Rajeev A. Vaidya. IFSR 5 parts of disciplined buying. Disclaimer in plain language: 4/11/2019. Opinions are like noses, everyone has one!

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1 IFSR 5 parts of disciplined buying Rajeev A. Vaidya Disclaimer in plain language: Opinions are like noses, everyone has one! You are going to see mine today!! I am simply sharing my perspective. This is not investment advice or recommendation. Form your own opinion, make your own decisions. 1

2 Today s Class Market Update The S&P 500 chart Rajeev S&P500 breadth indicator chart 5 parts of disciplined buying 2 Rajeev Vaidya OLLI

3 S&P500 Weekly Standard Chart - Expanded 10/16 11/7 12/3 2/25 3/1 3/4 3/ /10 Rajeev Vaidya OLLI 3

4 S&P500 Market Breadth Advance / Decline on the NYSE cumulative %age of S&P500 stocks above their 200dayMA 4

5 Factset Analyst projections April 5 th

6 Disciplined buying Investment thesis: This is a good investment because. Valuation Entry Point: This is a good price / entry point to buy because. Position Size: I can buy XXX shares for my portfolio If I am right, I will make gains by selling the Exit Rules: If I am wrong, I will limit losses by exiting the 6

7 First Investment Decision: Quality Is this a good company to own? Indicators of Quality Demonstrated sales growth in a growth market Demonstrated earnings growth Good Profit Margins High return on Invested Capital and Equity Good Management Team Typically we are looking for leaders in an industry group. It is very important to understand a company relative to its peers in an industry Comparison of financial measures across industry groups can lead to misleading conclusions. A bad stock is not worth owning at any price!! 7

8 Industry specific Business profile investment intensity capital structure (debt vs. equity) return on equity and assets profit margins inventory & inventory turns growth rates period of a business cycle etc... 8

9 The 9 Buffet questions Consumer monopoly in a growth market? Strong earnings with an upward trend? Conservatively financed? Consistent high return on equity? Are earnings retained? Small expenditures to maintain operations? Management track record in investing retained earnings Can company adjust prices with inflation? Do retained earnings increase market value? 9

10 Investment thesis The industry leader XYZ is a good investment because: Reason 1 Reason 2 Reason 3 Risks to this investment are Risk 1 Risk 2 Come back to re-examine this thesis frequently 10

11 Disciplined buying Investment thesis: This is a good investment because. Entry Point: This is a good price / entry point to buy because. Position Size: I can buy XXX shares for my portfolio If I am right, I will make gains by selling the Exit Rules: If I am wrong, I will limit losses by exiting the 11

12 Three key Questions & Two ways to answer Is the stock undervalued? If so, what could the price rise to? Where could I exit and minimize losses, if my analysis is wrong? Fundamental Analysis Technical Analysis 12

13 Second Investment Decision: Value Is this a good price / entry point to buy at? Fundamental analysis Value vs. Price The buying decision High Quality Company Price above value Wait to Buy Price below value Buy Technical analysis Current position vs. trend vs. support and resistance Current momentum / strength Price / Volume patterns Not Short? Walk Projected / Predictable outcomes Price - market tells you this everyday. Value - your analysis based on data - today s value - future value 13

14 Fundamental Analysis Value: Is this a good price to buy at? Measures of value p/e ratio dividend yields book value p/cash flow ratio p/sales ratio Benchmarks of value vs. history vs. industry peers vs. market Look at aspects of Fundamental Analysis using P/E ratio 14

15 P/E Ratio P/E ratio = quarterly eps actuals q-4 q-3 price q-2 trailing 12 months earnings per share Current Price = P q-1 Value Line q+1 q+2 quarterly eps forecasts q+3 q+4 forecast 12 months time 15

