stock market investment-092911
TRANSCRIPT
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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
9 / 2 9 / 2 0 1 1
Enhanced Value InvestingTM--Beyond Graham, Buffett and Greenwald
Contents and Trademarks are intellectual property of the author and thusproprietary in nature
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Outline
Long-term Behaviors of Stock Market
Short-term Behaviors of Stock Market
A Holistic Framework for Stock Valuations
A Unified Model for Value Investing
Business Model Analysis for Value Investing
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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 a
Dollar (i.e., a Margin of Safetyat 50%) 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(Intrinsic Reward)
Market DependentReward(Emotional Reward)
]
)(
)([*]
)(
)([
)P(t
)P(tR
1
2
1
2
1
2
tPE
tPE
tE
tE
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A Pictorial View of Expected Stock Returns
Cruise Speed Head/Tail Wind
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Long Term Stock Return Patterns
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Mid and Long-term Stock Returns
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Robert Haugen-- Guru of Stock Market Behaviors
Studied 35 years of stock market behaviors via vigorous RegressionAnalysis tracking 70+ parameters per company
Good News
You can predict the stock price change 30 days from today with thecompanys past financial and price information
Bad News
Accuracy: 10%; Noise: 90%
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Robert Haugen Short-term Stock Price Volatility
Three types of Price Volatility (Standard Deviation)
--Event-Driven Volatility (fast reaction to company news)
--Error-Driven Volatility (residual reaction to company news)
--Price-Driven Volatility (purely driven bymarket sentiment) Price-Driven Volatility contributes to 80% of the total
Volatility
Price-Driven Volatility is unpredictable and thus indivertible
Historically the yearly S&P 500Price Volatility has beenaround +/- 20% from the yearly average price; thusmaintaining a Margin of Safety >20% helps minimize thechance of having near-term losses due to short-term volatility
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How to Determine the Market is Overvalued?
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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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Emergent
Growth
Fast Growth Stable Growth Mature
Fair P/E=
8.5 + G/2
Fair P/E
= 8.5 + G
CSCO
MSFT
WMT
F5
JNPR
ARUN
IRDM
TSYS
CKSW
G=20% G=10-15% G
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Don Yachtmans Investing in Stocks like Bonds
Bond Investing Criteria
Company Credit Rating (AAA, AA, , CCC) for RiskAssessment
Promised Annual Interest Rate by the Issuer
Stock Investing Criteria
Company Quality Rating for Risk Assessment
Expected Annual Return Rate (IRR)
A Unified Reward/Risk InvestmentFramework for All Classes of Assets!
Investment Vector = (Expected IRR in N Years, Risk Level)
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A Unified Model for Value Investing
Investment Vector = (Expected IRR in N Years, Risk Level)or IV= (IRR-N, Risk Level)(Risk is the most undefined and ambiguous term in Finance!)
Enhanced Investment Vector (EIV)=(IRR-N, 1- Risk Level)or EIV = (IRR-N, Confidence Level)where
1. Risk Level + Confidence level = 12. Risk Level: (0 ~ 1)3. Confidence Level: (0~1)
Why the Efficient Market Hypothesis is Erred?Its Key Assumptions:
1. The higher the Risk Level, the higher the Reward.2. The market is always efficient.3. You can not outperform the market, use full diversification to mitigate the risk.
Fact: Only the market mechanism is efficient. The market results are often inefficientbecause the majority of market participants are inefficient.
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Why Buffett Advocates Concentrated Portfolio?
Its all about Confidence Level establishment--Personal understanding of the industry--Personal understanding of the business model--Personal understanding of the management team--Personal understanding of the balance sheet quality
--Personal understanding of the potential technological substitute threats
Buffett: I have 2 views on diversification. If you are a professional andhave confidence, then I would advocate lots ofconcentration. Foreveryone else, if it is not your game, participate in totaldiversificationCharlie and I normally operate with 5 positions
(Source: Buffetts 2/15/2008 speech at the Business School of UT Austin)
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Why True Value Investors Have an Edge?
