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Value Investing

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Title: Value Investing


1
Value Investing
  • Buying Good Companies that
  • Are out of favor with the market.
  • CHEAP!

2
Main Theme Tonight
Making in Financial Crisis
3
Value Investors
  • To name only two of many
  • Warren Buffet
  • David Dreman

4
Making Market Panics Profitable
  • Be fearful when most others are investing
    aggressively.
  • Invest aggressively when most others are fearful.
  • But invest selectively
  • Think Panic, time to make !

Warren Buffet, approximate quotation
5
Tell em what yur goin a tell em
  • I hope you read Dremans book.
  • This evening well 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

6
Handouts, etc
  • GE Cash Flow Statement from Sept. 2009
  • JP Morgan Cash Flow Statement
  • TEVA Income and CF Statement, latest quarterly,
    (6-K)

7
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

8
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

9
Possible Value CompaniesWell 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
  • Dont just buy them!!

10
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

11
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

12
Go to SSGs of
  • GE General Electric
  • FRE Freddie Mac
  • JPM JP Morgan Chase
  • TEVA Teva Pharmaceuticals

13
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.

14
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

15
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

16
Consider the Business Cyclean econometric model
  • Just a taste Consider doing more research on
    this if interested.

17
Qinsights Insight
High at about 14,200 Oct. 07
Ease Off
Early Revival
Ease off Close to Plunge
Plunge
Dow
05
06
07
08
09
18
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

19
Qinsights Insight
High at about 14,200 Oct. 07
Ease Off
Early Revival
Ease off Close to Plunge
Plunge
Dow
05
06
07
08
09
20
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.

21
Risks of Buying Value Stocks
  • Bankruptcy
  • Breakup of Company
  • Sale of Company
  • Sale of Assets or Chunks of Company while the
    company survives.

22
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

23
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

24
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?

25
GE selling NBC
  • About half of GEs 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

26
Things to Consider
  • Cash Position of the Company
  • Does the company have liquid saleable assets?
  • Is it Financially Strong Enough to Weather the
    Crisis?

27
Things to Think About
  • Get a higher return for more risk.
  • Is the company cheap because of the general
    economy?
  • What controls the companys destiny?
  • The market?
  • The government?
  • International events?

28
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?

29
David Dremans Rules
  • From CONTRARIAN INVESTMENT STRATEGIES, The Next
    Generation
  • Rule 29 Buy during a panic
  • Rule 30 Analyze reason for lower prices
  • Were they the companys own doing?
  • Is the management still in place?

30
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

31
and now
Nancy
32
Psychological Barriers to Thoughtful Investing
  • Or
  • How to Avoid Going off the Deep End

Adapted from Contrarian Investment Strategies By
David Dreman
33
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

34
Understand Them!
  • Understanding these pressures is the best
    protection against stampeding with the crowd, but
    easier said than done.

35
Cognitive Bias
  • Limitations of Information-Processing
    Capabilities
  • Systemic Bias of Information-Processing
    Shortcuts

36
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

37
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 events probability

38
Dremans Rule to Overcome trap of
Representativeness
  • 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

39
Cognitive BiasLaw 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

40
Dremans Rules to Overcome the Law ofSmall
Numbers
  • Dont be influenced by the short-term record of a
    money manager, broker, advisor or pundit
  • Dont accept cursory economic or investment news
    without significant substantiation
  • Dont rely solely on the detail of the present
    situation take into account the known prior
    probabilities of profit and loss

41
Cognitive BiasIgnoring 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

42
Dremans Rule to Overcome Trap
  • Dont 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

43
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

44
Dremans Rule to Overcome the Trap
  • Dont expect a good strategy to prove a quick
    success in the market give it a reasonable time
    to work out

45
Cognitive BiasAvailability
  • 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

46
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.

47
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

48
Time for a Break !
49
Will the Company Survive?
  • Check the
  • Financial Statements

50
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)

51
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

52
Why GE
  • BI Magazine, September, 2009 p 8
  • Club Accounting 1 most active _at_ 147 buys and 30
    sells
  • Bivio 2 most active _at_ 131 buys and 43 sells
  • SSG looks mature
  • Big price dip looks value

53
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 cant continue to operate without
    cash.

54
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

55
Saleable Assetson 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

56
Start with the GE Cash Flow Statement
  • 9 months ended
  • Sept. 30, 2009

57
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 gt 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

58
Does Anyone need 5 ?
Next are Helpful Notes from the Consolidated . .
.
59
Will GE Survive?
  • Managing Debt
  • Cash Cash Equivalents
  • For Sale Securities
  • Short Term Borrowings
  • Saleable Assets, see Business Segments

60
For Sale Securities
53 B
61
Short Term Borrowings
Due within 12 Months
62
Saleable AssetsBusiness Segments
30 B
63
Saleable AssetsBusiness Segments
65B ?
75B ?
30 B
90B ?
20B ?
64
Lets Add it up!
  • GE needs 70B to 160 B to service debt in next
    12 months
  • Cash Flow Operations Est. gt 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

65
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

66
It's a Squeeker !
67
More ConclusionsLeverage is not a good thing !
  • Borrowing more money is costly or impossible when
    they cant service their debt from earnings
  • Debt is a terrible thing to have in a financial
    crisis.
  • Not well positioned to buy good deals
  • Wont have the cash to speed their recovery

68
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 Ill
    give you a great bargain

69
GE is raising cash like CRAZY !
70
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
  • Growing sales
  • Somewhat flat earnings
  • Flat stock price
  • Growing cash flow from operations

71
Does Anyone need 5 ?
Next is Price to Book
72
Price to Book Value (a conservative metric)
  • Buy companies with book value per share
    greater than price per share
  • If the company passes, then look no further
  • Many assets appreciate, e.g. land, buildings
  • No Brainer!
  • Dreman wrote in 1998 about SP 500 Average
    Price Book Value gt 5
  • Compare book value to the companys competitors.

73
Calculating Book Value
  • Total Assets less
  • Intangibles, (goodwill, patents, etc.)
  • Less long term liabilities
  • Less preferred stock, etc. equals Net Assets
  • Net Asset outstanding shares book value.
  • From Barrons Finance Investment Handbook, 4th
    Edition, 1995, ISBN 0-8120-6465-8, p. 207,

74
GE Book Value
  • Assets 787.8 B
  • Less Liabilities -662.0 B
  • Less Goodwill -84.9 B
  • Book Value 40.9 B
  • Shares Outstanding 10.6 B
  • Book/Share about 4/Share (3.86/share)
  • Trading about 4x book

75
Types of Value Investors
  • Low P/E
  • High yield
  • Low market value to book
  • Value of assets and/or cash flow LBO specialists.

76
Buy
  • Rule 14 Buy solid companies, out of favor
  • Low P/Es
  • Low Price/cash
  • Low Price to book
  • High dividend yield
  • Man overreacts to negative news Profit from it!
    P. 141
  • Rule 13 High Flyers under perform the market,
    buy out of favor stocks. P. 140

77
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

78
Tell em what yu told em
  • We recommended Dremans book.
  • Weve 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

79
Do you have Questions?
80
Next BI Event
  • Mark your Calendars !
  • February 4th, 2010
  • Thursday between 630 and 900 PM
  • Right here
  • Club Accounting
  • Using Took Kit 6, The Stock Selection Guide
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