Know when to sell. Don't sell just because the price has gone up or down, but give it some serious thought if one of the following things has happened:
- You made a mistake buying it in the first place,
- the fundamentals have deteriorated,
- the stock has risen well above its intrinsic value,
- you can find better opportunities, or
- it occupies a too high proportion in your portfolio.
Investor's Checklist: Seven Mistakes to Avoid
- Don't try to shoot for big gains by finding the next Microsoft. Instead, focus on finding solid companies with shares selling at low valuations.
- Understanding the market's history can help you avoid repeated pitfalls.
- If people try to convince you that "it really is different this time," ignore them.
- Don't fall into the all-too-frequent trap of assuming that a great product translates into a high-quality company. Before you get swept away by exciting new technology or a nifty product, make sure you've checked out the company's business model.
- Don't be afraid to use fear to your advantage. The best time to buy is when everyone else is running away from a given asset class.
- Attempting to time the market is a fool's game. There's ample evidence that the market can't be timed.
- The best way to reduce your investment risk is to pay careful attention to valuation. Don't make the mistake of hoping that other investors will keep paying higher prices, even if you're buying shares in a great company.
Cash flow is the true measure of a company's financial performance, not reported earnings per share.
for 5 or 10 years
- free cashflow / sales > 5%
- net profit margin > 15%
- ROE > 15%
- bear case study (risk analysis)
In general, there are five ways that an individual firm can build sustainable competitive advantage:
- Creating real product differentiation through superior technology or features
- Creating perceived product differentiation through a trusted brand or reputation
- Driving costs down and offering a similar product or service at a lower price
- Locking in customers by creating high switching costs
- Locking out competitors by creating high barriers to entry or high barriers to success
Investor's Checklist: Economic Moats
Because success attracts competition as surely as night follows day, the most highly profitable companies tend to become less profitable over time. That's why economic moats are so important: They help great companies stay that way. For concrete evidence of an economic moat, look for firms that consistently earn high profits. Focus on
- free cash flow,
- net margins,
- return on equity, and
- return on assets.
After you've looked at these specific measures, try to identify the source of the company's economic moat. Companies generally build sustainable competitive advantages through
- product differentiation (real or perceived),
- driving costs down,
- locking in customers with high switching costs, or
- locking out competitors through high barriers to entry.
Think about economic moats in two dimensions: depth (how much money the company can make) and width (how long it can sustain above-average profits). In general, any economic moat based on technological innovation is likely to be short-lived.
Although the attractiveness of an industry doesn't tell the whole story, it's important to get a feel for the competitive landscape. Some industries are just easier to make money in than others.
6 red flags of financial fakery:
- net income is growing quickly while cash flow is flat or declining;
- make numerous acquisitions;
- take many one-time charges;
- chief financial officer leaves or if the firm changes auditors;
- accounts receivable is growing much faster than sales;
- underfunded pension or using pension income/investments gains to boost reported net income.
Banks:
- credit risk: trend of charge-off rates/non-performing loans & delinquency rates, credit culture & conservative
- liquidity risk: liquidity management, large low cost deposit base & diversified loan portfolio
- interest rate risk
economic moats in banks:
- Huge balance sheet requirements
- Large economies of scale
- A regional oligopoly type industry structure
- Customer switching costs
Hallmarks of Success for Banks
- Strong Capital base (equity/asset >8%, large loan loss reserve relative to nonperforming assets)
- ROE >15%, ROA=1.2 - 1.4%
- efficiency ratio <55%
- net interest margin= 3-4%
- fee income/total revenue ~40%, fee income growth
- P/B lower than normal range (2-3 for large banks)
Asset Managers to consider:
- Asset Under Management (AuM), diversified products & investors
- net inflow in various market conditions
- market leadership
Life Insurers:
- prudent premium growth rate (~6% in U.S.)
- ROE > cost of capital, ROE>15%
- high credit rating (at least AA)
- diversified investment portfolio, high quality investment (low junk bond to total assets)
- assets: investments + deferred acquisition costs (+ separate account assets)
- liabilities: actuarially estimated policyholders' benefit (+separate account liabilities)
- revenue: premium + fees + investment incomes
- expenses: benefit & dividend to policyholders, amortization of deferred acquisition cost
