GOLDEN RULES OF INVESTING

7:36 AM 4/25/2021
LESSON 1: THE SEVEN GOLDEN RULES OF INVESTING ………………………………………………………………….3
Introduction …………………………………………………………………………………………………………………………………………….3
ARE YOU AN INVESTOR? ……………………………………………………………………………………………………………………..3
SECTION 1 ………………………………………………………………………………………………………………………………………………..5
Who are Investors? ……………………………………………………………………………………………………………………………………5
Starting Early ……………………………………………………………………………………………………………………………………………6
WHAT DOES IT REALLY MEAN TO INVEST IN THE STOCK MARKET? …………………………………………..7
SECTION 2 ……………………………………………………………………………………………………………………………………………….9
BEATING THE MARKET ……………………………………………………………………………………………………………………….9
QUESTIONS TO CONSIDER: ……………………………………………………………………………………………………………….10
SECTION 3 ……………………………………………………………………………………………………………………………………………..11
THE SEVEN GOLDEN RULES ………………………………………………………………………………………………………………11
LESSON 2: THE VALUE OF A STOCK ……………………………………………………………………………………………………16
Introduction …………………………………………………………………………………………………………………………………………..16
SECTION 1………………………………………………………………………………………………………………………………………………17
WHY DO STOCK PRICES FLUCTUATE SO MUCH? ………………………………………………………………………….17
MR. MARKET ……………………………………………………………………………………………………………………………………….17
SECTION 2 ……………………………………………………………………………………………………………………………………………..19
WHAT IS THE VALUE OF A BUSINESS? ………………………………………………………………………………………………19
SECTION 3 ……………………………………………………………………………………………………………………………………………..24
UNDERSTANDING THE TERMINOLGY …………………………………………………………………………………………….24
THE “GO-TO” WAY TO VALUE A BUSINESS: P/E RATIO …………………………………………………………………..25
LESSON 3: WHAT MAKES A GOOD BUSINESS? ………………………………………………………………………………….27
Introduction …………………………………………………………………………………………………………………………………………..27
SECTION 1………………………………………………………………………………………………………………………………………………28
HOW DO I KNOW IF A COMPANY IS A GOOD BUSINESS? ……………………………………………………………..28
SECTION 2 ……………………………………………………………………………………………………………………………………………..30
WHATEVER FLOATS YOUR MOAT …………………………………………………………………………………………………….30
Types of Economic Moats ……………………………………………………………………………………………………………………..30
LESSON 4: FINDING STOCKS TO INVEST IN ……………………………………………………………………………………..41
Introduction …………………………………………………………………………………………………………………………………………..41
SECTION 1 ……………………………………………………………………………………………………………………………………………..42
HOW DO I COME UP WITH INVESTMENT IDEAS? ………………………………………………………………………..42
SECTION 2 ……………………………………………………………………………………………………………………………………………..44
STOCK SCREENS ………………………………………………………………………………………………………………………………….44
IS THE COMPANY GOOD? ………………………………………………………………………………………………………………….45
TABLE OF CONTENTS
IS THE COMPANY GROWING? …………………………………………………………………………………………………………..45
IS THE STOCK CHEAP? ……………………………………………………………………………………………………………………….45
THE S&P 500 & THE DOW JONES: ……………………………………………………………………………………………………..47
SECTION 3 ……………………………………………………………………………………………………………………………………………..48
RESEARCH REPORTS: ………………………………………………………………………………………………………………………….48
GIVING DUE DILLIGENCE ITS DUE ………………………………………………………………………………………………….49
LESSON 5: LEARNING TO SPEAK THE LANGUAGE OF FINANCE ……………………………………………………52
Introduction …………………………………………………………………………………………………………………………………………..52
SECTION 1………………………………………………………………………………………………………………………………………………53
WHY DO COMPANIES PREPARE FINANCIAL STATEMENTS? ………………………………………………………..53
WHO USES FINANCIAL STATEMENTS? …………………………………………………………………………………………….53
WHAT ARE THE THREE FINANCIAL STATEMENTS? ………………………………………………………………………54
THE BALANCE SHEET …………………………………………………………………………………………………………………………54
SECTION 2 ……………………………………………………………………………………………………………………………………………..56
THE INCOME STATEMENT ………………………………………………………………………………………………………………..56
THE STATEMENT OF CASH FLOWS ………………………………………………………………………………………………….57
SECTION 3 ……………………………………………………………………………………………………………………………………………..59
HOW DO I FORECAST REVENUES OF A COMPANY? ……………………………………………………………………..59
HOW DO I FORECAST MARGINS OF A COMPANY? ……………………………………………………………………….60
COMPANIES …………………………………………………………………………………………………………………………………………63
APPENDIX A: SELECTED FINANCIAL STATEMENTS ………………………………………………………………………64
LESSON 6: THE INVESTMENT THESIS ……………………………………………………………………………………………….73
SECTION 1 ……………………………………………………………………………………………………………………………………………..75
WHAT IS AN INVESTMENT THESIS? …………………………………………………………………………………………………75
SECTION 2 ……………………………………………………………………………………………………………………………………………..78
LESSON 7: INTRINSIC VALUE ………………………………………………………………………………………………………………82
SECTION 1 ……………………………………………………………………………………………………………………………………………..84
SECTION 2 ……………………………………………………………………………………………………………………………………………..86
Determining the Intrinsic Value of a Company ………………………………………………………………………………………86
Te Discounted Cash Flows method ………………………………………………………………………………………………………86
SECTION 3 ……………………………………………………………………………………………………………………………………………..89
Te Relative Valuation Method ………………………………………………………………………………………………………………89
Two Primary Valuation Options …………………………………………………………………………………………………………….92
GLOSSARY OF TERMS …………………………………………………………………………………………………………………………..93
5
LESSON 1:
THE SEVEN GOLDEN RULES OF INVESTING
Welcome Young Investors! It is our goal to make you master investors. Many of
the lessons you will learn have been used by successful investors over several
generations. You will notice that a recipe for success is easy to follow but is actually
followed by few. Let’s start with a question:
ARE YOU AN INVESTOR?
Are you a spender or an investor? Pop Quiz. Ready. Go.
Question #1
I’ll give you $100 today or a new Mercedes next year? Which one will you take?
A) Te cash
B) Te car
C) Why are you even looking at other options, you’d be crazy not to take the car!
Question #2
I’ll give you $100 today or $100 next year. Which one will you take? Tink about
it…
A) Te cash today
B) Te same cash tomorrow
C) Of course you wouldn’t wait! What’s the point? You wouldn’t get anything in
return for waiting.
In one minute we’ve narrowed down whether you are an investor or a spender.
You’re a spender if you don’t get a return. You’re an investor if the future is worth
somewhere between $100 and a new car. Te question of whether you will invest is
really just a question of how much you believe tomorrow can ofer.
How much could the future be worth for a bit of sacrifce today?
Tat is the key question that every investor asks themselves….
Introduction
6
QUESTIONS TO CONSIDER:

1. How much cash would you be willing to give up today in return for a
   promise to receive $500 5 years from now from that investment? $50?
   $100? $300? $450?
2. What does a low number ($50) say about you? What does a high number
   say about you ($450)?
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   7
   SECTION 1
   Who are Investors?
   The truth is that WE ARE ALL investors. When we hear the word investors,
   we may think of a high-fying Wall-Street banker in a blue-pin striped
   suit. Tat is certainly one type of investor, but so is the business owner, the
   family trying to save for their kids’ college, and the college student trying to
   scrape up enough quarters to eat dinner. We all need to manage the money we
   make, and we all hope to end up with as much money as possible.
   Te question of building wealth in your life will really boil down to two
   questions?
   1) Are you able to save each year?
   2) When you save, where do you put the money?
   Hypothetical
   Let’s assume you’re 20 years old and just took a job as a freman,
   your childhood dream (what kid doesn’t want to be a freman,
   right?). Your salary is meager, but you make the goal to save $1,000
   dollars per year and put it in a retirement account. You work and
   save for the next 50 years until you retire.
   Does it really matter where I put that money, I mean it’s
   only a thousand bucks a year? Well you have a couple of
   options, let’s evaluate.
   1). Te savings Account (otherwise known as the
   “Under the Mattress” approach). Te easiest and “safest”
   thing is you could just put the money in cash. Nice and
   safe! It will never go away and it won’t go up and down.
   Average Annual Return: 0%
   Amount Accumulated in 50 Years: $50,000
   2). Bonds or Real Estate. Most people say that they get
   most of their retirement funds from investing in their
   home and watching it increase in value. Or investing
   in bonds. Both of these options will grow in line with
   infation, which on average is about 3% per year.
   Average Annual Return: 3%
   Amount Accumulated in 50 Years: $116,000
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   8
   3). Te Stock Market. Scary, right? It goes up and down. Tere are times
   when it can decline by 20% in a short period of time, inducing panic and
   scary headlines. But over time, the stock market grows with how fast
   corporations grow. In every ten year period, the stock market earns you
   8-10% returns. In fact, over the last century, the S&P 500 (the largest 500
   companies in the US) have returned 9.8% per year.
   Average Annual Return: 9.8%
   Amount Accumulated in 50 Years: $1,359,199
   So does it really matter where you put your money? Uh, yeah! It makes all
   the diference in the world. In fact, the more money that you can put in the
   stock market early, the more the magnifying efect of “compound interest” or
   “compounding” can work in your favor.
   “Compound interest is the eighth wonder of the world”
   -Albert Einstein
   Now, I know what you’re thinking. If going from 3% to 10% return gets me
   an extra million dollars, what does getting a 20% return do? Warren Bufett,
   the legendary investor, for example earned 30% return over a period of 30
   years. (called the famous “30/30”).
   4). Beating the Market. Tis isn’t easy, it isn’t for everyone, but let’s say you
   take a few hours per week, and you do your homework, and invest in
   some exceptional companies through the stock market, and earn an
   extraordinary 20% return per year. Tis is a very high return (even 12%
   per year is quite a feat) but let’s just assume you’re really good at fnding
   great stocks.
   Average Annual Return: 20%
   Amount Accumulated in 50 Years: $109,826,119 (Yes, that’s over $100
   million dollars)
   Tat’s a huge fortune for a freman saving just $1k per year. So, now you
   know why you heard your dad’s friend bragging that he “beat the market” on
   his investment portfolio last year. Te diference between 3% and 10% may
   seem small, but it makes all the diference in the world towards building wealth.
   Starting Early
   Compound interest is a powerful efect, and the EARLIER you start
   investing the more it will work for you. Consider the example above with the
   freman, but instead of starting to save at 20 years old, instead he starts to save
   at 40 years old. Instead of retiring with $1.3 million he will retire with only
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   9
   $190k. Look at the results below assuming he invests in the stock market:
   Started saving $1,000 per year at
   ֍ at Age 40 = $190,773 (at age 70)
   ֍ at Age 30 = $535,682 (at age 70)
   ֍ at Age 20 = $1,359,199 (at age 70)
   And then, let’s say you join Young Investors Society and start investing
   when you’re 15 years old. What does an extra 5 years get you?
   ֍ at Age 15 = $2,224,948 (at age 70)
   Notice that the diference is almost a million dollars diference if you start just
   5 years earlier!
   In summary, the TWO CRITICAL FACTORS of COMPOUND INTEREST
   are:
   5). Earn a High Return (i.e. the stock market)
   6). Start Early
   And remember, we’re all investors, whether we like it or not!
   WHAT DOES IT REALLY MEAN TO INVEST IN THE STOCK MARKET?
   Questions:
3. What is a “stock”?
4. What is the stock market?
   Te following link is a great video explaining a “stock” and the “stock
   market”, please review Lesson 1 (What is the Stock Market) and Lesson 2
   (What are Stocks) done by our partner, Wall Street Survivor.
   https://younginvestorssociety.org/videos/stock-market-101/
   You can see from this that investing in the stock market is “serious business,”
   at the same time it can be a fun game. Never forget that when you buy shares
   in a company, you become one of its owners!
   QUESTIONS TO CONSIDER:
5. What does it mean to buy a “stock”?
6. Why does the Stock Market go up and down?
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   10
   All companies have owners. A small company started by a single individual
   may have only him or her as the single owner. Te large corporations that
   have stock (shares that are traded by the general public) have many owners.
   To simplify and organize the buying and selling of these shares by the general
   public, companies use the stock market. In fact, US government regulations
   require that a company, once it reaches a certain number of owners, must go
   public. Tis is to allow its now large number of owners to be able to buy and
   sell their shares of stock in the company more easily.
   Just think about it this way. Let’s pretend that your sibling or a close friend
   is starting a small company. He or she is doing really well, but needs more
   money (capital) to expand. He or she asks you to become a part owner in the
   business by investing some of your savings. You agree. Would you try to sell
   your ownership in the company just a few days later? Most likely not! It should
   be the same thing when you decide to buy a public company’s stock. Te only
   real diference is that your sibling’s or friend’s company is a private company
   with just two shareholders, whereas there are many more owners in a public
   company with shares in the “stock market.”
   “Without a saving faith in the future, no one would ever invest at all. To be an
   investor, you must be a believer in a better tomorrow” Benjamin Graham
   ACTIVITY: FIND THE STOCK
   Investing in a stock is buying a piece of the company.
   Search the internet to match the brands with the company (stock) that
   owns it. What stock ticker (example AAPL for Apple) would you buy if you
   wanted to invest in the growth of the following products?
   ֍ ESPN
   ֍ Pampers
   ֍ YouTube
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   11
   SECTION 2
   BEATING THE MARKET
   To start, let me introduce you to Warren Bufett. Mr. Bufett has been the
   single most successful investor since the late 1950s.
   Let’s set the stage. Te year is 1984. Recently, there had arisen a
   growing consensus that the stock market was fully efcient, called
   “Efcient Market Teory.” Basically, academics and investors were
   declaring it impossible for someone to consistently pick stocks
   that would beat the overall market average, because everything
   was priced in already. Columbia Business School hosted an epic
   debate as a contest between Michael Jensen, a professor from the
   University of Rochester and one of the leading voices of the Efcient
   Market Teory versus Warren Bufett, famed stock-picker. Jensen
   went frst. He argued that if you fipped a coin 50 times, there would
   be someone that happened to get heads 50 times in a row, but that
   didn’t mean that that person had skill. He called picking stocks
   a “coin fip”.
   Ten Bufett spoke. He said “let’s imagine that we had a coin
   fipping contest. And that of course we could have some lucky winners and
   losers. But then, let’s assume that all the winners had something in common.
   What if all the winners of the coin-fipping contest came from Omaha, or had
   an unusual technique. Wouldn’t you be curious to fnd out what made this
   high concentration of winners? Bufett then went through the investment
   performance of nine successful investors that just so happened to all practice
   the same methodology and all had the same teachers, Benjamin Graham
   and David Dodd. He called them “Te Superinvestors of Graham-andDoddsville.” Bufett was unequivocally declared the winner afer his masterful
   speech. No one could doubt the numbers or the logic. Te clear conclusion
   is that you can be successful in picking stocks, and it requires following the
   investment principles of Graham and Dodd and Bufett.
