invest in stocks not to preserve capital, but to make money. Then you take yourprofits and invest in more stocks, and make even more money.

Why to invest

efficient-market hypothesis(that everything in the stock market is “known” and prices are always “rational”)

Efficient-Market-Hypothesis(EMH)

“Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.”

Don't Gamble

market-capitalization rule: Size is measured by multiplying the number of outstanding shares by the current stock price.

Market Cap

Consistent winners raise their bet as their position strengthens, and they exit the game when the odds are against themConsistent winners also resign themselves to the fact that they’ll occasionally be dealt three aces and bet the limit, only to lose to a hidden royal flush.They realize the stock market is not pure science, and not like chess, where the superior position always wins. If 7 out of 10 of my stocks perform as expected, then I’m delighted. If six out of ten of my stocks perform as expected, then I’m thankful. 6 out of 10 is all it takes to produce an enviable record on Wall Street.

Consistent Winners

<ul>
<li>Patience</li>
<li>Self-reliance</li>
<li>Common sense</li>
<li>A tolerance for pain</li>
<li>Open-mindedness</li>
<li>Detachment</li>
<li>Persistence</li>
<li>Humility</li>
<li>Flexibility</li>
<li>A willingness to</li>
<li>Do independent research, an equal willingness to admit to mistakes, and the</li>
<li>Ability to ignore general panic.</li>
</ul>

PERSONAL QUALITIES IT TAKES TO SUCCEED

• Don’t overestimate the skill and wisdom of professionals.• Take advantage of what you already know.• Look for opportunities that haven’t yet been discovered and certified by WallStreet—companies that are “off the radar scope.”• Invest in a house before you invest in a stock.• Invest in companies, not in the stock market.• Ignore short-term fluctuations.• Large profits can be made in common stocks.• Large losses can be made in common stocks.• Predicting the economy is futile.• Predicting the short-term direction of the stock market is futile.

Lessons from section 1 :

• The long-term returns from stocks are both relatively predictable and also farsuperior to the long-term returns from bonds.• Keeping up with a company in which you own stock is like playing an endlessstud-poker hand.• Common stocks aren’t for everyone, nor even for all phases of a person’s life.• The average person is exposed to interesting local companies and productsyears before the professionals.• Having an edge will help you make money in stocks.• In the stock market, one in the hand is worth ten in the bush.

The best place to begin looking for the tenbagger is close to homeCan’t think of any such opportunity in your own life? What if you’re retired, live ten miles from the nearest traffic light, grow your own food, and don’t have a television set? Well, maybe one day you have to go to a doctor. The rural existence has given you ulcers, which is the perfect introduction to SmithKline Beckman.people who buy stocks about which they are ignorant may get lucky and enjoy great rewards, it seems to me they are competing under unnecessary handicaps

Stalking the Tenbagger

This gives an incredible head start in anticipating an improvement in earnings—and earnings, as you’ll see, make stock prices go higher.You’re looking for a situation where the value of the assets per share exceeds the price per share of the stock. In such delightful instances you can truly buy a great deal of something for nothing. I’ve done it myself numerous times.

Edge as a consumer:

I could go on for the rest of the book about the edge that being in a businessgives the average stockpicker. On top of that, there’s the consumer’s edge that’shelpful in picking out the winners from the newer and smaller fast-growingcompanies, especially in the retail trades. Whichever edge applies, the excitingpart is that you can develop your own stock detection system outside the normalchannels of Wall Street, where you’ll always get the news late.

Invest in things you know about. Neither of us should let an opportunity pass us by again.Investing without research is like playing stud poker and never looking at the cards.

Know what to own

place it into one of six general categories:slow growersstalwartsfast growerscyclicalsasset playsand turnarounds.

THE SIX CATEGORIES

Usually these large and aging companies are expected to grow slightly faster than the gross national product.Slow growers didn’t start out that way.They started out as fast growers and eventually pooped out, either because they had gone as far as they could, or else they got too tired to make the most of their chances. Sooner or later every popular fast-growing industry becomes a slow-growing industry, aluminum was a fast-growth industry. In the twenties the railroads were the great growth companies,

The slow Growers

Then cars became the fast-growth industry, and for a time it was steel, then chemicals, then electric utilities, then computers.Another sure sign of a slow grower is that it pays a generous and regular dividend. companies pay generous dividends when they can’t dream up new ways to use the money to expand the business. You won’t find a lot of two to four percent slow growers in my portfolio, because if companies aren’t going anywhere fast, neither will the price of their stocks. If growth in earnings is what enriches a company, then what’s the sense of wasting time on sluggards?

When you traffic in stalwarts, you’re more or less in the foothills: 10 to 12 percent annual growth in earnings.In fact, when anyone brags about doubling or tripling his money on a stalwart (or on any company, for that matter), your next question ought to be: “And how long did you own it?” In many instances the risk of ownership has not resulted in any advantage to the owner, who therefore took chances for nothing always keep some stalwarts in portfolio because they offer pretty good protection during recessions and hard times.

