Monthly Archives: June 2010

My Investing Blueprint

In order to be a successful investor, you need a proven, rational framework.

In my Investing Blueprint, I’ve taken my years of studying the investment process and distilled it down into ten steps.

The ten steps are simple and straight forward, but they require commitment and work to put into practice.

This process has been proven to work over and over by some of the greatest (and wealthiest) investors in the world.

I believe it is the best risk-adjusted way to achieve long-term success in the stock market.  Students of Warren Buffett will immediately recognize that the following ten steps are largely based on his teachings.  I am grateful to Warren Buffett and many others who have shared their insights and experience.

I strive to follow this blueprint in my own investing and believe it will help you if you learn it and put it into practice.

It serves as a great checklist that you can use to evaluate your investing behavior and achieve success as an investor.

Here’s the blueprint:

1. Search Broadly and Continually for New Investment Ideas.

To a large extent, finding great investments is a numbers game.  You need to look at a large number of companies before you find a truly great opportunity.

In this regard, its not that different from a sales funnel.

In order to close a sale, a salesperson might first need to make one hundred cold calls.  Great sales people realize this and do the necessary seed work to meet their goals.

When Buffett was getting started, he took the Moody’s Manual and went through it page by page in alphabetical order so he could look at every company.

2.  Act Like an Owner.

You need to think of yourself as a business owner, not someone who buys a piece of paper and then sells it a few days or weeks or months later.  This is not the way to build wealth in the market.

Your objective is to buy a piece of a great business and then hold on tight for many years as the business develops and throws off cash.

Don’t let macroeconomic concerns get in the way of your primary objective.

Imagine if you had an opportunity to buy the best business in your city, one that had been around forever and that prospered in good season and bad.  Would you take a pass simply because of macro-economic concerns?

A truly great business is probably the best way to protect and grow your purchasing power, regardless of economic conditions.

3.  Only Buy Things you Understand.

This seems obvious, but it is violated all the time.  You would never buy an entire company if you did not thoroughly understand the business.  Otherwise it would be impossible to evaluate its long-term prospects.

This requires thorough research.  Think of yourself as an investigative journalist who is trying to determine the value of the company.

One reason so many people violate this principle is that they do not view investing as buying a piece of a business.

Often, they buy a stock simply because it is going up, thinking that they can sell it to someone else at a higher price and make a quick profit.

If you don’t know what you’re doing, sooner or later you are going to get burned.  Think of all the real estate “investors” who thought they were going to get rich flipping houses.  Did they really understand real-estate investing?

It worked until it didn’t.

Focus your efforts on a few industries that you truly understand.  Remember, every time you purchase a stock there is someone on the other side of the trade.  If you’re not highly certain that you have an informational advantage, you should take a pass.

One quick test is to imagine that you had to give a presentation on a stock you want to buy to a room full of savvy industry veterans and then take their questions.

How would you do?

Be honest with yourself.  If you couldn’t do it, maybe the purchase is not such a great idea.

4.  Buy Good Businesses.

Even the best management teams run into trouble when the fundamentals of the underlying business are bad.  Turnarounds rarely turn and often end up losing investors a lot of money.

A good business, on the other hand, throws off a lot of free cash that can be distributed to shareholders or used for reinvestment in the business.  A great business can sustain cyclical downturns and external shocks.

Look for businesses that have generated a high return on invested capital over a long period of time.  Also look to see if the company has enjoyed a steady, growing market share.  These are excellent signs that the company is a good business.

Above all, you must determine if the business has a durable competitive advantage.  Capitalism is brutal: the process of creative destruction is continuously at work as successful industries and businesses attract capital and competition.

Having a durable competitive advantage provides a margin of safety by making it difficult or impossible for competitors to attack the business and reduce its profits.

5.  Invest in Companies with Great Management.

Look for talent, a proven track record and high-integrity.

High integrity may be the most important because, if it is lacking, management has the power to rob shareholders of their fair share of the profits through excessive compensation, empire building and outright theft.

Execution is critical to business success.  Even a business with great economics requires good management to grow the business and evolve it to meet ever changing conditions and new challenges.

Why not insist on investing alongside the very best managers available?

6.  Buy the Cheapest Business Available.

Naturally a prospective investment needs to pass your filters, but among those that do, you should invest in the cheapest available.

By cheapest, I mean the one that will deliver the most cash back on a time adjusted basis for the cash you lay out in making the investment.

Before making a purchase, always write down why the business is a good value.

7.  Focus on Your Best Ideas.

Good ideas are hard to come by.  Many great investors consider themselves fortunate if they can generate one or two good ideas a year.

When you find one, it should be fairly obvious that you want to invest a meaningful amount of your capital in that business.

Think about how you would operate if you were going to invest in one or more private businesses in your town. Would you want to own fifty or a meaningful piece of the very best five or ten?

Many highly successful businesspeople have their entire net worth invested in their business or farm.

Learn what you’re doing and your margin of safety will come from truly understanding a few great companies where you can watch your capital multiply over the years.

8.  Practice Patience.

You need patience both when looking for new investments and waiting for them to payoff after you make a purchase.   There is no way to know how long you must wait before a good idea comes along.  Your only choice is to prospect away until something comes along where the odds are overwhelmingly in your favor.  After you make an investment, you do not know how long it will take for its intrinsic value to be recognized.