   (Te Article can be found at the web address:
   http://www8.gsb.columbia.edu/alumni/news/superinvestors)
   Bufett references Benjamin Graham and David L. Dodd. Together
   Graham and Dodd wrote Security Analysis in 1934. Tis book, still in print
   afer several editions, has infuenced many great investors since the very frst
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   12
   publication. Additionally, Benjamin Graham wrote Te Intelligent Investor
   in 1949. Mr. Bufett frst read this book in 1950 and considers it, “by far the
   best book on investing ever written.” Benjamin Graham is considered the
   father of value investing and so we start here. As you read the article make a
   note of the key concepts that are referenced. Some are repeated several times.
   QUESTIONS TO CONSIDER:
7. What are the common traits of successful investors?
8. If there is a clear recipe for investment success, why do you think so few
   people follow it?
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   13
   SECTION 3
   THE SEVEN GOLDEN RULES
   Being successful at anything requires following a set of rules. Good rules are the accumulation of
   decades of wisdom summed up into the few components that really matter. Successful football
   players win because they avoid penalties and because of the way they train. Successful students get A’s
   because of the way they study.
   Investing in the stock market is no diferent, except that when you succeed in investing you make
   money – a lot of money. Take Warren Bufett for example; he started out with $10,000 and turned it
   into a net worth of $60,000,000,000 (Tat’s 60 BILLION!) . But he’s not alone. Peter Lynch, Bill Ruane, Walter Schloss, Bill Miller, Charlie Munger, Joel Greenblatt, and many others generated similar
   extraordinary investment returns, consistently, over a long-term time horizon. Each successful fund
   manager’s style was slightly diferent, but if you study them each carefully you’ll start to see signifcant
   patterns. We summed these patterns into Seven Golden Rules.
   So, without further ado, here are the Seven Golden Rules of Successful Investing so that you can
   crush it in the stock market.
   Trying to time the stock market or risking it all to “double your money in a
   year” is at best speculating, at worst gambling. You may as well just take your
   money to Vegas and lose it there. Tose who are able to successfully navigate
   the stock market are not speculators or gamblers, they are investors. Investors know they can beat the market because they think diferently, they think
   smarter, and they think longer-term.
   “Time horizon arbitrage” means that if investors learn to think long-term and can see beyond the daily and quarterly noise, they can gain a real upper hand. In 1964, American Express
   was a great company but the stock was getting hammered due to an insurance scandal. Te company
   had to pay millions of dollars in fnes due to accidentally underwriting barrels of vegetable oil that
   turned out to be water. Tat is exactly the time when Warren Bufett began purchasing the stock. Te
   best investors look beyond short term distress and keep their eyes on the long-term horizon.
   “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”
   -Warren Bufett
   RULE 1: THINK LONG-TERM
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   14
   RULE 2: GOOD COMPANIES MAKE GOOD
   INVESTMENTS
   People need to understand
   that investing is not
   like placing a bet on whether the Cowboys
   will cover the spread against the Packers in
   the big game. Investing is not trying to get the quarterly press release a
   microsecond before the other person. It is not even about trying to predict
   which stock that you think will go up the most. Fundamental Investing is
   buying a tangible piece of a business, or a share of that business. And your
   investment portfolio (the collection of all the diferent shares you own) is
   only as good as sum of the companies in that portfolio.
   If you buy shares of high quality companies at reasonable prices, you’ll
   end up with a high quality portfolio with less risk. It’s as simple as that.
   Good companies are ones that have a unique advantage that others can’t
   copy. Good companies are ones that generate high returns on capital.
   Good companies don’t need to borrow a lot because their business is selffnancing.
   “It’s far better to buy a wonderful company at a fair price than a fair
   company at a wonderful price” Warren Bufett
   “It’s far better to buy a
   wonderful company at
   a fair price than a fair
   company at a wonderful
   price”
   RULE 3: BUY WITH A MARGIN
   OF SAFETY
   Nearly every professional investor began
   his career reading Benjamin Graham’s, Te
   Intelligent Investor. Warren Bufett
   called it, “by far, the best book on investing ever written.” What makes it so
   special? One of the reasons is because it introduced the important concept “Margin of Safety.”
   In investing, a margin of safety is formed when one buys an investment
   at less than its value, while using conservative assumptions. Te idea of a
   margin of safety is that you want to buy a business at a price that is low
   enough that your assessment could be completely wrong and you wouldn’t
   lose much.
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   15
   “Heads I win. Tails I don’t lose much.”
   -Mohnish Pabrai, Dhandho Investor
   RULE 4: DO YOU OWN HOMEWORK
   AND OWN WHAT YOU KNOW
   Tere is no substitute for your own work.
   Buying a stock because CNBC recommended
   it, or because your uncle recommended it, or
   the stock chart looks good is a sure way to lose
   money.
   Successful investors know what they own. Tey buy stocks
   of companies with products they believe in. Successful investors go the
   extra mile to analyze the fnancials of the company to make sure they’re
   not missing anything. Remember, most of the extraordinary gains made in the
   stock market come afer a stock is punished or afer it has already risen a lot,
   but you’re not going to have the conviction to stick with it unless you really
   know the company.
   “You have to know what you own, and why you own it.”
   -Peter Lynch
   RULE 5: DON’T FOLLOW THE HERD,
   STAY CALM AND RATIONAL
   Te typical buyer’s decision is usually heavily
   infuenced by those around him: buy when others are
   buying, sell when others are selling. Unfortunately,
   this is a recipe that is bound to backfre. Te best
   investors are ones that can fght this urge and
   remain calm through a storm, and remain
   on the sidelines through a bubble.
   Te world’s greatest investor Warren Bufett said it best, ”Be fearful when
   others are greedy, and be greedy when others are fearful!”
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   16
   RULE 6:DON’T PUT ALL YOUR EGGS IN ONE BASKET,
   BUT DON’T HAVE TOO MANY BASKETS,
   EITHER
   Diversifcation is one of the most critical
   strategies for your portfolio so
   that if one stock blows up, it
   won’t sink the entire ship. As
   much as we think we won’t
   make a mistake, we will. Even
   the masters do and that is why we
   can’t put all our eggs in one basket.
   Tere’s power in diversifcation.
   However, research suggests that 90% of diversifcation benefts can be
   obtained in most markets with a portfolio of just over 20 stocks. Te more
   you diversify beyond that, the less you know about each investment (See
   Rule #4). Your frst and second best ideas are always better than your 100th
   best idea, so while diversifying is crucial, make your best ideas count!
   Warren Bufett
   “We try to avoid buying
   a little of this or that
   when we are only
   lukewarm about the
   business or its price.
   When we are convinced
   as to attractiveness,
   we believe in buying
   worthwhile amounts”.
   RULE 7: NEVER STOP
   LEARNING
   Perhaps the most important rule
   is learn, learn more, and then keep
   learning. Te fun thing about investing
   is that the markets are always diferent
   and companies are constantly changing.
   Never stop learning about businesses, never
   stop learning from other great investors, and never stop
   learning from your own mistakes. Humility and an eagerness to learn are
   two traits found in all of the great investors. Even Warren Bufett credits
   his partner Charlie Munger with teaching him that it’s better to buy a
   great company at a fair price than a fair company at a great price.
   “Te game of life is the game of everlasting learning.
   At least it is if you want to win.”
   -Charlie Munger
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   17
   8TH BONUS RULE WHEN YOU MAKE A LOT MON- EY, FIND MEANINGFUL WAYS TO GIVE IT BACK.
   Bill & Melinda Gates took their fortune and lifed millions of people out
   of poverty through their foundation. Warren Bufett has done the same
   with his billions. If you make millions or even billions of dollars through
   the concepts taught by YIS, we hope that you will take it and make the
   world a better place. And even if you don’t make millions, you can fnd
   important ways to give back to your community. Giving, can be done not
   only with money, but also with your time, your energy and your talents. At
   YIS, we believe it’s possible to really make our investments count. Tat’s
   why we’re investing in you.
   KEY TAKEAWAYS
   ֍ Warren Bufet and many others made it clear that it is very possible
   to make exceptional returns from the stock market, following a few
   simple rules.
   ֍ Investing is simple, but it is not easy. Te Golden Rules of Investing
   are widely known but difcult to follow in practice.
   ֍ By investing in a stock you are owning a portion of a business.
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   18
   LESSON 2:
   THE VALUE OF A STOCK
   Introduction
   I
   magine in front of you is a box of
   a dozen doughnuts. How much
   would you pay for one donut? If all
   the donuts in the box are the same,
   is one worth more than the other?
   What if the world had a shortage
   of sugar and this was the last box
   of donuts in the world, with none
   being able to be made for the next
   year? Does the scarcity increase
   the value of the good? How about
   if you just ate a box of donuts and
   can’t eat any more, does the value you would pay for a donut decrease?
   Te box of 12 doughnuts represents a company. When you break the
   company down, everyone has an opportunity to own some of the donuts, or
   part of the company. But people may pay wildly diferent prices for the same
   donut. If you want to maximize the value of a box of donuts, what might
   be the best approach? One method is to convince people that these are the
   tastiest donuts in the world and they will only be around for a limited time.
   In a nutshell, this is how the market works. Te stock market is made up of
   people that get excited about something or sick of something depending on
   their mood. What is obvious is that occasionally the market goes nuts!
   Consider watching the following video to see how legendary investor
   Warren Bufett responds to the question, “What do you do when the market
   goes down?” How is Warren Bufett using common sense about when
   things are “on sale?” Do you agree?
   https://www.youtube.com/watch?v=ss0cHrqFr3Q
   19
   SECTION 1
   WHY DO STOCK PRICES FLUCTUATE SO MUCH?
   Open any fnancial newspaper like the Wall Street Journal. Turn to the
   stock quote section, pick any company at random, and look at the high and
   low stock price from the past year. (or go to yahoo.fnance)
   Ok, let’s see here. We have GM. Tey make cars and trucks.
   Over the past 52 weeks, their stock traded as low as $28/share
   and as high as $39/share. Tey have 1.6 billion (bn) shares
   outstanding, so that means that the market value of GM
   was as low as $45bn and as high as $62bn. Tat’s a
   diference of $17 billion dollars in value. Now the car
   business doesn’t really change that much. You sell plus
   or minus 5% more vehicles per year. Chevy Silverado
   is a Chevy Silverado and they’re not fguring out how
   to replace gasoline for water, or how to fy to the moon. It’s
   basically the same business this year as it was last year. So how in
   the world could the value fuctuate by $17 billion dollars? And more so, why
   is this happening with every single company in the stock market?
   Was last year an exceptional year of price swings? Nope
   Is there something the market knows that we don’t know? No.
   So, what’s the explanation? Well, it can be summed up into four short
   words: “THE MARKET GOES NUTS!”
   MR. MARKET
   Let me tell you a story. It’s a story that legendary investor Benjamin
   Graham told. It is about a business partner of yours, named Mr. Market.
   Imagine you own a business together. Now, Mr. Market is a good guy,
   but he sufers from wild mood swings. One day he wakes up, and the
   sky is blue and he is feeling really, really good. So he ofers to
   buy out your stake in the business for way more than it is
   worth. Ten the next day, he wakes up and it’s raining, he’s
   feeling desperate, and he is screaming that the world is going
   to end. He ofers to sell you all of his stock in the company for
   half of what you paid for it. You take it! Te next day, Mr. Market ofers
   to pay a price that is neither extraordinarily high nor extraordinary low,
   so you just do nothing. Now the value of the business didn’t really
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   20
   change from day to day – what changed was the erratic moods of Mr. Market.
   In short, Mr. Market is one moody dude.
   So does this mean that we shouldn’t invest in the stock market, because
   of these wild swings in the short term? To the contrary! Te fact that we are
   ofered deals from time to time should make us very, very excited. Our goal
   is to 1) identify what the company is worth and 2) to wait for Mr. Market to
   have a bad day and buy it at a large discount. Benjamin Graham called this
   giving ourselves a “margin of safety.” Tis is the equivalent of buying dollars
   for ffy cents.
   Ok, you’re thinking. Tis is all well and good. Wait for the market to go
   crazy and buy below the fair value. However, there is one problem: How can
   we be sure that we can even come close to knowing the value of a company?
   How can we be sure that our forecasts (a.k.a. wild guesses) are even in the
   ballpark? Aren’t there a ton of smart people and computer programs waiting
   to scoop up a bargain as soon as it becomes available?
   Surprisingly, not as many as you think.
   QUESTION TO CONSIDER:
9. Tink about something that you got a really killer deal on that you
   bought in the past, how were you able to get that deal? How is this
   similar to the stock market?
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   21
   SECTION 2
   WHAT IS THE VALUE OF A BUSINESS?
   We’ll only invest in a company when the price we pay today is
   signifcantly less than the value we will get tomorrow.
   Example: Teacher picks a student at random. Teacher holds up a $10 bill
   and asks the student, “What is the value of this bill?” Ten dollars. Teacher
   holds up ten $1 bills. She asks the same question, “What is the value of these
   dollar bills?” Ten dollars. Teacher ofers to sell the student the $10 bill for
   the ten $1 dollar bills. Tis is a wash so maybe he’ll take it, maybe he won’t.
   Ten Teacher ofers to sell the $10 for only fve $1 dollar bills. Of course he
   should take it. Ask the question to the rest of the class at large, “How many
   of you would buy this?” Do the reverse. Ask to sell the $10 bill for twenty $1
   bills? How many would take this? None of them.
   Te best investors are able to snatch up $10 bills when the market is only
   asking $5 for them. But how is this possible? It is possible because 1) the
   value is tricky to calculate and 2) the market is irrational.
   Remember the Market goes nuts. Is this a good thing or a bad thing for
   you? It’s a very good thing. If all investors based their investment decisions
   on rational and conservative estimates of intrinsic value, it would be very
   difcult to make money in the stock market. Fortunately, the participants in
   the stock market are humans subject to the corroding infuence of emotions.
   Many investors will give into hype around stocks, or people will hop on a
   trend, because they have optimistic views that they can beat the system. As
   young investor geniuses, we will always check emotions at the door and buy
   stocks based on what they are really worth.
   But how do we know what the value of the company is?
   Let’s take Apple. What is the value of the world’s largest business of
   consumer electronics? Te value of any business is the present value of all
   future cash the company will make minus the cash it needs to invest to
   make this happen. Ok, that’s a bit of a mouthful, stay with me.