16 P/E Ratio vs. company history Find Highest price and Lowest price for any year Find EPS for that year High P/E ratio = High price earnings per share Low P/E ratio = Calculate High, Low and Average P/E for each year Compare current P/E ratio to history If current P/E ratio is low relative to history stock may be undervalued If current P/E ratio is high relative to history stock may be overvalued Low price earnings per share Sources of information Value Line sheet data for manual calculation S&P report shows Hi and Lo P/E by year Ford Equity Report shows graph 16

17 P/E vs. Industry Industry Name Current P/E Industry Name Current P/E Industry Name Current P/E Steel (Integrated) 9.71 Beverage (Alcoholic) Bank (Canadian) Auto & Truck Precision Instrument Market Petroleum Grocery Bank Petroleum Diversified Co Retail Store Auto Parts 10.7 Food Processing Coal Canadian Energy Hotel/Gaming Thrift Air Transport Restaurant Medical Services 31.1 Utility (Foreign) Chemical (Diversified) Insurance (Life) 31.5 Maritime Power Drug 35.3 Home Appliance Human Resources 22 Industrial Services Chemical (Basic) Semiconductor Beverage (Soft Drink) Tobacco 12.8 Shoe Bank (Foreign) Building Materials Textile Medical Supplies Homebuilding Household Products Financial Svcs. (Div.) Paper & Forest Electronics Bank (Midwest) Natural Gas (Distrib.) Water Utility Newspaper Natural Gas Apparel Telecom. Equipment Steel (General) Recreation Telecom. Services Electric Util. (Central) Publishing Retail Building Furn./Home Food Wholesalers Information Services Semiconductor Cap 15.5 Investment Co Computer Software & Cement & Trucking/Transp Investment Co Electric Utility (East) Securities Brokerage R.E.I.T Railroad Retail (Special Lines) Advertising Packaging & Oilfield Manuf. Housing/Rec 64.6 Machinery Toiletries/Cosmetics Gold/Silver Mining Metals & Mining Environmental Educational Services Tire & Rubber Office Equip & Pharmacy Services Metal Fabricating Computer & Entertainment Chemical (Specialty) Foreign Insurance Aerospace/Defense Electrical Equipment Foreign Telecom Biotechnology Aswath Damodaran - stern.nyu.edu 1/2002 Be careful comparing P/Es across industry 17

18 P/E vs. Market What is the P/E for the market? How does that compare to the P/E for the company? How has this varied over time? Value Line Every week in Selection and Opinion Average and median P/E for the universe of 1700 stocks How this has varied over time For every company Relative P/E of company to median for the market How this relative P/E varies over time 18

19 Fundamental Analysis Value: Is this a good price to buy at? Measures of value p/e ratio dividend yields book value p/cash flow ratio p/sales ratio Benchmarks of value vs. history vs. industry peers vs. market Fundamental analysis Value vs. Price The buying decision Price above value Price below value Sources of information Value Line sheet S&P report Ford Equity Report High Quality Company Wait to Buy Buy What is the right range for these valuation ratios For the company in question? Not Short? Walk How does the current value for these ratios compare to this range? to peers in the industry? to the market? 19

20 Fundamental Analysis Value: Today vs. the future Measures of value p/e ratio dividend yields book value p/cash flow ratio p/sales ratio Benchmarks of value vs. history vs. industry peers vs. market Fundamental analysis Value vs. Time The buying decision Sources of information Value Line sheet S&P report Ford Equity Report Current Value vs. price Hi Low No Why bother? Maybe Yes How does the current value for these ratios compare to this range? Low Hi Future Value vs. today What is the future potential value for the company? 20

21 Fundamental Analysis Value: Future Potential? Measures of value p/e ratio dividend yields p/book value p/cash flow ratio p/sales ratio Benchmarks of value Sources of information Value Line sheet S&P report Ford Equity Report vs. history vs. industry peers vs. market Future High Future Average Price projection = X EPS Hi P/E ratio Projected EPS sales growth EPS growth P/E ratio history Expected high P/E What is the right range for these valuation ratios For the company in question? What will the future value of the denominator be? Sales EPS Cash flow Etc. Sources of information Value Line sheet future price projection S&P report 12 month price target Analyst reports MorningStar 21

