The Little Book that Beats the
Stock Market
Chapter 1
Bubblegum sales business:
Earns $500 for next 6 years
What would you pay ?
Write down a number.
Concept: Time Value of
Money or Net Present
Value
What are the Risks to Buying
this Business ?
A) Competition
B) Not as good at Selling
C) New Technology- Kids
prefer something else
What are Opportunities to
Buying this business
A) Can you sell more ?
B) Can you cut costs ? Sam’s
C) Expand Market ?
D) New Products ?
Buying Stock is like Buying a Business !
Chapter 2
Options to Invest $1,000 ?
A) Mattress – Pros / Cons ?
B) Savings Account Bank-Pros/Cons?
C) Corporate Bond –What is a
corporate Bond ? Pros/Cons ?
D) US Treasury Bond- What is a US
Bond Pros/Cons ?
And of course Equities/Stock !
US Treasury Bond
- Called “Risk Free” or “No Risk” –
Why ?
- Almost 100% Guaranteed
- Every Investment Option you
chose should exceed this
Question: If Teddy starts “Gilman Investment Co”
and guarantees a return, what should the return at
minimum be ?
Chapter 3
Jason’s Gum Business Has Grown !
JASON's GUM SELLING BUSINESS
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
$
10,000,000
(6,000,000)
4,000,000
(2,000,000)
2,000,000
(800,000)
1,200,000
Decides to Do an IPO (Initial Public Offering),
What is the value ? What would you pay ?
2012
Corporations / Stock
$685B
+90%
1) Why form a corporation ?
2) IPO:
a) Initial Public Offering
b) Need to be something in Demand-What
do you think will be in 2013 ?
c) Need Underwriter
d) Go on road show-Generate Buzz
e) Extremely Stressful
f) Can make a lot of moneyGM: $23.1B, Facebook $104B
IPO – Initial Public Offering-Facebook
-
In 2006 Offered $750,000 from Viacomm ?
In 2007 Microsoft buys 1.6% for $240 Million
beating Google (Valuation $15B)
May 18th, 2012 goes public at $38/share worth
$104 Billion
Today what is stock price ?
40 Lawsuits after the IPO, Botched IPO
2013/14 IPO’s
Twitter
Dropbox
Priced at $20 11/4/2011
Closed at $26 first day
Gone down to $5.73
Would you want to work for a start-up ?
What are Pro’s / Con’s to you ? –
Stopped 2/25/13
PROS
•To see business ideas develop.
•To contribute to those ideas and chart a course of action.
•Collaboration with creative, enthusiastic professionals.
•Changing demands and a flexible, changing schedule.
•Greater autonomy and authority.
•A quick education in how a business works.
•The potential for large financial rewards.
Cons
•Lower Salary / Benefits
•No Job Description/Unsure how to get things done
•Limited Resources
•Can be Long Hours
•Risk of Losing Job Quickly
2013/14 IPO’s-Forbes Magazine
Twitter
Dropbox
http://www.forbes.com/pictures/eihm45mdmf
/spotify-2/
Priced at $20 11/4/2011
Closed at $26 first day
Gone down to $5.73
Jason’s Gum Business Has Grown !
JASON's GUM SELLING BUSINESS
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
$
10,000,000
(6,000,000)
4,000,000
(2,000,000)
2,000,000
(800,000)
1,200,000
Sell 1,000,000 Shares at $12/share.
What is Earnings per Share ?
What is Rate of Return on Buying 1
share ? Called ?Earnings Yield.
1.20
1.2/12 = 10%
Jason’s Gum Business Has Grown !
JASON's GUM SELLING BUSINESS
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
$
10,000,000
(6,000,000)
4,000,000
(2,000,000)
2,000,000
(800,000)
1,200,000
Is 10% Acceptable ? Why
What would you like to know to
make this decision ?
Chapter 4
Look At Apple Article:
52 Week High:
52 Weeks Low:
EPS Changed much ?
What is apple worth ?
What is Margin of Safety ?
What would you like to know to
make this decision ?
Chapter 5
Recall Jason’s Gum Selling Business
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
Sell 1,000,000 Shares at $12/share.
What is Earnings per Share ?
What is Earnings Yield on Buying 1
share ?
$
10,000,000
(6,000,000)
4,000,000
(2,000,000)
2,000,000
(800,000)
1,200,000
1.20
1.2/12 = 10%
Suppose Net Income Rises to:
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
Sell 1,000,000 Shares at $12/share.
What is Earnings per Share ?
What is Earnings Yield on Buying 1
share ?
