transformational investing workshop...“the trick in investing is to just sit there and watch pitch...
TRANSCRIPT
Transformational InvestingWorkshop
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Disclaimer • © 2021 Rule #1 Investing, Inc. All rights reserved. Neither Phil Town, Rule #1 Investing,
Inc. or its subsidiaries nor any of their respective officers, employees, representatives, agents or independent contractors are, in such capacities, licensed financial advisers, registered investment advisers or registered broker-dealers. Neither do they provide investment or financial advice or make investment recommendations, nor are they in the business of transacting trades.
• Personal trading examples are to demonstrate and educate individuals. They are not representative of the consistent returns in an account, or an expectation of future gains. Speaker and trainers may have other positions, which are positive or negative. Trading examples are solely for an educational purpose. Neither the information nor any opinion represented by Rule #1 Investing, Inc. or any of its affiliates constitutes a solicitation or offer to buy or sell any securities, future, or options, or other financial instruments.
• You, the trader, assume the entire risk as to the results and performance of the trading methods.
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Table of Contents • INTRODUCTION PAGE 4• MEANING PAGE 9• MOATS PAGE 33• MANAGEMENT PAGE 61• MARGIN OF SAFETY PAGE 76• EVENTS PAGE 136• INVERSIONS & REBUTTALS PAGE 146• OPTIONS 101 PAGE 157• OPTIONS TERMINOLOGY PAGE 159• RULE ONE PUTS PAGE 178• RULE ONE CALLS PAGE 197• THINKORSWIM CONFIGURATION PAGE 215• COST BASIS REDUCTION PAGE 221• INTRODUCTION TO TECHNICAL INDICATORS PAGE 232• INTRODUCTION TO CREDIT SPREADS PAGE 251
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Welcome to Rule One Investing
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Transformational Investing
Building generational wealth with the Rule #1 investing strategy
as taught by Warren Buffett and Charlie Munger
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Transformational Investing
How Rule #1 investing knowledge creates Generational Wealth Why Buffett says you only need 4 companies in a lifetime to get rich How to find great companies to own How to know what Buffett and other greats are buying right now How to know a business is wonderful How to use the Rule #1 Toolbox to find out the company’s true value How to create an inflation-proof portfolio How Buffett creates “no-risk” cash flow How to reduce risk with dividends, buybacks and options How to create immediate cash flow with only $2000 How Phil Town turned $1000 into $1.5 million in 5 years ……….and how Warren Buffett (net worth $84B) did it with just $100
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©Rule One Investing, LLC 2018
Checklist for InvestingClick box to play video
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RULE #1 Four “M’s”
• MEANING:
• MOAT:
• MANAGEMENT:
• MARGIN OF SAFETY:
_________________________
__________________________________
________________________
________________
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MEANING
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The Importance of Meaning
“THE MOST IMPORTANT THING IS TO BE ABLE TO DEFINE
WHICH COMPANIES YOU CAN MAKE AN
_____________________________.”
Warren Buffett
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Ted Williams Science of Hitting
Career: .344 batting average 521 home runs .482 on-base % The highest of all time
His career batting average is the highest of any MLB player whose career was played post 1920, and ranks 7th of all-time.
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A Fat Pitch
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Wait for YOUR Fat Pitch
“The trick in investing is to just sit there and watch pitch after pitch go by and wait for the right one, right in your sweet spot. And if people are yelling, ‘Swing, you bum!’, just ignore them.”
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Finding YOUR “Sweet Spot”
3 Circles of Understanding
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Where YOUR “Sweet Spot” Industries Intersect
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YOUR High Percentage Industries
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EXERCISE
Where is YOUR
“Fat Pitch”?
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Search Tab – Search 3 Circles
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“Stock Watch” Results for Companies to Research
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Other Ways to Fill Your “Stock Watch” With Potential Companies
• _________ - Watch what the__________________
• Direct search in _______________________
• Add individual companies you already ________ and____________ ___________________________________
• Read the_______________ for companies or industries that look promising to You
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Definitions of _____________
• Buy – __________________ in the listed period when they previously owned ________ in the prior period
• Increase – _____________ in the listed period, thus adding ______________
• Reduce – ___________ in the listed period, but they ______________
• Sell – ________________ in the listed period resulting in _____ remaining position
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General _______ Guidelines
• If you think a Company is ___________ and ______ , there should be ______ who have come to the same conclusion & are ____________________________
• If you think a Company is ____________ but __________ _______________, some ______ should _____________
• If you think a Company is ____________ but over priced, it is OK if there are ____________________ or there are no ______________ at all.
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Search Industries & Sectors
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Industry = Black Font with Gray Highlight Sector = Black Font no Highlight
Sub-Category = Underlined Blue Font Link
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Click on Sub-Category to View Companies
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Sort by Moat, Mgmt & Rule #1 Score by Selecting Each Header Title
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Navigating to an Individual Company in the Toolbox
Type the ticker symbol or the name of the company, then select desired company from list and click “GO”
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Click “Add to Stock Watch,” to Add a Company to Your Stock Watch
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Removing Individual Companies from Your Watch List – Remove from Stock Watch
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Your Stock Watch Goal for Today is _________________________
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Meaning Quiz• What are the 4 M’s of Rule One Investing?
____________ , ________, __________________, _______________________
• According to Warren Buffet, “The most important thing is to be able to _________ which companies you can make an intelligent ____________ about.”
• What are some tools we can use in the Toolbox to find companies? _____________, ________, __________, _______________
• What are the 3 Circles in life where we experience companies that might have meaning to us? Our _____________, ____________, __________
• A ___________ is used to filter companies in the Toolbox by specific categories.
• What feature in the Toolbox allows us to cross-reference our various lists of companies to find the most pertinent ones? ___________
• We can clone a “Fat Pitch” by following ___________ investments.