Employ Margin of Safety >= 20% of Fair Price Discipline* Minimize the chance of having near-term losses due to Price Volatility
* Create long-term gain when the Margin of Safety gap is closed by themarket (e.g., from 20% undervalued to 20% overvalued in PE Ratio)
Concentrate on a few well studied stocks that have superiorEIV= (IRR-5, Confidence Level) profile based on the investors Circle ofCompetence
* Buffett: Investment is all about Compounding!
*Alice Schroeder*: Buffett requires each investment to have at least
15% IRR.
(* Author of The Snowball: Warren Buffett and the Business of Life)
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Enhanced Value InvestingTMFramework
Follow the EIV = (IRR-5, Confidence Level)Unified Model
Consider making an investment bet when
--IRR-5 >= 20%--Confidence Level >=80%
(via Business Model Analysis)
--Current PE = (1 + Beta*20%)* Fair PE Ratio
Focus on 3-5 solid investment targets a year
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Enhanced Value InvestingTM Illustrated
$
-portfolio setup (researched)- buy/sell decisions (systematic)- trade size decisions (systematic)- timing (systematic)
=
>=20% long-termcompounding goal
Sell
Buy
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A Pictorial View of Expected Stock Returns
Cruise Speed(Intrinsic IRR)
Head/Tail Wind(Emotional IRR)
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Sources for Superior Stock Returns
Valuation Premium
Current PE much lower than Fair PE (The difference is theMargin of Safety)
Wide Moat Quality Premium
Wide Moat Quality stocks consistently outperformed No Moatstocks by an average IRR of 3% historically
Small Cap Growth Premium
Double-counting effect (Price= EPS * PE): 3-6% IRR extra gain
Business Model Optimization (BMO) Premium*
2-3% IRR per year (IBM is the most viable case-in-point)
(* Courtesy of the Author)
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Business Models Core--Buffetts Wide Moat
Wide Moat = High Entry Barriers
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Business Model- A Systemic Perspective
Fi i l P f T k CEO
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Financial Performance Tracks CEOsBusiness Model Optimization Paths
CEOs Key Decisions
Competitors
Moves
Financial Outcomes(ROE, Earning GrowthRate, Asset Quality,
Debt Ratio)
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Blueprint for Business Model Optimization
Goal for Business Model Optimization Creating sustainable and growing EPS (excludingstock buy-back effect)
Adopt a Growth Strategythat is continuously leveraging the business CORE possessinghigh entry barriers--The most critical part of Business Model Optimization--Most public companies failed at adopting the right Core-Centric Growth Strategy; 3 in 4
acquisitions turned out to be big failures
(Chris Zooks Focus Expand Redefine Cycle)
Align business Internal Organizational Economies with the evolving Core-centric GrowthStrategy--Most public companies are nave about Internal Organizational Economy; especially not
aware ofEconomy of Scope only applies to the same customer group which is the majorcause for acquisition failures
(Russ Ackoffs Multi-dimensional Organization)
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Conclusion
Enhanced Value InvestingTM is a systematic way of achieving superior long-terminvestment returns via a thorough integration of
1. Stock Market System Behaviors--Long-term Predictability vs. Short-termVolatility (i.e., Complex Adaptive System characteristics)
2. Competitive Business System Behaviors--Business Model Analysis and Optimization3. The CJPR Holistic Valuation Framework4. A Unified Model for Asset Investment: EIV= (IRR-N, Confidence Level)
A Chronological Evolution of Value Investing-Generation 1: Ben Graham (1934)Generation 2: Warren Buffett (1980)Generation 2.5: Bruce Greenwald (2001)Generation 3: Enhanced Value InvestingTM (2011)
Contents and Trademarks are intellectual property of the author and thusproprietary in nature
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Case Studies
Visa
IBM
Apple
Juniper Altria
Aruba
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VISA
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IBM
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APPLE
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JUNIPER
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ALTRIA
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ARUBA