Monday, 5 October 2015

How Buffett Interprets the Cash Flow Statement

  • Capital Expenditures
    • Never invest in telephone companies because of big capital outlays 
    • Important: company with durable competitive advantage uses a smaller portion of earnings for capital expenditure for continuing operations than those without. 
    • To compare capex to net earnings, add up total capex for ten-yr period and compare with total net earnings over the same period 
    • Important: if historically using less than 50%, then good place to look for durable competitive advantage. If less than 25%, probably has a competitive advantage.
The Cash Flow Statement Summary Table
Capital Expenditureshistorically using
< 50% then good place to look for d.c.a.
< 25% probably has d.c.a.
Add up total cap exp for ten-yr period and compare
w/ total net earnings over period.
Stock Buybacksindicator of d.c.a. is a history of repurchasing/retiring its sharesLook at cash from investment activities. “Issuance
(Retirement) of Stock, Net”
 Read more on the Cash Flow Statement Analysis  on my previous post - http://intelligentinvestor8.blogspot.my/2014/06/cash-flow-statement-analysis.html

Or, take a look on How Buffett read other financial statements:-

References:-

How Buffett Interprets the Balance Sheet

  • Cash and Equivalents:  
    • A high number means either:
    1. The company has competitive advantage generating lots of cash 
    2. Just sold a business or bonds (not necessarily good)
    3. A low stockpile of cash usually means poor to mediocre economics. 
    •  There are 3 ways to create large cash reserve. 
      1. Sell new bonds or equity to public 
      2.  Sell business or asset 
      3.  It has an ongoing business generating more cash than it burns (usually means durable competitive advantage)
    • When a company is suffering a short term problem, Buffett looks at cash or marketable securities to see whether it has the financial strength to ride it out. 
    • Important: Lots of cash and marketable securities + little debt = good chance that the business will sail on through tough times.
    • Test to see what is creating cash by looking at past 7 yrs of balance sheets. This will reveal how the cash was created.
  • Inventory
  • Manufacturers with durable competitive advantages have the advantage that the products they sell do not change, and therefore will never become obsolete. Buffett likes this advantage.
  • When identifying manufacturers with durable competitive advantage, look for inventory and net earnings that rise correspondingly. This indicates that the company is finding profitable ways to increase sales which called for an increase in inventory.
  • Manufacturers with inventories that spike up and down are indicative of competitive industries subject to boom and bust.
  • Net Receivables 
    • Net receivables tells us a great deal about the different competitors in the same industry. 
    • In competitive industries, some attempt to gain advantage by offering better credit terms, causing increase in sales and receivables.
    • If company consistently shows lower % Net receivables to gross sales than competitors, then it usually has some kind of competitive advantage which requires further digging.
  • Property, Plant & Equipment
  • A company with durable competitive advantage doesn’t need to constantly upgrade its equipment to stay competitive. The company replaces when it wears out. 
  • On the other hand, a company without any advantages must replace to keep pace.
  • Difference between a company with a moat and one without is that the company with the competitive advantage finances new equipment through internal cash flows, whereas the no advantage company requires debt to finance.
  • Producing a consistent product that doesn’t change equates to consistent profits. There is no need to upgrade plants which frees up cash for other ventures. Think Coca Cola, Johnson & Johnson etc.
  • Goodwill
    • Whenever you see an increase in goodwill over a number of years, you can assume it’s because the company is out buying other businesses above book value. 
    • GOOD if buying businesses with durable competitive advantage.
    • If goodwill stays the same, the company when acquiring other companies is either paying less than book value or not acquiring. Businesses with moats never sell for less than book value.
  • Intangible Assets
  • Intangibles acquired are on balance sheet at fair value.
  • Internally developed brand names (Coke, Wrigleys, Band-Aid) however are not reflected on the balance sheet.
  • One of the reasons competitive advantage power can remain hidden for so long.
  • Total Assets & Return on Total Assets
  • Measure efficiency using ROA
  • Capital is barrier to entry. One of things that make a competitive advantage durable is the cost of assets needed to get in. This is why we calculate the Asset Reproduction Value along with the EPV.
  • Many analysts argue the higher return the better. Buffett states that really high ROA may indicate vulnerability in the durability of the competitive advantage.
  • E.g. Raising $43b to take on KO is impossible, but $1.7b to take on Moody’s is. Although Moody’s ROA and underlying economics is far superior to Coca Cola, the durability is far weaker because of lower entry cost.
  • Current Liabilities
    • Includes accounts payable, accrued expenses, other current liabilities and short term debt.
      • Stay away from companies that ‘roll over the debt’ e.g. Bear Stearns
    • When investing in financial institutions, Buffett shies from those who are bigger borrowers of short term than long term debt.
      • His favorite ‘Wells Fargo’ has 57 cents short term debt for every dollar of long term
      • Aggressive banks (like Bank of America) has $2.09 short term for every dollar long term
    • Durability equates to the stability of being conservative.
  • Long Term Debt coming Due
    • Some companies lump their yearly long term debt due with short term debt on the balance sheet. This makes it seem like there is more short term debt than the real amount. 
    • Important: Companies with durable comparable advantages need little or no LT debt to maintain operations. 
