Value Investing Bootcamp: How to Invest Wisely

In today’s lesson you will learn the crucial difference between price and value. Also, we’ll cover three types of value and how to differentiate them.

Summary:

• Price is what you pay, value is what you get
• There are three types of value: relative, absolute, and perceived value
• Relative value examines what company is worth compared to its competitors
• Absolute value estimates what a company is realistically worth based on its performance and the things it owns
• Perceived value is the value people assign to something in their head
• Stock prices reflect investors’ perception of reality, not necessarily reality itself
• In the short run, a stock price says nothing about the value of the underlying company
• In the long run, stock prices will eventually reflect the absolute value of a company
• Benjamin Graham’s Mr. Market metaphor is a great way to think about investing and still applies in today’s world

In this lesson we will explore in detail why stocks get mispriced, how our mind sometimes works against us, and how this can cause stock market bubbles.

Summary:

• On average, financial experts perform worse than a monkey when it comes to picking stocks
• The Efficient M arket Hypothesis an outdated theory which states it is impossible to ever perform better than the market average
• Warren Buffett believes markets are efficient in the long run, but highly irrational in the short run and these irrational prices is what he exploits to consistently earn above average returns year after year
• Irrational prices are caused by emotions and cognitive biases which cloud our decision making process
• Behavioral Finance studies the effect of cognitive biases on our financial decisions
• The cumulative effect of countless of irrational investment decisions can cause financial bubbles and crises
• The best way to counter the effect of cognitive biases is by removing emotions from the equation by following the financial news less closely and by sticking to a strategy based purely on business facts
• In order to earn above average returns, you have to do things differently from the crowd
• Your emotions have the power to render your financial education and investment strategy completely useless, so having the right mindset is crucial to your investment success

Today we will learn about certain special events which have the ability to push the stock price of an undervalued company closer to its absolute value. These so called catalysts of value realization do not only allow you to profit faster, but also reduce risk, because they often lead to a shorter holding period and are therefore better to predict.

Summary:

• A catalyst of value realization is an event which has the potential to close the gap between price and value in an accelerated timescale.
• Catalysts reduce risk because they often lead to shorter holding periods and therefore have outcomes which can be predicted with more certainty.
• Examples of catalysts are liquidations, spinoffs, buybacks, takeovers, additions to an index, lawsuits, and investigations.
• Each of these events has its own unique way of stimulating an upward price movement
• Do not base your entire investment strategy on catalysts, but see them as a bonus
• Two ways to find out about catalysts are by setting up automatic email updates using Google Alerts and by reading through company filings on the SEC website
• Buying great companies at discount prices should remain the main focus of your investment strategy
• Even if a catalyst seems to exist, this is no guarantee that things will play out the way you expect

Every investor must learn to calculate the value of a company in order to know a bargain when they see one. In this lesson I will describe the theory behind these "intrinsic value" calculations. This lesson contains additional material in the form of an Excel file with three intrinsic valuation models.

Summary:

• Intrinsic value is simply a different word for absolute value
• Every investor must learn to calculate the value of a company in order to know a bargain when they see one
• There is no simple formula to precisely calculate the intrinsic value, it is always an estimate based on several assumptions, like future growth rates
• Being conservative in your estimates is the only way to protect yourself from major losses
• You might miss a few great opportunities by being conservative, but you will also avoid many mistakes this way
• There are several ways to calculate the intrinsic value of a stock, and none of them is perfect
• You should combine the results of the different valuation models and then lean towards the more conservative estimate
• Book value does not offer an accurate representation of the true value of a company’s assets
• One dollar today is worth more than one dollar in the future
• The present value of a future sum of money is called the Net Present Value
• The imaginary interest rate used to calculate the Net Present Value is called the discount rate
• Some companies are to complex or unpredictable to value with any degree of accuracy
• Spreadsheets are a great way to speed up intrinsic value calculations, but you should use them with care

Because it is rather hard to explain valuation models in a video, I created this eBook for you which describes three valuation models in detail, including real-world examples, calculations, and where to get the required input data from.

In this quiz we'll see if you remember the difference between price and value

In this lesson we will cover the important topic of risk. In order to avoid risky situations, we must first have a clear understanding of what risk actually is, because there are many painful misconceptions in this area.

