Warren Buffett and I Analyze Companies, part 1.

Greetings all! Today I’ve finally found some free time to put together a more thorough posting. (Yes, even in the middle of finals week!) I have been interested in evaluating a list of companies from different sectors of the economy using Warren Buffet’s methodology and my personal methodology. Note, these are just a few of the criteria Warren and I will use to evaluate a company for investment; this is by no means an exhaustive list, nor should stocks be bought based solely on these recommendations. Always do your own due diligence. What follows is a list of what Warren Buffett uses to evaluate companies:

1. Has the company consistently performed well?
Sometimes return on equity (ROE) is referred to as "stockholder's return on investment". It reveals the rate at which shareholders are earning income on their shares. Buffett always looks at ROE to see whether or not a company has consistently performed well in comparison to other companies in the same industry. ROE is calculated as follows:

= Net Income / Shareholder's Equity

Should look at ROE from last 5 to 10 years to get a good idea of historical performance.

 
2. Has the company avoided excess debt? The debt/equity ratio is another key characteristic Buffett considers carefully. Buffett prefers to see a small amount of debt so that earnings growth is being generated from shareholders' equity as opposed to borrowed money. The debt/equity ratio is calculated as follows:

= Total Liabilities / Shareholders' Equity

3. Are profit margins high? Are they increasing?
The profitability of a company depends not only on having a good profit margin but also on consistently increasing this profit margin. This margin is calculated by dividing net income by net sales. To get a good indication of historical profit margins, investors should look back at least five years. A high profit margin indicates the company is executing its business well, but increasing margins means management has been extremely efficient and successful at controlling expenses.

4. How long has the company been public?
Buffett typically considers only companies that have been around for at least 10 years.

5. Do the company's products rely on a commodity?
Initially you might think of this question as a radical approach to narrowing down a company. Buffett, however, sees this question as an important one. He tends to shy away (but not always) from companies whose products are indistinguishable from those of competitors, and those that rely solely on a commodity such as oil and gas.

6. Is the stock selling at a 25% discount to its real value?

In order to find real value, it is advised to use a DCF (Discounted Cash Flow) analysis.

(Source: Investopedia)

Basically, Warren Buffett wants to find a company that has been around a while and has a solid history of performance. He wants that company to have a durable competitive advantage, and most importantly wants to purchase it for below its real or “intrinsic” value.

Warren Buffett is a genius and there is no disputing that. Nowadays he is even a bit of a self-fulfilling prophecy. That is, if he buys a stock, the stock will usually increase in value just because he, Warren Buffett, has bought it. (Although this hasn’t held true as of late for his investment in Bank of America.)

I am aspiring to be an investor of Warren Buffett’s genius, but we will see if this comes to fruition later in my life. For now, I must start where I can, with research, reading, and dabbling in the market. My basic investing philosophy is: invest in companies that are either selling at or below market value with a solid business model and good products, or purchase riskier, higher growth potential stocks whose prospects are bright. I can afford the latter strategy because of my youth. After all, how can you really make a killing if you don’t take risk every now and then? Underpinning every investment I make is an analysis of the greater macroeconomic trend and fundamental analysis to make sure the company is sound. I also enjoy timing investments using technical analysis. (This is used more often in short-term investments.)

So what do I look at?

1.PEG ratio of 1 or less. Price to earnings to growth ratio is what PEG is. That is, I want to purchase a company only if its P/E ratio is equal to or less than its growth rate. This ensures you are paying a fair price for a company.

2.Little or no debt. Like Buffett, I want to see that the company I am invested in generates most of its revenue from equity and not borrowed cash. In my research, I have observed that companies that perform incredibly well over the long term have very little or no debt.

3.Forward P/E- This is just one indicator that would let me know if I can purchase a company at a price now that is a discount from where it will be trading in the next year. Ex.- Apple trades at a P/E of 13.5. It’s forward P/E is 9.6. Theoretically, I can purchase the company at a lower price now than it will be trading at in the future.

