Stock Valuation Spreadsheet Blog

Last week I posted my thoughts on the importance of learning how to invest. It must have connected with some people based on the emails I received.

One that caught my attention was from a reader who shared with me his experience and was kind enough to allow me to share it with you.

This reader in particular is interesting because he has plenty of analysis experience coming from the a private equity background and has now changed from a top down investor to a more fundamental, bottoms up investor.

See if you can take away anything from what he is sharing.

An Investor has to be Realistic but Pay a Discount for “Pessimism”

A few underlying theses that a lot of investors in emerging markets go with are

• multiples will expand
• the market will re-rate the stock since it is  a market leader
• the management is world class

but you can’t go into the show banking on it.

Investing on the back of an expected tailwind from the market is like buying  a car hoping for crude oil to fall to $50 a barrel once there is peace in middle east.

When extraordinary management meets an average business, it is always the business that wins, at least most of the times. Many high quality entrepreneurs have tried to turn around things in retail, aviation, commodities. However, the business quality outlasts their efforts.

Look at JC Penney.

Capital Allocation Skills are ALWAYS Different to Execution

These are two very different skill sets often mistaken as the same.

People who are good at execution tend to be “alpha males” – aggressive, focused who get stuff done. Similar to what Charlie Munger describes as a “locker room culture” which is a culture of always trying to win and be right.

On the other hand, great investors are cerebral, relaxed and do not focus on reaching the end-goal all the time. They have a wide view of what goes on around them.

Capital allocators go into a situation to calculate the potential and walks away if the return is not there. Executors go into a situation and the only goal is to turn it around and to come out on top.

In a way, the capital allocators are the more ruthless ones. Emotionless, cold and calculated seeking a profit over ego.

Liquidity Can’t Solve a Business Model Problem

Too many times, businesses that are losing cash get happy about raising cash and continue with their model.

It’s like filling up your car with a leaking gas tank.

You won’t get far.

You need to fix the problem.

My favorite whipping boys of these types of business are the ones in retail, aviation, social media, consumer brands going against a giant without any different proposition.

Understanding Why You Made or Didn’t Make Money is More Important than Making Money

You hear this too often in the venture capitalist world.

“We got this deal cheap at 100 x sales – our competitor fund paid 200 x sales for their investment “.

This is common especially in new and upcoming industries where there are no comparable benchmarks or demonstrated track records of FCF and ROE.

This type of relative comparison and anchoring bias leads to situations where you think the investment is worth a billion dollars whereas the actual market value is a million.

Given the lack of liquidity and any mechanism to discover price, such mispricings stay hidden for 5-6 years before the entire rug gets pulled out from under your feet in one go.

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Written by

Jae Jun

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I am a fan of Tim Ferriss and his obsession with doing things better, smarter and more efficiently.

Reading through some old material related to The 4 Hour Chef, it is amazing to see examples of ordinary people doing extraordinary things.

• A 132lb girl deadlifting 400lbs
• Shinji Takeuchi, a Japanese man who started swimming at the age of 37, is the #1 watched swimmer on youtube. Blows Michael Phelps and Ian Thorpe out of the water. But why?

The theme throughout Ferriss’ book is that ordinary people can excel beyond the pack and achieve phenomenal tasks by knowing how to train instead of what to train.

I found myself thinking how relevant this information is for people wanting to learn or get better at investing.

A lot of investing blogs, books, papers and other materials tell you what to learn, but not how to learn it.

This simple concept can be the difference between struggling for years to break through a learning plateau and leaping through it into newfound confidence.

Too Many Big Ideas

As much as I admire Buffett, the only difficulty that I have with his letters, speeches and books about him is that there is no real practical information on how to invest for the small investor.

This goes for a lot of the value gurus. It is understandable because gurus have moved onto a different level and have different agendas. They don’t have the luxury of writing weekly newsletters or blogs to explain every detail.

This is why, when they do put out reports, books, paper, interviews etc, it is all based on big ideas. Nothing small and actionable enough for people like you and me to handle easily.

The Investment Gurus are Cursed

To really improve your investing, you have to understand that Buffett was going to be successful no matter what happened. He was born with investing and businessman blood.