$
12,000,000
(6,000,000)
6,000,000
(2,000,000)
4,000,000
(1,600,000)
2,400,000
2.40
2.4/12 = 20%
Suppose Net Income Rises to:
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
$
12,000,000
(6,000,000)
6,000,000
(2,000,000)
4,000,000
(1,600,000)
2,400,000
So is 2.40 better than 1.2 ? 20% better
than 10% ?
Does this mean it’s a good company
that you should buy ? Why or Why not ?
Look at Blockbuster:
-
1994 Bought by Viacomm for $8.4Billion?
2008 Tries to buy Circuit City
1/10/10: Got two quarters? Congrats, you can now buy one share of Blockbuster Inc.
(NYSE:BBI), today they finished trading at 50 Cents. Blockbuster's stock fell 31% today,
times have changed for the company that still holds the crown as the largest U.S.
movie-rental business.
Volume and selling was screaming on Blockbuster shares today 28.5 million BBI shares
have traded hands, that's more than 14X the daily average.
As shares were falling its, Earnings
Yield was doing what ? Was it a good
buy ?
Suppose Net Income Rises to:
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
$
12,000,000
(6,000,000)
6,000,000
(2,000,000)
4,000,000
(1,600,000)
2,400,000
Why do you think Sales grew ?
Two Scenarios:
a) What if you know that each store Jason opens costs $400,000 and would earn
$200,000 per store. Is that good ? What return ?
b) If you could invest in another company of comparable risk that costs $400,000 and
would earn $100,000 per store, should you ?
Called Return on capital Return / Investment. a) 50%, b) 25%
2 Main Concepts:
1) Buy Good Companies
(High Return on Capital)
2) Buy at Bargain Prices
(High Earnings Yield)
Chapter 6
Steps To Take:
-
Take 3,500 largest companies
Rank 1-3500 on Return on Capital
Rank 1-3500 on Earnings Yield
Add up Rankings for each company, divide by 2
Could a company with a top return on
capital be ranked lower overall than the
1,500 ranked Company ?
17 Year Period Studied: Magic
Formula=30.8%, Market Avg: 12.3%, S&P
12.4%
Chapter 7
Class Agenda / Hope to Accomplish
1) Quiz 9-10
2) Max Presentation
3) Alex Presentation
4) Little Book Review
5) Stock Market Game
2 Main Concepts:
1) Buy Good Companies
(High Return on Capital)
2) Buy at Bargain Prices
(High Earnings Yield)
https://personal.vanguard.com/us/funds/vang
uard/all?sort=type&sortorder=asc
“The performance data shown represent past performance, which is not a
guarantee of future results. Investment returns and principal value will fluctuate,
so that investors' shares, when sold, may be worth more or less than their
original cost. Current performance may be lower or higher than the performance
data cited.”
Magic Formula works for large companies with established
Earnings history. Not recommended for Small/Penny Stocks
What is a Penny Stocks ?
-
Small (In US defined as under $5/share)
Tend to be Thinly Traded
Highly Volatile
Can be manipulated easily. Be careful !
Chapter 8
Issues w/ Magic Formula:
-
Faired poorly in 5 out of every 12 months
Failed to beat market one out of four years
One out of ever six periods did poorly 2 years in a
row ?
What are your thoughts on these statements ?
BILL MILLER
Questions:
a) What happened to Bill Miller in 2007-2009 ?
b) Why did he lose ? What investments did not work ?
c) Is he a good manager ?
Lessons
1) Unfortunately Everyone Loses – Miller,
Buffett, Graham
2) Avoid putting your eggs/investments in
One or very few baskets – Financial Sector-Miller
3) We’ll be reading about Mr. Miller again in
“The Big Short”
ACTIVE VS. PASSIVE
1) What is an Active Investment Strategy ?
2) What is a Passive Investment Strategy ?
3) 60% - 80% of the time a Passive Strategy
Beats an Active Manager ? Should you invest Active?
Why Active ?
1) Manager over time consistently beats index
2) As investor believe in certain sector (no index)
3) Want to try and beat average-Not content with
average.
4) Strategy of manager may fit with overall portfolio
Read Article for Discussion, then Review
Morningstar and answer these questions.
1) Growth or Value / Large Cap or Small Cap ?
ACTIVE VS. PASSIVE
2) How has Fund done last three Years ? What type of market (Bull or Bear) did this fund perform best?
3) Has Fund Done well relative to Benchmarks ?
4) Tell me three other things that matter?
Mr. Greenblatt:
-
Invested with the Smartest Money Manager he knows
Hundreds of Top Investors
Had tough 3-4 years
Only 4 original clients stayed with him
Came back, Top Performing Fund since Inception
Why did people leave ? Why did people leave Mr. Miller ?