4.Industry comparables- I want to make sure that the company I am invested in is not superficially over valued compared to its competitors. Many factors can play into this, however, such as brand identification, loyalty, trust, a better product, etc.

5.Quick Ratio- This can give me a snap shot of the financial health and efficiency of a corporation. Comon, I am a time strapped college student, and sometimes I need something quick and easy! (not advisable to invest this way)

6.Is the product unique?

I want to make sure that the company either has a unique product, which sets it apart from its competitors and gives it an advantage, or I want to know that many people will use the product for years to come. The reason I add the last part is, for example, I am not against investing in oil and gas companies. These products may not be unique, but they are used by many and will be for quite some time.

7.Do I like the company?

-As a young man very immersed in the world and knowledgeable about consumer culture, I believe that I possess a good idea about what makes a company good and whether or not it will be successful. As an example, I could have told you to buy Google or Chipotle stock when they first came public. I used Google as a 4^th grader before it was public, and while my librarian was telling me to use Askjeeves.com. I understood that Google had a better product, was a better company, and would beat out askjeeves. The same is true for Chipotle. I recognize their uniqueness, the intelligence of management, and their prospects for growth. This is more of a gut feeling, I guess you could say. Follow your gut on investments. I once purchased a company called Motricity, because Jim Cramer recommended it as a possible acquisition target for a larger company. The service they provide is to offer internet connectivity to non smart phones. I knew right away this was going to be a dead business in a few years, as smart phones were the future. I invested anyway, because I thought Jim Cramer knew what he was talking about. I bought it at 20, sold at 17 (cut my losses), and it is now trading at 1.36 (phew). I do not regret the experience, as I now know to forever trust my gut when investing.

8.Technical analysis
-Like Warren Buffett, technical analysis is a bit of a self-fulfilling prophecy as well. It really only works because people think it will work and then they trade off of that, further making it work. All moves in the market, after all the fog clears, will be made by corporate earnings and macroeconomic conditions. Technical analysis does work and can be used to time trades if you have a shorter term investing horizon.

9.I also like to check stock ratings in Investor’s Business Daily and ratings done by research analysts. These people are paid to research companies and recommend investments. Take everything with a grain of salt, but it is helpful to get their opinion on the companies you want to invest in.

So, now that I’ve outlined the criteria for analyzing companies, we must choose a list of stocks we would like to investigate. From this list, I want to compile a virtual stock portfolio to manage, so I am going to choose companies across different sectors of the economy. Lets choose energy, food, retail, technology, agriculture, and industrial type companies.

Energy: Chevron, Stone Energy, Chesapeake Energy.

Food: Chipotle, Hain Celestial, Whole Foods

Retail: Lululemon, Deckers Corp., Coach

Technology: Apple, Skyworks Solutions, Arm Holdings

Agriculture: John Deer, Potash, Mosaic

Industrial: Boeing, Caterpillar, General Electric

This is just part 1, stay tuned tomorrow for part 2 which will get into the actual analysis.

Cheers,

EZ

Can We Use Natural Law as an Investment Strategy?

Natural Law is any system of law which is purportedly determined by nature, and thus universal (Wikipedia). This definition is a bit vague, so I will take from it what I determine to be the Natural Law.
I've always had this idea in my head about what I considered to be my "Law of Universal Truth". This is the way that I named it. What I mean by it is this:

I've noticed again and again that systems of nature often show themselves repeatedly, in slightly different forms, across all forms of life. These forms of life can be biological, economical, social, etc. Let me explain by way of example. Plants need roots to grow. These roots go out, anchor the plant into the ground, and provide a system for the plant to harness nutrients from the soil. Without these roots, the plant will be malnourished and will surely die. This same system can be observed across many different biological forms, and also transcends into social and economical interactions. Let me explain another biological example in which this is observed. Let's think about cancer growth. Recent cancer research has revealed that in order for cancer to proliferate it needs to grow its own blood vessels which feed the cancer. This process is called angiogenesis. Similarly to the plant example, without these blood vessels (roots) to feed the cancer, it dies. It makes sense then that anti cancer drugs are being developed to stop the process of angiogenesis. (A quick lesson here in anti cancer eating habits. Green tea, red wine, and turmeric have all been shown to have angiogenesis inhibiting properties).