Ask the most muscular guy in the gym how he works out and do the same routine. It won’t work for you. The gym guy was born with great genes, while some people gain weight just drinking water and others find it difficult to gain and maintain muscle unless they consume 4,000 calories a day and ultimately become sick.

Same concept with the gurus. They may be gurus but they are cursed.

They have the curse of knowledge. They forget what it’s like to be a beginner.

I once listened to my vet talk for one hour about the structure of my dog’s teeth and the surgery involved. All I realized at the end was that my wallet was $1,000 skinnier.

Buffett is a great role model for analysts and investment managers, but not a relevant role model for retail investors who are trying to get to know more about their own stocks. He was born to be an investor, as this timeline of his life shows.

His words are gold, but it can confuse and mislead you unless you know exactly what context he is talking about. After he says something, there is still great debate about what he meant.

You need to find the Shinji Takeuchi’s of the investing world because you will learn exactly how to invest through these people.

There is no confusion. It’s just clear.

It’s people like Joe Ponzio of F Wall Street that you need to identify and cling to.

My Personal Story

If you are fairly new to old school value, you may have the wrong perception that I’m some smart numbers guy. That couldn’t be further from the truth.

I didn’t study in the USA, and if I converted my academic score to a GPA, it is probably between 2.5 – 2.8.

As you can see, I didn’t thrive in my studies. The world is full of people smarter and better than I.

Combine that with never having taken any finance, business, accounting or economics classes and it’s amazing to see how I got here.

It just turns out that the educational system does not suit my style of learning.

It was only after I figured this out, that things started to turn around because I found a method that worked for me.

So What’s my Secret?

First, take a look at this familiar question from Quora.

I’m 18 years old and want to learn how to invest my money. How do I get started?

Here is the top rated answer.

Great advice?

If I was that 18 year old, would I follow that advice? Absolutely not.

Although the very first investing book I read was the Intelligent Investor, it was a horrible experience. I didn’t understand anything, the text was extremely dry and there was no practical advice that I took from it. The only thing I remember is the concept of Mr Market. Nothing else.

My secret?

It all came down to how I learned. Not what I learned.

I realized I needed to write notes to organize and clarify the jumble of information I had been reading. I started with this blog and publicly posted notes, articles and analyses for critique. I got slammed and chewed in the beginning, but it helped with learning and growing a thicker skin.

The second vital part was realizing that investing is extremely tedious and redundant. Being an efficiency nut, I needed a way to simplify and speed up repetitive tasks.

That’s when I started making excel spreadsheet models like the ones you can download for free by signing up with your email. In the process of building financial models, I combed through books and technical papers to understand how a specific model worked.

Figure out what your strength is and twist it in a way so that you can apply it to investing.

Know Your Strengths, Weaknesses and Situation and Take Advantage of It

Make investing relevant to your interests.

Just want get better at writing investment analyses?

• Find a stock analysis style that you like, break it up into manageable sections, find the information and fill up the sections.
• It will get better the more you do it.

Are you a small business owner?

• Think of your business as a public company instead of a small family business.
• Find public companies in the same industry and see how they run the business.
• What key performance indicators are important?
• Learn the strategies and competitive advantages
• Go through your accounting books and try to convert it to a full set of financial statements

In no time, you’ll be an expert in your industry and will be confident in analyzing and investing in such companies.

Same thing applies to any day job. Don’t just do it. Think of yourself as the CEO and look at the bigger pictures.

Do You Handle the Money in Your Home?

• Personal finance is just like a business. Think of your household as a business.
• Go through your bank statements and try to create your household financial statements.
• Budgeting, projecting, allocating, depreciating is something you do everyday already. Why not think of it like managing a business?

Here’s what I did to monitor my household cash flow using a cash basis method.

Are You a Programmer?

• Why not try to program simple tasks? That’s what I did with my spreadsheets.
• Create an easy investment game
• or just a simple stock portfolio spreadsheet

Don’t Have a Good Memory or Weak with Numbers?

