My Philosophy in Investing
After learning and testing out all the various investing techniques available; top-down approach, bottom-up approach, stock screening, sector rotation, fundamental analysis, technical analysis, macro-economic analysis, momentum trading, swing trading, contrarian investing etc….
I finally found that what made me the largest and most consistent profits was ‘Value Investing’. This is a medium term (or long term), bottom up, selective contrarian approach to investing that was practiced by Benjamin Graham and Warren Buffett (the world’s greatest investor, and world’s Richest man- 2007).
My investing strategy has basically three steps.
Step 1: Identify stocks of very good businesses.
A very good business is one that I can predict with a high degree of confidence that over time, the profits will increase consistently and predictably. Hence, the value of the company and the stock will appreciate significantly over time.
In order to be able to grow its profits consistently, the business I look for must have no competitors (i.e. a monopoly) or very insignificant competitors (i.e. the company has huge economies of scale, a strong brand that allows it to dominate the market). When there is no credible threat from competitors stealing market share or cutting prices, the business will be able to keep generating higher sales and profits annually.
For example, in the context of Singapore, SMRT and Singapore Exchange (SGX) are monopolies with no competitors. IN the context of the US, companies like Google, Wal-Mart, Coke, Visa are consumer monopolies with insignificant competitors that threaten them.
The business I buy must also make a product (service) that does not go obsolete easily. It must make a product that people must use regularly. This way, future earnings are predictable. For example, US company Apollo Group provides academic education, a product that will never go obsolete. This is in contrast with Research in Motion (RIMM) that makes the Blackberry phone. Although it is doing very well now, its ability to succeed 5-10 years from today is unpredictable as technology can be made obsolete very fast.
Finally, the business I buy must have a very strong balance sheet, with lots of free cash flow and insignificant debt. This way, there is no threat of bankruptcy and in fact, the company will have the cash to buy out any competitors.
Step 2: Only Buy When the Stock Price is Selling Way Below the Intrinsic Value of a Business.
The biggest mistake investors make is to pay too high a price for a stock. This is when investing becomes very risky. Whether a stock’s price is high depends on what its intrinsic value (IV) is. IV means what the stock is actually worth based on its profits and cash flow.
For example, a great company that I wanted to buy in Singapore was Raffles Education. It was selling at $0.80. After falling from a high of $1.60, many amateur investors thought that it looked really cheap (50% below the highest price).
However, after calculating its intrinsic value, I found that it was worth $0.44. So at $0.60, it was actually overpriced. Sure enough, those that bought at $0.60 (and way above) got screwed! The stock fell to $0.35 and below!
On the other hand, I only found it a good buy at $0.35, when it went BELOW the intrinsic value of the stock. When you buy at a price below intrinsic value, you can be certain that there is very little downside. Buffett’s calls this the MARGIN OF SAFTEY. One thing I learnt from studying this great man is ‘it’s not risky when you buy stocks at a fraction of what they are worth’.
I have found that whenever I bought stocks way below their intrinsic value, I very rarely lost money. While the downside was low, the upside was really very high. When US-company American Express (AXP) fell to $16, during the financial crisis, I bought like crazy! The stock’s intrinsic value is worth $35. At a 50%+ discount to its true value, it was a sure-win deal. Sure enough, when confidence returned to the stock market, AXP shot back up to $40, making me a nice profit.
(Intrinsic value is calculated manually, It is the present value of the future cash flows of the company. In my Wealth Academy programmes, I spend hours teaching how this is done using an intrinsic value calculator)
Step 3: Wait for the Market to Recover and the Stock Price to Rise Above Intrinsic Value
Usually, the stock of a very good company sells at a price way below intrinsic value when there is a stock market crisis and lots of people are selling out of fear (this happens every couple of months and very severely every few years).
After a buy a stock at a great price, I can never predict when the stock market confidence will come back and push stocks back to its high prices. It could be a few days, weeks or even months…nobody can predict with certainty.
So, I wait patiently for it to happen and collect my huge profits when it does. So, has this three-step method worked for me? You bet! Here are some recent profits I made from these US and Singapore companies.
As a wealth academy program graduate, you can exclusive private access to my personal stock portfolio and I even send you my buy and sell orders with 24 hours. Here is a screen shot of my portfolio. As you can see, I have average success rate of 75% and a 100% success rate so far with Singapore stocks ever since I put this portfolio online 2 years ago.
Hi Adam,
To calculate the intrinsic value, we will have to know what is the risk free interest rate. I’m from Malaysia and I would like to know how can I get the risk free interest rate for Malaysia. Thanks.
Even for singapore stocks, I will take US treasury bills (3 years) as default risk free rate. You can go to http://www.bloomberg.com/markets/rates to have a look
For discount rate, I normally take
Current risk free rate + Beta x Historical Market Risk Premium (i.e. 5%)
Discount rates should be between 5% (for low bets stocks) to 9% (for high beta stocks)
Thanks Adam. In this case, from the webside, am i going to refer to 1.125 (under coupon, 3 years)?
Yes. However, for historical risk premium, I take the market return to be 10% and the historical risk free rate as 5%. So, market risk premium is 10%-5% = 5%
Honestly I do not understand what is the risk premium that you mentioned, is it important to figure out the intrinsic value as well? Guess I’ve to put more effort and much to learn bout stock investment.
Hi Adam,
I’ve read your post about calculating intrinsic values (by taking PV of future cash flows) and understand that there are several ways to calculate the intrinsic value if a company.
(a) To calculate the intrinsic value, do you use:
1. Benjamin Graham’s formula of – EPS*(8.5 2g)*4.4/Y
or
2. Do you calculate the Intrinsic value as:
PV of EPS (compounded by 10yr average earnings growth rate and discounted by the investor’s hurdle rate) less Long Term debt?
(b) In your response to Lim, you mentioned the CAPM formula to calculate your discount rate. Do you use the industry betas or the company’s beta? I’m having trouble finding beta numbers and was wondering whether you could shed some light please?
I tried re-calculating the intrinsic value of the companies you’ve mentioned in your post but am not getting similar figures to you. Its probably due to the differences in our assumptions and valuation points. But nonetheless, was hoping to get insight from you please?
I’ve been reading your updates which I’ve found extremely valuable!
Many thanks,
Hilary
After testing all the different valuation methods, I use a hybrid of the many of the common methods available. I find that it is the most accurate for me so far. I take the present value of the ‘Cash flow from operations’ for the next ten years.
Unlike other valuation methods, I do not take a terminal value (assuming the company will last forever). I take only 10 years of projection because I am super conservative. I do not take dividends, earnings, free cash flow like most valuation methods. I take ‘Cash flow from operations’, also known as ‘net cash flow operations’
As for the discount rate, I take it from 5% (low beta stock) to 9% (high Beta stock). I take the stock’s beta and not the industry beta. You can get the stock’s beta at http://www.reuters.com/finance/stocks. I use the formula, discount rate = current risk free rate + (Stock Beta x 5%). You can read how I value stocks in my books Secrets of Millionaire Investors or Profit from the Panic
Hi Adam,
I am new to the site. Found it useful.
I have 2 questions for you. Do you believe in dividend investing? Is it using the same method above to select stocks to invest ?
Thank you
Yes, of course. When looking for high dividend stocks, I normally buy REITs that have yields of at least 6%-8%
Hi Adam and all
There is some qns on investing. I heard there are 2 ways of generating income from investing:
1st) Capital Gain: where you buy low and sell high.
2nd) “Hold long” theory. and have consistent income.
I have read some books (by Warren and Robert Kiyosaki). They mention that it is better to invest in the 2nd method.
But how can i hold long (or forever) and not selling and yet generate income? What they mean? Is it through dividend? if through dividend, does that means i should always buy stock that has dividend? or is there other ways than through dividend?
From Bao (P.s Read SSMM, it’s great book)
The way to earn income from stocks is to buy stocks that have high dividend yield of at least 5%-8%. Every year, these companies pay out a share of their profits as dividends to you. Another way is to buy Real Estate Investment trusts (REITs) where they payout 90% of the profits they earn from rental income. The dividend yield for REITS is now 6%-9% for Singapore REITs
Hi Adam.
Thanks for the quick reply.
So if i prefer long term investment, i should and can only profit from dividend?
There is another “favor” like to ask. hee..
I read your SMI book, and you provided several good source of investment info such as morningstar, etc (BIG THANKS!). However, i can only find little info regarding company listed on SGX.
Is there good link to SGX company’s financial info?
Or i had to sign up and pay for these info?
Thank You.
From: Bao
You can check out http://www.shareinvestor.com
Hi Adam,
1)I heard professionals said that we must always stay vested in the market despite the crisis.
Do you know what does it mean? How do we do that ?
2)How do we achieve the effect of dollar cost averaging in stock investments?
Thank you
Phyllis
Whether you should stay vested in the market despite a crisis depends on what kind of investments you hold. If you are holding stocks that are undervalued, have low debt and strong profit models, then it does not make sense during a crisis. In fact, it is the opportune time to buy more of these stocks at these attractive prices. However, if you are holding stocks that are highly overvalued (e.g. Raffles Education, Cosco) or weak financial strength (high debt, low cash), the it would be better to cut losses/take profits and they have the potential to drop alot and never recover back
Dollar cost averaging means buying a fixed dollar amount of stocks at regular intervals. It is best used when buying an index ETF like the STI ETF. For examp, every 6 months, buy $5000 worth of STI ETF shares. So, when the stock price is high, your $5,000 will buy less shares. During a crisis, when the price is low, your $5,000 will buy relatively more shares. So over time, you are buying the stocks at an AVERAGE PRICE. This ensures you do not buy at an overvalued price. Over the long term, it is a pretty
safe way to make consistent profits
Hi Adam,
I’ve read your book Secrets of Millionaire Investors. In the section bout calculating intrinsic value, what I understand is we get the discount value from projected value (PV) by formula PV/(1 risk free rate)^n, after that we sum up all the discounted value for next ten years and divided by outstanding share. But from the book I did not see anything regarding Beta value. Please correct me if I am wrong.
Hi Adam,
You mentioned using stock Beta to calculate discount rate. But it is not mentioned in your book Secrets of Millionaire Investors,under topic intrinsic value calculation, am I having the wrong understanding? Thanks.
Hi. In my book, I give a simpler method of calculating Intrinsic value by just taking the risk free rate. In fact, Warren Buffett does this. However, using BETA actually takes into account the volatility and hence riskiness of different stocks. So, higher risk stocks will be forced to have a lower intrinsic value due to the uncertainty of its future earnings. This ensures that we buy volatile stocks only when their stock prices are much lower, giving a higher margin if safety. I only teach these more advance techniques in my courses.
Hi Adam
In your book Secrets of Millionaire Investors, there is a formula to find the annual growth of a company for a period. I think is CAGR.
However i find that this formula is not accurate at all. Because it takes into account the value of the intial and the final year (e.g. 1st year and 5th year for a 5 years period).
So how can it be accurate and useful? Because let’s says the 2nd year has a very low value, then if i calculate the CAGR of the last 4 years instead of 5yr, the result will be a much higher CAGR.
Is my interpretation wrong?
Is there a formula out there to calculate the average growth that will take each and every year into consideration??
Thanks
HI Bao
Yes, if the two points you take (i.e. year 1 and year 5) and years where there is an exceptional high or low cash flow, then results can be distorted. What you need to do is to roughly plot the cash flow for each of the years of a graph. Then draw a line of best fit between the cash flows of the following years. As long as you take the two points that are somewhere along this historical growth trend, you will get an accurate growth rate
Hi Adam.. Help!!
I used the formula according to the SMI book to calculate the Intrinsic Value (IV) of a company. However, the IV i got is very Big.
E.g. I used it on the company “YangZiJiang”. According to the statistic, i used the 5-yrs CashFlow (from operation) to calculate the annual growth (CAGR), and the growth is a good 58.17% (1st year = 411.7M; 5th year = 2578M).
And using this rate, it project it over the next 10 yrs and used the total 10 yrs discounted CF to find the IV. And the result is $98. BUT the current stock price is $1.05.(???)
I am very thrilled abt the finding, however i used the calculation for the rest of the company i picked (around 20), and i found that all the IV is WAY higher than the current stock price.
I tried using the IV calculator you provided, and the result is the same.
What is missed out?? How can all the company i picked happen to be good. Is there other criteria i need to check???
The company may have grown at a CAGR of 58.17% over the last 5 years, however, it is unrealistic to think that it can continue to grow at 58% every year for the next 10 years. I usually put a maximum cap of 15% CAGR over the next 10 years. At the same time, it depends on the discount rate you are using. NEver take a discount rate of less than 5%, even if the risk free rate is lower than 5%. 5% is the minimum. However, for riskier stocks (like small caps, especially S-chips), take a discount rate of 9% would be more conservative. Plug in the figures and see what you get
Hi Adam =]
Thanks for the reply. *Appreciated*.
After putting a max of 15% CAGR, the Intrinsic Value indeed fallen to reasonable range.
Now after all these researches, i guess now it’s up to me whether have the courage, faith, gut, or whatever to put the fear aside and invest.
Hi Adam,
Another question here, how do we determined whether the BETA value is high or low? Thanks.
Hi Adam,
I was reading “Profit from the Panic” on the chapter on “Buying MARKETS & SECTORS IN CRISIS PART 2″.
What I do not understand is how do you know whether which sectors will rise or fall in which months? Is it based on the news of the world or there are some guidelines ? What do we look out for ?
Thank you
Regards
Phyllis
Hi Adam,
May I know how do apply the 5% and 9% discount rate? According to SMI book, there is a discount factor, which is calculated from risk free interest rate. By considering stock’s volatile, are we going to use the discount rate instead of just using risk free interest rate? Please correct me if I were wrong. Thanks!
Hi Adam,
I was reading another of your book “Secrets of Millionaire Investors”.
I have a question on how to calculate the intrinsic value of a stock. The value = PV of 10 yr cash flows / total number of outstanding shares
How do I get the value of the total number of outstanding shares?
Thank you
Regards
Phyllis
Hi Adam,
Thanks very much for your sharing and for autographing my copy of SMI after your talk last Thursday. Hope you have recovered from your cold.
I have begun to read SMI and have completed Chapter 4 on Value Investing today.
Under your intrinsic value calculation, you advise us to use “cash from operations” in our DCF calculation.
I’ve a few questions here:
1) In the context of SGX-listed stocks, is this the figure found in the cash flow statement under the “net cash generated from operations” line item, or the “cash from operations before working capital changes” line item (ie. a proxy for EBITDA)?
2) Why not use free cash flow, or at least in some way, account for capex (or at least maintenance capex)? After all, businesses do need to spend money to grow or (worse) just stay competitive.
Stephen
Hi Adam,
May I know what is discount rate?
The discount rate is the rate which you use to discount future cash flows to today’s present value. It represents the opportunity cost of your capital. For example, Buffett uses the risk free rate for his discount rate while I use the Risk free rate + Beta x Market risk premium.
Hi Stephen
Sorry for this late reply
1) The item is found under ‘Net Cash Generated from Operations”. Ensure that this figure is BEFORE dividends are paid
2) Most finance books actually advocate using free cash flow or dividends to discount. However, they normally take the present value of ALL FUTURE CASH FLOW to perpetuity. This means they assume the company will grow forever at a certain terminal value. In my valuation, I only assume that the company will only last for 10 years. Because of this, if I use free cash flow, I get a distorted valuation that is too low. That is why I use cash flow from ops
Sorry for this late reply. You can get a company’s total number of shares outstanding by going to http://www.reuters.com/finance/stocks
Different investors use different discount rates. Buffett uses the long term US bond yield as his discount rate. If you want to factor in the riskiness of a stock, you have to factor in the stock’s beta
In general, for low risk stocks, use discount rate of 5%. For higher risk, use 9% and medium risk, use 7%
There is a whole study on sector rotation. Changes in interest rates are what cause money to flow or rotate between sectors. Sector rotation is also dependent on the economic cycle. You can read more on this by google searching Sam Stovall, Director for Research at S&P
Usually a Beta of more than 1 is high and less than 1 is low
Hi Adam, you mentioned above:
‘it’s not risky when you buy stocks at a fraction of what they are worth’.
may I know why that is so? Is it because no matter how low the stock price will go or even if the company goes bankrupt, by hook or by crook you will still get back the ‘intrinsic value’ worth of money?
As long as the company’s fundamentals like earnings, cash flow, sales remains good and debt remains low then any temporary dip in the share price because of market sentiment provides the investor with a good opportunity. Of course, if the company’s business model deteriorates, then it will be worth less, and an indication to sell the stock
Hi, another question. You mentioned in your talks that we should set aside like lets say $200 every month for investment. But where can we put that $200 in? Most stocks cost way more than that
Hi Adam, after reading your books, i have decided to invest in reits. Is it safe to hold on to industrial reits like Cambridge or health reits like First Reit during times of crisis? Thank you.
Hi Adam,
Thanks for the fantastic books you have published.
They managed to convey difficult concepts to newbies like me in the most easily understandable terms.
May i ask you a couple of questions to enhance my understanding?
1. How do you calculate CAGR for stock with one value, either initial or final value, in the negative? For those that flutuate alot, i assume you will still use the same formula but capped at a max of 15% and a min of 5%?
2. How will you be able to determine if net operating cashflow as listed in websites like shareinvestor does not include paid dividends?
Many thanks for taking the time to answer my queries!
You need to points (initial and final value) to calculate CAGR. The only way to confirm that cash flow from operations does not include dividends is to check the actual annual report