THE STALWARTS

These are among my favorite investments: small, aggressive new enterprises that grow at 20 to 25 percent a year. If you choose wisely, this is the land of the 10-to 40-baggers, and even the 200-baggers. With a small portfolio, one or two of these can make a career.A fast-growing company doesn’t necessarily have to belong to a fast-growing industry.All it needs is the room to expand within a slow-growing industry. Beer is a slow-growing industryThere’s plenty of risk in fast growers, especially in the younger companies that tend to be overzealous and underfinanced.

THE FAST GROWERS

Wall Street does not look kindly on fast growers that run out of stamina and turn into slow growers, and when that happens, the stocks are beaten down accordingly. Once a fast grower gets too big, it faces the same dilemma as Gulliver in Lilliput. There’s simply no place for it to stretch out.But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits. The trick is figuring out when they’ll stop growing, and how much to pay for the growth.

A cyclical is a company whose sales and profits rise and fall in regular if not completely predictable fashion. In a growth industry, business just keeps expanding, but in a cyclical industry it expands and contracts, then expands and contracts again.The autos and the airlines, the tyre companies, steel companies, and chemical companies are all cyclicals. Even defense companies behave like cyclicals, since their profits’ rise and fall depends on the policies of various administrations.

THE CYCLICALS

Charts of the cyclicals look like the polygraphs of liars, or the maps of the Alps, as opposed to the maps of Delaware you get with the slow growers.Coming out of a recession and into a vigorous economy, the cyclicals flourish, and their stock prices tend to rise much faster than the prices of the stalwarts. This is understandable, since people buy new cars and take more airplane trips in a vigorous economy, and there’s greater demand for steel, chemicals, etc.

You can lose more than fifty percent of your investment very quickly if you buy cyclicals in the wrong part of the cycle, and it may be years before you’ll see another upswing. Cyclicals are the most misunderstood of all the types of stocks. The major cyclicals are large and well-known companies, they are naturally lumped together with the trusty stalwarts.

Timing is everything in cyclicals, and you have to be able to detect the earlysigns that business is falling off or picking up. If you work in some professionthat’s connected to steel, aluminum, airlines, automobiles, etc., then you’ve gotyour edge, and nowhere is it more important than in this kind of investment.

These aren’t slow growers; these are no growers. These aren’t cyclicals that rebound; these are potential fatalities.Turnaround stocks make up lost ground very quickly.The best thing about investing in successful turnarounds is that of all the categories of stocks, their ups and downs are least related to the general market. There are several different types of turnarounds, and I’ve owned all of them at one time or another. There’s the bail-us-out-or-else kind of turnaround where the whole thing depended on a government loan guarantee.

TURNAROUNDS

There’s the who-would-have-thunk-it kind of turnaround, such as Con Edison. Who would ever have believed you could lose this much money in a utility, as the stock price fell from $10 to $3 by 1974; and who would have believed you could make this much, as the price rebounded from $3 to $52 by 1987?

There’s the little-problem-we-didn’t-anticipate kind of turnaround, such asThree Mile Island. This was a minor tragedy perceived to be worse than it was,and in minor tragedy there’s major opportunity. I made a lot of money inGeneral Public Utilities, the owner of Three Mile Island. Anybody could have.You just had to be patient, keep up with the news, and read it with dispassion.

I try to stay away from the tragedies where the outcome is unmeasurable, suchas the Bhopal disaster at the Union Carbide plant in India. This was a terriblegas leak that resulted in thousands of deaths, and how much the families wouldget out of Union Carbide in damages was an open question

There’s the restructuring-to-maximize-shareholder-values kind of turnaround,such as Penn Central. Wall Street seems to favor restructuring these days, and any director or CEO who mentions it is warmly applauded by shareholders.Restructuring is a company’s way of ridding itself of certain unprofitable subsidiaries it should never have acquired in the first place.The earlier buying of these ill-fated subsidiaries, also warmly applauded, is called diversification. I call it diworseification.

An asset play is any company that’s sitting on something valuable that you know about, but that the Wall Street crowd has overlooked.The asset play is where the local edge can be used to greatest advantage.Asset opportunities are everywhere. Sure they require a working knowledge of the company that owns the assets, but once that’s understood, all you need is patience.

THE ASSET PLAYS

Companies don’t stay in the same category forever. Over my years of watching stocks I’ve seen hundreds of them start out fitting one description and end up fitting another.Fast growers can lead exciting lives, and then they burn out, just as humans can. They can’t maintain double-digit growth forever, and sooner or later they exhaust themselves and settle down into the comfortable single digits of sluggards and stalarts.Cyclicals with serious financial problems collapse and then reemerge as turnarounds.

HIGHFLIERS TO LOW RIDERS

Growth companies that can’t stand prosperity foolishly diworseify and fall out of favor, which makes them into turnarouds McDonald’s is a classic fast grower, but because of the thousands of outlets it either owns or is repurchasing from the franchisees, it could be a great future asset play in real estate.