   Let’s assume that today Apple sells 200 million (mn) products per
   year at an average price of $1,000 each. So they make $200 billion dollars
   a year in sales. But to make those 200mn products, they spend $700
   per device to design and make them and $100 to buy the equipment. So
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   22
   they’re taking home $200 per device, or 40bn dollars. Would you pay $40
   to receive $40 next year? No, not unless you think Apple is going to keep
   making money the following year. Ok, let’s assume Apple sells 5% more
   products every year at the same price of $1,000. Next year they make $44bn,
   the following year they make $48.4bn and so on. Te value of Apple then
   becomes everything under the line. Let’s assume Apple can keep this trend
   for the next 40 years. Te total amount of profts going forward, at today’s
   value is about $675 billion dollars. Not bad, eh? Divide that by the number
   of shares outstanding, and we have the value of the shares at about $111
   dollars per share.
   Annual Proft
   Products sold200 million
   X Average Price$1,000 each
   = Sales $200 billion

• Product Cost $160 billion ($700 + $100 X 200 million)
  Proft $40 billion (or $200 per device)
  QUESTION TO CONSIDER:

1. How much proft would Apple make if it sold 500 million products
   per year at the same price and the same proft per device?
   Apple Financials, assuming that they sell 5% more devices per year at the same price:
   2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 CONT..
   Price $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000 $ 1,000
   Sold (mn) 200 210 220.5 232 243 255 268 281 295 310 326 342
   Revenues 200,000 210,000 220,500 231,525 243,101 255,256 268,019 281,420 295,491 310,266 325,779 342,068
   Cost -$800 -$800 -$800 -$800 -$800 -$800 -$800 -$800 -$800 -$800 -$800 -$800
   Profit $40,000 $42,000 $44,100 $46,305 $48,620 $51,051 $53,604 $56,284 $59,098 $62,053 $65,156 $68,414
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   23
   Now let’s tweak with the numbers. Let’s say instead of growing 5% per
   year, Apple only manages to sell the same amount of devices every year going
   forward. Te graph becomes fat and the total value of Apple is nearly cut in
   half to $391mn, or $64/share. At the current share price that means you’re
   going to lose half your money.
   Now, let’s assume that Apple manages to have very strong growth of 15%
   per year for a few years, but in year four the company has competitive pressure
   and profts get cut in half. Ten they get cut in half again and profts remain
   at this level going forward. Te value of Apple plummets to $220bn or $36/
   share. Ouch!
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   24
   So frst we have the market defnition of what a company’s value is and
   second, we have tips and tricks from other investor geniuses. Te value of what
   a company is worth really rests on just two questions:
   1) How much are profts going to grow and
   2) How long are these profts sustainable?
   Tose are the two things that determine how much value comes back to
   you in the long run as an owner of the business. ‘How long will this last?’ is
   probably the most important question you can ask yourself, in trying to fgure
   out what a company is worth.
   Now, even the best investors will tell you they have been dead wrong on the
   value of companies on many, many occasions. Tey’ll also admit to you that
   for half of the companies on the market, they frankly have no idea what the
   true value of the company is. Why? Because the future of many companies is
   too uncertain to predict.
   If you don’t know how long those profts will last, you can’t compute what
   the company is worth. For most companies it is a wild guess how long those
   profts can last because they don’t have any real defenses. Tey don’t have an
   economic moat. Te good news is that there are some exceptional companies
   with a substantial moat around their castle that we know can’t be competed
   away easily. By investing in these high-quality businesses we can have much
   more assurance that they will have a good value today as well as tomorrow.
   Tese are the companies we can feel confdent that we are at least in the right
   ballpark when calculating their long term value. So when Mr. Market comes to
   us in one of his bad moods wanting to sell us shares of really great companies
   at a discount, we say, “Sure! Give me all you got!”
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   25
   ACTIVITY: ONLINE VS. STORES?
   Question: Why do you think Amazon.com (Ticker AMZN) has nearly the
   same market cap as Walmart (Ticker WMT) even though it makes less today
   in profts? Which company do you think will be valued more in 10 years?
   Go to Finance.Yahoo or other resources. Discuss the following:
   1) Who is growing sales faster?
   2) Who is growing profts faster?
   3) Which business do you think has profts that are more sustainable?
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   26
   SECTION 3
   UNDERSTANDING THE TERMINOLGY
   Acompany’s worth – its total value – is called its market capitalization
   and it is represented by the company’s stock price. Market cap (as it is
   commonly referred to) is equal to the stock price multiplied by the number of
   shares outstanding.
   For example, a stock with a $5 stock price and 10 million shares outstanding/
   trading is worth $50 million ($5 x 10 million). If we take this one step further,
   we can see that a company that has a $10 stock price and one million shares
   outstanding (market cap = $10 million) is worth less than a company with a
   $5 stock price and 10 million shares outstanding (market cap = $50 million).
   Tus, the stock price is a relative and proportional value of a company’s worth
   and only represents percentage changes in market cap at any given point in
   time. Any percentage changes in a stock price will result in an equal percentage
   change in a company’s value. Tis is the reason why investors are so concerned
   with stock prices and any changes that may occur since even a $0.10 drop in a
   $5 stock can result in a $100,000 loss for shareholders with one million shares.
   QUESTIONS TO CONSIDER:
2. What is the Market Cap of a Company with a stock price of $20/share
   and 10 million shares outstanding?
3. What is the current Market Cap of Apple? How many shares do they
   have outstanding and what is the stock price?
   Te next logical question is: Who sets stock prices and how are they
   calculated? In simple terms, the stock price of a company is calculated when a
   company goes on sale to the public, an event called an initial public ofering.
   Tis is when a company will pay an investment bank a lot of money to use very
   complex formulas and valuation techniques to derive a company’s value by
   determining how many shares will be ofered to the public and at what price.
   For example, a company whose value is estimated at $100 million may want to
   issue 10 million shares at $10 per share or they may want to issue 20 million at
   $5 a share.
   As we saw in the example with Apple, a company’s value is dependent on
   how much the company can grow its earnings in the future. When a company
   sells more items or enters a new market or improves margins, it can grow
   profts.
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   27
   THE “GO-TO” WAY TO VALUE A BUSINESS: P/E RATIO
   One way to determine the value of a business is with the Price-to-Earnings
   Ratio or P/E Ratio.
   Te price-earnings ratio can be calculated as:
   Market Value per Share (Stock Price) / Earnings per Share
   For example, suppose that a company is currently trading at $43 a share
   and its earnings over the last 12 months were $1.95 per share. Te P/E ratio for
   the stock could then be calculated as $43/$1.95, or about 22x.
   In essence, the price-earnings ratio indicates how many years an investor
   has to wait at the current earnings to get all their money back. If the P/E ratio
   is 22x, you are saying at this level of earnings, it will take you 22 years for the
   company to earn how much you bought the stock for $43. In general, a high
   P/E suggests that investors are expecting higher earnings growth in the future
   compared to companies with a lower P/E. A low P/E can indicate either a
   company may currently be undervalued or the company’s profts are expected
   to decline.
   Tink of a P/E as the price you pay for a stock.
   In general, there are a couple of Price / Earnings (P/E) rules of thumb:
   ֍ Te average P/E over the past decade is 15x. An average company,
   should be worth about 15x.
   ֍ Really great companies (very high returns with consistent earnings
   growth) tend to trade about 20-25x P/E.
   ֍ Bad companies, ones whose earnings are unpredictable and make low
   returns, usually trade at below 10x P/E.
   ֍ A company should trade at about the P/E as its earnings are expected
   to grow in the future. Companies growing profts 30% per year may
   be justifed to trade at 30x P/E. Companies growing 15% per year may
   trade at 15x P/E. Companies not growing may trade at 5-10x P/E.
   Here is a quick chart to gauge what the P/E Ratio should be:
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   28
   As you can see, valuing stocks is like going to a grocery store. You get what
   you pay for. If you want to buy the best product, you’re likely going to have
   to pay for it.
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   5 P/E 10 P/E 15 P/E 20 P/E 25 P/E
   Low growth
   Cyclical
   Low quality
   (ROE <10%) Low growth Cyclical ROE 10-2% Average Company Above Average Company Over 20x P/E indicates a strong company ROE>15%
   High growth
   Or Very
   High Quality
   Company
   ROE>20%
   KEY TAKEAWAYS
4. Stocks fuctuate wildly on a yearly basis. Te true value of the business
   does not actually change much.
5. Te reason behind this is that there is a man named Mr. Market that is
   just plain NUTS!
6. If someone ofers you a dollar for ffy cents, take it!
7. Te two most important things that determine the value of a company
   are 1) how much profts are going to grow to and 2) how long that proft
   level is sustainable.
8. Te P/E ratio is a good starting point to determine the value of a
   company.
   29
   LESSON 3:
   WHAT MAKES A GOOD BUSINESS?
   Introduction
   Think fnding a good long-term business is easy? Just take a quick look
   at history and you’ll see that only a handful of companies survive
   over time. For example, create a list of businesses that have failed or gone
   bankrupt in the past 20 years. (Examples: Chrysler, Enron, Delta Airlines,
   Countrywide Mortgages, and Lehman Brothers) Why do you think that
   some companies succeed while others fail? How can we identify the winners
   from the losers for investment purposes?
   30
   SECTION 1
   HOW DO I KNOW IF A COMPANY IS A GOOD BUSINESS?
   I
   magine we have two friends who will both open a small business. Our frst
   friend, Jack, wants to open a chain of candy stores called “Jacks Candy Shop.”
   It will cost him $2,000 to build and each will earn him $1,000 per
   year in profts. Tat’s a whopping 50% return on investment!
   (ROI) ($1,000/$2,000) In two years, he will have made his $2,000
   investment back. In four years, he will have doubled his money-
   -assuming the stores stayed just as proftable at $1,000/year.
   Tis is certainly a pretty incredible business.
   Now, our other friend, Jill, wants to open a chain
   of specialty pet stores called “Just Rodents.” It
   also costs $2,000 to build per store, but it’s a bad
   business– (who wants to own a pet rat, right?).
   And additionally, it only makes $40 per year in
   profts, or a 2% return on investment. ($40/$2,000)
   Both stores cost the same to build but one simply
   makes more than the other.
   Both owners approach you to potentially invest and buy half of their respective
   stores for $1,000 each. Do you invest in Jack’s Candy shop or Jill’s Rodent Shop?
   Of course, the answer is obvious: you choose the higher return business (50% in
   this case).
   A business that earns a high return on capital (or sometimes called return
   on equity or ROE) is always the best business. Tink of the ROE as the amount
   that a business gives back to you each year as a shareholder. It’s the diference of
   receiving a $20 bill each year or a $10 bill each year. A 20% ROE (return on equity)
   is better than a 10% ROE and Jack’s 50% return on capital business is phenomenal.
   But, is a business that earns a high ROE today always worth more than one that
   earns a lower ROE today? Not necessarily.
   Take this example: Would you rather receive $20 dollars today and then $10
   dollars-a-day for the rest of your life, or $15 dollars today and $15 dollars-aday for the rest of your life?
   Answer: You’d defnitely want to take $15 for the rest of your life. (Te diference,
   in case you’re curious, is that you’ll receive $350k for the $15/day and $233k for
   the $10/day).
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   31
   So, Jack’s Candy shop earns a fantastic 50% return on equity today. And
   this is great– but since everyone knows what the business is earning today,
   the real question is: can they keep earning those high returns years into the
   future? What happens when the Ice Cream Shop in town realizes that Jack’s
   Candy Shop is making amazing profts, so they start selling candy in their
   store as well? What happens when a retail giant like Wal-Mart decides to
   open their own Candy stores to compete? Does Jack have to lower his prices
   so that he only makes $200 proft per store, and that 50% ROE becomes 10%
   over time? Tese are the key questions a savvy investor must ask himself.
   Tere are a couple of important laws in investing. Much like the law of
   gravity, Murphy’s Law and under the laws of economics, any time a business
   like a candy shop earns exceptionally high returns, forces will come in to
   reduce those returns. If Jack’s candy shop is earning a 50% return on capital,
   like a magnet, this is certainly going to attract more people to open candy
   shops, charge lower prices, advertise more, and eventually those returns will
   be reduced. Tis is economics 101: If a company earns a return on capital
   above the average, competition is going to come in and compete it away. High
   returns on capital attract competitors like bees to honey. And most high
   returns end up being whittled down to average over time.
   Unless, however, this company has something unusually powerful that
   others can’t imitate. Warren Bufett called this an “economic moat”. Like a
   medieval castle, some very good companies are protected by a wide moat to
   keep competitors at bay.
   Te best companies are the ones that provide high returns on capital, but
   are also able to protect and grow those returns through a unique protection
   (moat) that makes it very difcult for those competitors at the gates to come
   in and take them away.
   QUESTIONS TO CONSIDER:
9. If Wal-Mart decided that Candy Shops were a great high-return business,
   would their Candy Shops be better, the same, or worse than Jack’s Candy
   Shops? What do you think would happen to Jack’s return on capital if
   Wal-Mart is now a direct competitor?
10. What is an economic moat and why is it important for the long term
    success of a company?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    32
    SECTION 2
    WHATEVER FLOATS YOUR MOAT
    Bigger is not necessarily better when it comes to digging an economic moat.
    It is very easy to assume that a company with a high market share also has
    a sustainable competitive advantage—how else would it have acquired such a
    big chunk of the market? —But history shows us that leadership can be feeting
    in highly competitive markets. Kodak (flm), IBM (PCs), Netscape (Internet
    browsers), General Motors (automobiles), and Corel (word processing
    sofware), are only a few of the frms that have discovered this.
    In defning an economic moat, what should you look for? Tere’s a couple
    types of moats that have been proven to last the test of time. Here’s your list:
    Types of Economic Moats
    ֍ Intangible Assets: A company can have intangible assets, like brands,
    patents, or regulatory licenses that allow it to sell products or services
    that can’t be matched by competitors.
    ֍ High Switching Costs: Te products or services that a company sells may
    be hard for customers to give up, which creates customer switching costs
    that give the frm pricing power.
    ֍ Network Efect: Some lucky companies beneft from network economics,
    which is a very powerful type of economic moat. It says that the more
    people you have on your platform or in your distribution system, the
    better the value for them, which creates a virtuous cycle.
    ֍ Low Cost Advantage: Finally, some companies have cost advantages,
    stemming from process, location, scale, or access to a unique asset, which
    allow them to ofer goods or services at a lower cost than competitors.
    Tese four categories cover the vast majority of frms with moats. Now
    that you know them, you can begin to identify them. Tey are used by the best
    stock investors to identify great companies.
    QUESTIONS TO CONSIDER:
11. Can you name one business that you think has a “wide moat”? (one that
    is unlikely to have its competitive market position eroded 10 years from
    now).
12. Can you name one business that you think has a “narrow moat” (one that
    has a good business today, but whose high returns are unlikely to last 10
    years from now).