    • Too much debt coming due in a single year spooks investors and can offer attractive entry points.
    • However, a mediocre company in problems with too much debt due leads to cash flow problems and certain bankruptcy.
  • Long Term Debt
  • Buffett says that durable competitive advantages carry little to no LT debt because the company is so profitable that even expansions or acquisitions are self financed.
  • We are interested in long term debt load for the last ten years. If the ten yrs of operation show little to no long term debt, then the company has some kind of strong competitive advantage.
  • Buffett’s historic purchases indicate that on any given year, the company should have sufficient yearly net earnings to pay all long term within 3 or 4 year earnings period. (e.g. Coke + Moody’s = 1yr)
  • Companies with enough earning power to pay long term debt in less than 3 or 4 years is a good candidate in our search for long term competitive advantage. 
    • BUT, these companies are targets for leveraged buy outs, which saddles the business with long term debt
    • If all else indicates the company has a moat, but it has ton of debt, a leveraged buyout may have created the debt. In these cases the company’s bonds offer the better bet, in that the company’s earnings power is focused on paying off the debt and not growth. 
  • Important: little or no long term debt often means a Good Long Term Bet
  • Total Liabilities & Debt to Shareholders Equity Ratio
  • Debt to shareholders equity ratio helps identify whether the company uses debt or equity (includes retained earnings) to finance operations.
  • Company with a moat uses earning power and should show higher levels of equity and lower level of liabilities.
  • Debt to Shareholders Equity Ratio : Total Liabilities / Shareholders Equity
  • Problem with using as identifier is that economics of companies with durable competitive advantages are so great they don’t need large amount of equity or retained earnings on the balance sheet to get the job done. 
  • Important: if the Treasury Share Adjusted Debt to Shareholder Equity Ratio is less than 0.8, the company has a durable competitive advantage.
  • Retained Earnings: Buffett’s Secret
  • One of the most important indicators of durable competitive advantage. Net earnings can be paid out as dividends, used to buy back shares or retained for growth.
  • If the company loses more than it has accumulated, retained earnings is negative.
    • If a company isn’t adding to its retained earnings, it isn’t growing its net worth.
    • Rate of growth of retained earnings is good indicator whether it’s benefiting from a competitive advantage.
    • Microsoft is negative because it chose to buyback stock and pay dividends
    • The more earnings retained, the faster it grows and increases growth rate for future earnings.
  • Treasury Stock
    • Carried on the balance sheet as a negative value because it represents a reduction in shareholders equity.
    • Companies with moats have free cash, so treasury shares are hallmark of durable competitive advantages.
    • When shares are bought back and held as treasury stock, it is effectively decreasing the company equity. This increases return on shareholders equity.
    • High return is a sign of competitive advantage. It’s good to know if it’s generated by financial engineering or exceptional business economics or combination.
    • To see which is which, convert negative value of treasury shares into a positive and add it to shareholders equity. Then divide net earnings by new shareholders equity. This will give the return on equity minus effects of window dressing.
  • Important: presence of treasury shares and a history of buyback are good indicators that company has competitive advantage
The Balance Sheet Summary Table
To continue seeing the full summary tables for the balance sheet and cash flow statement, just click any of the social buttons to unlock the content immediately.
Cash and Equivalentslots of cash and marketable securities + little debtTest to see what is creating cash by looking at past 7 yrs of balance sheets
InventoryLook for an inventory and net earnings that are on a corresponding riseinventories that spike up/down are indicative of  competitive industries prone to (boom/bust)
Net Receivablesconsistently shows lower % net receivables to gross sales than competitorsd.c.a. no need to offer generous credit
Goodwillincrease in goodwill over number of years assume because company out buying companies >BVd.c.a.’s never sell for less than BV
LT Investmentscan have valuable assets on books at valuation < market price (booked at lowest price)tells us about investment mindset of management
(Looking for d.c.a.?)
Intangible AssetsInternally developed brands not reflected on BS
Total Assets + ROA
(Measure efficiency using ROA)
Higher return the better (but: really high ROA may indicate vulnerability in durability of c.a.)Capital = barrier to entry
ST Debtfinancial institutions. Buffett shies from those who are bigger borrowers of ST than LT debt
LT Debt Dued.c.a. need little or no LT debt to maintain operations
Total CL + Current Ratiohigher the ratio, the more liquid, the greater its ability to pay CLd.c.a.’s don’t need ‘liquidity cushion’ so may have <1
LT DebtLT debt load for last ten yrs. ten yrs w/ little LT debt = d.c.a.earning power to pay their LT debt in <3/4 yrs = good candidates
Total Liabilities + Treasury Share-Adjusted debt to Shareholder Eq Ratio If <.80, Good chance company has d.c.a.
Preferred + Common Stock in search for d.c.a. we look for absence of preferred stock
Retained Earnings Rate of growth of RE is good indicator
Treasury Stockpresence of treasury shares and a history of buyback are good indicators that company has d.c.a.convert –ve value of treasury shares into +ve and add shareholder eq.
Divide net earnings by new shareholders eq. give us return on equity minus dressing.
Return on Shareholder equityd.c.a. show higher than average returns on shareholders equityIf company shows history of strong net earnings, but shows –ve sholder equity, probably d.c.a. because strong companies don’t need to retain
Read more on the Balance Sheet Analysis  on my previous post - http://intelligentinvestor8.blogspot.my/2014/05/balance-sheet-analysis.html

