going it alone on wall street - aaii.com by market capitalization • referred to as: micro-caps,...

Going it alone on Wall Street by Lauren Rudd

Copyright Savannah Capital 11/08/07

Going it alone on Wall Street

Lauren Rudd - Introduction• 40 years Wall Street experience• Newspaper columnist for 20 years

- Streetwise and MarketView

• Professional money manager• Wall Street analyst• Publisher of The Rudd Report• www.RuddReport.com



Sample Performance Record

• 15 stocks in Streetwise this year followed for 3 or more years. Performance from 1/3/05 thru 6/15/07

• 2.5 year performance of Streetwise as of 6/15/07 - 13%

• 2.5 year performance of the S&P 500 6/15/07 - 10%



Why “Going it alone on Wall Street”Because:• You can find profitable investments• Without mutual funds of any species • Without help from others• Without attending “free” lunches• Without attending “free” dinners• Without a full service brokerage house



Everyone tries to predict the market

• Prognosticators try• Bookstore and magazine racks filled

with titles trying• Brokerage firms try• Analysts try



The truth is:

No one can predict the market and only you can determine what you should be investing in.



You should be investing in stocks unless you meet the following criteria:

• You are dying• Have no heirs• Have no friends or family• No charities you care about• You are hoping to take it with you



Question: When is the best time to invest in stocks?

Answer: ANYTIME – regardless of what the market does.

• As Warren Buffett said, “Buy when others are scared and selling.”

• However, you will need the fortitude to invest in today’s market…here is why



Energy Information Administration

• Raised its forecast for domestic oil prices to $79.92 per barrel.

• Rising oil consumption and OPEC production may not be sufficient to arrest the inventory decline.



Fed Governor Frederic Mishkin

"If the Fed overshoots and eases policy too much, it needs to be willing to expeditiously remove at least part of that ease before inflationary pressures become a threat."



Billionaire investor George Soros

"We are on the verge of a very serious economic correction. We have borrowed an awful lot of money and now the bill is coming due."



Dollar Decline

• Inflationary• Aggravates trade deficit• Supports crude oil prices• Puts us under the thumb of the likes of

China



Level 3 Asset Problem• Financial Accounting Standards Board's

rule 157 - Putting market prices on securities that are the hardest to value.

• Known as Level 3 assets• Values based on unobservable inputs;

reflect the holder’s own assumptions. • We call that “mark-to-make-believe.”



Level 3 Expounded

• Goldman Sachs - $72 billion in Level 3 assets

• Goldman Sachs – Capital $36 billion• Goldman Sachs existence could rely on

Level 3 interpretation



Level 3 continued

• Lehman - $22 billion 100% of capital• Bear Stearns - $20 billion 155% of

capital• JP Morgan - $60 billion 50% of capital



• What drives the markets – GREED• Do not fall for false yield traps• You must invest for the long term• Forget the Dow• Throw away the rear view mirror• Select companies you understand• Do your own analysis• USE A DEEP DISCOUNT BROKER



• You do not have to be a genius• Project earnings• Use intrinsic value• Use Dow 5 theory• Understand that P/E is not the answer• Learn about free cash flow



Six Rules to Start

• Understand the markets• Pick your industry• Know your prey• Study the past – project the future• Ask “what if”• Know your risk



Sore Points• Free Lunch• Mutual funds• Impatience• Traders – John Boogle• Index funds – including ETFs• Bonds• Brokerage Houses – Financial Advisors



Key aspects of a good investment

• Profits• Leader in the field• Dividends• Substantial free cash flow• Positive intrinsic value



Intrinsic Value

• Probably the most important criteria• As a rule only consider companies with

an intrinsic value greater than share price

• Free cash flow to the firm approach• Discounted earnings approach• Dividend discount model



Intrinsic ValueFree cash flow to the firm approach

• ValuePro.net• Described in Valuing a Stock by Gray,

Cusatis and Woolridge• Software program available



Intrinsic ValueDiscounted Earnings Approach

• Quicken.com – free• Earnings are not considered a good

parameter on which to base a projection

• Experience does not prove this out



Intrinsic ValueDividend Discount Model

• DividendDiscountModel.com• Free• Calculations not illustrated



Key aspects of a good investment cont.