Are you looking for slow growth, fast growth, recession protection, a turnaround, a cyclical bounce, or assets?Putting stocks in categories is the first step in developing the story.Getting the story on a company is a lot easier if you understand the basic business.The simpler it is, the better I like it. When somebody says, “Any idiot could run this joint,” that’s a plus as far as I’m concerned, because sooner or later any idiot probably is going to be running it.

The story of the perfect stock

“Any idiot can run this business” is one characteristic of the perfect company,the kind of stock I dream about. You never find the perfect company, but if youcan imagine it, then you’ll know how to recognize favorable attributes,

Any idiot can run this business

The perfect stock would be attached to the perfect company, and the perfect company has to be engaged in a perfectly simple business, and the perfectly simple business ought to have a perfectly boring name. The more boring it is, the better.

(1) IT SOUNDS DULL—OR, EVEN BETTER, RIDICULOUS

I get even more excited when a company with a boring name also does something boring. A company that does boring things is almost as good as a company that has a boring name, and both together is terrific. If a company with terrific earnings and a strong balance sheet also does dull things, it gives you a lot of time to purchase the stock at a discount.

(2) IT DOES SOMETHING DULL

Better than boring alone is a stock that’s boring and disgusting at the same time. Something that makes people shrug, retch, or turn away in disgust is ideal.

(3) IT DOES SOMETHING DISAGREEABLE

Spinoffs of divisions or parts of companies into separate, freestanding entitiesLarge parent companies do not want to spin off divisions and then see those spinoffs get into trouble, because that would bring embarrassing publicity that would reflect back on the parents. Therefore, the spinoffs normally have strong balance sheets and are well-prepared to succeed as independent entities. And once these companies are granted their independence, the new management, free to run its own show, can cut costs and take creative measures that improve the near-term and long-term earnings

(4) IT’S A SPINOFF

If you find a stock with little or no institutional ownership, you’ve found a potential winner.Find a company that no analyst has ever visited, or that no analyst would admit to knowing about, and you’ve got a double winner.

(5) THE INSTITUTIONS DON’T OWN IT, AND THE ANALYSTS
DON’T FOLLOW IT

It’s hard to think of a more perfect industry than waste management.If there’s anything that disturbs people more than animal casings, grease and dirty oil, it’s sewage and toxic waste dumps.

(6) THE RUMORS ABOUND: IT’S INVOLVED WITH TOXIC
WASTE AND/OR THE MAFIA

In this category my favorite all-time pick is Service Corporation International (SCI), which also has a boring name.At last count the company owned 461 funeral parlors, 121 cemeteries, 76 flower shops, 21 funeral product-and-supply manufacturing centers, and 3 casket distribution centers, so they’re vertically integrated. They broke into the big-timewhen they buried Howard Hughes.

(7) THERE’S SOMETHING DEPRESSING ABOUT IT

I prefer to invest in a low-growth industry like plastic knives and forks, but only if I can’t find a no-growth industry like funerals.That’s where the biggest winners are developed.In a no-growth industry, especially one that’s boring and upsets people, there’s no problem with competition. You don’t have to protect your flanks from potential rivals because nobody else is going to be interested.

(8) IT’S A NO-GROWTH INDUSTRY

I’d much rather own a local rock pit than own Twentieth Century-Fox, because a movie company competes with other movie companies, and the rockpit has a niche. Twentieth Century-Fox understood that when it bought up Pebble Beach, and the rock pit with it. Certainly, owning a rock pit is safer than owning a jewelry business. If you’re in the jewelry business, you’re competing with other jewelers from across town, across the state, and even abroad, since vacationers can buy jewelry anywhere and bring it home. But if you’ve got the only gravel pit in Brooklyn,

(9) IT’S GOT A NICHE

you’ve got a virtual monopoly, plus the added protection of the unpopularity of rock pits.The insiders call this the “aggregate” business, but even the exalted name doesn’t alter the fact that rocks, sand, and gravel are as close to inherently worthless as you can get. That’s the paradox: mixed together, the stuff probably sells for $3 a ton. For the price of a glass of orange juice, you can purchase a half ton of aggregate, which, if you’ve got a truck, you can take home and dump on your lawn.

I’d rather invest in a company that makes drugs, soft drinks, razor blades, or cigarettes than in a company that makes toys. In the toy industry somebody can make a wonderful doll that every child has to have, but every child gets only one each. Eight months later that product is taken off the shelves to make room for the newest doll the children have to have—manufactured by somebody else.Why take chances on fickle purchases when there’s so much steady businessaround?