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    33
13. Can you name one business that you think has “no moat” (one that
    is a highly competitive, bad business today and in the future as well).
    QUICK MATCHING GAME:
    Te following companies have stood the test of time, which probably
    indicates they have some sort of economic moat. Can you identify what
    their economic moat is? (brand, high switching costs, network efect, low
    cost advantage)
    ֍ Coca Cola
    ֍ Bank of America
    ֍ Google
    ֍ Wal-Mart
    ֍ Exxon Mobil
    Hint: Tere can be more than one per company!
    Conclusion
    All businesses are not created equal, some are bad, most are average,
    but some are really, really good. Selling candy is better than selling rats,
    and even better is to sell Coca-Cola or iPhones. Te goal of the long term
    investor is to identify really good companies that can earn high returns
    on capital for decades into the future. Te only way to defend these high
    returns though is with a deep economic moat.
    Types of Economic Moats
    ֍ Intangible Assets / Brands
    ֍ High Switching Costs
    ֍ Network Efect
    ֍ Low Cost Advantage
    Te surest way to make money in the stock market is to invest in good
    companies that make exceptional returns and can defend these returns for
    decades into the future. In this lesson, you learned how to identify these
    companies. If you master this skill, you will gain one of the most valuable
    investing tools a great investor will ever learn.
14. Most businesses will fail.
15. Tere are some exceptional businesses out there that have an
    “economic moat”.
    Warren Bufett
    “Time is the friend
    of the wonderful
    company, the
    enemy of the
    mediocre.”
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    KEY TAKEAWAYS
    34
16. Great companies have the economic moats of Brand, High Switching
    Costs, Network Efects or a Low Cost Advantage.
17. Don’t open a rat store.
    ACTIVITY
    Good businesses have something unusual about them. Tey have a
    product or brand image or network efect that is so strong that you can be
    certain they will retain their advantage for many years to come. Tis type of
    business has some unique characteristic(s) that can’t be replicated.
    For example, the year is 2005. Kelly Clarkson just won American Idol.
    Facebook and YouTube were just launched. Brad Pitt and Jennifer Aniston
    were still married. Yikes. 11 years ago!
    Which company do you think managed to keep their return on capital
    (ROE) over the next decade (2005-2014), in line or higher than the previous
    10 years? i.e. retained their moat
    Apple: 13.7% ROE (1995-2004)
    Company Background:
    Makes computers, phones, sells sofware and apps, and operates retail stores
    2005-2014: ?
    Hewlett Packard: 12.2% ROE (1995-2004)
    Company Background:
    Te largest computers company in the worlds. Also sells sofware services
    2005-2014: ?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    35
    Te answer of course is Apple. Apple increased from 13.7% to 30.9% return
    on equity (ROE) compared with HP whose ROE decreased from 12.2% to
    10%. People simply like iPhones more than PCs, and Apple has a much
    stronger brand image, ecosystem around its products, and quality of design
    than HP. Specifcally, Apple benefts from the economic moats of 1) a strong
    brand (they price their products at a premium) and 2) high switching costs
    (the Apple ecosystem makes it costly to switch to Android or Windows once
    you’ve bought movies, music and apps on iTunes). HP really just makes
    another run of the mill computer for cheap. And their stock prices? Stock
    performance follows company performance, so Apple’s stock increased 975%
    while HP increased by a measly 40% over the time period.
    ALIEN INVASION ACTIVITY:
    Situation:
    Te year is 2005, and Aliens have invaded earth! Tey are going
    to destroy every human in the world, except they notice something
    they don’t understand: how is it possible that some imaginary
    creatures, called “Companies” can be so dominant. Tey assume
    it will lead them to universal domination if they can discover the
    secret. So they make all humans a wager: if anyone is smart enough
    to know the secret of how to identify what companies will continue
    to make the same or higher return on equity over the next decade,
    then you get to live. If you can’t, you die!
    You will have a series of four tests. Only one of the two companies
    on each list could be defned as highly defensible, exceptional
    businesses that can protect its return on capital. Can you identify it?
    Your life depends on it. Te aliens want to speak to “your leader”
    so you should debate on what to pick within the club, and eventually the
    portfolio manager will decide which stock to choose for the group. Ready
    earthlings!?
    Question 1
    Walt Disney: 12.6% (1995-2004)
    Company Background: Operates Teme
    Parks, Makes Movies, Sells Merchandise,
    owns ESPN Networks and Disney
    Channel.
    2005-2014: ?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    36
    Nintendo: 15.1% (1995-2004)
    Company Background: Makes video game systems, video
    games, including Nintendo Wii, and Nintendo DS.
    2005-2014: ?
    Questions to think about:
18. What were the main things that happened to Disney and Nintendo
    during the next decade (2005-2014)?
19. What could you identify as Disney’s moat? What about Nintendo’s?
20. What is it about that businesses that makes them sticky? Is one “stickier”
    than the other?
    Question 2
    Abercrombie & Fitch: 55.0% (1995-2004)
    Company Background: Te most popular clothing retailer
    for teenagers, with very strong brand appeal
    2005-2014: ?
    Coca Cola: 17.9% (1995-2004)
    Company Background: Te leading beverage company in the world
    with the brands Coca Cola, Sprite, Fanta, PowerAde
    2005-2014: ?
    Question 3
    Southwest Airlines: 13.2% (1995-2004)
    Company Background: A well-run airline that is known for lowcost airfare.
    2005-2014: ?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    37
    McDonalds: 17.1% (1995-2004)
    Company Background: Te leading fast food operator in the
    world.
    2005-2014: ?
    Question 4
    Microsof: 25.2% (1995-2004)
    Company Background: Maker of Computer Sofware: Windows, Microsof
    Ofce and Xbox Vid.
    2005-2014: ?
    Verizon: 20.8% (1995-2004)
    Company Background: Leading cell phone operator in the US.
    Operates cable and fber optic networks.
    2005-2014: ?
    Round-up:
    Did you survive? If not, what tripped you up?
    If you keep practicing and become a student of businesses, pretty soon you’ll
    become a pro at identifying economic moats within companies around you.
    When you’ve learned it, it’s one of the most valuable skills you will ever learn
    in the business world.
    ANSWERS TO ACTIVITES
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    38
    QUICK MATCHING GAME:
    1). Coca Cola – Brand, Network Efect (Distribution around the world)
    2). Bank of America – High Switching costs, (It’s a pain to switch banks, so
    most people don’t).
    3). Google – Network Efect (the more people that use Google search, the
    better it becomes)
    4). Wal-Mart – Low Cost (Wal-Mart’s buying power allows them to buy
    products at the lowest cost) and Network Efect (Superior distribution
    and supply chain).
    5). Exxon Mobil – Low Cost (Exxon has low-cost oil felds that make money
    in almost any oil price)
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    39
    Comparative Stock Charts using StockCharts.com
    ALIEN INVASION ACTIVITY
    Question 1: Walt Disney vs. Nintendo?
    Answer: Walt Disney
    Results: Walt Disney went from 12.6% ROE (1995-2004) to 13.01% (2005-2014)
    while Nintendo went from 15.1% ROE (1995-2004) to 9.4% (2005-2014). Te
    stock prices? Disney was up 298% and Nintendo was down 11.5%.
    Rationale: Walt Disney Corporation has a strong brand of characters and theme
    parks; not to mention that ESPN is the most proftable television stations in the
    world. Teir brands are about as strong as they come, just ask any kid under
    the age of 10. Nintendo, on the other hand, does have a decent brand, but video
    games are a hit and miss business. Nintendo actually lost money in 2011 and
    2013 because of poor sales.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    40
    Comparative Stock Charts using StockCharts.com
    Question 2: Abercrombie & Fitch vs. Coca Cola?
    Answer: Coca Cola
    Results: Coca Cola went from 17.9% ROE (1995-2004) to 29.5% (2005-2014)
    while Abercrombie & Fitch went from 55% ROE (1995-2004) to 16.4% (2005-
    2014). Te stock prices? Coca Cola was up 110% and Abercrombie & Fitch was
    down an astonishing 56%.
    Rationale: Coca Cola is probably one of the strongest brands ever built. Tey
    also have a distribution advantage (network efect) throughout the world
    as they dominate the sof drinks industry with over 50% of global sales.
    Abercrombie & Fitch is a clothing retailer, which is a very difcult business.
    Just think about going into a mall, there are hundreds of competitors, and the
    viability of the business in the future depends on staying “cool” and being on
    the cutting edge of fashion. Very tough to predict given the high amount of
    competition. Both companies would have a “brand” but this shows that one
    brand is much stronger than the other.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    41
    Comparative Stock Charts using StockCharts.com
    Question 3: Southwest Airlines vs. McDonalds?
    Answer: McDonalds
    Results: McDonalds went from 17.1% ROE (1995-2004) to 29.3% (2005-
    2014) while Southwest Airlines went from 13.7% ROE (1995-2004) to 7.5%
    (2005-2014). Te stock prices? McDonalds rose 178% and Southwest Airlines
    actually held in there ok, up 157%.
    Rationale: Although you might not care for Big Macs, McDonalds is still a
    legendary brand, especially overseas where it is a symbol of the American
    lifestyle. Teir greater scale also enables them a cost advantage relative to other
    fast food chains. Southwest Airlines, is the best of a really terrible business:
    Airlines. It’s an example of the investment adage “it’s better to bet on a good
    horse than a good jockey,” meaning a bad business with great managers is
    likely a losing bet. Airlines are capital intensive (planes are expensive!) and are
    highly competitive on price. During this decade, Delta Airlines, Continental,
    and American Airlines all went bankrupt, so at least Southwest didn’t go
    bankrupt.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    42
    Question 4: Microsof vs. Verizon?
    Answer: Microsof
    Results: Microsof went from 26.2% ROE (1995-2004) to 35.1% (2005-2014)
    while Verizon went from 21.2% ROE (1995-2004) to 15.0% (2005-2014). Te
    stock prices? Microsof rose 78% and Verizon rose 73%.
    Rationale: Microsof benefts from one of the most powerful economic moats,
    the network efect. People use their ofce products (Microsof Word, Excel)
    because everyone else does, which makes it the standard. Windows is also
    the standard operating system for most businesses. One could argue that
    Microsof was one of the poorest run companies during this decade (throwing
    away billions of dollars into Nokia, mobile phones, Bing), but it didn’t matter.
    Te network efect was too powerful for even incompetent management to
    break. Verizon, is not a bad business, with a pretty good brand and a network
    efect (the more friends and family that are on Verizon the more valuable it
    is to you), but owning fber optic cables and towers is a very capital intensive
    business so high returns are tougher to sustain. Not to mention Verizon was
    late to get the iPhone.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    43
    LESSON 4:
    FINDING STOCKS TO INVEST IN
    Introduction
    Looking for good stocks is a treasure hunt. Identifying an exceptional
    company is rare, but fnding an exceptional company that is on sale
    is truly a feat. But the good news is it’s not impossible! Deals are almost
    always out there. You just need to know where to look. It requires some
    searching, some diligence, and a lot of homework, but it’s certainly worth it.
    Discussion Question: Tink of things that you spend money on every
    month (examples: Netfix, Chipotle, video game monthly subscription,
    new clothes, etc.). What makes these purchases so “sticky”? Could these
    companies make for good investments?
    Besides investing in companies whose products you use, you can also
    fnd fantastic stock ideas by reading reports written by other investors and
    by doing stock screens (more on what this is later) to search for specifc
    variables. We’ll show you how!
    44
    SECTION 1
    HOW DO I COME UP WITH INVESTMENT IDEAS?
    Now, we’re getting to the fun part – picking stocks. But where do we start?
    One common investment motto is to “invest in what you know.” Tis is
    a good place to start, but we also need to be careful. Many companies we
    know are actually terrible investments. For example, let’s go back 15 years.
    In the year 2000, what were the companies that the average person knew? We
    shopped at Sears every weekend, we surfed the internet on Netscape, we took
    pictures with Kodak flm, we bought GM cars and we few on Delta Airlines.
    Alright, sweet! Load up a portfolio of the things we know!
    Te problem is that all fve of those well-known companies would go
    bankrupt in the next decade and we would lose all our money. Just because
    something is well-known, doesn’t mean that it’s a good business.
    Warren Bufett taught that we do indeed want to own simple, easy to
    understand businesses, but that these businesses need a competitive moat
    around them. Te problem with all of the businesses we mentioned before
    is that none of them really had a protective moat around them. Sears was
    out-priced by Wal-Mart, Netscape lost out to Microsof Explorer, Kodak was
    uprooted by a change in the technology, GM’s cars went out of favor, and
    Delta went bankrupt along with just about every other airline. (By the way, if
    you want a business that is good at torching piles of cash, airlines are always
    a good place to start!)
    So how do we start fnding truly good businesses? Remember back to
    Lesson 3 on Economic Moats.
    Start by asking yourself a few questions:
    ֍ What products am I happy to pay a price premium for because the
    service they ofer can’t be replicated by another? (Brand, Quality)
    ֍ What services do I continue paying for because switching services
    would be too costly or a huge inconvenience? (High Switching Costs)
    ֍ What platform do I use because it is the only one where I can meet up
    with a certain type of people and because the network or marketplace
    can’t even be compared to a peer? (Network Efect)
    ֍ What products have been around for generations – you can picture
    your parents and grandparents enjoying them and easily picture your
    grandkids enjoying them as well? (Sustainability, Brand)
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    45
    Legendary investor Peter Lynch, who averaged a 29% return per year over
    23 years at Fidelity, tells the story of his wife coming home from the grocery
    store and mentioning a new product – pantyhose in an egg shaped case called
    “L’eggs.” She raved about what good products they were. He also noted that
    she was picking up more pantyhose than ever, because she was visiting the
    grocery store twice a week compared to the department store which she only
    visited maybe every other month. With this knowledge in hand, he began
    aggressively buying shares in Hanes, the maker of the L’eggs pantyhose. Te
    stock became a 30-bagger for his fund, meaning it didn’t just double or triple,
    it went up 30x! He found the idea, not from the Wall Street Journal, but from
    paying close attention to how people were using the products around him.
    Peter Lynch’s legendary book One Up on Wall Street is a great resource to see
    how one of the most successful investors of his time came up with some of
    his best investment ideas.
    ACTIVITY: CAN’T LIVE WITHOUT IT
    Make a list of three companies that have products that you “can’t live
    without” considering the questions above. Do you think this company could
    make a good investment?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    46
    SECTION 2
    STOCK SCREENS
    Another useful way to search out great stocks is to run a stock screen.
    Basically, when you run a stock screen you are running the stock market
    through a giant flter to sort out the characteristics that you want. It’s similar
    to choosing a car: you know you want a blue, four-door car with good gas
    mileage, at a certain price, with a minimum horsepower. You put all this info
    into a search engine and come out with your “Goldilocks” car. Te concept is
    similar for a stock screener. When you know what to look for, a stock screen
    is a wonderful starting point.
