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- Wiley
More About This Title ValuFocus Investing: A Cash-Loving Contrarian Wayto Invest in Stocks
English
How to Pick a Stock is written for the contrarian investor who wants an investing method that is based on cash flow facts, not on media hype and speculative impulse. This book combines an accessible presentation of a contrarian investment model and the ValuFocus tool that offers a highly studious, detailed explanation of understanding a company's true intrinsic value.
If you can calculate a company's intrinsic value on the basis of knowing if the market is currently under, fairly, or over pricing its stock, then it is possible to invest wisely in the stock market. Investors who want to buy undervalued stocks, or sell (short) overvalued ones will find this book immensely useful. The ValuFocus investing tool calculates the intrinsic value of every company in their database automatically. Thus, an individual investor can become an "A" student of a modeling process, or can go right ahead in using this tool to pick stocks and manage their own portfolio. Additionally, this book helps to develop an enhanced framework to fundamental equity valuation.
- Contains the ValuFocus tool for calculating the intrinsic value of every company in the LCRT Nucleus database
- Offers specific and innovative valuation techniques of practicing professionals for individuals to use in picking stocks long-term
- Highlights the most state-of-the-art approaches to unconventional stock-picking for investors and corporate finance professionals
Offering encouragement to individual investors by outlining a model that delivers satisfying returns, How to Pick a Stock is especially useful for those who are patient and believe in longer-term investing horizons.
English
Rawley Thomas is President of LifeCycle Returns, Inc. (LCRT). He served as assistant treasurer of SuperValu Stores, joined Callard, Madden in 1981, cofounded Holt Planning in 1985, and directed Value Management research for The Boston Consulting Group for eleven years. Thomas is past Vice President of Practitioner Services for the Financial Management Association International (FMA) and is Chairman of the FMA Practitioner Research Committee. Currently, he serves on the Northern Illinois Accountancy Board and chairs the Financial Management Association Practitioner Demand Driven Academic Research Initiative (FMA PDDARI) supported by the CFA Society of Chicago.
WILLIAM MAHONEY is a veteran investor relations practitioner, journalist, and author. He spent twenty years as a communications and investor relations professional with companies such as Motorola, Scott Paper, and Esmark, and twenty-five years as an editor of investor relations and corporate governance publications, including Update, which is the official publication of the National Investor Relations Institute; Shareholder Value magazine; and the newsletter Valuation Issues. He has written a half-dozen books on investor relations and corporate governance. Mahoney began his career as a reporter for the Ft. Wayne News-Sentinel after graduating from Marquette University.
English
Preface xvii
Acknowledgments xxi
SECTION ONE The LCRT Investment Process 1
CHAPTER 1 Introducing Our Investment Process 5
Key Takeaways 8
CHAPTER 2 A Better Way to Invest in Stocks 9
Put the Focus in the Right Place: On a Company’s Fundamental Value 9
We Bring You an Improved Methodology 10
Basing Decisions on Under- and Overvaluation by the Market 12
The Key: Recognizing the Inflection Points 13
Looking at Our Model 14
Key Takeaways 16
CHAPTER 3 Advantages of Economic, Cash-Based Modeling 17
Key Takeaway 21
CHAPTER 4 Analyzing Mental Models 23
Key Takeaways 26
CHAPTER 5 The Value Creation Process 27
Cost of Capital and Company Return on Capital 27
The Importance of Adjusting for Inflation 28
Where We Are Going 29
Key Takeaways 31
CHAPTER 6 The Corporate Perspective 33