Or, take a look on How Buffett read other financial statements:-

References:-

How Buffett Interprets the Income Statement

It is important to investigate further & drill down to detect what the quality of earnings are made up of and what the numbers intepret.

  • Gross Profit Margin: firms with excellent long term economics tend to have consistently higher margins
  • Durable competitive advantage creates  a high margin because of the freedom to price in excess of cost
  • Greater than 40% = Durable competitive advantage
  • Less than 40% = competition eroding margins
  • Less than 20% = no sustainable competitive advantage
  • Consistency is key 
  • Sales Goods and Administration: Consistency is key. Companies with no durable competitive advantage show wild variation in SG&A as % of gross profit
  • Less than 30% is fantastic
  • Nearing 100% is in highly competitive industry
  • R&D: if competitive advantage is created by a patent or tech advantage, at some point it will disappear.
  • High R&D usually dictates high SG&A which threatens the competitive advantage
  • Depreciation: Using EBITDA as a measure of cash flow is very misleading
    • Companies with durable competitive advantages tend to have lower depreciation costs as a % of gross profit
  • Interest Expenses: Companies with high interest expenses relative to operating income tend to be either: 1) in a fiercely competitive industry where large capital expenditure required to stay competitive 2) a company with excellent business economics that acquired debt in leveraged buyout
  • Companies with durable competitive advantages often carry little or no interest expense.
  • Warren’s favorites in the consumer products category all have less than 15% of operating income.
  • Interest expenses varies widely between industries.
  • Interest ratios can be very informative of level of economic danger. 
  • Important: In any industry, the company with the lowest ratio of interest to Operating Income is usually the one with the competitive advantage.
  • Net Earnings
  • Look for consistency and upward long term trend.
  • Because of share repurchase it is possible for net earnings trend to differ from EPS trend.
  • Preferred over EPS
  • Durable competitive advantage companies report higher % net earnings to total revenues. 
  • Important: If a company is showing net earnings history greater than 20% on total revenues, it is probably benefiting from a long term competitive advantage.
  • If net earnings is less than 10%, likely to be in a highly competitive business