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MOATS
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MOAT
• “An __________, _______________________ advantage.”
• Something that protects the company’s ___________ and __________ and makes it easier to take the ________________________ and_________.
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“Intrinsic” Is Crucial• A “Wonderful business” has certain advantages that are _______ into
its very structure. These are called, “intrinsic” because we can’t ___________ the company and its __________ _______from its__________. This advantage is critical to the company’s _______________.
• Intrinsic qualities would be:• _______unique_________________• _____________systems to move___________• _________ unique______________________• _________ unique ______________ systems.
• Intrinsic MOATs are what gives the company the ability to ______ ___________________ over decades, and what gives us _______________ that our investment is going to __________ _______over time.
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5 1/2 Types Of MOATS
1. ___________________
2. ___________________
3. ___________________
4. ___________________
5. ___________________
5.5 __________________36
1. _____ – _________ return to get the same _________________________
Niche Market
Global Recognition
Regional Recognition
Industry Recognition
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2. _____ – lowest _____________
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3. ______ – Often ________ or hard to ___________________________
Proprietary Processes
Proprietary Ingredients
Proprietary Technology
Proprietary Inventions
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4. __________ – Virtual ________
Right of Way
Laws or Regulations
Prohibitive Cost to Duplicate
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5. _________ – Hard for _________ to leave due to ___________________
Loss of Expertise
User Knowledge/Training
Systems Integration
Cost of Replacement
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5.5 _________:Customers don’t _______ because the _________ is so dominant
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Characteristics of Big MOAT Companies
• Slowly changing businesses that don’t have to reinvent themselves (and their MOAT) frequently
• Steady revenues, earnings and growth
• Companies that have more than one type of MOAT
• The MOAT (or MOATs) are very strong
• Mature businesses that have had time to establish multiple deep MOATs
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Finding MOAT Details• Where to look: ___________________________
• What does management say about ___________________ than their competition? In your experience, is it true?
• Look for any statements of _________, ____________ ____________ the company has, and do they align with their _______. Also identify the ___________ ______________.
• Read or listen to __________________________to uncover a company’s_________. _____________________________________________.
• Read Articles by _____________
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Select Regulatory Filings, Filter on “Annual Reports”, Find the Most Current Year 10K, 20F or 40F and Open the PDF to
Read
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Research Starts With The 10-K
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10-K Business Section
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Research The Corporate Web Site
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Company Website Find Investor Relations
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Find The Quarterly Earnings Calls
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Other Sites that Offer Transcripts or Articles (seekingalpha.com)
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Follow or Subscribe to Receive Future Notifications
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Google Search – Trade Journals
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Search for Video Articles youtube.com
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gurufocus.com – More Articles
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MOAT Score in the ToolboxSCORING SYSTEM
Growth Rate > 10% = Green / 25 PointsGrowth Rate 5%-10% = Yellow / 12.5 points Growth Rate < 5% = Red / 0 points
• Green is good and means that the company has been doing a good job of growing its profits over time.
• It takes a strong MOAT to be able to _______________ consistently.
NOTE: A MOAT Score that is not green might be ______________ __________by an ________ and still might be worth a look.
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Use The Rule One Toolbox To Help With Moat
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Big 4 ______________
Book Value per ShareEarnings per ShareOperating Cash per ShareSales per Share
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MOAT Score Impacted By Event
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MOAT Quiz• A MOAT is a durable competitive _______________
• A MOAT that depends on customers identifying with the company’s name or
the name of their products is what kind of MOAT? __________________
• What are two types of MOATs that Microsoft has?
________________ ________________
• Does a bad MOAT Score mean the company has no MOAT? _______
• What kind of MOAT usually depends on patents? ________
• A Price MOAT doesn’t mean the company sells their stuff the cheapest. A good price MOAT requires the lowest what? ___________________
• What are two MOATs Coca Cola has? ___________ ___________
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MANAGEMENT
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Company Management
The Board of Directors - Oversee the Executive Team➢Chairman of the Board
• The Head of the Board of Directors➢Board Members
• Often Executives at other Successful Companies or Large Investors
Executive Team - Oversees daily management of the Company➢CEO – Chief Executive Officer
• Responsible for all facets of the entire company ➢CFO – Chief Financial Officer
• Responsible for all facets of the company’s finances➢COO – Chief Operations Officer
• Responsible for all facets of the company’s operations
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Where the Buck StopsA company’s Chief Executive Officer (CEO) has a huge impact on the nature of the company.
• He or She can drive employees forward or drive them down and out. They set the tone for the _______________________.
• Instead of having a money manager invest our money in a mutual fund, we are ______________________with the ______.
• We have to research the CEO to see if they are _____________, _________ and _________________________________.
• It is not easy to uncover information on most CEOs. Put on your detective hat and dig up everything you can.
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Management CharacteristicsCraig Jelinek
Costco ____________
Tim Cook Apple
______________
Gary Kelly Southwest Airlines
__________________
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CEO Should Bleed The Corporate Colors
Lisa Su – Advanced Micro Devices (AMD) 65
Researching The CEO
Tools to investigate CEO’s Google search on their name.
• Read their ________________________________
• Look for interviews and articles on_____________________
• Look for interview and articles in ______________________
• Look at Company___________________________________
• Look at ___________________ to see if they are ____________
or __________ shares. Hint: Selling > _____________________66
Corporate Web Site - Investor Relations - Annual Reports
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Finding Shareholder Letters
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Shareholder Annual Report (not the 10-K)
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Read Between The Lines To Get To Know The CEO & Company
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Read Between The Lines To Get To Know The CEO & Company
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Management Score
• Management is responsible for creating solid and steady Return (Earnings) using the total amount of profits invested in the company over time (Equity).