(10) PEOPLE HAVE TO KEEP BUYING IT

When insiders are buying like crazy, you can be certain that, at a minimum, the company will not go bankrupt in the next six months. When insiders are buying, I’d bet there aren’t three companies in history that have gone bankrupt near term. Long term, there’s another important benefit. When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries becomes a first priority. Since bigger companies tend to pay bigger salaries to executives,

(11) IT’S A USER OF TECHNOLOGY

there’s a natural tendency for corporate wage-earners to expand the business at any cost, often to the detriment of shareholders. This happens less often when management is heavily invested in shares.If the stock price drops after the insiders have bought, so that you have a chance to buy it cheaper than they did, so much the better for you.But there’s only one reason that insiders buy: They think the stock price is undervalued and will eventually go up.

Buying back shares is the simplest and best way a company can reward its investors. If a company has faith in its own future, then why shouldn’t it invest in itself, just as the shareholders do? The announcement of massive share buybacks by company after company broke on October 20, 1987 the fall of many stocks, and stabilized the market at the height of its panic. Long term, these buybacks can’t help but reward investors.

(13) THE COMPANY IS BUYING BACK SHARES

When stock is bought in by the company, it is taken out of circulation, therefore shrinking the number of outstanding shares. This can have a magical effect on earnings per share, which in turn has a magical effect on the stock price.If a company buys back half its shares and its overall earnings stay the same, the earnings per share have just doubled. Few companies could get that kind of result by cutting costs or selling more widgets. common alternatives to buying back shares are (1) raising the dividend, (2) developing new products, (3) starting new operations, and (4) making acquisitions.

The reverse of buying back shares is adding more shares, also called diluting.

Diluting of shares

If I could avoid a single stock, it would be the hottest stock in thehottest industry, the one that gets the most favorable publicity, the one that every investor hears about in the car pool or on the commuter train—and succumbing to the social pressure, often buys.If you aren’t clever at selling hot stocks (and the fact that you’ve bought them is a clue that you won’t be), you’ll soon see your profits turn into losses, because when the price falls, it’s not going to fall slowly, nor is it likely to stop at the level where you jumped on.

Stocks I’d Avoid

Another stock I’d avoid is a stock in a company that’s been touted as the next.

BEWARE THE NEXT SOMETHING

Instead of buying back shares or raising dividends, profitable companies often prefer to blow the money on foolish acquisitions. The dedicated diworseifier seeks out merchandise that is (1) overpriced, and (2) completely beyond his or her realm of understanding. This ensures that losses will be maximized.These frequent episodes of acquiring and then regretting, only to divest and acquire and regret once again

AVOID DIWORSEIFICATIONS

If a company must acquire something, I’d prefer it to be a related business, but acquisitions in general make me nervous. There’s a strong tendency for companies that are flush with cash and feeling powerful to overpay for acquisitions, expect too much from them, and then mismanage them. I’d rather see a vigorous buyback of shares, which is the purest synergy of all.

I get calls all the time from people who recommend solid companies for Magellan, and then, usually after they’ve lowered their voices as if to confide something personal, they add: “There’s this great stock I want to tell you about. It’s too small for your fund, but you ought to look at it for your own account.It’s a fascinating idea, and it could be a big winer.”Whisper stocks have a hypnotic effect, and usually the stories have emotional appeal.You can get tenbaggers in companies that have already proven themselves. When in doubt, tune in later.

BEWARE THE WHISPER STOCK

The company that sells 25 to 50 percent of its wares to a single customer is in a precarious situation. Short of cancellation, the big customer has incredible leverage in extracting price cuts and other concessions that will reduce the supplier’s profits. It’s rare that a great investment could result from such an arrangement.

BEWARE THE MIDDLEMAN

It’s too bad that Xerox didn’t have a name like David’s Dry Copies, because then more people would have been skeptical of it. As often as a dull name in a good company keeps early buyers away, a flashy name in a mediocre company attracts investors and gives them a false sense of security. As long as it has “advanced,” “leading,” “micro,” or something with an x in it, or it’s a mystifying acronym, people will fall in love with it.

BEWARE THE STOCK WITH THE EXCITING
NAME

Sometimes it takes years for the stock price to catch up to a company’s value, and the down periods last so long that investors begin to doubt that will ever happen. But value always wins out.Analyzing a company’s stock on the basis of earnings and assets is no different from analyzing a local laundromat, drugstore, or apartment building that you might want to buy. Although it’s easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership of a business.Although it’s easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership of a business.

Earnings, Earnings, Earnings

Any serious discussion of earnings involves the price/earnings ratio—also known as the p/e ratio, the price-earnings multiple, or simply, the multiple. This ratio is a numerical shorthand for the relationship between the stock price and the earnings of the company.The p/e ratio can be thought of as the number of years it will take the company to earn back the amount of your initial investment— assuming, of course, that the company’s earnings stay constant. However, you don’t have to go through this exercise because the p/e ratio of 10 tells you it’s ten years.