Summary:

• “Risk comes from not knowing what you’re doing”
• Speculating is like gambling and is based purely on luck
• Investing based on fundamental data shifts the odds in your favor
• Risk/reward is not positively correlated for value investing, meaning that you can minimize risk while maximizing potential returns
• To a large extend, your purchase price determines the risk you take. All other things being equal, the lower the price, the lower risk
• Volatility is not risk. In fact, you should expect volatility and use it to your advantage.
• Beta is not risk. You should not pay any attention to this metric, even though many financial models rely on it
• Uncertainty is not risk, it merely makes it harder to estimate risk which in turn makes people feel like there is more risk than there actually is. In fact, uncertainty is your friend, because most investors tend to overreact to uncertainty because they are generally risk-averse, which creates attractive buying opportunities
• Risk is a combination of the probability of a loss and the amount of money you might lose
• Risk cannot be quantified, it is a perception
• No matter how much research you perform, you can’t possibly know everything and will have to act on imperfect information
• Buying at a discount gives you room for error and lowers your chances of losing serious amounts of money

In the previous lesson we explained the nature of risk on the stock market. Armed with this knowledge we can now look at ways to minimize downside risk.

Summary:

• To reduce risk, we have to either reduce the probability of a loss or reduce the amount of money we can lose in a worst case scenario
• Diversification is the practice of spreading the risk over several investments instead of putting all your eggs in one basket
• Diversification creates the illusion of a smoother ride by minimizing volatility
• Limited diversification is good and ySou should spread the risk of your portfolio by purchasing several companies, preferably in different industries
• However, don´t overdo it! Less is often more when it comes to diversification, so limit yourself to 10 great stocks or less
• According to Warren Buffett, Margin of Safety are the three most important words in investing
• Margin of safety is the difference between value and price and functions as a safety buffer, so that even if the company does not perform as well as you expected, you still have a big chance of making money or at the very least protection against major losses.
• A margin of safety is similar to pushing a ball underwater. The lower you push it, the more upward pressure builds up and the harder it is to push it even lower
• Stop-loss orders give you a false sense of security and limit your ability to “average-down”, which is why you should not use them
• As a value investor, declining prices are your friend, because they allow you to buy more of a great company at even better prices.
• It is impossible to know when a stock price has reached its bottom, therefore never buy a full position at once, but instead “average-down” as prices decline
• Only buy financially healthy companies which you understand, stick to what you know

This quiz will test your understanding of the often misunderstood concept of risk

As an investor, you will have to understand the basics of accounting to be able to identify financially strong companies and avoid companies which experience financial troubles. In this lesson I will try my best to explain this topic in an easy to follow, non-boring way.

Summary:

• You have to understand the basics of accounting to be able to identify financially strong companies and avoid companies which experience financial troubles
• Accountants keep track of the money flows and product flows within a company and document every transaction a company makes
• Financial statements are the documents in which these transactions are recorded
• If you do not understand the basics of financial statements, you cannot apply a value investing strategy, because value investing is based on thorough financial statement analysis
• Accounting and financial statements are not difficult, but they can be confusing at first because of the specialized vocabulary
• There are three main financial statements: the balance sheet, the income statement and the cash flow statement
• The balance sheet shows you an overview of what a company owns today, its assets, how much the company owes today, its liabilities, and how much a company is worth today, its shareholders’ equity.
• On the income statement you find how much a company sold in a given period, sales, how much money it had to pay, costs, and finally how much money was left after paying these costs, net income.
• The cash flow statement tracks the movement of cash throughout the business, so where the company gets cash and where that cash goes.
• Income is not the same as cash, and even a highly profitable company might still be unable to pay its bills if it runs out of cash
• The balance sheet, income statement and cash flow statement all work together to show you a complete picture of a company’s financial position, but they all have their own specific purpose

Financial ratios are what you get when you combine some figures from the financial statements in smart ways. This lesson will cover some of the most important financial ratios for value investors.