    Tese are some of the fnancial characteristics that you should screen for
    among your initial list of investment candidates. Ideally you want to fnd a
    great company that is growing and you can buy cheap. Here are a couple of
    factors you can look for:
    ֍ A business that has very stable earnings, with little fuctuation year to
    year
    ֍ A company that has positive cash generation (Cash generation is the
    cash profts minus the investment costs to grow the business.)
    ֍ A company that consistently makes a healthy return on capital
    ֍ A company that pays a dividend that grows consistently every year
    One of the most popular (and free!) stock screeners out there is Google’s.
    Below is a screenshot.
    https://www.google.com/fnance/stockscreener?hl=en&ei=jjr7VYH_
    KdaL0ASusarQCg
    Google’s Stock Screener allows you drag the range for a number of diferent
    criteria. It also allows you to go to “Add Criteria” and customize what you
    want to screen.
    Tere are many diferent metrics to screen for, but here are some helpful
    starting points:
    (If you see terms you don’t recognize below, refer to the glossary at the end of
    this page or investopedia.com)
    Go to Google Stock Screener and start playing around with the following
    screens.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    47
    IS THE COMPANY GOOD?
    ֍ 5y Return on Equity: greater than 12% (Also use Return on
    Investment)
    ֍ Good companies ofen have high margins (Gross Margin > 30%,
    Operating Margin > 15%)
    ֍ Interest Coverage above 3 times
    ֍ Stable earnings and Return on Equity through the years (look at a
    chart, or look over the past 10 years, on Morningstar.com or zacks.
    com)
    IS THE COMPANY GROWING?
    ֍ 5y revenue growth greater than 4% per year
    ֍ 5y earnings growth (and EPS) greater than 4% per year
    ֍ Forecasted growth in the next 5 years
    IS THE STOCK CHEAP?
    ֍ P/E ratio below 15x (market average)
    ֍ Dividend yield above 3%
    ֍ P/Book ratio below 2x
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    48

• Note, just because a company doesn’t meet all of these thresholds does
  not automatically mean that the company is not a good investment. A very
  high quality company that is growing and that is very cheap is ideal, but is very
  rare. If you’re trying to buy a new Ferrari under $10,000 you aren’t likely to fnd
  many results. Tradeofs will ofen need to be made, but the best investors stay
  disciplined and fnd the best combinations.
  Additional Stock Screening Tools:
  Tere are many free stock screening tools available online. Other useful
  screeners are Zacks.com (screenshot in on the right), Yahoo Finance, GuruFocus
  (subscription required) and Uncle Stock.
  As you learn more about the stock market and read stories of successful
  investors, pay attention to what metrics they examine. For example, some
  successful investors look for high growth companies (companies growing more
  YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
  49
  than 20% per year) that also have high margins (gross margin above 50%).
  Tese would be considered growth investors. Other successful investors
  look for very cheap companies (Price / Book below 1x). Tese would be
  considered deep-value investors. Tere are many ways to successfully invest,
  and screening helps give you a great starting point.
  THE S&P 500 & THE DOW JONES:
  One more list that is helpful is the Dow Jones Industrial Average. Tese
  are 30 of the largest and most signifcant companies in the United States.
  Tere will be many companies on this list that you will know, and these are
  companies that have been leaders for decades and even centuries, such as
  IBM, Procter & Gamble and Nike.
  Next you could look at the S&P 500. Here you will fnd a list of 502
  companies (not exactly 500, some companies are listed twice!) that represent
  the largest, most common companies in the United States. As you scan
  through these lists you can think to yourself:
  ֍ Does that sector look interesting?
  ֍ Do I know and like this company’s products?
  ֍ Do I have certain expertise about this company’s products that would
  give me an edge?
  ֍ Do I expect this company to grow?
  Or just click on a company randomly and see where it takes you. You
  might fnd your treasure.
  See a list of the current Dow Jones components in the Activity Section of
  this lesson. Search online for the full list of S&P 500 companies.
  YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
  50
  SECTION 3
  RESEARCH REPORTS:
  One of the best sources of investment ideas is other investors! Remember,
  there’s no rule in investing that says you can’t own a stock that another person
  owns. Cherry picking is encouraged! One way to fnd ideas is to read blogs
  or reports on stocks. Also, successful investment managers publish quarterly
  investment letters where they describe their top holdings and why they own
  them.
  Here are a couple of places to start reading:
  ֍ Seeking Alpha: Seekingalpha.com is an excellent databank of investor
  reports on companies. Some of the writers are professional investors,
  some are not, but there is a plethora of articles written on companies,
  both large and small.
  ֍ SumZero: Similar to Seeking Alpha, sumzero.com is an online platform
  where investment professionals write investment reports and promote
  stock ideas.
  ֍ Wall Street Journal and Te Financial Times: Tese are the two
  newspapers that every needs investor reads each day. Most people need
  to pay for online access, but you can read the articles for free if you copy
  the article’s title into Google and access it through Google directly (a
  legal and very useful trick!).
  ֍ Motley Fool: Fool.com is an always-interesting mix of fnancial news,
  investment strategies, and large doses of humor balanced by hard
  hitting serious news and opinion. Tom and Dave Gardner and their
  talented staf have been delivering their unique and informed message
  since 1993 and the Fool is now a full-service fnancial media enterprise.
  If you’d like your investing information tinged with some pleasant
  sarcasm and edgy laughs, the Fool might be perfect for you.
  ֍ Jim Cramer: Te host of CNBC’s Mad Money and co-founder of
  TeStreet.com is a journalist, lawyer, and “infotainer” (his term).
  He’s been dispensing fnancial and investment information to anyone
  listening since the mid-1990s. If you need a break from reading fnancial
  statements or waiting for your stock screener to advise you on your next
  hot investment, Cramer might add some zest to your day. A former
  hedge fund manager, Cramer has been in the investment trenches for
  some time. You may not agree with all that he says, but you will be
  informed and entertained.
  YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
  51
  ֍ GuruFocus: GuruFocus.com tracks the stock trades of successful
  investment managers to see what they are buying and selling. It also
  provides stock recommendations based on diferent investment criteria and has a robust stock screening tool.
  ֍ Value Investors Club: Valueinvestorsclub.com is an online investment
  club where top investment managers come together to share their
  best stock ideas.
  ֍ Beyond Proxy: Beyondproxy.com is one of the most successful investment blogs. It compiles interviews with portfolio managers and
  stock reports.
  Beyond this list, there are literally thousands of investor blogs out there.
  Some are good, some are not, and a few are truly excellent. Te point is that
  there are many free sources available to provide thoughts on companies and
  the market.
  GIVING DUE DILLIGENCE ITS DUE
  Once we come up with a list of a few interesting companies to potentially
  invest in, it’s time to roll up our sleeves and kick the tires. Remember that
  buying a stock of a company is really like buying a piece of that company –
  you are becoming a company owner! You would not make such a big decision
  before carefully considering your investment. Would you? It is funny that
  people ofen spend more time researching a movie to see or carefully studying
  the specs of a piece of electronic equipment they are planning to purchase
  than when buying a piece of their own company! In the early stages of the
  investment process, it is particularly useful to use the company’s products
  frst-hand.
  Learn as much as you can about the company in which you are going to
  invest. Here are a couple of steps to think about when doing your company
  “due diligence” (as the pros call it).
  Make sure the company is actually investible, or publicly traded. You can
  search for companies’ stock tickers on Yahoo Finance, or Morningstar.com.
  Go to the company website, click on the “Investor Relations” tab, and
  fnd a recent company presentation. Tis will give you an overview of the
  business.
  Read through the more in-depth Annual Report, also on the company
  website. Sections to focus on are the Management Discussion & Analysis
  and the Segment Reporting.
  YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
  52
  Read other investors’ opinions on the company on resources such as
  seekingalpha.com.
  Look through the company’s fnancials on sites like Morningstar.com.
  Evaluate the trends of the main company metrics.
  Remember our Golden Rule #3, DO YOUR OWN HOMEWORK. As you
  follow these steps and use all the resources available to you to do your detective
  work, you will begin to know the company inside and out. Remember, great
  investors see things that others don’t. Tey think outside of the box. Tey do
  their own work and develop a conviction in their investments.
  Te stock market “aggregates” or adds up all the opinions and knowledge
  of market participants to come up with what the “consensus” (or the general
  market) thinks a company is worth at any given point in time.
  Some people will just follow the crowd and invest along with this consensus.
  But as a wise investor who has done your own homework, you will have a
  strong sense of how the company is likely to perform in the future and you
  can take advantage of the “misunderstandings” that take place in the stock
  market every single day. Scary news headlines may motivate other (perhaps
  less knowledgeable or prepared) investors to panic by selling the stock.
  If you feel you got a great price on a stock you bought for the long-term,
  you are more likely to hold on to it through thick and thin. In our experience,
  this is almost always the right thing to do with the stocks of great companies.
  Here it is worth making a distinction between great companies and great
  stocks. In some cases, and especially in the short term, these may not always
  be the same thing. However, in the long run, since stocks are no more than
  pieces of companies, great companies are really great stocks.
  QUESTIONS TO CONSIDER:

1. What does it mean to be a shareholder of a company?
2. How is it possible to believe in a company or know it so well that you
   are confdent that you are right and the market is wrong about what it
   is worth?
3. Why does the market get it wrong sometimes?
   Afer completing this lesson, you should start to use the skills you learned
   in Lessons 1-4 to make a list of companies you came up with by doing some
   detective work. You start out with products you know and like, but gather
   additional evidence by seeing what other consumers are doing. You begin to
   run your own stock screens. You know that by buying a stock, you become a
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   53
   part owner of the company that issued that stock. You know that it is important
   to really understand the company so that you feel more comfortable trying
   to predict its future. You are now ready to go to the next step. You need to
   narrow your list to the stocks you really want to buy (the companies in which
   you want to be an owner). And you’re learning how to hunt for treasure!
   KEY TAKEAWAYS:
4. Finding great stocks is like a treasure hunt, a very, very rewarding
   treasure hunt.
5. Invest in what you know and do your homework.
6. Stock screens can be a powerful way to identify good companies.
7. Remember, there’s no rule in investing that says you can’t own a stock
   that another person owns! Reading research reports can be a great
   way to learn more about investing.
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   54
   LESSON 5:
   LEARNING TO SPEAK THE LANGUAGE OF FINANCE
   Introduction
   Suppose a friend came to you and asked you to
   invest in her new business. She has started a
   website design business and she would like more
   money to buy a new computer. Before you decide
   if you should invest in her business or not, think
   about the questions you would want to ask her.
   What questions did you come up with? Here’s a few
   you might have thought of:
   ֍ How much cash does the company already
   have?
   ֍ How much revenue has the company made
   since it was started? In the past year?
   ֍ How much revenue does the company expect to make in the future?
   ֍ What has the company spent its cash on in the past?
   ֍ Does the company have any debt?
   In order to answer these questions, a good place to start would be to look
   at the company’s fnancial statements.
   Learning to read Financial Statements is like learning a new language.
   If you want to order a good dish in a French Restaurant, you will need to
   speak French to read the Menu. Similarly, with companies, if you want to
   fnd a good stock to invest in, you will need to speak the language of fnance
   and read their fnancial statements. Just like learning any new language, it is
   difcult at frst, but the more you practice, the more fuent you will be come!
   55
   SECTION 1
   WHY DO COMPANIES PREPARE FINANCIAL STATEMENTS?
   All companies need to keep track of their fnances. Tis means the company is
   keeping track of all of the money coming in and money going out, as well as other
   transactions that don’t necessarily involve the exchange of money. At the end of each
   month, quarter (three months), and year, a company will prepare fnancial statements,
   which are a summary of all the fnancial transactions for that period.
   For a company that is publicly traded (meaning shares of the company stock are
   sold on a stock market) it is required that the company prepare and fle quarterly and
   annual fnancial statements so the government and the public can see how the company
   is doing.
   WHO USES FINANCIAL STATEMENTS?
   Lots of diferent parties will be interested
   in the fnancial statements of a company.
   First, the company’s management and board
   of directors will use the fnancial statements to
   track performance. Te fnancial statements
   show how the company has done in the past,
   and will help management make decisions
   about the future.
   Lenders (like banks who have made loans
   to the company) may also want to see the
   fnancial statements. Some loans may have
   certain requirements, such as the company’s
   debt to equity ratio cannot be more than 0.3
   in order to receive that loan. Or, the lender may just want to see how much cash the
   company has to estimate how likely it is the company will be able to pay back the loan
   and interest in a timely manner.
   Investors are also very interested in seeing the fnancial statements. Tey are making
   decisions about whether to buy or sell stock in the company, so they need to know how
   the company is doing to help inform their decisions.
   Can you think of anyone else who might use the fnancial statements of a company,
   other than management, banks and investors?
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   56
   WHAT ARE THE THREE FINANCIAL STATEMENTS?
   Let’s look at Apple, Inc. to learn about fnancial statements. Tere are three
   primary fnancial statements, 1) the balance sheet, 2) the income statement,
   and 3) the statement of cash fows. See below to fnd Apple’s 2014 fnancial
   statements. Also found online at
   http://www.apple.com/pr/library/2014/10/20Apple-Reports-Fourth-Quarter-Results.
   html
   THE BALANCE SHEET
   Let’s start by watching this video, made by Wall Street Survivor, a partner
   company of YIS.
   https://www.youtube.com/watch?v=Gyu5LnWSn5Y
   Te balance sheet (above) is a snapshot of the business
   at a single point in time. Tink of it like a photograph. It
   is a picture of what the business looks like on the day the
   picture is taken. Te balance sheet shows a snapshot of the
   company’s assets (its resources that it expects to create value
   in the future), liabilities (the loans and other obligations due
   to others), and owners’ equity (also known as shareholders’
   equity or stockholders’ equity—the stake that the owners or
   investors have in the business).
