009 ?
  • Why did he lose ? What investments did not work ?
  • Is he a good manager ?

37
Lessons
  • Unfortunately Everyone Loses Miller,
  • Buffett, Graham

2) Avoid putting your eggs/investments in One or
very few baskets Financial Sector-Miller
3) Well be reading about Mr. Miller again
in The Big Short
38
ACTIVE VS. PASSIVE
  1. What is an Active Investment Strategy ?

2) What is a Passive Investment Strategy ?
3) 60 - 80 of the time a Passive Strategy Beats
an Active Manager ? Should you invest Active?
39
Why Active ?
  1. Manager over time consistently beats index
  2. As investor believe in certain sector (no index)
  3. Want to try and beat average-Not content with
    average.
  4. Strategy of manager may fit with overall portfolio


Read Article for Discussion, then Review
Morningstar and answer these questions.
40
1) Growth or Value / Large Cap or Small Cap ?
ACTIVE VS. PASSIVE
2) How has Fund done last three Years ? What type
of market (Bull or Bear) did this fund perform
best?

3) Has Fund Done well relative to Benchmarks ?
4) Tell me three other things that matter?
41
Mr. Greenblatt
  • Invested with the Smartest Money Manager he knows
  • Hundreds of Top Investors
  • Had tough 3-4 years
  • Only 4 original clients stayed with him
  • Came back, Top Performing Fund since Inception
  • Why did people leave ? Why did people leave Mr.
    Miller ?

42
What are you going to be ?
  • Speculator Try to anticipate and profit from
    market fluctuations. Sell when things are going
    down, buy when things are going up ? It can be a
    drug, feeling great when going up, killing you
    when coming down.
  • Investor Try to acquire and hold suitable
    securities at suitable prices. Market movements
    present great opportunities to buy or sell.

Kahneman/Tversky Pain of a loss is 2 times as
great as pleasure of a gain. Losing is so
painful, leads to panic and near bottom and not
buying more, even when price is great !
43
March 10th, 2000
  • Nasdaq hits all time high, Cisco highest market
    Capitalization. Ralph Acampora says Norfolk
    Southern or Cisco Where do you want to be?
  • Over next year Cisco lost 70, Norfolk gained
    35
  • Graham The primary cause of failure is that
    individual investors pay too much attention to
    what the stock market is doing

44
Mr. Greenblatt
  • People hate to Lose
  • Investment Horizons tend to be short
  • Those that look at stocks more often do worse
  • The magic formula works because it takes emotion
    out of it
  • Everyone gets caught up chasing a winner. Very
    dangerous in Bull Markets
  • All Bull Markets must end and usually badly
  • Black Tuesday 10/29/1929- 13 in 1 day, down 89
    next three years
  • Black Monday 10/19/1987-23 in 1 day, 2 years to
    recover
  • Black Week Starting 10/6/2008 20 down, DJIA
    High was 14,164 10/9/2007, currently XXXXX down
    XX

45
Tough not to get caught up
  • Everyone talks about their winners ! Not losers !
  • Winners draw attention, prices go up, becomes
    speculative
  • Leads to constant checking, panic

Paul Andreassan (Harvard/Columbia psychologist)
Investors who received frequent updates on
portfolio earned half the returns of those who
did no check at all !
46
You mess with the Bull, You get the Horns !
47
Chapter 9
48
Suppose Net Income Rises to

Sales 12,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 6,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 4,000,000
Taxes (40) (1,600,000)
Net Income 2,400,000
  • Revisit Jasons Stores
  • What if you know that each store Jason opens
    costs 400,000 and would earn 200,000 per store.
    Is that good ? What return on capital ?
  • What could Jason do with this 2.4M ?
  • What would you like him to do ?
  • Do you want Dividends ?

49
This is a great business High Return on Capital,
High Earnings Yield

Sales 12,000,000
COGS (Cost of Goods Sold) (6,000,000)
Gross Profit 6,000,000
SGA (Selling, General, Admin) (2,000,000)
Income Before Taxes 4,000,000
Taxes (40) (1,600,000)
Net Income 2,400,000
  • What is likely to happen (American Capitalism at
    work) ?
  • Competiton !
  • Less Gum Sold
  • Lower prices to attract business
  • Someone builds a better gum shop or gum
  • In the end, Lower Profits ! Good Businesses
    attract competition ! Often from inside employees
    why

50
Bad/Declining Business could be opportunities
  • Why did Dish buy Blockbuster ?
  • Why did Blockbuster want to buy Circuit City ?
  • Year 2000 I am working at PG They are buying
    Sunny Delight ! Why ? What happened ?
  • Do you think Starbucks maintained the premium
    coffee market ?
  • Petes, Dunkin Donuts, McDonalds
  • Less Gum Sold
  • Lower prices to attract business
  • Someone builds a better gum shop or gum
  • In the end, Lower Profits ! Good Businesses
    attract competition ! Often from inside employees
    why

51
A Rising Business could be opportunity depending
on timing
  • What are some businesses that are new and rising
    that are being copied?
  • Frozen Yogurt, Mexican, Made to Order (Panera,
    Cosi after Subway)

52
So can be difficult to maintain a High Return on
Capital. To do so
  • New Products / Constant (RD)
  • Better Products
  • Good Brand Name ? Name some
  • Strong Competitive Postion Ebay 1st, Economic
    Motes

53
Chapter 10
54
The performance data shown represent past
performance, which is not a guarantee of future
results. Investment returns and principal value
will fluctuate, so that investors' shares, when
sold, may be worth more or less than their
original cost. Current performance may be lower
or higher than the performance data cited.
  • Why does performance change if solid for number
    of years ?
  • Often Management changes. 1st Question we ask
    when reviewing managers.