• Don’t try to improve your memory.
• Investing math is just plus, minus, division and multiplication.
• Create a simple glossary of the terms that you hear and use all the time from investopedia. Keep it as a cheat sheet. This isn’t school. It is encouraged.

Never Have Enough Time?

• I recently hired a part time virtual assistant for $300 a month. A part time employee for $300 a month is a steal.
• My virtual assistant goes through company reports, writes up point form summaries which I can read and analyze quickly.

Do You Travel Regularly?

• Get some audio investing books and listen to it on the road.
• Convert Khan Academy youtube videos to MP3 format and take it with you.
• Download podcasts like Sound Investing by Paul Merriman that are short and focused on specific topics.
• There are lots interesting people at the airport. Find someone reading investment news and talk to them.

Or Start Your Own Simple Business

• By starting even something small and insignificant like selling on ebay, you will learn about an entire industry.
• Try to import something cheap and sell it on ebay. You’ll learn what companies have to go through in the import/export business. Or just try to sell things around the home.
• Selling on ebay requires that you know how to position your product, market it, word it and make a successful sale.
• Shipping multiple items gives you insight into the shipping industry.
• Starting your own business opens a can of worms and you will be a better investor for it.

There are Countless Possibilities

I don’t know everything about your situation so it’s difficult to try and come up with a recommendation for every scenario, but you get the point.

No matter what your skills are, there is a way you can benefit from learning how to invest. And best of all, doing it your way will make it stick.

Make Use of How to Tutorials

Still not sure? Then start with these topics and keep filtering down.

• How to value stocks
• How to perform financial statement analysis
• Learn the specifics of accounting concepts for investing
• How to improve productivity in investing

Summing Up

• Learn the how, not the what.
• Follow and learn from people who are like you but managed to make the jump to elite status. These are the people who will understand your situation and can help you get to the next level.
• Gurus are not good role models for the layman.
• You know what you are good and bad at. Use it to your advantage and make it relevant to investing.

Written by

Jae Jun

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Being able to take things into context is important.

Many companies and investors love to throw around numbers that sound impressive, but it ultimately means nothing.

In other industries, it’s called vanity metrics. Not sure what it’s called in finance.

Let me give you an example of a vanity metric.

The average time a visitor spends at oldschoolvalue.com is 2min 49s per visitor compared to 1min for other sites.

This means OSV is performing better than the average site by 183%.

Impressed? Don’t be, because it means nothing.

A visitor could have stumbled upon this site, started clicking all sorts of things, go for a coffee break, or simply wait for some big files to download.

Same concept with investing. Many companies boast about earnings growth, subscriber growth or improving operations, but these are just “power” words. Words meant to convey importance without much context or relevance.

Vanity Fundamentals and Investing Ratios

Previously I wrote about why you need to learn accounting.

To sum it briefly, it is the language of business. If you want to live in a foreign country, you must learn the language to be able to understand and interpret it.

Knowing the accounting concepts is like knowing the business vocabulary, but the important part is knowing how to interpret it.

Having a good understanding of accounting and how it all ties into business will help you avoid vanity fundamentals and investing.

But there are still fundamentals and ratios that

• mislead investors
• do not add value
• should not be used on its own

Some Examples of Vanity Investing Ratios

I do use the below ratios but I want to show you the proper way of using it.

• EPS (Earnings Per Share)
• PE (Price to Earnings)
• PB (Price to Book)
• ROE (Return on Equity)

Vanity Metric #1: Earnings Per Share

Earnings growth. Loved by Wall Street and most investors, but it really doesn’t tell you much.

There is so much to earnings, but boiling it down to just a single value is overkill. The important factors have been eliminated and looking at earnings growth as a measuring stick for business growth is pure vanity.

Look at the following two companies.

• Company ABC and Company XYZ both achieved $100k in earnings from $1m in revenue.

Now look at the two companies again.

• Company ABC achieved revenues of $1m and net income is $100k.
• Company XYZ’s revenue came in at $800k with other income of $200k making up a total of $1m revenue. Net income is also $100k.

With this extra information, you can see how different the two companies are. But most people simply look at the earnings line and judge the company based on a single number without taking the number in context.