   Apple, Inc. prepared a balance sheet for the year ended September 27,
8. Here are some of the assets the balance sheet shows:
   $13.8 billion Cash (in fnance terms, cash is not just dollar bills, but all
   money held in checking accounts, savings accounts, etc. plus actual dollar
   bills on hand, if any)
   $17.5 billion Accounts Receivable (this means someone else bought
   something from Apple, but instead of paying right away, they still owe the
   money, and Apple is expecting to receive it in the future)
   $2.1 billion Inventories (these are the Macs and iPhones and iPads that
   Apple currently has in warehouses and stores, intended to be sold to customers)
   $20.6 billion Property, plant and equipment (this is the amount of land,
   buildings, and machinery that the company owns and uses to manufacture
   and sell goods)
   Here are some of the liabilities the balance sheet shows:
   YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
   57
   $30.2 billion Accounts Payable (this is the fip side of Accounts Receivable,
   so in this case, Apple has bought something from others and has promised to
   pay them for it in the future)
   $18.5 billion Accrued Expenses (this could include things like the
   obligation to pay interest to lenders and taxes to the government)
   $29.0 billion Long-term Debt (this means loans from a bank)
   Here are some of the equity balances the balance sheet shows:
   $23.3 billion Common Stock (this is the stock sold to investors on the
   market)
   $87.2 billion Retained Earnings (this is the amount of profts made in
   previous years that has been reinvested in the business to help it grow, rather
   than distributed to stockholders as dividends)
   QUESTIONS TO CONSIDER:
9. Why a balance sheet is important?
10. All things equal, would you rather have more liabilities or less?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    58
    SECTION 2
    THE INCOME STATEMENT
    Next, let’s watch this video on the Income Statement by Wall Street Survivor.
    https://www.youtube.com/watch?v=2RupCSFcY7w
    Te income statement shows a business’s performance over a period of time, such
    as a year. Tink of it like a video. It shows what happens to the business over time. Te
    income statement shows how much revenue the company made over the year, how
    much it cost to sell its main products, how much it cost to pay its employees over the
    year, and how much it owed in interest and taxes for the year. On a very basic level, if
    the company makes more revenue than it spends in costs, it is a proftable business. If
    the company’s costs are greater than its revenues, then it is not a proftable business.
    It is always good to remember not to look at just one fnancial statement and think
    it tells the whole story of the business. A good investor should learn to read all the
    fnancial statements, and look at trends occurring over time, from balance sheet to
    balance sheet and from income statement to income statement.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    59
    Apple, Inc. prepared an Income Statement for the year ended September 27,
11. Te income statement shows that Apple has sales of $182.8 billion during
    that year. Tat is how much revenue Apple made from all its sales of computers and
    phones and apps and songs on iTunes and everything else it sells. Tis is an increase
    from $170.9 billion in 2013 and $156.5 billion in 2012.
    Next, the Income Statement shows expenses, starting with Cost of Sales of
    $112.3 billion. Tis means in order to make all the products it sold for that $182.8
    billion revenue, it cost Apple $112.3 billion. Other expenses include $6.0 billion
    research and development costs, $12.0 billion selling, general, and administrative
    costs, and $14.0 billion tax expense.
    Finally, the Income Statement shows Net Income, which is known as the bottom
    line because – you guessed it! – it appears at the bottom of the Income Statement.
    Apple’s Net Income for the year ended September 27, 2014, was $39.5 billion.
    QUESTIONS TO CONSIDER:
12. Why the income statement is important?
13. Which two lines on the income statement do you think are the most
    important?
    THE STATEMENT OF CASH FLOWS
    Te third of the primary fnancial statements is the statement of cash fows. Te
    statement of cash fows shows how much cash came into the business and how much
    cash went out of the business. It’s important to note here that when we use the term
    cash in the fnance world, we mean not only dollar bills, like you might think of, but
    also checks and electronic transfers and the balance in the bank account. In fact,
    most businesses will do a lot of their transactions through electronic transactions,
    but we still call this cash. Tink of cash as just meaning all forms of money.
    https://www.youtube.com/watch?v=9DcRJD9rbbQ
    Below is a snapshot of Apple’s Statement of Cash Flows.
    Cash generated from operating activities, is one of the most important metrics
    to monitor. Tink of this as earnings or net proft, but the actual cash earnings.
    Many times if a company has big non-cash charges or gains in a year, the more
    accurate proft number is found on the Cash Generated from Operating Activities.
    Te other key metric to look out for in the Statement of Cash Flows is the
    Capital Expenditure (also referred to CAPEX), or the Payments for acquisition of
    property, plant and equipment. Total for this category is the cash used to invest in
    the business.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    60
    One of the best measures of the proftability of a business, according to
    Warren Bufett and many great investors is the Free Cash Flow.
    Tis is calculated by:
    Net Income + Depreciation – CAPEX = Free Cash Flow. Tis is how
    much cash the business generated that year.
    Activity:
    Can you calculate the Free Cash Flow for Apple using the statements in
    this lesson?
    *Hint, some of the metrics are found on the Income Statement and some are
    found on the Statement of Cash Flows.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    61
    SECTION 3
    HOW DO I FORECAST REVENUES OF A COMPANY?
    In its simplest form, future revenue can be calculated by multiplying the
    average selling price of the company’s product by the number of expected
    products sold. However, forecasting revenue isn’t that simple and can involve
    considering many diferent factors. For instance, Apple would see increased
    revenue if it sold its iPhone for more money per unit, but only if the number
    of phones sold didn’t decrease as a result of the price increase. Apple would
    love for both the price per unit and the number of units sold to increase,
    but these two things can move in opposite directions as people tend to
    buy fewer units as the price of that unit increases. Apple can also increase
    the number of units sold by expanding geographically. If it were to begin
    selling phones in a new country it hadn’t previously sold in, that would add
    revenue. Tere can be other ofsetting factors too, however. When Apple frst
    introduced the iPhone, iPods were quite popular, but when people began to
    buy iPhones, which included integrated digital music players, they began
    buying fewer iPods. Tis efect made it so that while Apple gained lots of
    revenue from the sale of its iPhones, it began losing its normal iPod revenue.
    Companies can also gain additional revenue by taking market share
    from competitors. If, for instance, the number of smartphones sold in the
    world is 1.2 billion per year and Apple sells 50% of those this year and 60%
    next year, it will see a revenue increase, all else being equal. Tis means Apple
    sold 600 million phones (50% of 1.2B) this year and will sell 720 million
    phones (60% of 1.2B) next year. Tis is known as “taking market share,” as
    Apple essentially took a bigger piece of the pie by going from 50% of the
    market to 60% of the market. Another way a company can grow revenue is
    by being in a market where the market itself is growing. For instance, if the
    market (i.e., the number of smartphones sold) grew by 10% from 1.2 billion
    phones to 1.32 billion phones, even if Apple retained a 50% market share,
    it would still sell 10% more phones. Companies can also grow revenues
    through opening or building new stores, acquiring other companies, etc.
    To forecast the revenues of a company, one must evaluate the industry,
    the company, and its competitors. Looking at a company’s revenue growth
    rate for many years is a good start. However, you must be careful not to
    assume that an abnormal period of time is in fact normal. For instance,
    Apple’s revenue growth rate was well over 10% per year since the early
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    62
    2000s, and it even reached rates of over 50% afer the company released the
    iPhone and iPad, but by 2013 Apple was a very large company with no new
    products in a long time, resulting in a growth rate of under 10% for the year.
    Had the analyst assumed that the company would grow revenue at 50% a year
    for countless years to come, he/she would’ve been in for a rude awakening.
    In conclusion, forecasting revenue involves a lot of diferent variables, but a
    savvy analyst who has done his/her homework should be able to generate a
    good forecast in time.
    ACTIVITY: FORECAST REVENUES
    Chose a company that is on your list from Lesson 4 that you can up with
    from screens or from a grocery store visit, or from other sources:
    ֍ How fast has this company been growing revenues over the past 5
    years?
    ֍ How fast did this company grow revenues last year?
    ֍ Has this company been growing faster or slower than its competitors?
    ֍ What do you expect they will grow at over the next 5 years?
    Use resources such as Morningstar.com, Zacks.com and Yahoo.Finance to
    research these metrics.
    HOW DO I FORECAST MARGINS OF A COMPANY?
    When analyzing stocks, you will likely review the income statement,
    balance sheet and statement of cash fows. Te income statement provides a
    fnancial summary of the operating results of the frm over a period of time
    such as a quarter or year. Te frst section of the income statement shows
    gross margins, simply the total revenue (sales) minus the cost of goods sold.
    Financial companies and service-oriented companies tend to have high gross
    margins since they ofen have lower costs of goods sold. Whereas industrial
    and manufacturing companies have lower gross margins as they have high
    cost of goods sold.
    Does the car manufacturing company Toyota have high or low gross
    margins? Tat’s right they have low gross margins! Car manufacturing has
    one of the higher cost of goods sold out of any industry, one car is made up of
    thousands of parts. Adding up all those parts equals a high cost of goods sold
    and lower gross margins. Remember the gross margin is simply subtracting
    the cost of goods sold from the total revenue. Which can be helpful when
    looking at two companies in the same industry, take Apple versus Samsung.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    63
    Tey both make wonderful cellular phones, who would you guess has higher
    gross margin?
    A. Samsung
    B. Apple
    Apple has the higher gross margin and why is that important? Whether
    they charge a higher price or they have lower cost of goods sold can lead to
    competitive advantages over the long run.
    Going a step further on the income statement you will notice operating
    incomes or EBIT. Operating Income divided by total revenues is Operating
    margin. Operating margin is a measure of proftability, how much of each
    dollar of revenue is lef over afer both cost of goods sold and operating
    expenses. Te operating expenses include payroll, sales commissions,
    marketing, transportation, travel, rent and other general expenses. It’s likely
    easier to comprehend if you think about buying a pair of pants. You are in the
    mall and want to buy a pair of pants that costs $50, that’s a nice pair of pants
    right? Tey felt so nice you go ahead and buy them, did you know it only cost
    $20 to make those pants. Tat’s the cost of goods sold right, $20. Did you
    pay too much? Let’s think about it. Afer the company made the pants, they
    had to ship the pants to the store by semi-truck, someone had to unload the
    shipment of pants, the company pays rent to have a store in the mall, the store
    has employees who put the pants on display and sold them to you, a commercial
    was made to promote the pants and these operating expenses add up to $25 on
    top of the $20 cost of goods sold. Leaving the company with a proft of $5 or
    gross operating margin of 10%.
    GROUP ACTIVITY: MARGIN MATCHING
    Let’s play a matching game! Match the company with the operating margin
    they make: Walmart and Facebook.
    Company A has operating margin of 24%
    Company B has operating margin of 5%
    Hint, the secret behind Walmart is they ofer the lowest prices and while
    they make little proft per good sold, they make up for it because they sell so
    much more socks, shampoo, and cereal than any of their competitors.
    Match the operating margin to the following three companies, Coca-Cola,
    Nike and Boeing.
    Company A has operating margin of 8%
    Company B has operating margin of 13%
    Company C has operating margin of 25%
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    64
    CONCLUSION
    Is your head ready to explode yet? You probably feel a lot like you did
    in your frst week of Spanish class. A little lost with a splitting headache.
    But give it a bit of time and you’re well on your way to being able speak the
    language of fnance. Whether you become a world-famous stock investor in
    the future, an accountant, or maybe just a dentist trying to keep the records of
    the business, learning to read fnancial statements is critical. Te more fuent
    you are, the more successful you will be in almost any industry of business.
    KEY TAKEAWAYS:
14. Finance has a language (accounting) that you learn how to speak.
15. Tere are three main fnancial statements, Te Balance Sheet, Te
    Income Statement and the Statement of Cash Flows
16. You need to be able to forecast a company’s revenue and margins correctly if you want to invest in them.
    ACTIVITY
    Situation: MIXED UP FINANCIAL STATEMENTS Let’s assume you
    landed a summer internship working for the legendary investor, Warren
    Bufett himself. One team will be chosen to be his next protégés, and will
    eventually take over his $60 billion dollar empire, Berkshire Hathaway.
    One morning, Bufett, comes to you in a tizzy. He explains he was doing
    analysis on companies and going through their fnancial statements. He
    printed of their balance sheets and income statements, but lost track of the
    names of the companies. He says, “Can you match the list of companies I
    was doing work on with the correct fnancial statements? I’m positive if I
    can match the correct companies, I will be able to fnd the next multi-billion
    dollar investment idea, and I will hire you to run my company!”
    Try to match up the correct the fnancial statements in APPENDIX A with
    each of the following companies. Te team with the most correct answers is
    the winner. NO CHEATING BY LOOKING ONLINE!
    Questions to Consider: (HINTS)
17. Does the company make high margins (Gross proft / Revenue)?
18. What do growth trends of revenue and net income tell you?
19. Is the business capital intensive (do they require a lot of assets to make
    money)?
20. Does the company hold a lot of inventories relative to their overall sales
    level?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    65
21. Does the company have a high debt balance?
22. Which company makes the most sales?
    COMPANIES:
    1). Amazon.com (ticker AMZN)– the largest eCommerce website in
    the world. Fast growing company, also has kindle, Amazon Fire and
    cloud storage business. Because of fast growth phase, the company is
    currently not proftable.
    2). Coca-Cola Company (ticker KO) – Te largest beverage company in
    the world. Coca-Cola is a high margin and high return (ROE) business
    (above 20%). Revenue has declined a bit in the past two years
    3). Celldex Terepeutics (ticker CLDX) – an early stage biotech company
    working on an experimental brain cancer vaccine. Te company is
    spending signifcantly on research and development, but will not reap
    the rewards of this investment until many years down the road.
    4). Freeport McMorran (FCX) – One of the largest copper and gold
    miners in the world. Te business has been hit due to declines in the
    prices of gold and copper. Tey also own some oil and gas felds.
    5). Costco (COST)– Costco is one of the largest retail chains in the US,
    operating a warehouse model that charges a membership fee. Inventory
    management and increasing sales per assets (sales turnover) is an
    important part of the business
    6). Facebook (FB) – Facebook is the largest social network in the world.
    Te company has few real assets (buildings, equipment) and the bulk of
    their costs are employees. Te company is in a high growth phase.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    66
    APPENDIX A: SELECTED FINANCIAL STATEMENTS
    COMPANY 1
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    67
    COMPANY 2
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    68
    COMPANY 3
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    69
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    70
    COMPANY 4
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    71
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    72
    COMPANY 5
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    73
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    74
    COMPANY 6
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    75
    LESSON 6:
    THE INVESTMENT THESIS
    Introduction
    Successful businesses start with a clear mission statement. Marriages begin
    with the exchange of vows. Similarly, successful stock investors begin with a
    clear investment objective, called an “Investment Tesis”. Tis tells you why you
    own the stock and what you expect to happen. When deciding what a particular
    stock is worth, its intrinsic value, what we are really asking is “what is it worth
    to you”? A horse is worth more to a farmer than a sailor. A McDonalds happy
    meal is worth more to kids than, well, any other rational human being. Value
    is always in the eye of the beholder, and when you buy a stock, the beholder is
    you. For example, if you need a steady cash payment every year from a stock in
    the form of a dividend, and a company decides to stop paying its dividend, its
    Investment Tesis is no longer valid. Tis is critical to know.
    In Lesson 4 we learned about legendary investor Peter Lynch said how he
    advocated buying companies that you know. He made a fortune of of buying
    Hanes stock because he wife liked the pantyhose. Peter Lynch said in one of
    his most famous quotes “Know What You Own and Know Why You Own It”.