This process can be observed socially as well. Think about it. If you don't plant your roots into relationships in life you will never fully be nourished to the extent that you could be. Grow these relationships, and you will be nourished. Cut off these relationships and your happiness as a human being will surely decrease.

How about economically? Immediately I think about trade agreements. These agreements enrich the economies of the world without a doubt. Cut off these agreements, and exports will decrease and GDP will take a hit. Increase trade agreements and GDP shall rise. (Obviously this is a simplified discussion).

So what is the point of all of this? I had an interesting thought recently that this "law of universal truths," as I call it, could help an investor. What triggered my thought process and led me to this was the thought of the United States' and the European countries' debts. How can we liken this to a biological/natural process? I believe that if a good analogy can be constructed, that one could predict with accuracy how the situation will unfold. As they say, history repeats itself, and natural laws repeat themselves as well. Not only do they repeat themselves, but they are so efficient, that they have been adopted across many aspects of life, as explained earlier. Anyway, what is a good analogy for the debts of the United States and the European countries? I'm convinced that a better analogy exists, but for now let's think about consumption of food to keep our bodies moving. This is like debt, right? Countries need debt to maintain their operations. (Especially those that are now already over their heads in debt). We consume food, use it to operate, and then pass the food on as excrement. That is like paying back the debtholders. (Haven't figured out the interest part yet). Now, lets assume that we consume more food than we pass (pay back). One of two things may happen, you stop eating, or you vomit and start fresh. I believe, based on my "law of universal truths" that this situation is somewhat analogous to the debt issue and therefore can help me predict the outcome of the debt crises across Nations presently. We can stop consuming, and this is possible but not likely given our unwillingness to suffer now for the greater good later. Or we can vomit(default) and start fresh. If the latter case happens that would be quite a mess. (It's sort of like a forest needing a forest fire to replenish the nutrients to the soil.)

What the effects of a default would be is unclear. But, hey, at least we can say we predicted it. And if you are a big shot hedge fund guy or banker you might be able to purchase credit default swaps and cash out just in time before the insurer of the credit default swaps also goes bankrupt. Good luck with that.

So the point, after all of that, is that I believe that in all situations one can utilize this natural law to predict outcomes. Think of analogies that pervade throughout life all the way from the biological to the social, as these are probably universal truths that will hold true throughout all circumstances. They are tried and true by evolution and time.

Do I suggest using this to invest? Probably not, but it may just provide you with some killer insight and foresight.

Nobody comments on my blog, please let me know if I am completely insane or not!

BTW, I hope you all had a nice green day today, as I suspected we would have in yesterday's post. I know I did :)

Cheers,
EZ

P.S.- I'm going to try and put together some research piece tomorrow and from it pick a virtual portfolio. Who knows though my track record so far has been awful when it comes to promises. Sorry! School is hectic!

CYBER MONDAY!

Hello all,

My apologies for being MIA the last few days. School has really gotten the best of me. (Is gotten a word?) Anyway, the market should perform well today. (I'm writing this at 2 A.M.) The European markets are up today between 2 and 3.5%. This is great news for the American markets, and the pre market action is already showing optimism. The S&P is up 2.74%, the Nasdaq is up 2.35%, and the DOW is up 2.22% pre market. Use that extra bit of green you will most likely make tomorrow to buy some Cyber Monday Christmas presents for your loved ones!