What are you going to be ?
Speculator:
Try to anticipate
Kahneman/Tversky
– Painand
of aprofit
loss from
is 2
market
fluctuations.
Sell
when
things
are
times as great as pleasure of a gain. Losing
going down, buy when things are going up ? It
iscan
so be
painful,
leads
to
panic
and
near
bottom
a drug, feeling great when going up,
and
notyou
buying
even
when price is
killing
whenmore,
coming
down.
great !
Investor: Try to acquire and hold suitable
securities at suitable prices. Market
movements present great opportunities to
buy or sell.
March 10th, 2000
Nasdaq hits all time high, Cisco highest market
Capitalization. Ralph Acampora says Norfolk
Southern or Cisco: Where do you want to be?
Over next year: Cisco lost 70%, Norfolk gained
35%
Graham: The primary cause of failure is that
individual investors pay too much attention
to what the stock market is doing
-
Mr. Greenblatt:
People hate to Lose
Investment Horizons tend to be short
Those that look at stocks more often do worse
The magic formula works because it takes
emotion out of it
Everyone gets caught up chasing a winner. Very
dangerous in Bull Markets
• All Bull Markets must end and usually badly:
Black Tuesday: 10/29/1929- 13% in 1 day, down 89% next three
years
Black Monday: 10/19/1987-23% in 1 day, 2 years to recover
Black Week: Starting 10/6/2008 – 20% down, DJIA High was
14,164 10/9/2007, currently XXXXX down XX%
Tough not to get caught up:
Everyone talks about their winners ! Not losers !
Winners draw attention, prices go up, becomes
speculative
Leads to constant checking, panic
Paul Andreassan (Harvard/Columbia
psychologist) – Investors who received frequent
updates on portfolio earned half the returns of
those who did no check at all !
You mess with
the Bull, You get
the Horns !
Chapter 9
Suppose Net Income Rises to:
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
$
12,000,000
(6,000,000)
6,000,000
(2,000,000)
4,000,000
(1,600,000)
2,400,000
Revisit Jason’s Stores
a) What if you know that each store Jason opens costs $400,000 and would earn
$200,000 per store. Is that good ? What return on capital ?
b) What could Jason do with this $2.4M ?
c) What would you like him to do ?
d) Do you want Dividends ?
This is a great business: High Return
on Capital, High Earnings Yield
Sales
COGS (Cost of Goods Sold)
Gross Profit
SGA (Selling, General, Admin)
Income Before Taxes
Taxes (40%)
Net Income
$
12,000,000
(6,000,000)
6,000,000
(2,000,000)
4,000,000
(1,600,000)
2,400,000
What is likely to happen (American Capitalism at work) ?
Competiton !
a) Less Gum Sold
b) Lower prices to attract business
c) Someone builds a better gum shop or gum
In the end, Lower Profits ! Good Businesses attract competition ! Often from inside
employees …why
Bad/Declining Business could be
opportunities
Why did Dish buy Blockbuster ?
Why did Blockbuster want to buy Circuit City ?
Year 2000: I am working at P&G – They are buying Sunny Delight ! Why ? What
happened ?
Do you think Starbucks maintained the premium coffee market ?
Petes, Dunkin Donuts, McDonalds
a) Less Gum Sold
b) Lower prices to attract business
c) Someone builds a better gum shop or gum
In the end, Lower Profits ! Good Businesses attract competition ! Often from inside
employees …why
A Rising Business could be
opportunity depending on timing:
What are some businesses that are new and
rising that are being copied?
Frozen Yogurt, Mexican, Made to Order
(Panera, Cosi after Subway)
So can be difficult to maintain a High
Return on Capital. To do so:
1)
2)
3)
4)
New Products / Constant (R&D)
Better Products
Good Brand Name ? Name some
Strong Competitive Postion – Ebay 1st,
Economic Motes
Chapter 10
“The performance data shown represent past performance, which is not a
guarantee of future results. Investment returns and principal value will fluctuate,
so that investors' shares, when sold, may be worth more or less than their
original cost. Current performance may be lower or higher than the performance
data cited.”
1) Why does performance change if solid for
number of years ?
2) Often Management changes. 1st Question
we ask when reviewing managers.
What is Risk to you when it comes to
investing ?
1) Risk of losing money ?
2) Risk of not having enough for something
important in life: College, Retirement
3) Risk of underperforming vs. other options
A version of Risk: Boca Raton
Wealthy Retirement Community-Florida
Author interview retirees: Had they beaten
market over lifetime ?