The Focus for Both Constituencies: Value Creation 33
Earnings Are the Wrong Measure 36
Executive Compensation 38
Creating an Information Advantage 41
Key Takeaways 44
SECTION TWO A Brief History of Investing and Modeling 45
CHAPTER 7 Relevant Market History of Investing 47
Start with Concepts of Risk and Uncertainty 48
Migrate toward Value and Market Inefficiency 49
Enter Modern Portfolio Theory 50
An Emphasis on Earnings, Plus 51
Leading to Multifactor Modeling 51
Finding the Right Factors 52
Dissecting a Multifactor Model 53
Key Takeaways 54
CHAPTER 8 Interpreting Market History 55
Market Is Dealing with Price Change, Not Price Level 56
Bringing History Up to Now 59
Back to Earnings: Why They Still Prevail 60
Key Takeaways 62
SECTION THREE Brief Discussions of Various Investing Methods 63
How Best to Combine Investing Methods with LCRT’s Models 63
CHAPTER 9 Do Stocks Have Intrinsic Value? 65
Basing Investment Decision on Intrinsic Value 66
Value Assets on Economic Basis 68
Estimating Intrinsic Value through a DCF Model 69
Key Takeaways 70
CHAPTER 10 The Pros and Cons of Various Methods and Models 71
Why Price Level Matters 71
Why Use Analysts’ Traditional Cash Flow Forecasts. Why Not. 72
Why Use Dividends to Value Stocks. Why Not. 72
Why Use the Simplest Model, EBITDA. Why Not. 73
Why Use Earnings. Why Not. 74
Why Use Price Level from Regression Analysis. Why Not. 75
Why Use Net Free Cash Flow. Why Not. 76
Why Use Residual Income or EVA.® Why Not. 77
Why Use Cash Flow ROI, CFROI,® Economic Cash Margin, or Cash Economic Return. Why Not. 78
CHAPTER 11 Suppose You Love Your Current DCF Model 81
Dividend Discount Models 82
EVA® or Residual Income Models 83
CFROI® or Cash Economic Return Models 84
Regression Models of Price Level 84
Multifactor Models 85
SECTION FOUR Explaining LCRT’s Conceptual Framework in Detail 87
CHAPTER 12 Our Approach 91
Differences between Intrinsic Value and Market Value Approaches 93
Explaining Value 94
Attacking the Old Ways 97
Modeling on Economic Fundamentals, Not Accounting Mumbo-Jumbo 98
The Intricacies of the Price Formation Process 100
The Foundation Is Intrinsic Value 101
We’re Fighting Standard Practices, but We Can Win 102
Key Takeaways 103
CHAPTER 13 Focusing on Price Formation 105
Be Proactive, Not Reactive 106
Building a Price Formation Process 107
Oh-Oh: We’re Preaching Again 109
Key Takeaways 110
CHAPTER 14 Our Automated DCF Model—The Better Model 111
Four Primary Measurement Principles to Evaluate a Model 113
Key Takeaways 114
CHAPTER 15 Getting to Know Our LCRT Model 115
Adjustments to Improve DCF Modeling 116
Economic Output and Life of Each Asset 116
Capitalize Cash Flows 117
Understanding Abnormal Accruals 118
Cash Flows Fade: Down and Up 119
Looking at the Discount Rate 120
Summarizing the Model of Choice 121
The Next Generation Will Be Even Better 122
Key Takeaways 123
CHAPTER 16 Digging Deeper into the LCRT Model 125
Exponential Fading of both Cash Economic Return and Growth Rate 125
Certainty-Equivalent Value and the Use of the Area under a Curve 129
Dealing with Debt Leverage 130
Looking at the Discount Rate Again 132
Inflation Adjustments Revisited 134
Importance of Accuracy 135
Calculating Bounded Rationality (Rawley Ranges) 136
Three Fundamental Economic Drivers of Dispersion Affecting Stock Price 138
Buy and Hold Strategies 139
Short-Term Trading Strategies 139
Trading Strategies Shorting the Market 140
Market Sentiment and Micro and Macro Economic Drivers 140
Market Sentiment 140
Macro and Micro Economic Drivers 140
Improving the Model with Your Insights and Analyst Forecasting 142
Key Takeaways 143
CHAPTER 17 Putting Our Valuation Proposition into Perspective 145
SECTION FIVE How to Make Investment Decisions with ValuFocus 147
CHAPTER 18 ValuFocus—The Key Tool for Investing in Stocks 151
The Components of ValuFocus 153
The Relative Wealth Chart: Cash Economic Return, Growth, and Stock Performance 156