The Income Statement Summary Table
(DCA = Durable Competitive Advantage)Comments
Gross Profit Margin>40% = D.C.A.
< 40% = competition eroding margins
< 20% = no sustainable competitive
advantage
Consistency is Key
SG&A
(SGA as % of gross profit)
< 30% is fantastic
Nearing 100% is in highly competitive
industry
Consistency is Key
Depreciation
(depreciation costs as a % of gross profit)
Company with moat tend to have lower %
Interest Expenses
(interest expenses relative to
operating income)
Durable competitive advantages carry little
or no interest expense.
Buffett’s favorite consumer products have
<15%
Company with lowest ratio of interest to Operating
Income = competitive advantage.
Varies widely between industries.
Net Earnings
(% net earnings to total
revenues)
Net earnings history >20% = Long Term
moat
< 10% = in highly competitive business
consistency and upward LT trend
 EPS10-year period showing consistency and
upward trend.
Avoid erratic earnings pictures.
Consistency = sign products don’t need to change.
Upward trend = strong

Read more on the Income Statement Analysis  on my previous post - http://intelligentinvestor8.blogspot.my/2014/05/income-statement-analysis.html

Or, take a look on How Buffett read other financial statements:-

References:-

Tuesday, 1 September 2015

Buying Good Companies when the price is cheap.....

Emily suggested to buy good companies when the price is cheap.....



I think companies that met following condition might be a good candidates..
- Good Companies - ROE >= 15, Net Profit Margin >= 15
- Cheap? P/E <=8, P/NAPS <= 1.5, DY >= 3%

http://www.klse.my/stock/screener.jsp?Type=S&T4QROE-1=15&T4QNPM-1=15&T4QPEPS-2=8&T4QPNAPS-2=1.5&LFYDY-1=3



http://www.klse.my/stock/screener.jsp?Type=S&T4QROE-1=15&T4QNPM-1=15&T4QPEPS-2=8&T4QPNAPS-2=1.5&LFYDY-1=3

Thursday, 5 February 2015

Six Most Important Emotional Biase

Reading financial statements -> Carrying out valuations --> Facts....

Investors deal with facts  and emotions.

We may profit from the investors' irrational behaviour by understanding the cognitive biases investors have.

#1 Loss-Aversion bias

  • People tend to strongly prefer avoiding losses as opposed to achieving gains. 
  • Usually, the investor holds on to the losers until they break even, while selling the winners to realize gains and avoid further risks.

“The idea of excessive diversification is madness. We don’t believe that widespread diversification will yield a good result. We believe almost all good investments will involve relatively low diversification. If you took our top fifteen decisions out, we’d have a pretty average record. It wasn’t hyperactivity but a hell of a lot of patience. You stuck to your principles, and when opportunities came along, you pounced on them with vigor. Berkshire in its history has made money betting on sure things.” Charlie Munger  


#2 Overconfidence bias

  • People demonstrate faith in their own intuitive reasoning, judgments and/or cognitive abilities. This may result in overestimating knowledge levels, abilities and access to information.
  • We do this when we equate the quantity of information with its quality, which causes underestimation of risks and overestimation of expected returns.