Answer: Some yes, some no,One man: “Who
cares, All I know is my investments earned
enough for me to end up in Boca”
In the end what matters isn’t crossing the finish
line before anybody else but just making sure
you cross it (Reach where you want to go)!
Author will argue correctly:
Expected return must equal risk taken !
Rank these options in terms of return expected (write down return you
expect):
US Treasury
Internet Startup
Procter & Gamble
Best Buy
Bonds from Greece
Under Armour
Any time you take more risk, you must generate
more return !
Moving on: Investment
There is no such thing as a good or bad
stock, only cheap stocks and expensive
stocks
The best company (ie Apple) becomes a sell
when its price gets too high while a bad
company is worth buying if its stock gets
low enough
Over the Long Term Mr. Market gets it right:
Smart Investors jump in when opportunities
present themselves
Companies buy back their own stock (Stock
Repurchase) when they think undervalued.
Another Company buys the company whole (agreed
or hostile). Usually leads to stock price increase !
Stock Market Game
Chapter 11
How to avoid losing BIG: Diversification
Don’t put your eggs in One Basket ? What does this mean ?
You have 24 eggs to take home for dinner
for family, you can carry all in one basket
or put 12 in two baskets ? What would you
do?
One way to reduce Risk and Limit significant
losses: Diversification
Why does a street vendor sell umbrellas and sunglasses ?
Why did Hallmark Cards buy a Spanish TV station ?
Why did Phillip Morris (tobacco company) buy Miller
Brewing and Kraft Foods ?
Diversification -Why
1) All three examples: Want to continue to have sales or
Returns coming in- ideally constant, limit the significant
Ups and downs (standard deviation)
2) Investing is the same way. Want to keep investments
Giving positive returns – If you invest in 1 stock you have a
Standard deviation of 40%, you invest in 15 stocks you have
Standard deviation of 10%. Probability of loss w/ 5 Stocks
Is 23%, with 20 Stocks, 12%
3) Some investments do better when its raining and
Some investments do better when its sunny ? Like
Weatherman, can’t always predict what is needed !!
You Have a Choice
1) You have $10,000. In Year one you lose 50%. After that
You make 10%/year for 15 years ?
2) You have $10,000. In Year one you gain 5%. After that
You make 5%/year for 15 years ?
Investment 1
Year 15
18,987
Investment 2
20,789
You can double the return of investment 2 for 14 years straight
And still not make up for a significant loss !!!
Should you buy individual Stocks and When ?
Should you buy a lottery ticket ? When ?
Your going to do it. But make sure
you are prepared for potential losses.
A bit like gambling. Some smart
person is buying/selling the opposite.
Chapter 12
You have money to Invest? What will
you do / Who will you use ?
-
Stockbroker: +Understands markets generally, access to research, generally paid to sell/fees, good salesman sometimes
-
Mutual Fund: + Diversification, - Fees, Active tends to beat passive,
good ones attract money, less opportunities
Hedge Funds: + More Diversification, options, better managers, Must have lot willing to lose, high fees, best ones get full
Index Funds: +Lower Fees Mutual Funds, - Average Returns
-
Chapter 13
Recommendations !
Remember: Importance of Starting Early
Max puts $2,000 per year into the market between the ages of 24 and
30 (6 years), that he earned a 12% return, and that he continued to earn
12% per year until he retired at age 65.
Aric also put in $2,000 per year, earned the same return, but
waited until he was 30 to start and continued to invest $2,000
per year until he retired at age 65 (36 years).
Who has more at 65 ?
How much did Max put in ?
How much did Aric put in ?
Both $1M
$12,000
$72,000
Give Back- Every one of you receives 25% or
$6,250 because of some alumni !
Barbara Dodd Anderson: $128M to George School
Mr. Rollins - $30M to McDonogh: a scholarship student and
valedictorian of the class of 1915, became an attorney, businessman,
and 27-year McDonogh trustee who repaid the school many times over
until his death in 1985.
Mr. Bill Carey: $10M to renovate Carey Hall, Mr Jacobson: $5M to build
Lumen Center
Why ? Why does Harvard need more money ($31.7Billion) ?
Gilman gives all of you a chance to attend a good school. Gilman hopefully provides an
Education that gives a solid core. Gilman instills traits that will lead to making this
country . A better place, a stronger country. Hopefully you appreciate the efforts of
past alumni, you want Gilman to be stronger than McDonogh, you hope that by
investing in Gilman, the world is somewhat better.
Give Back
Make Money , Reinvest in
something that gives back and
grows and has meaning to you.
Appreciate all that got you to that
point ! Right things to do and you
will feel good about it !