    In other words, when you buy a stock, you need to know the WHY. Tis is
    important because the value of a particular stock can rise and fall multiple
    times in a month, week, day and even in an hour! Instinctively, we want to
    buy more when a stock price is soaring, and alternatively, we want to sell as
    soon as possible when the price drops. But many investors get caught up in a
    “herd mentality” and react to price fuctuations like stampeding cattle based
    on the direction they perceive the market is heading. Stock prices rise and fall
    for various reasons as new information (good or bad, accurate or inaccurate)
    enters the market. In order to know whether this new information should
    afect your decision to buy, sell or hold stock in a particular company, it is vital
    that you develop your own “investment thesis.”
    76
    QUESTIONS TO CONSIDER:
23. Other than in stock investing, can you think something in your life
    where it is essential to know the “WHY” of what you’re doing? How does
    knowing the “Why” help you succeed?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    77
    SECTION 1
    WHAT IS AN INVESTMENT THESIS?
    Before investing in a company, we need to have a carefully thought out
    “Investment Tesis.” An investment thesis is basically a simple and clear
    description of:
24. Why you own the company.
25. What you expect to happen.
26. What you see that the market does not give the company credit for.
    Many experienced investors will tell you that there is hardly anything as
    valuable in keeping them focused and intellectually honest as this simple
    exercise. Remember that the principles to successful investing are simple, but
    the hard part is adhering to them through the ups and downs of the market.
    In this sense, the investment thesis becomes our anchor, even when the waters
    get rough or (even more difcult) when the waters stay calm for a deceivingly
    long time. If the thesis is still valid, nothing else matters. If the thesis may be
    at risk, nothing matters more.
    Successful value investor Martin Whitman concluded:
    “Based on my own personal experience – both as an investor in recent years
    and an expert witness in years past – rarely do more than three or four variables
    really count. Everything else is noise.”
    So how do we know which variables count and which are just noise?
    Let’s walk through an example using a company we all know, Apple. If
    we were going to buy stock in Apple, we would begin by understanding the
    competitive landscape. We would analyze their smartphone, PC and sofware
    peers. We would look at the company’s strengths, weaknesses, opportunities
    and threats (also known as a “SWOT analysis”). We would analyze the fnancial
    statements and historical returns to shareholders. We would try to speak with
    someone at the company, speak with their suppliers, speak with customers, and
    speak with competitors. Now suppose afer all of this, we determine that Apple
    is a great stock to buy. Tat it has a sustainable competitive advantage, and the
    stock price is substantially lower than what the business is worth. We then take
    out a pen and paper (or smartphone) and write down the main points of why
    we are buying the stock.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    78
    A sample “Buy” case Investment Tesis for Apple may look something like
    this:
    ֍ Apple’s strong brand will enable the company to sell their products at
    premium prices. (BRAND)
    ֍ Apple’s ecosystem of inter-connected apps, videos and music fuels a
    loyal and sticky user base. (ECOSYSTEM)
    ֍ Smartphones and tablets are in their early stages of adoption globally,
    ofering signifcant growth potential. (GROWTH)
    ֍ Apple’s management promotes a culture of innovation and design for
    consumer electronics, creating a platform for future product launches.
    (CULTURE)
    On the other hand, maybe our research uncovers some concerns about that
    company so that we feel that Apple’s current position may not be sustainable
    going forward and that the company is a “Sell”. We may even short the stock,
    hoping to proft from its decline.
    A “Sell” Investment Tesis for Apple may look something like this:
    ֍ Apple competes in the highly competitive industries of PC and
    smartphones.
    ֍ History has proven that commoditization for consumer electronics
    industry is inevitable, which makes Apple’s premium prices and
    exceptionally high margins unsustainable.
    ֍ Afer the death of Steve Jobs, Apple’s product innovation has noticeably
    deteriorated.
    ֍ Apple is heavily reliant on their supply chain of components, which they
    do not control, and which will limit future innovation.
    Which thesis do you agree with? Perhaps more important than being right,
    is the mere fact that you are making a choice, writing it down, and constantly
    keeping yourself honest by referring back to it. Of course, that being said, you
    also want to be right!
    Let’s assume that you believe the frst scenario, and you go ahead and
    buy shares in Apple. You sit happy knowing that every time someone in the
    world that goes out and buys and iPhone, they are earning you a small share
    of that proft. You even go out and buy yourself a new iPhone using that same
    argument, fantastic! But then the news starts pouring in: Samsung is launching
    a fancy newfangled smartphone next month. Apple’s quarterly earnings were
    10% below expectations and suddenly the stock drops by 20%. CEO Tim Cook
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    79
    is having a bad hair day. What is going on?! Every day we wake up to either
    panic or euphoria in the news – how do we keep it all straight?
    Tere is one simple trick — constantly ask yourself the same question:
    “Is the investment thesis still intact?”
    For example:
    Does Samsung’s new smartphone have any impact on Apple’s (1) brand
    power, (2) ecosystem, (3) growth, or (4) culture of innovation? If not, then it’s
    just noise.
    Does Apple’s earnings for the quarter indicate anything about the company’s
    (1) brand power, (2) ecosystem, (3) growth, or (4) culture of innovation? If
    not, then it’s just noise.
    Does Tim Cook’s hairdo present any risk to the company’s (1) brand
    power, (2) ecosystem, (3) growth, or (4) culture of innovation? Possibly, then
    for heaven sakes, get the man a comb! If not, then it’s just noise.
    When we develop the habit of constantly checking new information against
    our investment thesis, we learn to efectively flter out the noise.
    But then let’s say that through conversations with second-hand resellers of
    Apple products, we fnd out that a one-year old used iPhone that used to sell
    for $400 is now selling for $300. We inquire as to why, and we are told that
    customers are telling us that there are other phones available that are nearly as
    good and they simply aren’t willing to pay a higher price for an iPhone. We also
    fnd that carriers are saying the same things. Now, we can legitimately begin
    to worry. Tere may be a crack forming in Point #1 (“Apple’s strong brand
    power will enable the company to sell their products at premium prices”). If
    we fnd we can no longer defend a key point of the investment thesis, then we
    sell the company. Period. It is simply not worth the time and the risk.
    QUESTIONS TO CONSIDER:
27. Do you agree more with Investment Tesis of “Buy” of Apple, or
    “Sell”?
28. Compare the Apple today vs. Apple of 2010, before the death of Steve
    Jobs, has the Investment Tesis been strengthened or weakened since
    then? What is the evidence to support your view?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    80
    SECTION 2
    Case Study:
    Portfolio Manager and founder of YIS, James Fletcher learned the
    power of the Investment Tesis early in his investment career. In 2007, he
    came across a company from South Korea that made online video games.
    Teir existing games had a remarkably sticky user base paying subscription
    fees every month. Te games had two powerful things that he looks for in
    companies: (1) a network efect — the more kids that played the game the
    more attractive the game becomes and (2) high switching costs — when
    someone invests seven years leveling up a character and amassing virtual
    items, they were unlikely to switch to another game and have to start over.
    Te company had a rare competitive moat that was both wide and deep. But
    they hadn’t had a hit game in a while, so the market was rather gloomy on
    the company despite what was considered to be a top-notch development
    team. As any parent who has had to try and pick a video game for their kids,
    the video game industry is an unpredictable “hit or miss” industry. Trying
    to forecast whether a game will be a hit is very difcult. It’s ofen a roll of the
    dice. However, James took a long-term approach and built an investment
    thesis on three pillars:
    1). the existing games would continue to retain their loyal user base and
    pay handsome returns,
    2). despite being a “hit-or-miss” industry, the development team would
    eventually get a hit,
    3). the current stock price implied no probability to a new game success.
    Shortly afer buying the stock, the company launched a new fagship game.
    Here it was! Te game had all the makings of a blockbuster: substantial buzz
    in the gaming community, a legendary lead-developer, three full years of
    development, a huge marketing budget, and positive reviews. Te game hit
    the shelves, and then… it fopped! It just simply didn’t sell. James watched
    the stock price fall for the company by nearly 50% in a month. He felt sick to
    his stomach! He stumbled back to the drawing board — his investment thesis
    — and asked himself: was the original investment premise intact?
29. Did the company still have a sticky, loyal user base on existing games?
    Yes.
30. Was the development team still likely to have a hit game in the future?
    Yes.
31. Was the stock undervalued? Yes, even more so.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    81
    Tis meant that all of the despair in the market was actually just noise.
    Feeling a bit more comforted afer reviewing the investment thesis, he
    continued to hold the stock. In 2008, the company launched another game.
    Tis time, expectations were even higher. Te launch was timed for the holiday
    season and the game was a mix between car racing and online fghting–which
    every industry expert believed was a sure formula for success. Te game hit
    the shelves and low and behold…another fop! Te game mostly sat on the
    shelves and everyone that bought the game ended up returning it because there
    was no one online to play it with. Investors were exasperated and the stock
    plummeted by another 40%. James’ clients began to notice poor performance.
    At this point, to his knowledge, James’s company and its clients remained the
    only international shareholders to continue to own the stock, which by default
    made them feel both stupid and lonely. Tey even had the audacity to add
    to our position. But here is the reason why: not one thing had changed from
    the original investment thesis, except for the fact that the stock price looked a
    whole lot more attractive now than it ever had!
    Some may call this sticking to your guns. Some may call this being just
    fat-out stubborn. Investors like to refer to this as “high conviction.” Despite
    what you call it, however, James’ conviction came from having a clearly defned
    investment thesis, giving him the ability to block out the noise.
    Te following year, the company launched another game that was largely
    ignored by the market because it was more of a niche game for an Asian
    audience. Everyone’s expectations were rock bottom afer the previous failures.
    Te game was released and turned out to be one of the bestselling video games
    of all-time in Korea, and then later, a blockbuster hit in China. Te stock price
    shot through the roof. Two years later the company followed it up with another
    successful game launch, and the stock climbed even higher. From James’ initial
    investment, he had now made over a 500% return. He and his clients were
    dancing in the aisles.
    Looking back, James recounts that the success was basically due to just one
    factor: “that I had written down those three simple bullet points down from
    the very beginning”. He says if he had not he surely would have sold his shares
    when times get rough. Without the rock-solid conviction of why they owned
    it, they would have followed the herd and cut their losses. He was grateful he
    stayed true to his investment thesis.
    QUESTIONS TO CONSIDER:
32. Discuss the reasons why it’s difcult to keep holding a good stock when
    it is going down?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    82
33. Discuss the reasons why it’s difcult to sell a stock that you bought
    whose investment thesis may not be valid anymore?
    CONCLUSION
    In order to invest with confdence and properly flter out noise that might
    intimidate you, confuse you and cause you to make emotional decisions that
    could cost you money, it is important that you create an investment thesis of
    your own for every stock that you buy.
    KEY TAKEAWAYS:
34. Know the stocks you own and know why you own them.
35. Creating and constantly re-evaluating an investment thesis is the most
    crucial tool to keep investors on-track and disciplined.
36. If news doesn’t impact the investment thesis, then it is just noise. If new
    data gives us either higher conviction or higher concerns in our investment thesis, nothing matters more.
    ACTIVITY: Creating Your Own Investment Checklist
    Going hand in hand with creating an Investment Tesis for the each of
    the stocks that you own, is creating an overarching Investment Checklist. An
    Investment Checklist is the summary of your personal investment process. Te
    idea of an investment checklist was created by famed investor Mohnish Pabrai,
    whose fund has earned a 517% return compared to the S&P 500 up 43% since
37. Te idea, according to Pabrai, is to create a series of Yes or No questions
    to ask yourself before investing in a stock to make sure you don’t miss anything
    or make a mistake. A good Investment Checklist is like a constitution, a series
    of personal rules to make sure that you stay disciplined and focused. Te goal
    is create a series of over-arching questions that will maximize your chances
    of fnding great investments and minimize the chances of investing in a dud.
    Many successful investors such as Guy Spier and Charlie Munger (partner to
    Warren Bufet) also attribute the use of Investment Checklists as one of the
    hallmarks of their success.
    Below is an interview with Mohnish Pabrai talking about how he uses
    Investment Checklists
    https://www.youtube.com/watch?v=vkEUd_aju8c
    It is never too early to start thinking about and creating your own Investment
    Checklist. Refecting back on the things you have learned about investing through
    your YIS participation and other sources, consider the elements of what makes a
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    83
    company an attractive investment (e.g., strategic advantage or economic moat).
    Consider the case studies above and other companies that have been analyzed
    during your YIS meetings. What are some of the characteristics of successful
    companies and investments that justify acquiring stock in the company? What
    are some red fags in investing that you want to make sure that you avoid?
    Here are some examples of possible questions for an Investment Checklist:
38. Do I understand what is moving the stock price, what the market is
    pricing in, and where my view may be diferent?
39. Do I understand how the company earns money?
40. Does the company have a clear competitive moat?
41. Have I reached the investment conclusion on my own, and believe that
    even if people that like the stock now reversed their opinion, it wouldn’t
    sway me?
    Hint: Be sure to structure the checklist so for all the questions “Yes” means
    it’s good to invest and “No” means don’t invest.
    Activity – Take 15 minutes and write down a few points that you want to
    be in your own investment checklist. When you are done, break into groups
    of four and share your investment checklist with your peers. Be open to any
    additional insights or suggestions that your peers may have regarding how you
    might improve and clarify your investment checklist.
    Type your investment checklist on one page of paper, print it, and if possible,
    laminate it or use contact paper to preserve it. Commit to post your investment
    thesis in a place where you can review it when you review, execute trades and
    conduct your investment analysis.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    84
    LESSON 7:
    INTRINSIC VALUE
    Introduction
    As a value-investor your focus is to buy companies whose stock prices
    do not actually refect their true value, known as “intrinsic value”. If you
    can successfully select companies to buy whose stock price is trading below
    their intrinsic value, then you’ll be successful. Being able to correctly
    estimate something’s intrinsic value is one of the most important skills of a
    master investor.
    Looking at the graph below, when are the times that you want to buy
    to stock? When are the times that you want to sell the stock? Why do
    you think the market price is more volatile than the intrinsic value of a
    company?
    “The newer approach to security
    analysis attempts to value a
    common stock independently
    of its market price. If the value
    found is substantially above
    or below the current price, the
    analyst concludes that the issue
    should be bought or disposed
    of. This independent value has
    a variety of names, the most
    familiar of which is “intrinsic
    value”.
    – Ben Graham,
    Security Analysis
    (1951 Edition)
    85
    Looking at the graph below, when are the times that you want to buy to
    stock? When are the times that you want to sell the stock? Why do you think
    the market price is more volatile than the intrinsic value of a company?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    86
    SECTION 1
    Let’s Buy a House
    To get your mind working, let’s imagine that you are going to buy a house.
    We will think of buying the house in the context of its book value, market value,
    and its intrinsic value.