THE FAMOUS P/E RATIO

You’ll also find that the p/e levels tend to be lowest for the slow growers and highest for the fast growers, with the cyclicals vacillating in between.An average p/e for a utility (7 to 9 these days) will be lower than the average p/e for a stalwart (10 to 14 these days), and that in turn will be lower than the average p/e of a fast grower (14–20). Some bargain hunters believe in buying any and all stocks with low p/e’s, but that strategy makes no sense to me.

If you remember nothing else about p/e ratios, remember to avoid stocks with excessively high ones.  With few exceptions, an extremely high p/e ratio is a handicap to a stock.

Company p/e ratios do not exist in a vacuum. The stock market as a whole has its own collective p/e ratio, which is a good indicator of whether the market at large is overvalued or undervalued.Interest rates have a large effect on the prevailing p/e ratios, since investors pay more for stocks when interest rates are low and bonds are less attractive. But interest rates aside, the incredible optimism that develops in bull markets can drive p/e ratios to ridiculous levels.

THE P/E OF THE MARKET

Future earnings—there’s the rub. How do you predict those? The best you can get from current earnings is an educated guess whether a stock is fairly priced.what you’d really like to know is what’s going to happen to earnings in the next month, the next year, or the next decade.Earnings, after all, are supposed to grow, and every stock price carries with it a built-in growth assumption.

FUTURE EARNINGS

Once you got into this game seriously, you’d be boggled by the examples of stocks that go down even though the earnings are up, because professional analysts and their institutional clients expected the earnings to be higher, or stocks that go up even though earnings are down, because that same cheering section expected the earnings to be lower.If you can’t predict future earnings, at least you can find out how a company plans to increase its earnings.

There are five basic ways a company can increase earnings*: reduce costs; raiseprices; expand into new markets; sell more of its product in the old markets; orrevitalize, close, or otherwise dispose of a losing operation.

Already you’ve found out whether you’re dealing with a slow grower, a stalwart, a fast grower, a turnaround, an asset play, or a cyclical.The p/e ratio has given you a rough idea of whether the stock, as currently priced, is undervalued or overvalued relative to its immediate prospects.The next step is to learn as much as possible about what the company is doing to bring about the added prosperity, the growth spurt, or whatever happy event is expected to occur. This is known as the “story.”

The Two-Minute Drill

With the possible exception of the asset play (where you can sit back and wait for the value of the real estate or the oil reserves or the TV stations to be recognized by others), something dynamic has to happen to keep the earnings moving along. The more certain you are about what that something is, the better you’ll be able to follow the script.

Before buying a stock, I like to be able to give a two-minute monologue that covers the reasons I’m interested in it, what has to happen for the company to succeed, and the pitfalls that stand in its path. The two-minute monologue can be muttered under your breath or repeated out loud to colleagues who happen to be standing within earshot. Once you’re able to tell the story of a stock to your family, your friends, or the dog (and I don’t mean “a guy on the bus says Caesars World is a takeover”), and so that even a child could understand it, then you have a proper grasp of the situation.

2-Minute Monologue:

If it’s a slow-growing company you’re thinking about, then presumably you’re in it for the dividend, (Why else own this kind of stock?) Therefore, the important elements of the script would be: “This company has increased earnings every year for the last ten, it offers an attractive yield; it’s never reduced or suspended a dividend, and in fact it’s raised the dividend during good times and bad, including the last three recessions. It’s a telephone utility, and the new cellular operations may add a substantial kicker to the growth rate.”

Here are some of the topics that might be addressed in the monologue:

If it’s a cyclical company you’re thinking about, then your script revolves around business conditions inventories, and pricesIf it’s an asset play, then what are the assets, how much are they worth?Insiders are buying, and the company has steady earnings and there’s no debt to speak ofIf it’s a turnaround, then has the company gone about improving its fortunes, and is the plan working so far?If it’s a stalwart, then the key issues are the p/e ratio, whether the stock already has had a dramatic run-up in price in recent months, and what, if anything, is happening to accelerate the growth rate.

If it is a fast grower, then where and how can it continue to grow fast?Those are some basic themes for the story, and you can fill in as much detail as you want. The more you know the better. I often devote several hours to developing a script, though that’s not always necessary.

THE PRICE/EARNINGS RATIOWe’ve gone on about this already, but here’s a useful refinement: The p/e ratio of any company that’s fairly priced will equal its growth rate. I’m talking about growth rate of earnings here. How do you find that out? Ask your broker what’s the growth rate, as compared to the p/e ratio.

Some Famous Numbers

If the p/e of Coca-Cola is 15, you’d expect the company to be growing at about 15 percent a year, etc. But if the p/e ratio is less than the growth rate, you may have found yourself a bargain. A company, say, with a growth rate of 12 percent a year (also known as a “12-percent grower”) and a p/e ratio of 6 is a very attractive prospect. On the other hand, a company with a growth rate of 6 percent a year and a p/e ratio of 12 is an unattractive prospect and headed for a comedown.

In general, a p/e ratio that’s half the growth rate is very positive, and one that’s twice the growth rate is very negative.