“It is not an algorithm. It is a mindset. I think that we always try to stress the danger of overconfidence. I forget if I put it in the book, but it is better if you invest scared, if you worry about losing money, if you worry about being wrong, if you worry about being overconfident because these are the things you want to avoid. They should be foremost in your mind. The most dangerous thing is to think you got it figured out, or that you can’t make a mistake, or that your estimates are right because they are yours. You have to always recheck your information, bounce your ideas off of yourself and others.” Howard Marks 

#3 Self-control bias

  • People fail to act in pursuit of their long-term goals because of a lack of self-discipline.
  • Fail to save for retirement, prefer small payoffs now than large payoffs in the future. Spend today rather than save tomorrow.

“Spend each day trying to be a little wiser than you were when you woke up. Discharge your duties faithfully and well. Step by step you get ahead, but not necessarily in fast spurts. But you build discipline by preparing for fast spurts. Slug it out one inch at a time, day by day. At the end of the day – if you live long enough – most people get what they deserve.” Charlie Munger 


#4 Status Quo bias

  • People usually let the standard choices be the ones that rule our operations. Prefer things as they are even at a personal cost.
  • Fail to explore other opportunities, leave portfolios as they are instead of looking for more attractive investment options.

"I made at least one major mistake of commission and several lesser ones that also hurt... Furthermore, I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action." Warren Buffett 

 

#5 Endowment bias (Excessive Self-Regard)

  • People assign more value to an asset when they hold rights to it.

“We all commonly observe the excess self-regard of man. He mostly misappraises himself on the high side.” Charlie Munger 


#6 Regret-Aversion bias 

  • People tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly.
  • No action becomes the preferred decision. This happens when we take a very conservative stance fearing poor outcomes, or when we just follow the herd.

“Have the courage of your knowledge and experience. If you have formed a conclusion from the facts and if you know your judgment is sound, act on it - even though others may hesitate or differ. You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” Benjamin Graham

References:-

Jack Ma's Speech on "Our Hong Kong Foundation" at 02-Feb-2015


马云香港演讲实录 - 马云与青年有约:从梦想到成功创 业


1、马云演讲部分视频
2、马云与青年对话及观众问答环节




百听不厌的创业艰难史

我数学考过1分,大学考过3次,初中考重点中学考过3次,也没考上。我们那个学校也是当时杭州最差的学校,我考进大学,杭州师范大学,是杭州第四流大学。所有人看来我不具备创业,但是很奇怪,在人们看来几乎没有可能成功的,我们走了15年。

我今天很幸运,前面4年我创业,从中国黄页做了两年半到三年,到国家的外经贸部做临时工13个月,全失败了,没有人看到这些失败。我想跟大家分享在座如果你要去创业,多花点时间思考别人为什么失败,不要去思考别人为什么成功,成功有很多原因的。

我们三四年前,大家都认为阿里巴巴很糟糕,商业模式不行,技术不行、服务不行、产品不行,还有很多假货,反正看来都不行。我跟同事讲,我们其实比别人想象的要好。别人说你坏的时候,你也要想想其实我们也还可以了。所以我们就是这样不断调整自己心态走到今天。

改变世界的事情留给政治家去干,先改变自己

我 发现有一个事情,几乎所有成功者碰上麻烦、犯上错误 后总是先检查自己,我这个没有做好,我得调一调。我这个不对。真正成功的人一定是改变自己的人,改变别人的事情少做。我以前跟很多年轻人一样也是这么,我 要是总理的话,我肯定是怎么怎么怎么。我要是总统的话,我必须这样这样这样。后来发现根本不是这么一回事情。其实改变世界的事情留给总统、留给总理、留给 主席去干。改变自己显得更为重要。

香港的机会和未来的机会

今 天下午很多朋友问我你看我们 香港年轻人还需要什么技能才能创业。说心里话,我来香港机会比较多,我跟香港的很多年轻人交流,我们前一段时间有很多香港年轻人到阿里巴巴实习,跟他们交 流过程中,我是没有底气的,我觉得他们知识面太好了,其实他们很knowledgeable,香港所处的地理位置,香港的劣势,香港对全球化所处的位置上 金融、法治以及所有大学完善的教育,我认为中国大陆目前要具备这样素质的学生并不多。