    Book Value
    When the seller of the house frst bought the house, they most likely placed
    a down payment, and fnanced the rest of the house with debt. Let’s say for
    example that they bought the house for $200,000 and placed a down payment of
    $20,000. In essence, they paid $20,000, the bank gave them $180,000. In simple
    terms, we would say that the book value is the total amount of book equity
    plus the amount of liabilities. In this case, the book value would be $20,000 +
    $180,000 = $200,000.
    Market Value
    Remember that markets determine prices. Let’s say we want to buy that very
    same house in 5 years. By this point, due to a shortage of houses and increased
    demand, similar houses are selling for $250,000. Tat same house, even though
    its book value is still $200,000 now has increased in value and the market has
    priced that house and similar houses at $250,000. Te market value would be
    $250,000. Tis is the price that you would have to pay to buy that house. Should
    you buy that house for the $250,000? Is it actually worth $250,000?
    Intrinsic Value
    Now, let’s take a deeper dive into the $250,000 market value or wouldbe selling price of the house. You really want to know if that house is worth
    $250,000. If you determined the house is actually worth $250,000, you would
    be comfortable buying it. If you determined it was worth less than $250,000,
    you would not buy it. If you determined it was worth more than $250,000, you
    would buy it in a heart-beat and consider yourself a value investor.
    What are some things you should look at to determine if that house is really
    worth $250,000? You might look at the future housing market of that area. You
    might take a deeper look inside the house. You might look at the condition of
    the following: the kitchen, the roof, the yard, the appliances, the garage, the
    bathrooms, the rooms, etc. You also would need to take a look at how long
    that house will be able to support its residents. Afer you perform a thorough
    inspection of the housing market, you determine that house prices will increase
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    87
    over the next couple of years and the house will have a much higher resale
    value. You discover that the appliances of the house are brand new, the roof
    has recently been replaced, the yard is in great condition, and everything
    else seems to be in order with the house. You run a few calculations based on
    the condition of the house and future prospects of the housing market, and
    ultimately you value the house at $300,000. Because of your inspections and
    belief on the future condition of the housing market, you have determined that
    the intrinsic value (true) value is greater than the market value of the house.
    You should buy the house and consider yourself a value investor.
    QUESTIONS TO CONSIDER:
42. Why is determining the “Intrinsic Value” of a house more difcult than
    the “Book Value”?
43. What is the “Market Value” and the “Book Value” of something harder
    to calculate, like going to college? What is the “Intrinsic Value” of going
    to college?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    88
    SECTION 2
    Determining the Intrinsic Value of a Company
    Tere are many valuation metrics and techniques investors use to try to
    estimate a company’s worth. We will teach you two: Te Discounted Cash
    Flow Method and the Relative Valuation method.
    The Discounted Cash Flows method
    You want to impress someone you know who works in fnance? Tell them
    that you built a discounted cash fows or “DCF” model in school today! It’s
    like telling a hiker that you’ve hiked Mount Everest or telling an ice skater
    that you can do a triple axel. Yeah, doing a DFC is really that cool. And today
    you’re going to create one!
    A Discounted Cash Flows model is one of the go-to ways for investors to
    measure the value of a company. A company’s worth is the present value of all
    net future cash fows, or in simpler terms (I know that’s a mouthful), the value
    of a company today is the sum of all the cash fow they will earn each year in
    the future, but what that cash fow is worth in today’s dollars. A company’s
    value cannot be measured entirely by its total sales, nor buy its net income.
    We cannot necessarily say that just because a company has more revenue or
    net income that it is more valuable than its counterpart. A company is only
    worth the amount of cash it has lef over afer it has covered all of its expenses.
    Tat is what we mean when we say net cash fow. Net cash fow is the cash the
    company receives from its sales minus total expenses minus money spent on
    equipment or assets to grow the business (called Capital Expenditures). Te
    formula is: Net Cash Flow = Revenue – Expenses – Capital Expenditures.
    Tis type of valuation is referred to as a discounted cash fow analysis.
    Question: You are given the opportunity to choose to invest in either
    company ABC or company XYZ. ABC has total annual revenue of $100.00
    and is selling for $250/share; XYZ has total revenue of $80.00 and is selling
    for $300/share. Which one would you buy?
    Answer: It depends. You can’t judge whether to buy a company based
    purely of of its revenue. You would need to know the present value of its
    future cash fows, and then determine which company to buy.
    Alright, are you ready to rock and roll?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    89
    Go to “Resources” Tab on the Young Investors Society website (www.
    younginvestorssociety.org) and download the “Intrinsic Value” Spreadsheet.
    Here you will fnd a template that will walk you through creating your very
    own calculation of the intrinsic value of a company. It may seem daunting
    at frst, but it’s really not that complicated. And it’s a powerful tool once you
    know how to use it.
    Steps to use the Discounted Cash Flow (DCF) Analysis Tool:
44. Chose a company that you would like to estimate the intrinsic value for
    (e.g. Apple, Google, Netfix, Ford etc.)
45. Use fnance.yahoo.com or zacks.com to input the information in the
    yellow boxes (name, share price, shares outstanding, revenue, net
    income, free cash fow).
46. Your two main assumptions are 1) the future growth rates (Row 15 &
    16) and the cash fow margin (Row 26). Look at the trends the company
    has had in the past, think about if the future will be higher or lower,
    and make your best guess. Remember that most companies have fat
    or declining margins over time because of competition and technologic
    changes
47. In most cases, leave the discount rate at 12%. Also, in most cases, leave
    the terminal growth rate at 4 or 5%.
48. Play around with the assumptions. When you do, look at how the cash
    fow graph and the Intrinsic Value calculation changes.
49. In Row 33, you will see your Intrinsic Value calculated. If the Intrinsic
    Value is signifcantly above the Current Share price, then the stock is
    likely undervalued, and go BUY IT! If the Intrinsic Value is below the
    current share price, then the stock is likely overvalued.
    Below is a snapshot of how your DCF model will look. Be sure to save your
    sheet to your own drive for future use. And so when your dad’s friend that
    works in fnance says “No way, you didn’t really do a DCF in high-school!” You
    can prove it to him. He’ll probably ofer you an internship on the spot.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    90
    QUESTIONS TO CONSIDER:
50. Te “Intrinsic Value” calculation was most sensitive to changes in which
    assumption? (5 Yr growth rate, discount rate, terminal growth rate)
51. What did you learn while playing around with the model assumptions
    about the value of a company?
52. Would you rather buy a very predictable company that had 20% upside
    potential or high-growth company that has 50% upside potential?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    91
    SECTION 3
    The Relative Valuation Method
    A simpler, better known metric, to estimate a company’s valuation is its
    price-to-earnings (P/E) ratio. For companies with relatively stable earnings
    prospects, the P/E provides a reasonable approximation of the discounted
    value of its future earnings, as it tells the investor how many times one year’s
    earnings the stock price is currently discounting. For example, if a stock is
    trading at a 15x P/E, this means that at the current year’s earnings (E) it will
    take 15 years to get your money back. 30x P/E will take 30 years. Obviously,
    for an investment, the sooner the better. Tus, the P/E is a reasonable yardstick
    for a stock’s valuation. Everything else being equal, the lower the P/E, the more
    attractively valued the stock is said to be. However, there are many caveats to
    this statement. Diferent industries have diferent P/E ranges, the more stable
    the industry (and the company’s earnings streams), and the higher the P/E
    can be without necessarily making the investment “expensive.” Very cyclical
    industries tend to present additional challenges. High growth companies tend
    to trade at high P/E, and low growth companies tend to trade at low P/Es.
    Here is a quick chart to gauge what the “intrinsic” P/E should be:
    5 P/E 10 P/E 15 P/E 20 P/E 25 P/E
    Low growth
    Cyclical
    Low quality
    (ROE <10%) Low growth Cyclical ROE 10-2% Average Company Above Average Company Over 20x P/E indicates a strong company ROE>15%
    High growth
    Or Very
    High Quality
    Company
    ROE>20%
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    92
    As you can see, valuing stocks is like going to a grocery store. You get what
    you pay for. If you want to buy the best product, you’re likely going to have to pay
    for it. Our job as investors is to buy as quality a product as we can (high ROE,
    strong economic moat business) at as low a P/E as we can.
    Tere are value investors who prefer to focus more on “balance sheet” related
    ratios, such as the price-to-book (P/B) value of a frm. Te P/B compares the
    stock price to the value of company’s assets minus its liabilities.
    Are you ready to calculate Intrinsic Value using the “Relative Valuation”
    method? In practice, this is the method that most professional portfolio managers
    and analysts use to estimate the value of a company.
    Go back to your “Intrinsic Value” Spreadsheet and scroll down to the second
    section called “Relative Valuation Analysis”.
    Steps to use the Relative Valuation Analysis Tool:
53. Chose a company that you would like to estimate the intrinsic value for
    (e.g. Apple, Google, Netfix, Ford etc.)
54. If you flled in the section above in the DCF assumptions, the P/E of the
    company should already be calculated in C:56 (for example, 11.0).
55. You then want to think of three or four good comparable companies
    that operate in similar industries and have similar ROEs and growth
    expectations. If you are buying a house, this is like going to similar homes
    in the neighborhood and seeing what they sold for.
56. Look at the comparable average P/E (C:61). Is the average above or below
    your company? Go to Row 63, Column C and decide whether your
    company deserves to trade at a premium or discount to their peer average.
    For example, do they earn a premium ROE? Are they growing faster? Are
    they a more predictable business? If so, then they may warrant a premium.
57. C:64 is where you put in your Target Multiple. Use the chart above, and
    the comparable company table in your model to estimate a P/E ratio. Is it
    15 (average), 10 (below average) or 20 (above average) company? What P/E
    ratio range did it trade at in the past?
58. In F:70, you will see the earnings per share estimated 3 years in the
    future. Review this number, and decide whether you think this is a good
    assumption.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    93
59. In Row 72, you will see your Intrinsic Value calculated. If the Intrinsic
    Value is signifcantly above the Current Share price, then the stock is
    likely undervalued, and go BUY IT! If the Intrinsic Value is below the
    current share price, then the stock is likely overvalued.
    Tere, now you’ve done it!
    Compare your DCF Intrinsic Value Calculation to the Relative Valuation
    Calculation. Did they reach the same conclusion?
    Student Teacher:
    Choose one student to explain the concept of “intrinsic value” to the group.
    Have the student briefy describe the three ways discussed above, and then
    choose a company that has a low P/E ratio. Why is the P/E ratio a commonly
    used way to value a company?
    QUESTIONS TO CONSIDER:
60. Referencing your Intrinsic Value calculation, why is it risky to buy a
    stock that trades at a high P/E ratio?
61. Why is it risky to buy a company that trades at a low P/E ratio?
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    94
    CONCLUSION
    Intrinsic value is the true value of a company. Tis may or may not be refected
    in its stock price. A great investor is one that can fnd a stock that is trading at a
    signifcant discount to its intrinsic value. Many valuation techniques exist due
    to diferent preferences among investors.
    Two Primary Valuation Options
    ֍ Discounted Cash Flow Model
    ֍ Relative Valuation Model
    When measuring intrinsic value, we have to take into account a lot of random
    variables; therefore, the intrinsic value is ofen an estimate. Valuation is not 100
    percent precise, but if you are good at it and can continuously fnd companies
    that are trading at a discount to their future value, you will be in great shape.
    Intrinsic value is a necessary lens through which we need to see our investments.
    KEY TAKEAWAYS:
62. Intrinsic value is what something is worth, Price is what you have to
    pay. Tey’re not the same thing!
63. Buying stocks below their intrinsic value gives you a margin of safety
    and sets you up to make money in the market.
64. Te two most common methods for calculating value of stocks are the
    Discounted Cash Flow Model and the Relative Valuation Model.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    95
    1). Accounts Payable – a short term liability, representing money the
    company owes for purchases from a supplier
    2). Accounts Receivable – a short term asset, representing money the
    company is expecting to receive from sales made to customers
    3). Accrued Expenses – a liability, such as an obligation to pay interest to
    bank lenders or to pay taxes to the government
    4). Asset – a resource that the company owns or controls
    5). Book Value- Te sum of all liabilities and equity on the balance sheet
    6). Balance Sheet – one of the three primary fnancial statements, which
    shows a snapshot of the assets, liabilities, and equity of the business at a
    certain point in time
    7). Brokerage Firm – A fnancial institution that facilitates the buying and
    selling of fnancial securities (generally stocks or bonds) between buyer
    and seller.
    8). Brand – A distinguishing symbol, mark, logo, name, word, sentence
    or a combination of these items that companies use to distinguish
    their product from others in the market. Brand equity is the positive
    sentiment created by a product among its target audience over time.
    9). Brand – A distinguishing symbol, mark, logo, name, word, sentence
    or a combination of these items that companies use to distinguish
    their product from others in the market. Brand equity is the positive
    sentiment created by a product among its target audience over time.
    10). Brand – A distinguishing symbol, mark, logo, name, word, sentence
    or a combination of these items that companies use to distinguish
    their product from others in the market. Brand equity is the positive
    sentiment created by a product among its target audience over time.
    11). Cash – the money a company has on hand, whether in physical currency
    or in bank accounts
    12). Cash Flow – Cash fow or fows is the cash generated by a company. It
    is diferent from earnings because does not include non-cash items. For
    example, a company may make a large sale to a customer, which will
    count as earnings, but the customer has 30 days to pay for the purchase,
    so it is not yet cash received by the company.
    GLOSSARY OF TERMS
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    96
    13). Creditors – Investors or institutions (such as banks, among others) to
    which a company owes money.
    14). Capital – Another word for money.
    15). Common Stock – the stock sold to investors on the market
    16). Cost of Goods Sold – the costs required to produce the good or service
    sold to a customer
    17). Dividend – Te portion of a company’s profts that it pays out each year
    to shareholders in the form of cash.
    18). Discount Price- A price that is lower than the true value
    19). Discounted Cash Flow (DCF) Analysis- Forecasting future cash fows
    that the business will generate and then discounting them back to the
    present value at an appropriate discount rate.
    20). Discount rate- Rate of return that investors need to receive in order to
    be compensated for risk
    21). Diversifcation – A risk management technique that mixes a wide
    variety of investments within the portfolio. Te rationale behind this
    technique contends that a portfolio of diferent investments will, on
    average, yield higher returns and pose lower risk than any individual
    investment found within the portfolio.
    22). Equity Value- Intrinsic value of equity that is found by subtracting total
    debt from frm value
    23). Enterprise or Firm Value – Te total value of the company, including
    the portion of it that “belongs” to its creditors. It is calculated by adding
    the company’s net debt to its market cap.
    24). Equity – the total of all stock owned and earnings retained that belong
    to the owners
    25). Economic Moat – Te competitive advantage that one company has
    over other companies in the same industry. Tis term was coined by
    renowned investor Warren Bufett.
    26). Economic Moat – