## Friday, July 30, 2010

### When to Sell: What Are the Right Reasons?

This figure actually overstates the sell/buy ratio since each of the 10 pages containing references to selling stock has only a few lines about selling – roughly 10% of the page. 10% of 10 pages is one page equivalent out of 200+; less than 0.5% of the total pages.

Yet selling is just as important as buying. After all, for every share bought by someone that same share is sold by someone else – every time.

People sell stock for all sorts of reasons. Such as:

(1) Fear of losing money when the investment or the market is going down.

(2) Fear of losing money based on intuition.

(3) To lock in profits that seem “too high” or “high enough”.

(4) To raise cash for a personal emergency.

(5) To reduce portfolio risk as retirement approaches.

(6) To rebalance a portfolio in accordance with target asset allocations.

(7) Because the investment has risen to a target value.

(8) Because the investment has fallen to a “stop loss” price.

(9) Because the investment is “overvalued” or “fairly valued”.

(10) To raise cash for a “better” investment.

(11) Because their investment advisor recommended it.

(12) To raise cash for living expenses during retirement.

I’m sure there are many other reasons people sell their stock. These are just the ones that come to mind as I write this.

The questions for me are:

(1) Why have I sold stock?

(2) Why should I sell stock?

In the following series I’ll try to find my answers to these questions

Link to Topics in the Special Report: "When to Sell"

## Friday, July 23, 2010

### What Is Intrinsic Value? – Simplifying the Value Elements

My definition of intrinsic value boils down to “a wonderful company fairly valued”. In previous posts I defined 14 value elements describing what I mean by that phrase. Now I’m looking for a better, simpler way to present the elements & the way I use them.

**The 14 Elements Value Elements Are: **

(4) Consistent Dividend Increases

(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share

(9) Business Model I Understand

(10) A Durable Competitive Advantage

(12) Reliable Long term Dividend Income Stream

(13) Increasing Annual Dividends Faster Than Inflation

(14) Expect at least a 9% Total Return Compounded Annually

I use a three level hierarchy to test each stock. In previous posts I explained the 1st Level, the 2nd Level, and the 3rd Level analysis. Summarizing the three levels produces the following.**In the ****1st Level**** a company must:**

1. Pay dividends with a current annual yield of more than 2.00%

2. Have current earnings that cover the dividend payments

3. Have a forward looking Price/Earnings Ratio (P/E) of less than 16

4. Be favorably viewed by The Motley Fool CAPS community**In the ****2nd Level**** a company must:**

5. Generate expected positive cash returns to me above a 9.0% discount rate

6. Have increased revenues over five years

7. Be reasonably priced by the Ben Graham Intrinsic Value Formula

8. Have a Total Annual Return (growth rate plus dividend yield) greater than 8%**In the ****3rd Level**** a company must:**

9. Have superior financial performance; low debt; high cash flow, and high returns on equity & assets

10. Have a long term competitive advantage that I can recognize

11. Have a business model that I can understand

This list isn’t much help. It reduces the number of elements from 14 to 11 but more simplification is needed.

Numbers 1 & 2 can be combined into: Generate useful, reliable, and safe dividends.

Number 4 can be dispensed with. I use it but I also override it on occasion.

Number 3 and number 7 can be combined into: Be fairly valued or better at the current price.

Numbers 5, 6, & 8 can be combined into: Extrapolated earnings & dividends growth indicate market beating returns are likely.

Number 9 can’t be combined or ignored. I’ll have to keep it in roughly its current expression.

Numbers 10 & 11 can be stated in a single sentence as: Have a long term competitive advantage and a business model that I can understand.

My restated elements now become:

1. Generate useful, reliable, and safe dividends.

2. Be fairly valued or better at the current price.

3. Extrapolated earnings & dividends growth indicate market beating returns are likely.

4. Have superior financial performance; low debt; high cash flow, and high returns on equity & assets

5. Have a long term competitive advantage and a business model that I can understand.

I can further shorten them to concepts.**1. Generate useful & reliable dividends.2. Be fairly valued.3. Market beating returns seem likely.4. Demonstrated superior financial performance.5. Has a strategic competitive advantage and business model I understand.**

These then, are my revised & simplified value elements. They accurately represent my criteria for selecting the stocks I buy.

The next question is - when do I sell?