实事求是地讲,只是香港今天年 轻人敢不敢往前跨一步。 今天香港的麻烦,全世界都有。欧洲没有这个麻烦?美国没有这个麻烦?还是日本没有这个麻烦?大陆没有这个麻烦?麻烦都在。我那个时候也有麻烦。我爸有他的 麻烦,我爷爷有他的麻烦,每个generation都有麻烦。每一个国家和地区都有麻烦。尤其是现在,请问哪个成功的企业今天敢说他没有麻烦?我前两天麻 烦还没有过去呢。对不对? 

马云演讲时认为香港年轻人很knowledgeable,但不敢往前跨一步

难 道看到麻烦就跑了?看到麻烦你骂谁去呢?还得自己去解决。很多人在抱怨的时候,静下心来思考一下,我该继续抱怨下去?还是该改变自己?香港的机会我自己觉 得,我不是来安慰大家,我也没有这个能力安慰大家。我只是告诉大家,今天一定比我15年前有机会,整个社会在发生巨大变化,整个互联网 (Internet)时代,数据时代,仅仅刚刚开始。以前如果是一个制造的年代,今天是一个创造的年代。

企业越大,麻烦越多,责任越大

我 特别喜欢看香港这种电视剧,老板什么事都不干,雪茄抽一抽,很气派的样子,我想有一天我也做大了,我或许没有麻烦。现在明白了企业越大,麻烦越多,责任越 大。还不如自己在小房间创业的时候。每个阶段都有自己独特的,但是今天另外来讲,又把自己想明白了,能做阿里巴巴,能够给这么多人服务,能做这样的事情, 是一种福报,是修来的。别人想干还干不来,既然做了,就做下去。

成功人士为何成功?

这几年很荣幸,我有机会认识了所谓这个世界上很了不起的商界最牛的人。交流过发现有一样事情一定要分享给所有年轻人,他们一定是很乐观地看待未来。第二,他们永远不抱怨,只检查自己的问题。第三,他们超越常人的坚持。没有这些素质你是走不远的。

真的想创业,行动起来

最 近在中国大陆有一句话很流行,叫做:风来的时候猪都会飞。这个猪,pig,你如果躲在很好的风口,风一来,猪都会飞起来。所以很多人天天在找风。哪个机 会,扑到这个机会。其实风来了,猪都会飞。但是风过去了,摔死的都是猪。这些猪没有改变自己,不是创造自己猪该走的这条路。

我 觉得如果你真的想创业,行动起来!我看了太多年轻人晚上想想千条路,早上起来走原路。百分之五的人创业,你是看着他死的。只有百分之一的人能够成功。而这 百分之一的成功的人一定有一个很强的团队,他们互相支持、共同努力,他们乐观、他们改变自己,而你,我可以告诉你,你一定必须做那样,否则你会死在百分之 九十五,没有看见的地方。所以如果你自己不想当老板,找到一个比较好的老板,比方说阿里巴巴这样的公司。

在经验教训中找机会 淘宝网货不等于假货

提问阶段当被问及近日引起诸多争议的淘宝网假货问题时,马云坚持淘宝并没有太多假货,而公司在假货的监察方面主要是根据投诉处理。马云强调,公司有两千人专职及五千编外人员处理投诉有关问题,去年还因此将400多人送入监狱。

“如果你投诉,我们立刻有反应,但你不投诉,我们是很难发现的,毕竟我们要处理的是12亿的商品。”

马云同时澄清,淘宝网许多的货物并非“假货”而是“网货”,即生产者制造但未得到官方认证、注册的,在所谓“正品”以外。他指出,淘宝的许多商品、服务是大家过去从来没有听说过的,这是一个创新。

(视频来自香港传真,文字实录来自观察者网)