• ROE = Return on Equity
• ROIC = Return on Invested Capital• * ROIC Invested Capital includes Equity + Long-term Debt
• We prefer ROE & ROIC be green and consistent or rising
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Debt The Company Killer
• The Debt number is the number of years it would take to pay off the company’s Long-term Debt with last year’s Earnings.
• Companies with little or no Debt have a great advantage in bad times – Ex. 0.00 years earnings = Debt free.
• We prefer a company to be able to pay off their Long-term Debt within 3 years or less from last year’s Earnings.
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Management Scoring System
Return Rate > 10% = Green / 25 Points Return Rate 5%-10% = Yellow / 12.5 points Return Rate < 5% = Red / 0 points
Debt < 2.5 Years Earnings = Green / 25 points Debt 2.5 - 5 Years Earnings = Yellow / 12.5 points Debt > 5 Years Earnings = Red / 0 points
ROE & ROIC are not Growth Rates, they are “Return on Rates.”
NOTE: A Debt Score that is not green might be temporarily impacted by an event and still may be worth a look.
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Management Quiz
1. What are the three characteristics we want in a CEO?
___________ _____________ ________________________
2. The most important person in the company is the ___________
3. What three numbers or metrics do we check to see if the CEO is doing their job?
__________ __________ ____________
4. Can we invest in a company that has a CEO we don’t love? ______
5. If a CEO is selling 5% of their shares, should we be worried?______
6. Which is more important – the MOAT or the Management and why?
________, BECAUSE THE COMPANY MUST HAVE A _________________.
A CEO CAN BE REPLACED, THUS, JUST ____________________
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MARGIN OF SAFETY
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Three Margin of Safety Methods
• 3 independent ways of valuing a company
• All are correct
Ten Cap RateSticker Price/MOS
8-Year Payback Time
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10 CAP
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Berkshire 2013 Letter
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TEN CAP
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Berkshire 2013 Letter
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Berkshire 2013 Letter
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Rental Property Ten Cap Calculation
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TEN CAP Mentality
• Is the business ____________________________?
• Does it have a______________ ?
• Does it have ________________, high ___________and low_____________?
• Do you trust the _____?
• Will it be more _________________ in ten years?
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Steps in Calculating a TEN CAP
• Look up ___________________ on the Cash Flow Statement.• Subtract the portion of ___________________ required to
maintain the business.• Add the _______________ from the Income Statement• What remains is __________________.• Divide ________________ by the shares outstanding• Divide _______________________ by the ____________.• If the ratio is 10% or more, we have a _____________!
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Steps in Calculating a TEN CAP• Operating Cash Flow: _______________________• Subtract Maintenance Capex:
• In the Cash Flow Statement find ___________________(Capex).
• In the 10K try to find the _________________________. If this is not specified make your best estimate or use the default of _____________________.
• Add __________________: In the Income Statement
• ___________________= Operating Cash Flow – Maintenance Capex + Tax Provision
• Owners Earnings x 10 = ____________
• Ten Cap / Shares Outstanding = ___________________
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Start with the Cash Flow Statement
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CMG Operating Cash Flow (use a “normal” year)
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TEN CAP Calculation
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Expand “Investing Cash Flow” Section
May be called Purchase of Property & Equipment
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2 Types Of Capex (Capital Expenditures)
Growth • Capital expenditures that ______________
➢New _________➢New _________adding online_____________➢New __________to create________________
Maintenance• Capital expenditures to ____________________
➢__________________Equipment➢__________________Facilities➢Upgrading _____________________________
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Finding Maintenance Capex
• Not a number found in ____________________
• Company must ________or we have to_____________
• Sometimes they provide the $ or % of __________ __________. Total ________ – ______ = ___________
• If we can’t make an informed estimate, the default we use is _______________________.
• Search _________
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Open the 10K That Represents a Normal Year Search for Details Around Capital Expenditures
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2015 10K Find Capital Expenditures
PC: Ctrl + FMac: Cmd + F
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Look For Any Details About Capital Expenditures
Total Capital Expenditures $257 MGrowth Capital Expenditures - $200 M---------------------------------------------------------------------------Maintenance Capital Expenditures $57 M
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Replace Total Capex with Maintenance Portion
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Go to the Income Statement
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CMG Tax Provision (use a “normal” year)
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Total Owners Earnings
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TEN CAP Price Per Share
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Convert to Owner Earnings Per Share
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TEN CAP Price Per Share
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CMG Buy Price
$ 332TEN CAP PURCHASE PRICE
STICKER / MOS
8 Year PBT Price
Disclaimer: Prices shown are for educational purposes only. Perform your own analysis to make your investing decisions.
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Sticker Price / MOS Sale Price
In order to forecast a company’s growth as accurately as possible and come up with a MOS sale price, we must first validate 3 numbers in the MOS Calculator.
1) ______________________________________
2) ______________________________________
3) ______________________________________
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Numbers To Validate
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EPS TTMEPS TTM is the most recent earnings per share, being current as of the last reported quarter for the prior 12 months.
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EPS TTM Validation• As with all of our valuations, we must first verify that the numbers
we are using fall within a range of what we would classify as ___________________________________.
• If the current year is an ________________, we would need to ____________________to reflect where we think the company ____________ _________________, and begin our__________ ____________ from that point.
• If the _________ is temporary, often we will _____________ _____________________ and use the ___________from then, anticipating that when the ______________, the company will _____________________________________________.