55
What is Risk to you when it comes to investing ?
  • Risk of losing money ?
  • Risk of not having enough for something important
    in life College, Retirement
  • Risk of underperforming vs. other options

56
A version of Risk Boca Raton
  • Wealthy Retirement Community-Florida
  • Author interview retirees Had they beaten market
    over lifetime ?
  • Answer Some yes, some no,One man Who cares,
    All I know is my investments earned enough for me
    to end up in Boca

In the end what matters isnt crossing the finish
line before anybody else but just making sure you
cross it (Reach where you want to go)!
57
Author will argue correctly
  • Expected return must equal risk taken !
  • Rank these options in terms of return expected
    (write down return you expect)
  • US Treasury
  • Internet Startup
  • Procter Gamble
  • Best Buy
  • Bonds from Greece
  • Under Armour

Any time you take more risk, you must generate
more return !
58
Moving on Investment
  • There is no such thing as a good or bad
    stock, only cheap stocks and expensive stocks
  • The best company (ie Apple) becomes a sell when
    its price gets too high while a bad company is
    worth buying if its stock gets low enough

59
Over the Long Term Mr. Market gets it right
Smart Investors jump in when opportunities
present themselves Companies buy back their own
stock (Stock Repurchase) when they think
undervalued. Another Company buys the company
whole (agreed or hostile). Usually leads to stock
price increase !
60
Stock Market Game
61
Chapter 11
62
How to avoid losing BIG Diversification
Dont put your eggs in One Basket ? What does
this mean ?
You have 24 eggs to take home for dinner for
family, you can carry all in one basket or put
12 in two baskets ? What would you do?
63
One way to reduce Risk and Limit significant
losses Diversification
Why does a street vendor sell umbrellas and
sunglasses ?
Why did Hallmark Cards buy a Spanish TV station ?
Why did Phillip Morris (tobacco company) buy
Miller Brewing and Kraft Foods ?
64
Diversification -Why
1) All three examples Want to continue to have
sales or Returns coming in- ideally constant,
limit the significant Ups and downs (standard
deviation)
2) Investing is the same way. Want to keep
investments Giving positive returns If you
invest in 1 stock you have a Standard deviation
of 40, you invest in 15 stocks you have Standard
deviation of 10. Probability of loss w/ 5
Stocks Is 23, with 20 Stocks, 12
3) Some investments do better when its raining
and Some investments do better when its sunny ?
Like Weatherman, cant always predict what is
needed !!
65
Dont Lose Big Especially Early
You Have a Choice
1) You have 10,000. In Year one you lose 50.
After that You make 10/year for 15 years ? 2)
You have 10,000. In Year one you gain 5. After
that You make 5/year for 15 years ?
Investment 1
Investment 2
Year 15 18,987 20,789
You can double the return of investment 2 for 14
years straight And still not make up for a
significant loss !!!
66
Should you buy individual Stocks and When ?
Should you buy a lottery ticket ? When ?
Your going to do it. But make sure you are
prepared for potential losses. A bit like
gambling. Some smart person is buying/selling the
opposite.
67
Chapter 12
68
You have money to Invest? What will you do / Who
will you use ?
  • Stockbroker Understands markets generally,
    access to research, - generally paid to
    sell/fees, good salesman sometimes
  • Mutual Fund Diversification, - Fees, Active
    tends to beat passive, good ones attract money,
    less opportunities
  • Hedge Funds More Diversification, options,
    better managers, - Must have lot willing to lose,
    high fees, best ones get full
  • Index Funds Lower Fees Mutual Funds, - Average
    Returns

69
Chapter 13
  • Recommendations !

70
Remember Importance of Starting Early
Max puts 2,000 per year into the market between
the ages of 24 and 30 (6 years), that he earned a
12 return, and that he continued to earn 12 per
year until he retired at age 65.
Aric also put in 2,000 per year, earned the same
return, but waited until he was 30 to start and
continued to invest 2,000 per year until he
retired at age 65 (36 years).
Who has more at 65 ?
Both 1M How much did Max put in ?
12,000 How much did Aric put in ? 72,000
71
Give Back- Every one of you receives 25 or
6,250 because of some alumni !
Barbara Dodd Anderson 128M to George
School Mr. Rollins - 30M to McDonogh a
scholarship student and valedictorian of the
class of 1915, became an attorney, businessman,
and 27-year McDonogh trustee who repaid the
school many times over until his death in
1985. Mr. Bill Carey 10M to renovate Carey
Hall, Mr Jacobson 5M to build Lumen Center Why
? Why does Harvard need more money
(31.7Billion) ?
Gilman gives all of you a chance to attend a good
school. Gilman hopefully provides an Education
that gives a solid core. Gilman instills traits
that will lead to making this country . A better
place, a stronger country. Hopefully you
appreciate the efforts of past alumni, you want
Gilman to be stronger than McDonogh, you hope
that by investing in Gilman, the world is
somewhat better.
72
Give Back
Make Money , Reinvest in something that gives
back and grows and has meaning to you. Appreciate
all that got you to that point ! Right things to
do and you will feel good about it !
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