Commentary (Page 450)

In my book The Confident Investor I detail a possible trading example using 3 different methodologies.

1. Traditional “Buy and Hold” strategy
2. Traditional “Even incremental investment over time”
3. My GOPM strategy – “Grow on Other People’s Money”

I chose the example around IBM [stckqut]ibm[/stckqut] because it is such a well-known brand even if it may not be the best of companies in which to invest. I felt that it was important to show that my technique works with most fair companies. It works even better on a good company.

I also specifically chose 2007 and 2008 as my example time period. I chose this example since many people still do not invest in stocks due to the plunge that happened in November 2008. This plunge wiped out considerable value in the stock market and persuaded too many people that investing in stocks is foolish. My example shows that if you stick with the “traditional” methods of incremental investing and buy-and-hold then you will be very susceptible to these market corrections. GOPM tends to reduce this exposure and even take advantage of it.

The tag line of this site and of my book is “Learn How to Invest With Confidence in a Turbulent Market” and there were few times in the last 15 years when the market was more turbulent that 2007 and 2008.  So I chose the worst of times to explain how my GOPM method can make it the best of times.

In the first scenario, an investor buys IBM stock and sits on it.  A traditional buy-and-hold technique.  He loses money in the crash and like too many people gives up on the stock market as a method to provide for his retirement.

In the second scenario, an investor invests $2,000 in IBM every 3 months. He ultimately takes a bath in the fall of 2008.

In the third scenario, an investor has read my book and uses GOPM – Grow on Other People’s Money. Obviously, the crash of 2008 affects him but he loses none of his capital and has acquired 39 shares of stock in IBM for only $7.22 per share or about 10% of the value of the stock at the time (after the crash, IBM stock had dropped to about $75).

I used a slight variation of my traditional technique for simplicity. Typically, I suggest that an investor invest the same dollar amount using GOPM techniques but in this case I varied the dollar and bought 100 shares of stock in each transaction. Had I used the same dollar amount, the return would have been slightly higher but the math would have been a bit more complicated to explain in this very first example of the technique.

If you are concerned about a major correction in the stock market wiping out your net worth, you really should read my book. You can read a sample of the book here and it includes Chapter 4 which is the chapter containing this IBM explanation.

If you are a registered reader of my book then you will be able to see the table below that shows the time of each GOPM trade and the profit or loss from that trade. It is FREE to register for anyone that has purchased my book.[s2If current_user_can(s2member_level1)]

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I find that I can eliminate most companies from consideration with just a handful of metrics. The metrics are:

• The growth of the company’s sales.
• The growth of the company’s earnings per share of stock outstanding.
• The growth of the company’s market value compared to its earnings.
• The growth of the company’s earnings before taking into account interest and taxes.
• The value of the company compared to its earnings as compared to other similar companies.
• The productivity of the company employees relative to industry averages.

I explain how to find these metrics in my book, “The Confident Investor” which is for sale in paperback format or ebook format wherever books are sold.

There are other metrics that are important but for one reason or another I do not actively analyze them. For the most part, I find that these other important metrics tend to be reflected directly into one of the above values or in the price of the stock.

Dividend Rate or Dividend Yield – The dividend that a company pays is almost always completely reflected in the price of the stock. If the company raises the dividend then the stock price goes up a similar amount. If the divided is cut, it drops (sometimes even farther than it should). Also, I have seen too many investors stay with a company that pays a high dividend as the stock price drops 25% because of poor performance of the fundamentals of the company. This is penny-wise and pound foolish.  Finally, in my opinion, dividends mean the company cannot figure out a great way to use the cash to grow their business and reduce costs. Companies that are 3rd or 4th in market share that issue dividends show a lack of management effectiveness.

Beta – I really don’t think this matters too much. My system makes money when stocks go up and down. If a stock goes consistently up then I make more money.

Forward P/E – This number is a guess on what the price and earnings will be in the future. I would rather look at what the company’s management has accomplished in the past than on a guess for the future.

Return on Equity, Assets, or Capital – I actually do look at these values before I pull the trigger on a new investment.  I want to see a good return here but I may not change my mind. I also don’t really care what the ROE/A/C is 3 or 4 years ago.  Most of the metrics that I track, I want to improve over 10 years.

Debt to Equity – I casually look at this number but I have never disqualified a company because of it. I am far more worried about consistent growth of revenue and profit. If revenue and profit are growing at 10% or better over 10 years then this value will almost always be fine.

Revenue / Share – This number gets covered fairly adequately in watching the revenue top line. Dividing revenue by shares outstanding is a management game and not really relevant for analyzing the health of the company. As the management team buys back shares this gets reflected in the stock price which is the most important metric.

Institutional Ownership – I am not sure why anyone would buy or not buy a stock based on this number.  What does it matter? If the number is really high that means that professional and trained money managers like the company. If the number is lower than it is usually because the company has a good brand name and individual investors buy it because they think it is cool. Either way, it is rarely the fault of the company as to this number.

Free Cash Flow – A lot of people look at this number. It is important. Of all the metrics that I don’t put on my scorecard, I think this is the most valuable. However, since it is based on EBIT and profit to some degree I feel that it sufficiently is reflected in the metrics that I specifically cover.  Also, I am not convinced that FCF needs to increase consistently over time like the metrics that I monitor. I will occasionally not invest in a company that has poor FCF but passes my other metrics.