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“Normal” EPS History
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“Outlier” EPS History Due To An Event
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An “Outlier” Year That Fully Recovered After Event Ended
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Tax Reform and EPS
• Due to the 2017 Tax Reform Act, some companies have a tax benefit instead of tax expense in 2017 or 2018 (shown as a positive number on the income statement)
• This tax benefit creates and outlier for EPS because it’s a one-time, non-cash “event”
• To determine whether there is a tax outlier, look on the ________________and see if there is a ______________ even though the company has _____________________
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UNP Tax Outlier Example Negative Taxes Creates Inflated Net Income
OUTLIER
TAX
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Adjusting Tax Outliers
• We must ______________ any tax outliers for an accurate ________________
• For simplicity, use a ______ tax rate to estimate normal 2017 or 2018 EPS
• Multiply Pre-Tax Income from the Income Statement by _____ to calculate a normalized Earnings and then divide by Outstanding Shares to get a normalized EPS
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CMG Tax Outlier Check
NORMAL
TAX
NUMBERS
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Adjusted EPS TTM for CMG Due to Temporary Event
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Update the MOS Calculator
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Future Growth Rate
Estimate a 10 year future growth rate by reconciling• ___________________(from the_______________________)• __________________________(from your ______________)
Use the lower of your estimate or the toolbox default• The default is the ___________________________________• Analysts _____________to focus on ____________________• We must focus on___________________________________• Don’t assume that the analysts are going to be right• Do your own research and validate a reasonable long-term rate • For the workshop, do not use a growth rate higher than ______%.
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Estimating a Future Growth Rate
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Estimating Future Growth Rate
• Historical 10, 7, 5, and 3 year growth rates are calculated based on the most recent year; thus we must make sure it has “normal” results.
• If not, then it is an “outlier” (usually because they are entering or exiting an event) and the 10, 7, 5 and 3 year growth rates are skewed.
• In which case we must ___________for a more ___________________by looking at the ________ _______________section for__________________.
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“Normal” Growth Rates
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“Outlier” Growth Rates Due To An Event
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Update the MOS Calculator
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Future P/E• Future P/E = ______________________
___________________________________. Whichever is lower
2X
OR
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Update Values if Necessary and “Submit”
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CMG Current Price, Sticker Price & MOS Sale Price
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CMG Buy Price
$ 332TEN CAP PURCHASE PRICE
STICKER / MOS
8 Year PBT Price
$ 256
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8 Year Payback Time
Free Cash Flow• Not in the financial statements
Calculated from the Cash Flow Statement: Operating Cash Flow- ______________________________
The Toolbox calculates it based on the average _____________________ for the 10, 7, 5, 3 year historical averages
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Free Cash Ratio & Free Cash Flow Per Share
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CMG 8 Year PBT Sale Price
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CMG Buy Price
$ 332TEN CAP PURCHASE PRICE
STICKER / MOS
8 Year PBT Price
$ 256
$ 286
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Valuations Quiz• What are the 3 Valuation Methods?
____________ , ___________, ___________
• What two financial statements do we use to calculate estimated Owner Earnings? ____________________________, ________________________
• What does CAPEX stand for & what’s another term for CAPEX? _____________________________, _______________________________
• Where do you search for Maintenance Capex? ____________________________
• What two types of Capex do we need to identify? _________________, __________
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Valuations Quiz (Page 2)
• What are the 3 numbers we need to validate on the MOS Calculator? ___________, __________________________, _________________
• How many years out do we predict a company’s future growth rate? ______
• Future P/E is either ________________ the future growth rate OR the ____________ historical P/E, whichever is ______________.
• How many years would we like to be paid back from our investment’s free cash flow (Payback Time)? ___________.
• Free cash flow is calculated as Cash From Operating Activities minus Purchase of Property and Equipment? ___________
• Our buy price is the _________________ of the 3 valuation methods?
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CONTINUING OUR RESEARCH
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LOVE: Investing is about __________
• Make sure your investments ___________________
• Be sure you LOVE:• What _______________________• How they treat their ________________ • How they treat their ________________ • How they treat their ________________ • How they treat their ________________ • The impact they have on the __________________ • The impact they have on the __________________• How their ___________________
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BUILDING A STORY
MEANING MOATS
MGMTMOS
EVENT
INVERSIONS
REBUTTALS
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EVENTS
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COMPANY EVENT BP OIL WELL SPILL
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INDUSTRY EVENT FUKUSHIMA DISASTER
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ECONOMIC EVENT GREEK BOND CRISIS
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EVENT
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Economic Event
-50%
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Company Specific Event
-65%
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Acceptable Events
• Events should last less than ________. • We must ___________ the event.• We must know the __________ of the
event on the company.• We must know the ____________
before we buy.143
How do We Know if It’s Temporary?
• The problem is ______________.• We know the company didn’t break
_______________.• We know the __________________.• We have evidence ______________
_____________________.144
How Else Might We Know It’s Temporary? News
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STORY INVERSIONS&
REBUTTALS146
INVERSIONList each major reason to own this business and rebutt it.
Reason #1. Great moatInversion #1. The moat is brokenRebuttal #1. It isn’t because …
Reason #2. Predictable future growth rateInversion #2. The growth rate is about to radically dropRebuttal #2. It won’t because…
Reason #3. Excellent free cash flowInversion #3. The free cash flow isn’t from product salesRebuttal #3. It wasn’t but it will be because…
Reason #4. Experienced CEO and teamInversion #4. VP left who built the division that is responsible for all the growthRebuttal #4. He did but his #2 can handle it
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INVERSIONList each major reason to sell it listed by short sellers and rebutt it.
Inversion #1. Management fraud in accountingRebuttal #1. It isn’t GAAP but it isn’t fraud because …
Inversion #2. This fad is overRebuttal #2. It isn’t a fad and here’s proof …
Inversion #3. The business failedRebuttal #3. It did, but the net real estate is worth 4X the purchase price
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INVERSION
Things in our Story that could go wrong:• Any areas of the business _______________• Are their ___________ and are they _______________?• Has the Event broken ____________?• What can ______________ mess up?• What can cause them to miss ____________________?• Could the Event end up ________________?• What else don’t I see that _____________________?
