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More notes:
1. Intrinsic Value determination is hard; Business Model Quality Analysis Framework inconjunction with certain key financial parameters can be a big help here. Return onCapital is the most important parameter here.
2. Margin of Safety implies adopting the Contrarian type of investment strategy. You
have to bet against the market mainstream crowds at times when the stock market isoverly optimistic or pessimistic. Earning Yield is the most important parameterhere. You invest in stocks when their earning yields are high, and sell stockswhen their earning yields are low.
3. Per John Neff, the Stock Market tends to price stocks based on the P/E ratio, sodividends are kind of being free gift to the investors. Also, companies which offerstable dividends tend to perform better in sustainable earning power over the longer term.So dividend stocks deserve some more weight in portfolio decision.
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C.T. Wus Magic Formula Dividend:
1. Low P/E (=15%) and High ROA (>=12%)3. Good dividend yield (>= 10-YR T-Bill Rate) and track records4. Good EPS Growth Rates (>=15%) track records and future prospect5. Low debt/equity ratio (
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C . T . W U , P H D
T A I T A M O N T H L Y S E M I N A R
1 0 / 1 1 / 2 0 1 0
Value Investing
The Systematic Way
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Ben Grahams Value Investing Principle
Pay 50 Cents for a Dollar A Dollars Intrinsic Value is always a Dollar!
Pay 50 Cents for a stock whose Intrinsic Value is aDollar
How to determine the Intrinsic Value is a Dollar? (Valuation)
When the Market will offer you 50 Cents for a share whoseIntrinsic Value is a Dollar? (Patience)
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The Holy Grail of Value Investing
(Gee! Any 7th
Grader can be the Next Buffett!)
ning)(Price/EarEarning*Price
PEE*P
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Components of Expected Returns
A Superior Investment Strategy should be bothEconomicallyand Statisticallysensible!
Company DependentReward(Investment Reward)
Market DependentReward(Market Reward)
]
)(
)([*]
)(
)([
)P(t
)P(tR
1
2
1
2
1
2
tPE
tPE
tE
tE
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Representative Guru Value Investors
Warren Buffett Focus on High QualityLarge Cap Stocks
E(t2)/E(t1)>1 over several years (7 - 15% EPS Growth Rates)
PE(t1) at least 20% lower than the Fair PE Ratio
Peter Lynch Focus on High QualitySmall Cap Stocks
E(t2)/E(t1)>>1 over several years ( >25% EPS Growth Rates) PE(t1)
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Martin Whitmans Remark on Value Investing
Buy cheap (Ben Graham)
Buy only High Quality Stocks (Warren Buffett)
Buy Growth, but dont pay for it (Peter Lynch)
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Profile of High Quality Companies
Quality in Assets Strong balance sheet with good liquidity Low debt
Quality in Earning High and stable ROE (>15%) Free Cash Flows in line with GAAP Earnings High and sustainable entry barriers (Wide Moat)
Quality in Growth 7 15% EPS Growths for established market leaders (Buffett) >25% EPS Growths for emerging market leaders (Lynch)
Quality in Management Competent and ethical Concern for investors interest
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Don Yachtmans Investing in Stocks like Bonds
Bond Investing Criteria Company Credit Rating (AAA, AA, , CCC) for Risk
Assessment
Promised Annual Interest Rate by the Issuer
Stock Investing Criteria
Company Quality Rating for Risk Assessment
Expected Annual Return Rate
A Unified Reward/Risk InvestmentFramework for All Classes of Assets!
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Expected Annual Rate of Return (EARR) for Stocks
EARR= Expected Annual Investment Return (EAIR) +Expected Annual Market Return (EAMR)
Where
EAIR= Expected EPS Growth Rate + Expected DividendYield
EAMR= Expected EPS Growth Rate Current PE ImpliedEPS Growth Rate
EARR= 2*Expected EPS Growth + Expected Dividend Yield Current PE Implied EPS Growth
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Fair PE Ratio Valuation Formula
Ben Grahams 1934 Formula Fair PE = 8.5 + 2 * G (EPS Growth Rate)
C.T. Wus 2010 Formula Fair PE = 8.5 + 1.5 * G (based on Post WW II Regression Data)
Current PE Implied EPS Growth Rate= (Current PE 8.5) / 1.5
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EARR Calculation Examples (Yahoo! Finance 10/4/2010)
* Analysts Average on Yahoo! Finanace
Company Expected 5-YrEPS Growth
ExpectedDividend Yield
Current PEImplied EPS
Growth
EARR
IBM 11.5% 1.5% 2.8% 21.7%
APPL 20% N/A 8.3% 31.7%
TSYS 17.5% N/A 0% 35%
CKSW 20% N/A 6% 34%
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Wireless Communication Theory and Value Investing
System Objective Wireless Communications(Maximize Signal/NoiseRatio)
Value Investing(MaximizeReward/Risk Ratio)
Step 1 Received wideband signal Over 8000 publiccompany stocks
Step 2 Narrowband Filtering to filterout unwanted signals
Use High QualityCompany Criteria tofilter out 95% of stocks
Step 3 Demodulate signals to
baseband
Demodulate financial
data to Expected AnnualRate of Return (EARR)
Step 4 Signal detection by threshold(S/N >= C dB)
Consider investmentwhen EARR > 20%
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Build a Personal Portfolio of 6 Stocks
X + Y = 6 X: High quality large caps at reasonable PE ratio
Y: Potential high growth emerging market leaders within yourcircle of competence
Replace an existing stock only when another stockwith better reward/risk profile is identified
If you take out the top 15 20 investments by
Berkshire, you get mediocre results Charlie Munger, Vice Chairman of Berkshire
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Spotting the Emerging Market Leaders Early On
Two Asymmetrical Factors Motivations
Skills
Software-centric service/solution small caps TSYS (GPS / e-911 / SATCOM)
CKSW (Service Chain Optimization Software)
Emerging consumer franchises (Piloting -> Scaling)
Chipotle Panera Bread
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Key Factors Affecting Stock PE Ratios
Major company performance announcements Inflation & 10 year Treasury Bill yield
Secular Bull/Bear cycle reversion-to-the-mean forces(~ 720 years)
Cyclic Bull/Bear cycle reversion-to-the-mean forces(~ 13 years)
Short-term (
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Q & A
Are You Ready to be the NextGuru Value Investor?