## Thursday, July 15, 2010

### What Is Intrinsic Value? – 3rd Level Calculations

**The 14 Elements Value Elements Are:**

(1) Strong Cash Flow

(2) Strong Earnings Growth

(3) Dividend Consistency

(4) Consistent Dividend Increases

(5) Profitability

(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share

(7) Good returns on equity

(8) Little or No Debt

(9) Business Model I Understand

(10) A Durable Competitive Advantage

(11) Measure Risk

(12) Reliable Long term Dividend Income Stream

(13) Increasing Annual Dividends Faster Than Inflation

(14) Expect at least a 9% Total Return Compounded Annually

I use a three level hierarchy to test each stock. In previous posts I explained the 1st Level and 2nd Level analysis. In my recent post I reviewed the 3rd Level Data; Now, I’ll take up the 3rd Level calculations & decision criteria.

The essence of the 3rd Level analysis is a deeper look at the company’s financial data and including it in the resolution of the Meta-Parameter introduced in the 2nd Level analysis.

The Meta-Parameter is adjusted by the additional data but the same decision criteria are applied to the revised value.

All 3rd Level data discussed in the previous post are involved in the revision of the Meta-Parameter as are the following elements.

“Cash Flow per EPS” is a simple ratio and equals “Cash Flow per Share” divided by “Earnings per Share” (EPS).

“Inverse Cash Flow Payout Ratio” is similar and equals “Cash Flow per Share” divided by “Annual Dividend”.

**Financial Score:**

The “Financial Score” aggregates all 3rd Level data elements from the previous post with the two elements above. It’s calculated by:

**First**, testing the “Business Model” data element; If the value of “Business Model” is less than zero the Financial Score is assigned a value of negative one hundred (-100). If “Business Model” is greater than or equals zero then the calculation continues.

**Second**, the value of the data element “Inverse Current Ratio” is subtracted from an initial value of zero.

**Third**, two times the “Debt to Equity” value is subtracted from the interim value.

**Fourth**, “Cash Flow per EPS” is added to the interim value.

**Fifth**, “Inverse Cash Flow Payout Ratio” is added to the interim value.

**Sixth**, “Return on Equity” is added to the interim value.

**Seventh**, Two times the “Return on Assets” is added to the interim value.

**Eighth**, “Insider Owners” is added to the interim value.

**Ninth**, “Competitive Advantage” is added to the interim value producing the final value of the “Financial Score”.

The above calculations are performed on a tab separate from the 2nd Level Analysis tab. The value of the “Financial Score” element is then brought over to the 2nd Level Analysis Tab.

**Meta-Parameter Revision:**

When 3rd Level Analysis data is available an additional parameter, the “Financial Score Parameter”, is activated in the calculation of the Meta-Parameter value.

“Financial Score Parameter” = 0 if the value of “Financial Score” is less than zero; = 1 if the value of “Financial Score” is greater than or equal to zero; = 2 if the value of “Financial Score” is greater than 2.

The pre-existing Meta-Parameter value is multiplied by the new “Financial Score Parameter”. It's clear that a zero value of “Financial Score Parameter” will drive the Meta-Parameter to zero; a value of one will leave it unchanged and a value of two will double it.

The decision criteria remain the same, so if the revised Meta-Parameter value is greater than or equal to 16 (an arbitrary cut off) the stock passes the 3rd Level Analysis test.

My stock analysis for the buy decision is, for me, a very complicated algorithm. Working through it has helped me refine it, correct some mistakes, and understand it better.

Next, I’ll try to develop a way to summarize it so I can clearly communicate the concepts behind it.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?

## Thursday, July 8, 2010

### What Is Intrinsic Value? – 3rd Level Data

**The 14 Elements Value Elements Are:**

(1) Strong Cash Flow

(2) Strong Earnings Growth

(3) Dividend Consistency

(4) Consistent Dividend Increases

(5) Profitability

(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share

(7) Good returns on equity

(8) Little or No Debt

(9) Business Model I Understand

(10) A Durable Competitive Advantage

(11) Measure Risk

(12) Reliable Long term Dividend Income Stream

(13) Increasing Annual Dividends Faster Than Inflation

(14) Expect at least a 9% Total Return Compounded Annually

I use a three level hierarchy to test each stock. In previous posts I explained the 1st Level and 2nd Level analysis. Now I’ll take up the final and 3rd Level.

The 3rd Level analysis requires eight additional data elements. Five elements I pick up from The Motley Fool website. I enter the ticker symbol of interest in the search box that appears in the upper right corner of the site and press the “Search” button to the right of the box.

When the company data page appears I select the “Stats” tab located in the middle of the row of tabs just below the company name and description; And, I start collecting data.

**Inverse Current Ratio:**

With the “Stats” tab displayed I navigate to the “Financial Strength” group on the left side of the page and find the “Current Ratio”. I enter the current ratio in the designated cell of the 3rd Level Data Tab, but I enter it as its inverse; using the formula “=1/(Current Ratio)”.

**Debt to Equity:**

Two lines below the Current Ratio the “Total Debt/Equity” ratio is found. I copy this value into the “Debt to Equity” cell of my workbook.

**Cash Flow per Share:**

At the bottom of the left side of the page in the “Per Share Data” group, the value for “Cash Flow” is found. This value is entered in the workbook’s “Cash Flow per Share” cell.

**Return on Equity:**

On the right side of the page in the “Management Effectiveness” group I find the “Return on Equity” value and copy it into the “Return on Equity” cell of the workbook.

**Return on Assets:**

Just below the “Return on Equity” data the “Return on Assets” value appears. This value is entered in the “Return on Assets” cell in the 3rd Level Data Tab.

**Insider Owners:**

I get the “% of Shares Held by All Insiders and 5% Owners” value from the YAHOO! Finance web site under the subtitle “BREAKDOWN” in the upper left quadrant of the page. I enter this value as a decimal fraction in the “Insider Owners” cell in the workbook.

**Competitive Advantage:**

“Competitive Advantage” is a subjective value from “0” to “5” that I assign based on my understanding of the company’s business and markets.

**Business Model:**

“Business Model” is a subjective value from “-5 to “+5” that I assign based on how well I think I understand the how the company makes money.

These are the data I need for the 3rd Level analysis. In the next post I’ll review the calculations and decision criteria leading to the final “Buy” or “Reject” decision.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?

## Thursday, July 1, 2010

### What Is Intrinsic Value? – 2nd Level Calculations – Part 2

The 14 Elements Value Elements Are:

(1) Strong Cash Flow

(2) Strong Earnings Growth

(3) Dividend Consistency

(4) Consistent Dividend Increases

(5) Profitability

(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share

(7) Good returns on equity

(8) Little or No Debt

(9) Business Model I Understand

(10) A Durable Competitive Advantage

(11) Measure Risk

(12) Reliable Long term Dividend Income Stream

(13) Increasing Annual Dividends Faster Than Inflation

(14) Expect at least a 9% Total Return Compounded Annually

I use a three level hierarchy to test each stock. In previous posts I explained the 1st Level analysis, 2nd Level data collection, & began explaining the 2nd Level calculations continued here.

The remaining 2nd Level calculations screen my previously described results against a minimum standard; they apply weighting factors to rank the survivors. Each result is used to assign a parameter value.

To screen out the results that are below the minimum standard, I set the parameter value to zero. Some parameters are binary – their only possible values are zero or one. Other parameters have possible values greater than one.

When all parameters are multiplied together a meta-parameter is created. If any parameter is zero the meta-parameter is also zero. If all parameters are greater than zero the meta-parameter is relatively higher as more parameter weighting factors are employed. The meta-parameter determines whether or not the stock passes the 2nd Level test.

Parameter values are listed below.

“ScoreParameter” = 0 if Score is less than or equal to 0.5; = 1 if Score is between 0.5 & 30; = 2 if Score is greater than 30

“IRRParameter” = 0 if IRR is less than or equal to 0; = 1 if IRR is greater than zero but less than or equal to 30%; = 2 if IRR is greater than 30% buy less than or equal to 60%; = 3 if IRR is greater than 60%

“NPVParameter” = 1 if NPV is less than or equal to $0; = 2 if NPV is greater than $0 but less than or equal to $100; = 3 if NPV is greater than $100

“CAPSParameter” = 1 if CAPS is less than or equal to 4; = 2 if CAPS is greater than 4 (5 is the only allowable value of CAPS greater than 4)

“AchieversParameter” = 1 if the stock is not listed in the Dividend Achievers index or in the Dividend Aristocrats index; = 2 if it is listed in either or both indexes

“SalesGrowthParameter” = 0 if the Sales Growth Ratio is less than or equal to 1; = 1 if the Sales Growth Ratio is greater than 1 but less than or equal to 2; = 2 if the Sales Growth Ratio is greater than 2

“SafetyParameter” = 0 if the Margin of Safety is less than negative 50%; = 1 if the Margin of Safety is less than 0% but greater than negative 50%; = 2 if the Margin of Safety is greater than or equal to 0& but less than 20%; = 3 if the Margin of Safety is greater than or equal to 20%

“ReturnParameter” = 0 if the Total Return is less than 8%; = 1 if the Total Return is greater than 8% but less than or equal to 20%; = 2 if the Total Return is greater than 20%

“FlagParameter” = 0 if the stock fails (right now) the 1st Level test; = 1 if it passes the 1st Level test

These parameters are multiplied together to produce the meta-parameter. If the meta-parameter is greater than or equal to 16 (an arbitrary cut off) the stock passes the 2nd Level Analysis test.

It’s then subjected to the third and final level of analysis – the subject of the next post.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?