22 Disciplined buying Investment thesis: This is a good investment because. Entry Point: This is a good price / entry point to buy because. Position Size: I can buy XXX shares for my portfolio If I am right, I will make gains by selling the Exit Rules: If I am wrong, I will limit losses by exiting the 22

23 Support Levels Term from technical analysis: Definition: A price range where the market has repeatedly reversed a downward trend. Support levels can be read from the stock chart Support levels Offer downside protection Offer a place where prices will slow down in a decline If penetrated by a downtrend can signify further downside. Support levels are a good marker for Rethinking a buy decision Stop orders 23

24 Position Exits What will I do to limit losses if my bullish view is wrong? Position exits Just Below a support level or a moving average A fixed % or amount of loss Maximum projected loss per share Buy price planned exit price. 24

25 Buy with Good Upside Downside Ratio Price Estimated High Price Upside = Projected Hi - Current Current Price U/D Ratio = Upside Downside Planned Exit Price Downside = Current - Exit 25

26 Buy with good projected returns Price Estimated High Price % gain = Hi price X Current price Current Price Estimated Low Price Investments can generate returns in two ways: Dividends Capital gains - Stock price appreciation Time is a factor Capital gains per year (CAGR) Total return per year = CAP Gains CAGR + dividend yield 15% per year doubles money in 5 years Total return should be more than projected market average source Value Line 26

27 Disciplined buying Investment thesis: This is a good investment because. Entry Point: This is a good price / entry point to buy because. Position Size: I can buy XXX shares for my portfolio If I am right, I will make gains by selling the Exit Rules: If I am wrong, I will limit losses by exiting the 27

28 Position sizing rule: Set these parameters for your portfolio. Max position size for any one investment in the portfolio Max loss tolerated in any single investment As a % of the total portfolio As a % of the single investment Calculate maximum number of units of any investment based on: 1. Limiting max. position size in portfolio = Formula 1 2. Limiting max loss per investment in portfolio = Formula 2 Pick the lesser of the two numbers as your max position size. 28

29 Position sizing example: Example: Sue s total portfolio is $200,000. She wants to limit investment in any single instrument to 2% of her portfolio She wants to limit loss in any investment to 1% of her portfolio. Sue is considering buying stock of Wizz Co. The stock price is $10. She will exit the position if price drops to $8. Formula 1 Max. investment Formula 2 Max. loss Smallest of the two Sue can invest a max. of 2% of $200,000 in Wizz Co. = $4000 Sue can buy a maximum of 400 shares of Wizz co. $4000 $10 Sue will lose a maximum of 1% of $200,000 in any investment = $2000 Sue can lose a maximum of $10 - $8 per share on her Wizz investment = $2 Sue can buy a maximum of 1000 shares of Wizz Co. = $2000/$2 Sue s position size for Wizz is a maximum of 400 shares 29

30 Disciplined buying Investment thesis: This is a good investment because. Entry Point: This is a good price / entry point to buy because. Position Size: I can buy XXX shares for my portfolio If I am right, I will make gains by selling the Exit Rules: If I am wrong, I will limit losses by exiting the 30

31 Scaling at entry/exit Going in, coming out all at once Maximum return if you are right Maximum loss if you are wrong Scaling in and out Equal lots Pyramid Inverse Pyramid Scaling lower reward. Lower risk 31

32 Closing Thoughts Investment Plan/System Objectives, Criteria, Entry rules, Exit rules, Portfolio and Money Management. Trading journal Decisions, Decisions and more Decisions Watch Lists - Choosing companies to study 5 part disciplined buying decision Other portfolio decisions: When & how much to sell? Balance / diversity in the portfolio? etc. 32

33 Next classes 33 Rajeev Vaidya OLLI

34 Happy Investing!! Thanks!! My 34