• Understand the company• Rising stock price• Positive earnings growth• Earnings estimate out three years• Management – very subjective



Value

• (P/E) below a certain absolute limit • Yields above a certain absolute limit • Book value per share at a certain level

relative to the share price • Total sales at a certain level relative to

the company's market value



Growth

• Underlying quality of the growth rate of the business

• Increasing sales• Increasing profits• Do not buy hype



Momentum• The search for companies that are

“doing extremely well.” • "Well" is defined as either relative to

expectations or relative to all public companies as a whole.

• Momentum companies often routinely beat Street estimates



A good way to summarize a stock

• GARP - an acronym for growth at a reasonable price. Combines the value and growth approaches.



A Successful Approach

• The most successful approach for the “average” individual investor use a hybrid of value, growth, and GARP approaches.



Company size

• Keep in mind the size of a company• The most common way to address size

is by market capitalization• Referred to as: micro-caps, small-caps,

mid-caps, and large-caps, with "cap" being short for "capitalization."



Size Break Down

• Micro cap - $100 million or less• Small cap - $100 million to $1 billion• Mid cap - $1 billion to $5 billion • Large cap - $5 billion or more



Book Value

• Book Value - The shareholders' equity on a company's balance sheet is the book value for that company.

• Divide book value by the number of shares outstanding for a per share value



Diversification• Build a diversified portfolios. • You create a diversified stock portfolio

by buying a variety of stocks in a range of different industries.

• A practical approach is to own at least twelve stocks of approximately equal dollar amounts in six to eight diverse industries.



PEG

• The PEG approach is a simple valuation tool, popularized by Peter Lynch

• Supposedly the P/E ratio of any company that's fairly priced will equal its growth rate

• P/E divided by earnings growth rate.



PEG cont.

• Watch out – the PEG formula is strictly a rule of thumb, not a valid financial "law".

• Notice that the two sides of the formula have different units: you're comparing a fraction with a percent



• Free cash flow - money earned from operations that a business can actually put into its proverbial savings account after all is said and done.

• Free cash flow is cash from operations (also called operating cash flow) minus capital expenditures, which are investments in property, plant, and equipment.

• FCF = Operating Cash Flow (OCF) - Capital Expenditures



Stock Ideas• Finance – Bank of America• Consumer Prod. – Procter & Gamble• Medical – Allergan, Varian Medical• Pharmaceutical – Johnson & Johnson• Transportation – Harley Davidson• Misc. – Toro, Garmin, Monsanto



Stock Ideas cont.• Food – Starbucks, Kellogg• REIT – National Retail Properties• Retail – Best Buy• Comp. Hardware – Seagate, NVIDIA• Software – Adobe, Actuate• Energy – Exxon Mobil, Smith Industries• Energy – Transocean, Noble, Valero



High Yield Stocks

• National Bank of Australia (NAB) 6.2%• Magellan Midstream Partners, L.P.(MMP)

7.4%• Aluminum Company of China (ACH) 6.3%• Valero L.P. (VLO) 6.5%• National Retail Properties (NNN) 5.8%• Penn Virginia Resources (PVR) 6.4%



Canadian Investment Trusts

• Canadian income funds that buy assets which generate steady cash flow from operations or royalties.

• They are also called unit trusts, royalty trusts, or income trusts, depending upon their industry.




• Large dividends are the main draw

• Prime West Energy 12% • Paramount Energy Trust 15% • Harvest Energy Trust 20%.




• Capital appreciation can be surprisingly strong. In the past two years:

• Peyto Energy Trust up 300% • Bonterra Energy Trust up 150% • Canadian Oil Sands Trust up 200%




• U.S. tax treatment has been clarified by the IRS. Nearly all Canadian trust dividends are considered "qualified".

• Escape double taxation and are eligible for the 15% dividend rate.



Risks• All international investing carries

currency, political, and economic risks.

• They are potentially volatile. This is especially true of oil and gas trusts.



Resources

• "Canadian Income Funds" - by Beck and Romano

• http://www.canadianedge.com/ - a newsletter covers over 100 Canadian income trusts

• http://www.adviceforinvestors.com/ - profiles and quotes from MPL Communications, a large Canadian investment information firm



Resources Cont.