I believe the European markets are being pushed higher because of a possible deal that would fiscally unite the 17 sovereign nations. This would spark (hopefully) greater ECB intervention in the form of bond purchases, which they hope would contain the crisis. It just goes to show you how bad this situation has really become for them to propose this now. Months ago this proposal would have been laughed at and dismissed in an instant, and now these 17 countries seem to be seriously considering this. To me, it shows that without the central bank most of Europe is doomed. And does the central bank really have enough firepower to save the Euro zone? All of the details on this plan are not out yet. It will be very interesting to see exactly what they are proposing.

Retail sales this Black Friday were 7% higher than last years Black Friday bonanza. This is obviously a sign of a stronger consumer. As mentioned, tomorrow is Cyber Monday. Let's see how these sales stack up to Black Friday retail sales and the sales of Cyber Monday last year. More on that to come.

Tomorrow during the day I hope to get around to compiling a list of stocks that I follow and analyzing whether or not they fit Graham and Buffett criteria as investments. I will then analyze them from a technical standpoint and apply my own personal set of standards to them. From this, I hope to compile a list of 5-10 stocks/ maybe ETFs that will be my personal "ezfinanceblog" virtual portfolio. I will then manage the portfolio and post all trades, profits, and losses on this blog.

I know I've been full of empty promises lately but I promise to change that soon.

Cheers,
EZ

Economic Calendar

One quick thing. When I first started investing, I never knew where to go for up to the date data. Now that I've had some experience and have learned from seasoned investors, I'd like to share with you all some information I wish I had when I first got started. I'm going to list a few sites that you can go to to get up to the minute information regarding economic data, fed. data, etc.

Economic Calendar: http://www.bloomberg.com/markets/economic-calendar/

U.S. Bureau of Economic Analysis: http://bea.gov/

Federal Reserve: http://federalreserve.gov/

To check pre-market action: http://money.cnn.com/data/premarket/

That's it for now. The economic calendar is the one with the most information. Check it out! I know you all want to get up at 5:30 Pacific Time to hear the jobless claims and housing starts data. Get the data before the market opens to optimize your investing performance!

Cheerio,
EZ

Volatile Trading Day

This is a wild market. Have a look at the Dow's action for today.
Here is the chart for today's trading action in the Dow (look at the 1 day chart)
We started off down on fears of rising yields on European sovereign debt bonds. Rising oil prices ($102/brl WTI crude +2.27% today) also sent the markets down. Then the markets clawed their way back to even at mid afternoon on hopes that the ECB would step in wherever necessary to prop up the debt markets. Here is a quote from the WSJ,

"At the same time, the European Central Bank bought Italian, Spanish and Portuguese government bonds, bringing yields down and lending support to European shares. Even so, the yield on the Italian 10-year government bond remained stubbornly high, trading above 7%—a level near which other European countries have had to seek bailouts—before finishing at 6.992%."

But what fueled the late day sell off was a note from Fitch rating agency citing a possible downgrade of  U.S. bank credit ratings on U.S. bank exposure to European markets.
Here's the Fitch release:

U.S. banks have manageable direct exposures to the stressed European markets (Greece, Ireland, Italy, Portugal and Spain), but further contagion poses a serious risk, according to a Fitch Ratings report.
Fitch believes that unless the Eurozone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen. Fitch’s current outlook for the industry is stable, reflecting improved fundamentals at most banks combined with ratings lower than at pre-crisis levels. However, risks of a negative shock are rising and could alter this outlook.
U.S. banks have reduced direct exposure to stressed European markets considerably over the past year in Fitch’s view. Direct exposures appear manageable in the context of banks’ capital positions and diverse earnings streams.  Public disclosure of direct exposures has generally improved recently but varies from bank to bank.
The full report ‘U.S. Banks – European Exposure’ is available on the Fitch web site ‘www.fitchratings.com’. Specific country exposures for the large U.S. banks are provided in the report.

So there you have the action of today in a nut shell. Since this blog would be pointless without some opinion on the matter, (especially since I'm only currently able to blog once in a while) here we go.
Basically it's the same old story, except the story continues to get worse. The only good piece of news I heard today is that the U.S. banks have slowly "reduced direct exposure to stressed European markets considerably over the past year." That is taken directly from the Fitch release above. Without knowing how much or how little these banks are exposed to European markets it's hard to say what scale of an effect a European collapse/recession/bank failure/bank run would have on the U.S. markets. I think if anyone knew they would be very carefully calculating their bets to make a killing once all the facts are clear. Earlier, even a month ago, I thought that the European issue could be solved. I thought that they could put together a "comprehensive plan" that would be able to stabilize the European sovereign debt issues enough to allow us to enter into a nice little bull market. It appears that reality is drifting farther and farther away. As mentioned in a prior blog, I'm not an economist with a Ph.d, nor do I strive to be. I just enjoy utilizing my common sense and whatever knowledge I have of the stock market, and from those things deduce an opinion on the matter. My opinion is this: The European situation will end badly, it is a now a matter of when. Do I put my bets in now, or wait for a little rally? Timing is everything. However, to err on the side of caution, if I am going to place any bets, I think I would do it sooner than later. I would probably buy some selection of the following stocks: Gold, the VIX, SDS, SKF, TVIX, FAZ, TZA. These are all short ETFs basically, except Gold and the VIX, which is just an index. Most are also 2 or 3x leveraged.

Of course this is not an advisable portfolio. If the market turned around and started to go higher, you would certainly lose a lot of money. However, I would rather buy short ETFs than short individual stocks because if I short a stock and it goes up, I can lose an indefinite amount of money as it continues to climb. Whereas if I own an ETF I can only lose whatever money I put into it. Comment if you're not clear what I mean by that. Sure, the investments I listed above are not advisable, especially if not part of a diversified portfolio, but are owning stocks right now really that advisable?

Cheers,
EZ

Early Morning Thoughts

Hello all! This weekend I received some positive feedback on my blog from a good friend of mine, and it has encouraged me to know some people are out there reading this and that I must keep it going. I know I've lost some steam here in the midst of midterms and writing papers, and I promise to make it up to you all with some very thorough pieces of "research". (I'm sorry I sound like a broken record on that note.)

Getting back to the "research" I want to perform. Of particular interest to me are a few things currently:
1. The European sovereign debt crisis
2. How America could possibly become foreign energy independent and what this could mean for unemployment, the debt crisis, and a looming energy crisis.
3. Emerging markets, particularly South America
4. Performing the role of an analyst and projecting future cash flows for stocks of interest and setting price targets using a DCF model (Discounted Cash Flow).
5. What separates exceptional management from blah management and how one could invest accordingly by analyzing corporate management.
6. And lastly, I want to put together a virtual stock portfolio of say, 5-10 securities, and manage it for a set time period, posting all trades on the blog for all to see. And let's say I have $1 million to invest.

These are the things to come, I promise. Stick with me!

While Wall Street bankers, fund managers, etc. are slowly waking to check the European markets, I am fading fast. Goodnight.

Cheers,
EZ

Macro + Apple?

Markets rallied today, with the Dow up 113 points, on good jobless claims data this morning. The estimate for jobless claims was 400k, and the number came in at 390k. This 10 thousand claim decrease is a sign of employers hiring, which of course, is good for the economy and a sign that things in America may be getting better. Of course as always, this news is just a patch of blue sky in the larger European debt storm we are in.

Apple is down today, which is incredibly odd for a company who is 95/100 times in the green on a green day in the market. It is due to supply concerns for products designated for the iphone that are manufactured in Thailand. The supply is being constrained due to the flooding in Thailand. Citi analyst Richard Gardiner called the depressed stock price today a buying opportunity and maintains his $500 price target. On the other side, Jim Cramer of Thestreet.com wrote an article today saying how he is for the first time ever, worried about Apple. He says this has to due with a surfeit of tablets as well as rumors of iphone 4s sales not being up to par and ipod sales also being the same. Instead of simply restating what he said, have a look at his article. It is interesting. Here is Cramer's article.

Sorry for the short posts as of late. As much as I love blogging and wish I could devote hours a day to it, I simply cannot. School is getting crazy in these last few weeks of the quarter and I must turn my attention to that. I'll be back soon.

Cheers,
EZ

Hang in there

So, today I didn't even check the stock market once. That is how insane my days are becoming here at school. Paper here, midterm there, study here, and it starts all over again. Stay with me though, because as soon as the storm breaks I really look forward to putting more effort into this blog and even turning it into a website.

Did you see LULU today? Up 4%! Look to see the breakout follow through, perhaps with some above average volume. One thing I'd like to note to you all is an article I came across on Seekingalpha.com. The article spoke about how the Chairman of the company sold 60,000 shares between 10/10 and 10/17. Could it signal downbeat earnings to be announced in December? Or is he just taking this opportunity to make a little profit off the incredible run LULU has had? Only an insider would know. Here is a link to the article. Have a look.

That's it for me today. I have reading to attend to. I wish us all a green day in the market tomorrow and good news out of Europe (pie in the sky in the long term? Most likely yes.)

Cheers,
EZ

LULU (lemon)

First of all, I'd like to apologize to those of you anxiously awaiting my promised piece on how to invest in these crazy times. I have failed you all and for that, I'm terribly sorry. I've just had other things going on. I will do it soon, I promise. How about that game last night? Well, for most of America, 'that' game was the LSU/ Alabama game, but for those of us in Los Angeles it was the UCLA/ASU game. It was thrilling all the way to the end when the ASU kicker missed 2 field goal attempts back to back which would have given them the win; a true nail biter. The refereeing was atrocious at times, in favor of ASU.

Getting to the heading, LULU. A friend of mine was visiting this weekend and we had a conversation about how he wanted to start investing in the market. He told me to send him a list of stocks that I would recommend. In researching this for him, I stumbled upon LULU (Lululemon Athletica). Here is a quick run down of the company:

EPS % Change (Last Qtr) : 73%
3 yr. EPS growth rate: 54%
Sales % Change (Last Qtr): 39%
3 yr. sales growth rate: 39%
Profit Margin: 25.8%
Debt: 0
P/E: 57
Price to Book: 12
PEG ratio: 1.5
(All data from Investors Business Daily except for P/B and PEG, which are from Morningstar.)
It hit its 52 wk high on approximately July 20th at 64.5 and it is now trading at 55.98. That is a discount of 15.2%.

I like the stock. It's growing rapidy, which explains how expensive it is. By most metrics LULU is expensive: P/Earnings, P/Sales, P/Book, P/Cash Flow are all well above industry averages and S&P averages. This, therefore, is no value investment by Ben Graham's standards. He didn't want to touch any stock with a P/E above 20 (even that was expensive) or a P/Book of greater than 1.3 (If I remember correctly). But I'm not Ben Graham and a lot of money can be made by investing in high growth companies like LULU, BIDU, ARMH, NFLX (?), AMZN, CMG, etc.

Besides the fact that it is expensive, its fundamentals are incredible. Investors Business Daily gives it a 99 composite rating, the highest possible. It is #2 on its top 50 stock list. The numbers I posted above speak for themselves. I especially enjoy seeing the 0 debt. It reminds me of a wonderful company I know of with stock ticker AAPL. If my memory serves me that stock has performed amazingly in the last few years.

The Holidays are upon us, and I think Lululemon will sell a lot of yoga pants, sweatshirts, and whatever else they sell. It's next earnings report is not scheduled until Dec. 8. The story here is pretty basic. I'm very seriously contemplating picking myself up some LULU tomorrow. If I do, I will be sure to let you all know.

I don't want to over think this one. Here is the daily chart for LULU. Do yourself a favor and have a look at the weekly one as well on stockcharts.com

To me the stock appears to be accumulating. It is still in a newly formed uptrend. As always, keep an eye on Europe because high growth/expensive stocks are the ones that can be absolutely pummeled if the market sentiment turns sour. That's it for today, happy investing!

Cheers,
EZ