For this reason, when it comes to judging EPS, I always recommend the book Quality of Earnings. It goes into great detail of how to adjust the EPS to factor in changes due to tax rates, non-operating and non-recurring income.

Instead of taking EPS at face value, go beyond the vanity number and get to the core metric.

Look at earnings growth next to account receivables growth and inventory growth to see trends in the business.

You could do something like the format below to better gauge the business.

Owner earnings is an alternative to earnings you can use.

Vanity Metric #2: PE Ratio

On its own, the PE ratio is absolutely meaningless.

It is a relative measure so it is only useful when you compare it to another PE ratio. Plus, it is difficult to figure out what a company is worth with just the PE ratio.

The best it can do is give you an approximation of whether the stock is cheap or expensive.

Somebody telling you that Netflix is a sell because it has a PE of 609 sounds smart, but it doesn’t answer questions such as what the fair PE is and why the PE is so high to begin with.

The PE ratio is just Price divided by earnings per share and you just read what I thought on EPS. This is why PE is just as useless as a standalone investment ratio. It is the most misleading, misused and abused metric.

Instead, you could use something like the Absolute PE valuation method. This method forces you to think about the different aspects of the business and growth to determine the fair value PE which you can then use to judge whether the stock is over or undervalued.

Or consider using alternatives like P/FCF or EV/EBITDA. Both are similar but offer more insight.

Vanity Metric #3: PB Ratio

Here is one more inclined to value investors but still often misused.

One thing is that Graham never spoke of finding just low PB stocks. He specified net net stocks because he wanted companies trading at a low price to tangible assets.

Graham even took it one step further by looking for net net working capital stocks where assets are of high quality and easily convertible to cash.

With that in mind, when looking at PB, it’s always best to eliminate intangibles and goodwill from the equation.

Unless you are dealing with a company where the brand sells itself like Coke, Pepsi and Windows, or necessary for business like Expedia (EXPE), most goodwill and intangibles is not as valuable as the company makes it out to be.

Best thing to do is remove it.

PB would then become Price to Tangible Book which depicts a much clearer view of the company.

Vanity Metric #4: ROE

You may be surprised that ROE is on this list. If I wrote this one year ago, it wouldn’t be on here.

Although ROE is a very helpful measure, it can do better. By understanding the drivers behind ROE it goes from an OK metric to a powerful one.

The best way is to use the DuPont analysis to break up ROE into 5 segments as shown below.

Via the five step model, the interest burden is increasing, but the main culprit is due to a decline in operating margins.

By using ROE alone, you may have deduced that the company is just doing poorly, but by dissecting the vanity metric, you get to see that the core operation of the business is leading the drop in ROE.

Also consider using CROIC as well as ROE with the DuPont analysis.

Bringing it Together

It is very important that you don’t just accept data at face value. Take things into context. You invest to make money.

There is no need to start with a conclusion and then pick data to match your conclusion. I’ve only lost money that way.

One of the quickest ways is to find the metrics that you think if important and really ask yourself whether it adds value to the overall investment.

If you saved a stock analysis and looked at it again 30 days later, are you confident that you will know why you saved it in the first place?

This is a problem I see with Wall Street analyst reports. I try to read it again a couple of months later and I have no idea what the report is trying to say because the numbers are filled with sales growth of 25%, earnings growth or 19% year over year. Impressive but fluffy duffy stuff.

Please Share if You Find this Useful

If you find this useful, please help out Old School Value by sharing this article using the social sharing buttons.

The more you share, the more I know what type of content you really like and I will be able to provide more quality content.

Written by

Jae Jun

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This is something new that I’m trying out. Providing responses to emails on the blog or highlighting some helpful forum posts as I’m sure there are people with similar questions.

Journey to Becoming a Successful Value Investor

A question came up in the forum that resonated with me.

In my journey to become a successful value investor I am having trouble retaining knowledge, whether it be from reading, watching lectures, or researching companies. What are some methods that have proven effective to retain knowledge? Do you have any suggestions on how expertise can be developed in the most efficient manner?

To view the answer, follow this link.