Thing to remember about PE ratio

A slightly more complicated formula enables us to compare growth rates to earnings, while also taking the dividends into account. Find the long-term growth rate (say, Company X’s is 12 percent), add the dividend yield (Company X pays 3 percent), and divide by the p/e ratio (Company X’s is 10). 12 plus 3 divided by 10 is 1.5. Less than a 1 is poor, and 1.5 is okay, but what you’re really looking for is a 2 or better. A company with a 15 percent growth rate, a 3 percent dividend, and a p/e of 6 would have a fabulous 3.

Growth-rate to PE ratio

Find out how much cash is the company is sitting on formula= cash from opertions - Purchases of new plants,machinery etc - Long term debt  = Free cashNow just divide this cash by number of shares out standing and you will get Free cash per share. peter lynch found out that ford had accumulated the $16.30 a share in cash beyond debt, for every share of ford he owned, there was this $16.30 bonus sitting there on paper like some delightful hidden rebateThe $16.30 bonus changed everything. it meant that he bought ford not for $38 a share, but for $21.70 ($38 minus the $16.30 in cash)

THE CASH POSITION

Analysts were expecting Ford to earn $7 a share from its auto operations, which at the $38 price gave P/E of 5.4, but at the $21.70 price it had a p/e of 3.1.Nevertheless, it’s always advisable to check the cash position (and the value of related businesses) as part of your research. You never know when you’ll stumble across a Ford.

How much does the company owe, and how much does it own? Debt versus equity. It’s just the kind of thing a loan officer would want to know about you in deciding if you are a good credit risk.A normal corporate balance sheet has two sides. On the left side are the assets (inventories, receivables, plant and equipment, etc.). The right side shows how assets are financed. One quick way to determine the financial strength of a company is to compare the equity to the debt on the right side of the balance sheet.

THE DEBT FACTOR

“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”—John D. Rockefeller, 1901

DIVIDENDS

Book value gets a lot of attention these days—perhaps because it’s such an easy number to find. You see it reported everywhere. Popular computer programs can tell you instantly how many stocks are selling for less than the stated book value. People invest in these on the theory that if the book value is $20 a share and the stock sells for $10, they’re getting something for half price. The flaw is that the stated book value often bears little relationship to the actual worth of the company. It often understates or overstates reality by a large margin.

Book value

There’s another unwritten rule here: The closer you get to a finished product, the less predictable the resale value.When you buy a stock for its book value, you have to have a detailed understanding of what those values really are.

Just as often as book value overstates true worth, it can understate true worth. This is where you get the greatest asset plays.Companies that own natural resources—such as land, timber, oil, or precious metals—carry those assets on their book at a fraction of the true value.Brand names such as Coca-Cola or Robitussin have tremendous value that isn’t reflected on the books. So do patented drugs, cable franchises, TV and radio stations—all are carried at original cost, then depreciated until they, too, disappear from the asset side of the balance sheet.

MORE HIDDEN ASSETS

the amount that was paid for the bottling franchises above and beyond the cost of the plants, inventory, and equipment. It’s the intangible value of the franchises.tax breaks turn out to be a wonderful hidden asset in turnaround companies.

Goodwill

Cash flow is the amount of money a company takes in as a result of doing business.All companies take in cash, but some have to spend more than others to get it.

CASH FLOW

For instance, a $20 stock with $2 per share in annual cash flow has a 10-to-1 ratio, which is standard. A ten percent return on cash corresponds nicely with the ten percent that one expects as a minimum reward for owning stocks long term. A $20 stock with a $4-per-share cash flow gives you a 20 percent return on cash, which is terrific. And if you find a $20 stock with a sustainable $10-per-share cash flow, mortgage your house and buy all the shares you can find.

Must remember

There’s a detailed note on inventories in the section called “management’s discussion of earnings” in the annual report. I always check to see if inventories are piling up. With a manufacturer or a retailer, an inventory buildup is usually a bad sign. When inventories grow faster than sales, it’s a red flag.There are two basic accounting methods to compute the value of inventories,LIFO and FIFO. As much as this sounds like a pair of poodles, LIFO actuallystands for “last in, first out,” and FIFO stands for “first in, and first out.”

INVENTORIES

If you find a business that can get away with raising prices year after year without losing customers (an addictive product such as cigarettes fills the bill), you’ve got a terrific investment.One more thing about growth rate: all else being equal, a 20-percent grower selling at 20 times earnings (a p/e of 20) is a much better buy than a 10-percent grower selling at 10 times earnings (a p/e of 10).

GROWTH RATE

Profit before taxes, also known as the pretax profit margin, is a tool I use in analyzing companies. That’s what’s left of a company’s annual sales dollar after all the costs, including depreciation and interest expenses, have been deductedRetailers have lower profit margins than manufacturers. On the other hand, companies that make highly profitable drugs got 25 percent pretax or better.

THE BOTTOM LINE

There are three phases to a growth company’s life: the start-up phase, during which it works out the kinks in the basic business; the rapid expansion phase, during which it moves into new markets; and the mature phase, also known as the saturation phase

Rechecking the Story

STOCKS IN GENERAL• The p/e ratio. Is it high or low for this particular company and for similar companies in the same industry.• The percentage of institutional ownership. The lower the better.• Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.• The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where earnings may not be important is in the asset play.)• Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it’s rated for

The FINAL CHECKLIST

﻿STOCKS IN GENERALfinancial strength• The cash position. With $16 in net cash, I know Ford is unlikely to dropbelow $16 a share. That’s the floor on the stock.

SLOW GROWERS• Since you buy these for the dividends (why else would you own them?) youwant to check to see if dividends have always been paid, and whether they areroutinely raised.• When possible, find out what percentage of the earnings are being paid outas dividends. If it’s a low percentage, then the company has a cushion in hardtimes. It can earn less money and still retain the dividend. If it’s a high percentage, then the dividend is riskier.

• These are big companies that aren’t likely to go out of business. The key issue is price, and the p/e ratio will tell you whether you are paying too much.• Check for possible diworseifications that may reduce earnings in the future.• Check the company’s long-term growth rate, and whether it has kept up the same momentum in recent years.• If you plan to hold the stock forever, see how the company has fared during previous recessions and market drops.

STALWARTS

CYCLICALS• Keep a close watch on inventories, and the supply-demand relationship. Watch for new entrants into the market, which is usually a dangerous development.• Anticipate a shrinking p/e multiple over time as business recovers and investors look ahead to the end of the cycle, when peak earnings are achieved.• If you know your cyclical, you have an advantage in figuring out the cycles.

(For instance, everyone knows there are cycles in the auto industry. Eventually there are going to be three or four up years to follow three or four down years. There always are. Cars get older and they have to be replaced. People can put off replacing cars for a year or two longer than expected, but sooner or later they are back in the dealerships. The worse the slump in the auto industry, the better the recovery. Sometimes I root for an extra year of bad sales, because I know it will bring a longer and more sustainable upside.

FAST GROWERS:• Investigate whether the product that’s supposed to enrich the company is a major part of the company’s business.• What the growth rate in earnings has been in recent years. (My favorites are the ones in the 20 to 25 percent range• That the company has duplicated its successes in more than one city or town, to prove that expansion will work.• That the company still has room to grow• Whether the stock is selling at a p/e ratio at or near the growth rate• Whether the expansion is speeding up• That few institutions own the stock and only a handful of analysts have ever heard of it

• Most important, can the company survive a raid by its creditors? How much cash does the company have? How much debt? What is the debt structure, and how long can it operate in the red while working out its problems without going bankrupt? • If it’s bankrupt already, then what’s left for the shareholders?• How is the company supposed to be turning around? Has it rid itself of unprofitable divisions? • Is business coming back?• Are costs being cut?

• What’s the value of the assets? Are there any hidden assets?• How much debt is there to detract from these assets? (Creditors are first inline.)• Is the company taking on new debt, making the assets less valuable?• Is there a raider in the wings to help shareholders reap the benefits of theassets?

ASSET PLAYS

• Understand the nature of the companies you own and the specific reasons for holding the stock. (“It is really going up!” doesn’t count.)• By putting your stocks into categories you’ll have a better idea of what to expect from them.• Big companies have small moves, small companies have big moves.• Consider the size of a company if you expect it to profit from a specific product• Look for small companies that are already profitable and have proven that their  concept can be replicated• Be suspicious of companies with growth rates of 50 to 100 percent a year• Avoid hot stocks in hot industries

Here are some pointers from this section:

• Distrust diversifications, which usually turn out to be diworseifications.• Long shots almost never pay off.• It’s better to miss the first move in a stock and wait to see if a company’s plans are working out.• People get incredibly valuable fundamental information from their jobs that may not reach the professionals for months or even years.• Separate all stock tips from the tipper, even if the tipper is very smart, very rich, and his or her last tip went up.

• Some stock tips, especially from an expert in the field, may turn out to be quite valuable. However, people in the paper industry normally give out tips on drug stocks, and people in the health care field never run out of tips on the coming takeovers in the paper industry.• Invest in simple companies that appear dull, mundane, out of favor, and haven’t caught the fancy of Wall Street.• Moderately fast growers (20 to 25 percent) in nongrowth industries are ideal investments.• Look for companies with niches.

• When purchasing depressed stocks in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt.• Companies that have no debt can’t go bankrupt• Managerial ability may be important, but it’s quite difficult to assess. Base your purchases on the company’s prospects, not on the president’s resume or speaking ability.• A lot of money can be made when a troubled company turns around.• Carefully consider the price-earnings ratio. If the stock is grossly overpriced, even if everything else goes right, you won’t make any money.

These are some lessons that peter lynch thought us in one up on wall street

THE NATIONAL BESTSELLING BOOK THAT EVERY INVESTOR SHOULD OWN Peter Lynch is America's number-one money manager. His mantra: Average investors can become experts in their own field and can pick winning stocks as effectively as Wall Street professionals by doing just a little research. Now, in a new introduction written specifically for this edition of One Up on Wall Street, Lynch gives his take on the incredible rise of Internet stocks, as well as a list of twenty winning companies of high-tech '90s. That many of these winners are low-tech supports his thesis that amateur investors can continue to reap exceptional rewards from mundane, easy-to-understand companies they encounter in their daily lives. Investment opportunities abound for the layperson, Lynch says. By simply observing business developments and taking notice of your immediate world -- from the mall to the workplace -- you can discover potentially successful companies before professional analysts do. This jump on the experts is what produces "tenbaggers," the stocks that appreciate tenfold or more and turn an average stock portfolio into a star performer. The former star manager of Fidelity's multibillion-dollar Magellan Fund, Lynch reveals how he achieved his spectacular record. Writing with John Rothchild, Lynch offers easy-to-follow directions for sorting out the long shots from the no shots by reviewing a company's financial statements and by identifying which numbers really count. He explains how to stalk tenbaggers and lays out the guidelines for investing in cyclical, turnaround, and fast-growing companies. Lynch promises that if you ignore the ups and downs of the market and the endless speculation about interest rates, in the long term (anywhere from five to fifteen years) your portfolio will reward you. This advice has proved to be timeless and has made One Up on Wall Street a number-one bestseller. And now this classic is as valuable in the new millennium as ever.

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One Up On Wall Street

1. Institutional investors “sell” themselves to the masses as highly skilled stock pickers.2. Stock pickers buy on good news and sell on bad news.3. when stock picker sent prices spiraling to insane lows, graham saw a fantastic opportunity to make money. pankaj pawar

Institutional investors

4. “oversold businesses” at prices below their long-term intrinsic value, eventually the market would acknowledge its mistake and revalue them upward.

Oversold Businesses

Graham really didn’t care about the kind of business he was buying, in his world every business had a price at which it was a bargain. Graham was focused on finding companies trading at less than half of what they held in cash. He called it “buying a dollar for 50 cents.”Graham had other standards as well such as never paying more than 10 times company’s earnings and selling the stock if it was up 50%. if it didn’t go up within two years, he would sell it anyway.

Graham's View

Drawbacks- Not all of Graham’s undervalues businesses were revalued upward; some actually went into bankruptcy. With every batch of winners also came quite a few losers, Which greatly dampened overall performance.

Drawback's with graham's approach

graham protected himself with diversification.

How Graham tackled with Drawbacks

Warren noticed that prices of some stocks soar far above where they had been when graham unloaded them.these “superstars” all benefited from some kind of competitive advantage that created monopoly-like economics, allowing them either to charge more or sell more of their products.  company’s durable competitive advantage made these business investments a self-fulfilling prophecy.Because these business economics working in their favor, there was zero chance of them ever going into bankruptcy.

Warren's view

Because these business economics working in their favor, there was zero chance of them ever going into bankruptcy. The lower stock stock price also meant a greater upside potential for gain. Warren realized that he no longer had to wait for wall street to serve up a bargain price. He could a pay a fair price for one of these super businesses and still come out ahead, Provided he held the investment long enough. warren holds stocks for longer just so that he can avoid paying tax on his profits.

Warren's vie

Time will make him superrich when he invests in a company that has a durable competitive advantage working in its favor.

Does the company have any identifiable consumer monopolies or brand-name products.Do you understand how it works?Is the company conservatively Financed? Are the earnings of the company strong and do they show an upward trend? The company allocates capital only to those businesses within its realm of expertise? How frequently does the company buy back its own shares? How does the management spend the retained earnings of the company? The company’s return on equity above average? Is the company free to adjust prices to inflation?

Questions to ask yourself while doing your detective work

Do operations require large capital expenditure to constantly update the company’s plant and equipment?

Divide EPS by share price to get Initial rate of return (initial rate of return is the minimum return that you can expect from a stock)Divide the EPS of the particular stock by the long term government bond interest rateThe value that you get after doing so is the amount that you pay towards the stock to get the investment that you would get from government bonds.

Initial rate of return and relative value of government bonds

With an insider's view of the mind of the master, Mary Buffett and David Clark have written a simple guide for reading financial statements from Buffett's successful perspective. They clearly outline Warren Buffett's strategies in a way that will appeal to newcomers and seasoned Buffettologists alike. Inspired by the seminal work of Buffett's mentor, Benjamin Graham, this book presents Buffett's interpretation of financial statements with anecdotes and quotes from the master investor himself. Destined to become a classic in the world of investment books, Warren Buffett and the Interpretation of Financial Statements is the perfect companion volume to The New Buffettology and The Tao of Warren Buffett.

One Up On Wall Street

Warren Buffett and the Interpretation of Financial Statements

Just Keep Buying

pankaj pawar