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REBUTTALS
Factual evidence why the Inversions ______________.
Examples:• They’ve hedged their fuel costs for several years
against higher oil prices• Their key patents are good until 2030• They’ve survived Events like this before• Their backlog is growing so sales are returning• The lawsuits are settled now
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Where To Find Inversions & Rebuttals
_____________________________________________
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_______ – Risk Factors
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10K – Risk Factors
Do NOT rely on the ___ to spell out the REAL risks of the business in a way that makes those risks seem likely.
- boilerplate makes real danger look like … well, boilerplate.
- You shouldn’t need a ____ to see the real risk to the business if you understand the business well enough to own it.
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_______________ and Other Analyst Articles
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Conclusion of Research
RADAR: Gurus and 3-CirclesUNDERSTAND: Meaning Moat Mgt, Margin of SafetyLOVE: Values EVENT: Fear
______________________________________ ___________________ ___________________
WONDERFUL?
STORY INVERSIONS: Rebuttals
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Put it All Together in a Story
R – Radar – ___________________
U – Understand – ______________________
L – Love – Does it match your _______?
E – Event – Is there _______________?
S – Story Inversion – Why ___________?
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OPTIONS101
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Option Grid
ToSELL Shares
ToBUY Shares
ToBUY Shares
ToSELL Shares
CALLS PUTS
SELLERS
BUYERS
OBLIGATION OBLIGATION
RIGHTS RIGHTS
“Short Position”
“Long Position”
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OPTIONSTERMINOLOGY
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Options Terminology
BULLISH = Price is Rising
BEARISH = Price is Dropping160
Options Terminology
Short = Selling
Long = Buying
LONG
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What are Options?• OPTIONS are CONTRACTS – like an insurance contract
• OPTIONS are not the actual stock or security
• OPTIONS have their own market and are bought and sold just like stocks
• OPTIONS can be sold – just like an insurance company sells an insurance contract – it is a promise to do something during a certain period of time for a certain price
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Types of Option Contracts• Two Types of Stock Option Contracts:
• PUTS• CALLS
• Two things you can do with them:• SELL them• BUY them
• SELLERS have _________________
• BUYERS have __________________
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Entering & Exiting Option Contracts
• To enter into an option contract we _____ them• SELL _________• BUY _________
• To exit an option contract we CLOSE them• BUY _________• SELL ___________
• If we ____, to get out of the trade we must ____
• If we ____, to get out of the trade we must ____
________
________
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Options Terminology
Options are traded in # of Contracts: • 1 Contract controls 100 Shares
Underlying security: • the asset the option contract controls
ie. Stock/Equity, ETF, Index
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Options Terminology
Strike Price: • the price at which shares change hands … if
shares change hands
Premium: • the amount of money that is paid for the
option contractThe Buyer pays the premium The Seller receives the premium
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Options Terminology
Expiration Date: • the date the contract expires
Monthly Expiration Date: • the 3rd Friday of the month
Days to Expiration (DTE): • the number of days from the current date
until the expiration date167
TOS Trade Tab
©Rule One Investing, LLC 2018
PremiumsStrike Prices
ExpirationDate
DTE
168
Options TerminologyThe Money: the current market price of the underlying security
At the Money (ATM): the closest strike price to “The Money”
In the Money (ITM): any strike price that is profitable for the buyer if the contract is executed/assigned now
Out of the Money (OTM): any strike price that is not profitable for the buyer if the contract is executed/assigned now
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TOS Trade Tab
©Rule One Investing, LLC 2018
ATM
OTM ITM
OTMITM
The Money
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Options PremiumsThe Market Maker’s job is to put deals together, so they are constantly adjusting prices when the market is open. There are multiple prices associated with the premiums.
• Bid Prices: the market price set for the seller
• Ask Price: the market price set for the buyer
• Mark aka the Mid: the midpoint between the Bid and the Ask• This is the price we prefer to use as Rulers
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TOS Bid-Ask-Mark
©Rule One Investing, LLC 2018
Bid/Ask/Mark for Calls & Puts
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Options Order TypesMarket Orders:
• Guaranteed to get the order filled• Not guaranteed to get the Premium we want• Might get paid the Bid (when Selling) or charged the Ask
(when Buying) but could be much worse.
Limit Orders:• Guaranteed to require the Premium we want (or better!)• Not guaranteed to get the order filled
We use Limit Orders asking for the Mark173
Options Order DurationDay Order:
Order remains open until it is either:• Filled• Cancelled by you• Cancelled by the broker at the close of the day
Good Til Cancelled (GTC):Order remains open until it is either:
• Filled• Cancelled by you• Cancelled by the broker after 60 days or at Expiration Date
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Options Order Entry
©Rule One Investing, LLC 2018 175
Options Quiz
1. An upward price movement is ______________2. A downward price movement is ______________3. If you sell something you are ______________4. If you buy something you are ______________5. One option contract controls _____________ shares6. The price at which the shares will exchange hands (if
they exchange hands) is called the ___________________7. An option contract remains valid until _______________
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Options Quiz (Page 2)
1. Strike prices that would be profitable for the buyer if the contract was executed now is: ___________________
2. Strike prices that are NOT profitable for the buyer if the contract was executed now is: _______________________
3. The premium the market maker lists for the seller is called: ______________
4. The money the buyer pays the seller to bind the contract is called the: ______________
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RULE ONE PUT (ROP)
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Rule One PUT (ROP)
What is it?
A Rule One strategy that allows us to make money on something we were going to do _______- buy a Wonderful Company_______.
A great bonus is we can use this strategy before our Wonderful Company goes on sale and before we even own shares.
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Rule One PUT (ROP)
1. We MUST have _______________the company, determined it is ____________ and want to own shares at our Buy Price or "_____________” price.
2. We MUST have the funds in our account to purchase at least 100 shares at our Buy Price (1 contract = 100 shares).
CRITICAL requirements BEFORE considering a ROP
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Rule One PUT (ROP)
Primary Objective:To be obligated to buy a ________________at our
_______________ (or below) because we want to own the business and are ready to buy it.
Secondary Objective:Collect enough of a Premium that it gives us an
__________ _____ of ________ on our_________, in case we don’t get to buy the shares.
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Rule One PUT (ROP)
1. The Strike Price _______the________ at the Mark is less than or equal to our _________ _____________________________.
2. The ________ of the Premium at the Mark for that ______________ achieves a __________________________or better.
Two Rules to finding a ROP:
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ROP Details
If the option contract is assigned to us, we are obligated to buy the shares. So, we must be buying them on _______.
To make sure of this, we must choose a Strike Price where the Strike Price minus the Premium we get paid is ________ than or equal to our ________ Price. ___________Price – ___________ <= _______ Price.
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ROP Details
We may find several Strike Prices that meet our requirements.
We use _________ Return On ______ _________ (ARORC) to choose the best one.
We would like to get an ___________ equal to or greater than ______% ARORC.
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_________ Calculation on a ROP
1. Risk Capital (RC) = ___________- Premium
2. Return on Risk Capital (RORC) =_________ / Risk Capital (RC) _____________________________________
3. Multiplier (M) = ____/ ____ To _________
(DTE)
4. _______ Return On ______ __________ (ARORC) = RORC x Multiplier (M)
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Time Guidelines
• Choose any option chain with any number of days to expiration (DTE)
• ______ DTE usually helps achieve our goal Buy Price
• ______ DTE usually helps achieve our goal ARORC
• Start with a DTE between ____-____ Days.
• Start with a Strike Price nearest our Buy Price and move ______ to the _______ until we meet our ________ goal.
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Rule One PUT (ROP)
Only possible outcomes from a ROP strategy:
1. We are Put (sold) the shares of our Wonderful Company which means we get to_____ the ________ we want
at the _________ we want.
2. We are NOT Put the shares: Which means we _________ a ___% profit or more on the
_________that was being held for the____________.
It’s a ______-______ proposition.187
ROP Outcomes Must Balance the Scale
A successful ROP balances our two outcomesIf PUT Shares If not PUT Shares
___________
-____________
<=Buy Price
___________
>=20%
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Rule One PUT (ROP) Example: Chipotle Mexican Grill
• Chipotle Mexican Grill (hypothetical example)• Fair “Sticker” Price:__________• Example “On Sale” (Buy) Price: ______• Current Stock Price: _______
(Apr 14, 2018)
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Click on Analyze Tab, ThinkBack Enter CMG, Select 4/14/2018
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Checking the CMG $310 Strike The PUT = Premium of $11.87
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CMG ROP Checklist• Chipotle Mexican Grill hypothetical example
• Strike Price: __________• Premium received: ___________ • Risk Capital: __________ <= Buy Price of_________ • Return on Risk Capital (RORC): $11.87/298.13 = _____ • Days to Expiration (DTE): ______• Multiplier: ( _____/ 34 ______) = _______• Annualized RORC (ARORC): ______3.98% = _______%= > ____% ARORC
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When LIVE Trading in the Trade Tab, we complete the Order
We now have an order for a _________ at the $310 Strike Price, and we make it a _____ ____ for the ____, making sure to ask for the _______/_______, enter our desired # of _________, then select “__________ & _______.”
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ROP Results
1. Stock price goes down and is below the Strike Price at expiration of the contract, so it is In The Money (ITM):
• As the Seller of the option, we get _______ the shares and are required to _______ them at the _____ _____ we wanted, and we get to keep the __________ we were paid.
• OUTCOME: We get the shares we __________at the ________ we _____________.
Two Win-Win Possible Outcomes of the Trade:
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ROP Results
2. Stock price is at or above the Strike Price at expiration of the contract, so it is Out of The Money (OTM):
• As the Seller of the option, we are likely ________ _____________ the shares, but we get to _____ the ____________ and thus make a _____ ______ on our_________ that was held for the trade.
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ROP Reminders
!In both outcomes, WE _____ the ___________.
!With Options on an Equity, the buyer has a ________ to ______ their ______ and _____ us (sell) their shares anytime, so we must be _________.
!However, most of the time they only ________ the _____________if it is ____ _____ _________ (ITM) at expiration.
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RULE ONE CALL (ROC)
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Rule One Covered CALL (ROC)
What is it?
A Rule One strategy that allows us to make money on a stock we own, just for being willing to ____________________________.
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Rule One Covered CALL (ROC)
1. You MUST ____at least ___ _________
in your account (1 contract = ___ _______).
2. You MUST be willing to ________ your _____________.
Two CRITICAL Requirements:
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Rule One Covered CALL (ROC)
Primary Objective:To be _________to _______shares of a Company we
already own at a ______ _____ of our choosing.
Secondary Objective:
Collect enough of a __________ that it gives us an acceptable _____ of _________on the capital that is still in the company we own; in case we don’t end up ________ our ____________.
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Rule One Covered CALL (ROC)
1. Typically, the Strike Price is about _____% above our ________ ________ or higher.
2. We would like the _______ of the option trade to be _____% or better.
Two Guidelines to finding a ROC:
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ROC Details
If the option contract is assigned to us, we are __________to _______our shares at the strike price we set, so we must be sure we are selling well above the intrinsic value (Sticker Price).