The big money is made by sitting tight.  A great business doesn’t mechanically follow a quarterly cycle but develops overtime as its superior economics play out in the marketplace.

It takes time for this to happen.  Great wealth has been generated by practicing patience.

Finding a great business that is growing is rare.  Plus, as the investment grows in value you get to enjoy an interest-free loan from the government in the form of deferred taxes.  When you find a situation like this you should sit tight and let it compound.

9.  Avoid Stupid Mistakes.

What type of mistakes do investors make?  Let me count the ways.

It’s amazing how much success you can have by simply avoiding big mistakes.

What am I talking about?  Flipping stocks, buying things outside your circle of competence, investing in low return businesses with no barriers to entry, overpaying for stocks, using leverage, not doing your homework.  The list goes on and on.

The most common mistake may be letting the market price dictate the value of your investments rather than doing your own homework and making your own informed determination of value.

To be successful you need to be honest with yourself and identify your problem areas so you can take steps to improve.

Also, don’t forget about sins of omission.  It’s not only what you do, but also what you DON’T do that can cost you.

When you identify a great company, at a great price, and you fail to make a sizable investment, it can cost you a lot of money.

10.  Be a Learning Machine.

Read constantly and broadly.  Carefully study the core foundational books on investing.  Take an industry and try to master how it works.  Don’t go an inch deep and a mile wide.

Many investors have gotten rich by focusing on a few industries and learning them well.

Investing is a highly competitive endeavor.  To succeed you need to be constantly learning and growing.

Plus, investing is evolving.  Although the core principles are timeless, what worked twenty years ago may not work today.   Also, the companies you own are changing and you need to stay on top of them.

The good news is that this type of learning is cumulative.  Over time, you will develop a rich store of knowledge and experience that can’t help but improve your investing results.

Summary

If you learn the ten steps and work hard to put them into practice, you will become a successful investor.

I’d love you hear what you think.  Please share your own process.


Total (ticker: TOT): An Oil Stock with a Supersized Dividend – Barrons.com

An Oil Stock with a Supersized Dividend – Barrons.com

At 6.1 times 2011 earnings, the company is trading at a significant discount to its five-year average price-to-earnings multiple of 9.7. And once new projects ramp up, production could grow considerably.

It appears that investors have taken concerns about the stock into account, and then some. With Total’s shares trading well below their historical average and more production growth on the horizon, this could be the right time to take another look.

Miller: IBM the Most Remarkably Mispriced Name in the Market – Morningstar.com

Miller: IBM the Most Remarkably Mispriced Name in the Market – Morningstar.com

The Legg Mason manager says this tech giant is like Poe’s ‘Purloined Letter’: Hidden in plain sight. Plus, Miller on gaining a behavioral edge in investing.

At the micro level, there is a very pertinent one right now, the oil spill in the Gulf. So that’s caused a huge amount of panic on the part of investors with respect to BP, Transocean, Anadarko and some other companies that have been involved in it. And all those companies have been sold off extremely harshly, despite there being very different underlying data-driven conditions. So BP is responsible for the spill. Anadarko is responsible for part of the spill under certain conditions, and Transocean is responsible for none of the spill and is indemnified by BP, but as a week or so ago Transocean was actually off more than BP was.

Hughes: So, as we look at maybe some more of those names, as you look at the portfolio today, who is the up-and-comer, what’s your favorite idea?

Miller: Well, I guess, the name that I find the most remarkably mis-priced name in the market is IBM. And the reason for that is that IBM I think is representative of what you can get in mega-cap in the U.S. And the reason I use IBM is, it’s been around a 100 years. So, it’s not like Google, which is relatively new or companies that you don’t have a lot of data. You have a 100 years of data on IBM. You have data on how the markets’ valued and how it’s behaved in various economic conditions.

Moreover, IBM is followed by everybody that follows big-cap tech. So, there is a large numbers of people looking at it and trying to figure it out. Maybe, most interestingly, IBM is one of the most transparent companies in the market. They tell you their long-term goals, they tell you their long-term expectations with respect to earnings per share, free cash flow, operating margins, dividend policy. And then they tell you the short-term, too, they gave you – they have already upped their guidance twice this year.

So, if you think about that the long history, the large numbers of people looking at it, and the company being very open, you would expect that if anything is going to be properly priced in the market, it’s going to be IBM. You should be able to earn excess return by buying IBM in the marketplace today. Yet, if you look at their results over the past five years, what you see is IBM has doubled their operating earnings per share in the last five years. The dividend has grown over 20% a year over the last five years. They’ve bought back stock and shrunk the shares outstanding every year.

This year, they will have record earnings and record operating margins again. They had that two years ago actually during the worst recession since the Great Depression. So, if they can navigate through that kind of an environment, when the economy has been arguably as difficult as it’s ever been, when the economy gets better, as is doing right now, they should do even better, which is why they have increased guidance twice this year.

Yet, you can buy IBM today at around 10.5 times this year’s earnings and around 9.8 times next year’s earnings, the lowest multiple it’s ever traded at, with returns on capital in the 25% to 30% range.

If you run it through any valuation model, it will show that it’s 30% to 50% underpriced. Yet, nobody seems to care about it. In fact, when I mentioned it to other investors, they are like, ‘I haven’t looked at IBM in a long time.’ So, I think that’s the – it’s sort of like Poe’s Purloined Letter, it’s hidden in plain sight.