How to Learn Accounting if You have No Finance Background

Hey Jae,

I was wondering if you had any insight, or could speak from your experience on how you learned about accounting and how to interpret financial statement.  You mentioned the book, The Basics of Understanding Financial Statements, which is a very good recommendation.

Just wondering if you could recommend any other books or have any suggestions. I know you come from an engineering background, and I’m assuming you never took courses on finance and accounting, so I thought you would be a good person to ask being that I lack the experience in these subjects as well.

Keep up the good work with the blog, and thanks for all the free content.

Spot on. I’ve never take a course in finance. If you are asking questions, you are eager to learn and that’s all you need. If I can do it, so can you.

But here’s some practical advice.

Start with the list of best investment books on value investing. It has been arranged from easiest to hardest and six out of the ten books focus on accounting and interpreting financial statements.

Don’t bother reading The Intelligent Investor or Security Analysis yet. I don’t recommend it. You won’t make it through. I literally fell asleep every time I picked it up. Took me two months to skim through the Intelligent Investor.

The biggest obstacle I had to overcome was interpreting the financial statements for investing. To do so, you have to have a firm understanding of accounting.

After all, accounting is the language of business.

Try going to a foreign country and not  being able to speak their language. It’s tormenting.

Just because we speak about investments in English, it doesn’t mean it is correct. Learn the business language.

Many books only go as far as telling you to look for companies with low debt and growing cash, but that doesn’t mean much. Anybody can understand business with low debt and increasing cash flow.

However, what does it mean when raw inventory materials is up but works in progress is down?

If the percentage change in accounts receivables grows faster than sales, what does that mean?

These are things that accounting books won’t teach you, because accounting is like a dictionary. It’s the interpretation that brings the language to life.

Writing Difficult Concepts in an Easy to Understand Way

Hi Jae,

I have been your reader for almost 3 years, and I really enjoy reading your articles. Given English is not my first language, so it is not always easy to understand everything, but your articles have always been very clear and informative.

Is there some advice you could give in terms of how to write things the way you write ?

The question is actually deeper than a basic English question. Follow me through this and you’ll get the point.

• The objective of the question: find out how to write difficult topics that are easy to understand
• Other information: English is not primary language, wants to learn how to write, wants to write in a style that is easy to understand

See what I just did?

Given the information from the question, the objective was identified and then the information is broken down into manageable pieces.

In doing so, I’m trying to take a step back to understand who you are first and what your goals are before getting to the problem.

Just as I’m trying to understand who is sending this email, when writing, you must always start with knowing who you are writing for.

The key is to also understand that it’s never about you. It’s always about the reader.

The objective of this blog is to write for those who want to understand financial mumbo jumbo in a way that they can understand and I write like this because I was in the very same situation so I know how to frame it for the reader that stumbles on this site.

My writing style for the web can be broken down into the following:

• Start with a big idea you want to write about
• Write in a sequence of what should happen – just like a how to manual
• Use lots of headings – more the better
• Write like you talk
• Keep sentences short
• On the internet it is better to have one sentence paragraphs than blocks of text
• Know your material
• Use visuals wherever possible

Believe or not, two of the most popular articles are on accounting topics.

• FIFO and LIFO inventory valuation
• Straight line and accelerated depreciation methods

Analyze how I wrote those articles and you’ll see the pattern.

I shared this on the OSV Facebook page the other day.

If you must play, decide on three things at the start: the rules of the games, and the stakes, and the quitting time – Chinese Proverb

to which Seth made a great point.

Selling is much harder than buying. I know because it is my weakest area.

I can find, research and buy things easily, but selling has always been tough for me.

There are quite a number of articles on selling here already.

• When to sell stocks
• Stock selling strategies
• How to think when selling stocks
• When do I sell stocks?

I’ve already written a lot about the basic stuff when it comes to selling so I won’t bore you with the details again.

After all, it’s Friday.

Instead, the link I have for you takes a look at what to do about selling when there is a severe meltdown in market. A topic that I have not explored much.

The Sell Decision: What to Do After a Severe Market Meltdown

I hope the market continues to do fine, but you never know with what is going on. If Cypress can cause such issues, then you should be ready for anything.