• http://www.investcom.com/incometrust/inco metrust.htm - a financial site with a section on Canadian income trusts

• http://www.kpmg.ca/en/services/tax/tnfc05 04.html - a recent paper from KPMG Canada about U. S. taxpayers and Canadian income trusts



A real estate investment trust - REIT

• Pools the capital of investors to invest in various forms of real estate

• Income producing assets • Structured to generate regular

distributions of cash.



REITs• REITs seek out investment

opportunities and actively manage real estate assets.

• REIT investors are not directly investing in real estate property,

• REIT investors own REIT units that are publicly traded



REITS• REITs are attractive to those investors who

wish to participate in the real estate sector without the illiquidity of direct ownership.

• REITs offer a variety of investment choices, focused investment strategy (such as REITs which invest only in apartment buildings) diversified approach (REITs which focus on a mixture of commercial/industrial properties)



Categories of Investment Software

• Charting or technical analysis• Screening• Fundamental Analysis• Portfolio Management• Content Providers



Charting or Technical Analysis Programs• Summarize data• Allow the use of technical analysis tools• One of the most popular is Worden

TeleChart• Usually have to subscribe to a data

base or chart series• Investor Business Daily’s charts



Worden TeleChart

• Price range $300 to $700 depending on service selected

• Like all charts data is historical• Charting or technical analysis is a self-

fulfilling prophesy…at best



Screening Software

• Allows selection of companies based on some criteria

• Criteria can be user defined or predefined• Databases accessed either internal or

external• Databases usually require subscription• Valuable for most investors



Screening

• Excellent first cut at investment candidates

• Get a feel for Street expectations • View financial ratios • Enables relative analysis



Three major screening programs

• Reuters Powerscreener 3.0• Value Line Investment Analyzer• Stock Investor Pro



Reuters Powerscreener 3.0

• 600+ customizable variables • Create your own screens• Customize one of 19 pre-built screens• Export direct to Excel • Screen 8,765 stocks • No software to install• $39.99 per month


Going it alone on Wall Street cont.

Value Line Investment Analyzer

• New database every month• Screen 300 data fields - 8,000 stocks. • Over 200 different graph options• Includes Value Line alerts and ranks. • 60 different technical indicators • Standard Edition - $598 • Plus Edition - $995



Stock Investor Pro – AAII

• New data base every month• Quarterly earnings estimates • Eight quarters and seven years of

financial data• Relative price strengths for 4, 13, 26

and 52 weeks • 8,000+ stocks



Stock Investor Pro – AAII cont.

• Ten full years of monthly price data • Over 2,000 data fields per company • 50 stock screens • Percentile rankings, ratios, P/Es and

growth rates • $198 per year



Fundamental Analysis

• Comparative analysis using Excel• Intrinsic value• SEC filings – sec.gov/edgar.com• Company web sites• Spredgar.com



SPREDGAR V4 • Standard Industrial Classification (SIC)

comparative data and ratios• Fundamental data updated weekly• Free cash flow• Payout ratio, retention ratio, and

sustainable growth rate • Receivable, inventory and payable

days



Intrinsic Analysis

• Quicken.com free• ValuePro.net free• ValuePro software $44.95



Portfolio Management

• Brokerage statements• Quicken• Microsoft Money



Content Providers• AOL• MSN• Yahoo Finance• Reuters• WSJ online• Barron’s online• Google



On line/deep discount brokerages

• Scottrade – my suggestion• TD Ameritrade• E*trade• Charles Schwab• Fidelity



TIPS• Never rush to invest• Avoid newsletters• Use free services where possible• Take advantage of government sites• Use AAII resources• Avoid chat rooms• When in doubt – Google• Do not listen to others



Simple Methodology• Use a pre-defined screen• Use common sense• Pick companies you know• Check the intrinsic values• Look at Street earnings estimates• Estimate your return• Invest using a DEEP DISCOUNT FIRM



Reference MaterialIn order of importance

• Dividend Achievers Handbook• Valuing A Stock – Gray, Cusatis and

Woolridge• AAII Journal• AAII Computer Journal



The Most Important Key to Investing

PATIENCE

going it alone on wall street - aaii.com by market capitalization • referred to as: micro-caps,...

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