Rawley Ranges of Bounded Rationality 158
EPS and Sales Overrides 159
Analyzing Hewlett-Packard 162
Determining the Accuracy of the Value Calculations 164
Using the Value Chart 166
Earnings Results Can Be Misleading 167
The Market Often Is Slow to React to Value Improvements by Management 168
Picking the Right Model Version 169
Contrasting Hewlett-Packard with Coca-Cola 172
Neither Coke nor Pepsi 175
Incorporating Revenue and EPS Forecasts 179
Basic Purpose: Predict Future Stock Price 180
Taking Advantage of the Flexibility of ValuFocus 182
The Importance of Fade Rates to Intrinsic Valuation 184
Continuing Debate: Determining the Right Discount Rate Created from Long-Term Growth Rates 187
Key Takeaways 188
CHAPTER 19 Managing Your Stock Portfolio 191
Ways to Weight Stocks in Your Portfolio 194
Risk and Concentration 195
Rebalancing Your Portfolio 195
Key Takeaways 197
CHAPTER 20 Advanced Portfolio Concepts 199
Selecting Stocks 200
Value and Tracking Error 200
Diversification 200
Inflection Points 201
Buy and Hold Strategies versus SelectiveMarket Timing 202
Portfolio Weighting 206
Achieving Low Risk–High Return Trading around a Core Portfolio 207
Shorting Stocks Based on Value 209
Cash Generator 213
Key Takeaways 218
CHAPTER 21 What If You Don’t Want to Employ ValuFocus 221
CHAPTER 22 Always Going Forward 223
Key Takeaways 229
CHAPTER 23 It Is Time to Get Started 231
SECTION SIX Advanced Topics for Practicing Professionals 233
CHAPTER 24 Security Analysis and Modeling 235
Empirically Test Terminal Valuation Model against History 235
Benefits and Rewards 237
Analyst Dashboard 237
Financial Modelers and Ideas for Future Practitioner Research 240
Key Takeaways 242
CHAPTER 25 Wealth Management 243
Key Takeaway 246
CHAPTER 26 Portfolio Construction 247
New Theory 248
Begin with Under- and Overvaluation, Then Diversify 248
Weighting Schemes 249
Rebalancing Your Portfolio 249
Benefits of Concentration 250
Key Takeaway 251
SECTION SEVEN Advanced Topics for Academics 253
Inefficient Markets 253
Chapters in This Section for the Academic 253
CHAPTER 27 Another Tour through Our LCRT Model 257
Description of the LCRT Model 258
Constructing the Model 258
Basic Components of the Model 260
Dealing with the Many Assumptions 262
The Best of Both: Explaining Our Fade Process in a Single-Period Method 264
Fade and Model Accuracy 267
Starting with a Baseline Model 268
Importance of Understanding Economic Comparables 271
The Difference between Net Free Cash Flow versus Cash Economic Return 272
Comparing Conventional and LCRT Models 273
Validating the Model: The Proof Is in the Comparison 275
Calculation of Tracking Errors 275
Focusing on Cash Economic Return 280
Calculating and Delving into Cash Economic Return 284
Understanding the Growth Rate 290
Arriving at the Discount Rate for a Third Time 292
Summing Up 293
Key Takeaways 295
CHAPTER 28 Incorporating Risk into Our Model 297
Incorporating Risk and Fade into Our LCRT Model 298
How Risk Modeling for Stock Selection Has Evolved 300
Managing Risk in Our LCRT Modeling 304
Looking at Technical Analysis and Ranges of Bounded Rationality Again 305
Measuring the Extent of Over- and Undervaluation 306
Modeling the Dispersion of Stock Price 307
Applying Risk in Our Model 308
Key Takeaways 310
CHAPTER 29 Producing Lower Fat-Tailed Risk with Higher Returns 311
Alternatives to Stable Paretian Distributions 312
Comparison of Traditional Gaussian Measures with Stable Paretian 314
Key Takeaways 318
CHAPTER 30 Comparing Our Model against Three Popular DDMs 319
Evaluating the Three DDMs 322
Testing the Models for Robustness and Accuracy 324
Robustness, Accuracy, Nonbias Enhance Predictability 327
Removing Bias Caused by a Certain Parameter 328
Portfolio Results for Three ROPE Model Specifications 333
Using Our Sophisticated Free Cash Flow Process 335
Key Takeaways 337
CHAPTER 31 Suggestions for Additional Academic Research 339
Epilogue—Key Takeaways 341
About the Authors 343
Index 345