Summary:

• Financial ratios allow you to compare companies and get a better idea of how well they are performing
• Earnings per share shows you how much profit a company is making for each stock it has issued
• The Price/Earnings ratio is a valuation ratio, or multiple, which shows you how much investors are willing to pay for a stock per dollar of income
• P/E in itself does not say much about whether or not a company is undervalued with respect to its intrinsic value
• The net margin tells you what percentage of total sales is translated into bottom line profits
• Both P/E and net margin differ greatly per industry, which makes them unsuitable to compare companies across industries
• Return on equity shows you how much net income a company earns per dollar of equity, or in other words, how efficient a company uses its equity to generate profits
• While book value is often inaccurate, the growth of book value per share over time gives you a general sense of whether a company is creating value or destroying value
• The debt to equity ratio indicates how much debt a company has in relation to equity
• High levels of debt are dangerous, because the interest payments can bankrupt a company
• The current ratio is a liquidity ratio which measures a company's ability to pay its short-term obligations

In today’s lesson we are going to cover a very important, yet often overlooked metric called Free Cash Flow, or FCF.

Summary:

• Free cash flow is the amount of cash a company has left after is has paid for all of its expenses and investments required to keep the business running
• Free cash flow can be used for repaying debts, paying dividends to shareholders, buying back shares, or to facilitate the growth of its business
• Free cash flow is not reported in the financial statements. You have to calculate it yourself by taking cash from operating activities and then subtracting capital expenditures
• The absolute value of free cash flow does not tell you the whole story, you have to dig a bit deeper
• Ask where the cash is coming from. Is a company generating these cash flows from their own earnings or do they rely on debt?
• Ask what the company is spending its cash on. Are they investing in future growth, paying dividends, buying back shares, paying off debt, or are they simply spending it on maintenance costs?
• If a company consistently reports negative cash flows while reporting increased earnings, this is a big warning sign, because this is unsustainable in the long run and could indicate earnings manipulation
• Negative free cash flow might also indicate that a company does not have the liquidity to stay in business, at least not without taking on additional debt
• Falling free cash flows are a warning sign as well, because it could indicate that a company is experiencing a slowdown in business which means future earnings may not be able to grow
• Just as you can calculate a P/E ratio, you can also calculate a Price/Free Cash Flow ratio. However, these ratios both share the same limitations.
• Also check whether a company is growing its cash reserves or burning through its cash reserves
• Finally, always put these figures into perspective. They never tell you the complete story, you will have to dig a bit deeper to find out how a company is actually performing.

In this lesson you will learn why managers manipulate earnings in the first place, how they do it, what the dangers are for you as an investor, and how you can identify and avoid these so called “value traps”, which is one of the most difficult aspects of stock picking.

Summary:

• To determine whether or not a company is financially healthy, we have to look at their financial statements, but management sometimes manipulates these statements to make a company look more profitable than it actually is
• No matter how sophisticated your fundamental analysis and your intrinsic value estimates, if they are based on misstated information they are essentially worthless
• Managers manipulate earnings to keep the stock price high and to meet analyst expectations
• The GAAP allow several legal ways to manage earnings to a certain extend, which are sometimes misused
• A value trap is a stock which appears to be a great investment at first, but is actually experiencing serious fundamental problems which are permanent in nature
• The price of a true value investment is low because of irrational price movements, often caused by emotional reactions to temporary and solvable problems. TR
• Even the best value investors in the world regularly buy value traps, because it is very difficult to identify them
• There are two major scientific models to identify companies which might experience financial troubles in the near future: the Altman Z-score and the Beneish M-score. They are both useful, but not perfect
• Hewitt Heiserman developed a method of creating two alternative income statements which counter the flaws of a company’s reported earnings: the defensive income statement and the enterprising income statement
• Shareholder friendly management is important, because honest management is less likely to manipulate earnings
• Finally, always read the footnotes of a company’s financial reports, because they can reveal important details

This glossary document explains the most common financial statement items to help you improve your understanding of a company's reported figures.

This time we'll test your knowledge of financial statements

We are finally ready to start looking for some interesting investment opportunities. This lesson will explain several ways to perform the first crucial step in finding attractive investment opportunities: the idea generation phase.