We usually choose a Strike Price that is at least ____% above the current _______ Price on our _________ Company.
________Price >= ________Price + _____%
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ROC Details
We may have several ________ Prices that meet our first goal – to sell the shares at about ____% above our _____ Price.
We can use the __________to help choose the best ______ strike price to _______.
For the second goal, we would like to get an _______ of around _____% or better.
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ARORC Calculation on a ROC1. _______ ________ (RC) = Basis (average Purchase Price) -
________
2. _______ on ______ _________(RORC) = Premium ÷ Risk Capital (RC)
3. Multiplier (M) = ____ / _______ to __________ (DTE)
4. Annualized _______ on _______ ________ (ARORC) = ______ x Multiplier (M)
Note: ______ _______ is calculated______________ for a ROC than for a ROP.
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Rule One CALL (ROC) Example Chipotle Mexican Grill (CMG)
• After a great rise in price, CMG stock is selling for $688 on 4/17/19.
• We own shares with a _____ _______ of $309.
• ________ Price is $618.
• We are OK to sell some shares at _____% above ______ price which is $_______.
• We decide to shop for a good ______ on 4/17/19.
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STO CMG ROC• We go shopping for a _____ _______ that may get our shares sold at
_____% above the ________ Price and give us a nice return.
• We want a Strike Price of at least $742 (Sticker $618 x 205).
• We begin shopping the options contracts that expire with around ________Days To Expiration (DTE) to see if we can meet our _____ goals. Go out further in option contract time if necessary.
• We check our ARORC calculation and determine if it will pay us around 20% ARORC.
• If our shares don’t get called away (_____ ) then we will have lowered our _____ _____ by the premium we collect in this trade.
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$750 Strike
$7.90 Mark
Example: CMG April 17, 2019 Options Chains
Expiration Date
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CMG ROC Checklist• Chipotle Mexican Grill hypothetical example (17 Apr 2019)
• Example Average Purchase Price (______): $__________.• Sticker Price: $____________• Current Price: $ ___________• Strike Price: $__________ >= 20% above Sticker • Premium received: $ _________ • Risk Capital (Buy Price – Premium): $309.00-$7.90 = $301.10• Return on Risk Capital (RORC): $7.90 / $_______ = _____%• Days to Expiration (DTE) _________• Multiplier (365/30) = ____________• Annualized RORC (ARORC): ______ x_______% = ______%
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ROC Results
1. Stock price goes UP and Strike Price is In The _______ (ITM) at expiration of the contract:
• We have our shares called away as the Seller of the option and are ________ to____ them at the Strike Price we wanted and we get to keep the __________.
• Thus, we get to sell the stock we were going to sell anyway, at a _______we wanted and got _________to do it.
Two Win-Win Possible Outcomes of the Trade
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ROC Results
2. Stock price is at or below the Strike Price at expiration of the contract so it is ______ of The ____________(OTM):
• Our shares will NOT be called away so we don’t have to _____ our _____, but we get to keep the ____________ and thus make a solid ________ on our _________ that is invested in the company shares.
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ROC Reminders
!In both outcomes, WE keep _________________.
!With Options on an Equity, the buyer has a _________to exercise their option and _______ (_____) our shares away at anytime, so we must be prepared.
!However, the majority of the time they only ________the option if it is In The _____________ (ITM) at___________.
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ROP & ROC Quiz
1. Two Types of Stock Option Contracts:• ______________________• ______________________
2. Two things you can do with them.• ______________________• ______________________
3. SELLERS have ______________________
4. BUYERS have ______________________
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ROP & ROC Quiz (Page 2)
5. Primary two objectives of a ROP:• If PUT the shares, we are obligated to _______ shares of
our wonderful company at our ______________• If NOT PUT the shares, we make an acceptable return of
_____% _________ on our money
6. Primary objective of a ROC:• To be obligated to ________ shares of our wonderful
company _____________ the current Sticker Price• If the shares are NOT called away, we make an
acceptable return of _____% _________
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Option Grid
OBLIGATIONTo
______ Shares
OBLIGATIONTo
______ Shares
RIGHTTo
_____ Shares
RIGHTTo
______ Shares
CALLS PUTS
SELLERS
BUYERS
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THINK OR SWIM (TOS)
CONFIGURATION215
TOS Configuration Options Tab
• Confirm Layout Settings• Mark• Probability OTM• Delta• Mark
• Confirm Strikes are set to ”All”
Be sure to configure the options chain in your Think or Swim (TOS) account as follows:
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TOS Trade Tab
©Rule One Investing, LLC 2018
Option Contracts
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TOS Trade Tab
©Rule One Investing, LLC 2018
Select a contract to use for your trade
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TOS Trade Tab
©Rule One Investing, LLC 2018 219
TOS Trade Tab
©Rule One Investing, LLC 2018
Remove & Add items to fit this configuration
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Rule #1: Reduction of Cost Basis
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Ways to Reduce Cost ____
▪ Selling _______
▪ Selling _______
▪ Tranching
▪ Selling some shares at _________ or above
▪ ________________
▪ Stock ___________
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Selling __________
Dividing total investing for each company into 4 ______
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As price gets close to On-Sale, we can begin to sell ______
__________
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Dividing total investing for each company into 3-5 __________
Buy your first tranche at the first opportunity you have!
Selling ROPs
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Assume over a 3-year period we sold ROPs only 8 times
_____________
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Divide total investment into 3-5 slices
Note- the lowest price the stock has been in 5 years is $38.44
Selling __________
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As the price starts to return, we can sell ______
Selling Some __________
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Only look to sell once the stock is at/above ___________ price
The right time to sell is never! However, selling some shares at a profit is very effective in helping manage emotions.
_________ CollectedCompany pays out 30% of profit as a dividend
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Date Div/sh Shares Owned Dividend CollectedMar-2018 $0.23 200 $46May-2018 $0.32 200 $64Aug-2018 $0.34 200 $68Nov-2018 $0.21 200 $42Mar-2019 $0.28 200 $56May-2019 $0.29 200 $58Aug-2019 $0.14 200 $28Nov-2019 $0.11 985 $108.35Mar-2020 $0.18 985 $177.30May-2020 $0.35 985 $344.75Aug-2020 $5.42 685 $3,712.70Nov-2020 $0.52 685 $356.2
Total = $5,061.3
Stock ________Company XYZ has 19.8M shares in 2016
Company XYZ buys back 2M shares by 2020.This equals 10.1% of Company XYZ’s shares
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SUMMARY of Reduction of _____
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Rule #1: Introduction to Technical
Indicators232
Warren Buffett 1986 Letter to Shareholders
• Common stocks, of course, are the most fun. When conditions are right that is, when companies with good economics and good management sell well below intrinsic business value - stocks sometimes provide grand-slam home runs. But we currently find no equities that come close to meeting our tests. This statement in no way translates into a stock market prediction: we have no idea - and never have had - whether the market is going to go up, down, or sideways in the near- or intermediate term future.
• What we do know, however, is that occasional outbreaks of those two super-contagious diseases, fear and greed, will forever occur in the investment community. The timing of these epidemics will be unpredictable. And the market aberrations produced by them will be equally unpredictable, both as to duration and degree. Therefore, we never try to anticipate the arrival or departure of either disease. Our goal is more modest: we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.
• As this is written, little fear is visible in Wall Street. Instead, euphoria prevails - and why not? What could be more exhilarating than to participate in a bull market in which the rewards to owners of businesses become gloriously uncoupled from the plodding performances of the businesses themselves. Unfortunately, however, stocks can’t outperform businesses indefinitely.
233
Technical Indicators
• 3 Arrows
• Trendlines
• Fibonacci Retracements
234
Long Term Investing
• Meaning, Moat, Management
• Margin of Safety
• CERTAINTY
• PATIENCE
235
Technical Indicators
Where financial statements are the language of investing, technical indicators are the language of trading.
Technical Indicators help us see patterns that are already there.
236
Macro View
• Shiller PE
• Wilshire GDP
• 3 Arrows Indicators on DJIA
237
3 Arrows DJIA
238
3 Arrows
• Used for broad based Mutual Funds and ETFs• Not for investing in individual companies
• Settings:• 10 period simple moving average (SMA)• MACD (8,17,9)• Slow Stochastics (14,5,0)
• 10 Year Monthly Chart239
Testing the Arrows
SPY – S&P 500 Index Exchange Traded Fund (ETF)
• Get in on _________arrows
• Get out on ________ arrows
• Compare results using the ______ vs buy and hold
240
SPY Sep 2007 – Feb 2020
241
SPY Sep 2007 – Feb 2020
242
SPY 3 Arrows Results
243
Short Term Trading
• SPECULATION aka gambling
• Probabilities
• Odds
• Need an edge
244
__________ – Helpful for our Trades
• Helps us see the patterns that are already there – like looking up in to the clouds and seeing a shape
• Nothing goes up or down in a straight line
• Trends:
• _________ _____ – higher highs and higher lows
• _________ _____ – lower highs and lower lows
• ______________ – moving sideways
245
Up Trend
246
Down Trend
247
Channeling
248
Fibonacci Retracements• Fibonacci Spiral is found all through nature, art, architecture
• Shows up in Stock Charts too
• Can use Fibonacci Retracements to help us see ______ that may not be obvious at first glance
• ________ between a floor and a ceiling
• Generally, use a _________ month timeframe
• _______ Chart
• Looking for a good ______249
Fib Retracements
250
Rule #1: Introduction to Credit Spreads
251
Coverage $10,000
MONTHLY PREMIUM $50ANNUAL PREMIUM $600
CAPITAL REQUIRED $10,000
ANNUAL RATE OF RETURN 6%
252
Coverage $500,000
……AT $600/YR….ONLY 816 YEARSCAPITAL REQUIRED $500,000
MONTHLY PREMIUM $3,000ANNUAL PREMIUM $36,000ANNUAL RATE OF RETURN 7.2%
253
COVERAGE: $500,000 NET MONTHLY PREMIUM: $250 net Annual Premium: $3000 capital required: $10,000 annual rate of return: 30%
POLICY 1 – WE _______
COVERAGE: $500,000
MONTHLY PREMIUM: $3,000
ANNUAL PREMIUM: $36,000POLICY 2 – WE _______ COVERAGE $490,000 MONTHLY PREMIUM $2,750 ANNUAL PREMIUM $33,000
Re-insurance ________ model
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EXAMPLE 1 – APPLE without _______
DATE 12/2/16
CAPITAL $10,000
POLICY TERM 6 Months
OPTION CHAIN June 2017
STRIKE / RISK (STO) $100
CONTRACTS ($10,000/100 Shares/$100) 1
PREMIUM PER SHARE $3.78
6 MO PREMIUM (1x100x$3.78) $378
FINAL ANNUALIZED PREMIUM (X 2) $756
ARORC 7.6%255
EXAMPLE 2 – APPLE Hedged _______ ______
SAME OPTION CHAIN & STRIKE
SHORT STRIKE (STO) $100
LONG STRIKE (BTO) $97.50
SPREAD / RISK (SHORT-LONG) $2.50
CONTRACTS ($10,000/100 Shares/$2.50) 40
NET PREMIUM PER SHARE ($3.78 - $3.09) .69
6 MO PREMIUM (40x100x$.69) $2,760
FINAL ANNUALIZED PREMIUM $5,520
ARORC 55%
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