Summary:

• The internet has given us access to amazing tools and resources which make it easier for you to generate investment ideas
• There are thousands of stocks available, but only a handful of them will meet all your criteria, so you need a way to filter out the garbage
• The goal of the initial filtering process is to identify financially strong businesses with above average profitability and low debt levels who have enough cash to pay their short term obligations
• A stock screener is an online filtering tool which allows you to input some criteria and then shows you which stocks meet these criteria
• Filter on return on equity > 15% to return companies with above average profitability
• Filter on debt-to-equity < 0.5 to return companies with low debt levels
• Filter on current ratio > 2 to return companies which can easily pay their short term obligations
• There are many other criteria you can filter on, like market cap to show only small cap stocks or dividend yield to only show companies which are paying a dividend
• I do not recomm end filtering on P/E ratio or earnings growth, because this might exclude perfectly sound investment ideas, since a financially healthy company with 0% growth can still be an attractive investment if the price is right
• Besides stock screeners there are many other ways of generating investment ideas, like newsletters and 52 week low lists

In the previous lesson we generated a list of investment ideas. These are stocks we need to analyze a bit further in order to see if any of them are interesting companies to invest our hard earned savings in. That's what we'll do in this lesson.

Summary:

• You have to put in some serious effort in order to make the best possible investment decisions
• Fundamental analysis is assessing a company’s performance and financial health based on several years of historical financial statement data
• Gurufocus provides you with 10 years of financial statement data for free
• Look for patterns, trends, and consistency in the historical performance of the company by checking out how things like EPS, FCF, Book Value, Net margin and ROE developed over time
• Charts can help you visualize this data to make it easier to spot anomalies whicTEMh require some further analysis
• Find out if yo u are dealing with a temporary setback or fundamental problems which are more permanent in nature
• Qualitative analysis is assessing a company’s non-quantifiable aspects, like the quality of its management and the nature of its business
• Stick to businesses you understand, and drop the rest from the list
• Look for companies with a sustainable competitive advantage, with the emphasis on sustainable
• Think about risk factors and things that could negatively affect the company’s profitability in the future
• Finally, find out if management is honest, able, and shareholder friendly

Today’s lesson will answer two of the most fundamental questions of investing: when to buy and when to sell? As we shall see in this lesson, the optimal moment to purchase or sell a stock has little to do with timing and more to do with the stock price in relation to value.

Summary:

• Timing the market is impossible, because short term prices are irrational & unpredictable
• You don’t have to know when a stock has hit its bottom, you can simply “average-down”
• You should never purchase a full position in one go, but instead Nadd more and more stocks to your portfolio as prices decline
• Buy when you find a good company selling at a significant discount to intrinsic value, this is the secret recipe of value investing
• Holding on to stocks for the long term has many benefits. That’s why Warren Buffett’s favorite holding period is forever
• There are only three good reasons to sell a stock
• Sell when a stock reaches its intrinsic value
• Sell when you made a mistake
• And sell when a better investment opportunity presents itself

In this final lesson we will cover some important portfolio management tips to help you build and maintain a healthy stock portfolio.

Summary:

• There are several important factors you should consider when it comes to managing your portfolio
• Diversify by buying a mix of companies which operate in different industries to spread the risk of your portfolio
• Always keep some liquidity so you can act when new opportunities arise
• Regularly re-evaluate your current holdings to see if it is still a good idea to keep them in your portfolio
• Minimize the amount of trades you make to minimize the amount of transaction costs you have to pay
• Don’t buy a full position at once, but instead average down by buying more stocks as prices decline
• Keep adding money to your portfolio by automatically transferring a percentage of your monthly income to your investment account at the beginning of each month
• Don’t give up too quickly, the returns will come in time if you just stick to the strategy
• Finally, be patient, because time is a friend of the value investor, because it unleashes the incredible power of compounding

This investment checklist combines everything we discussed in the Value Investing Bootcamp course. Using this spreadsheet allows you to make sure you don't forget anything in your analyses.

This final quiz will test how well you remember the last lessons of this course

In this bonus video I explain why the rich get richer, how to avoid getting trapped in the “rat race”, and how you can achieve true financial freedom.

Several students requested me to write an analysis of real companies using the strategy taught in this course, and I am here to serve. I chose two big, well-known companies, Sony and Google, to show you how these behemoths differ and how this is reflected in the performance of their respective stocks prices. In other words, this document will present an example of a true value stock, as well as a stock you better stay far away from and how to identify such companies for what they really are.

This eBook explains the differences between the investment strategies of Benjamin Graham, the "Father of Value Investing", and his disciple Warren Buffett, the "Oracle of Omaha". Find out which of these giants comes out on top!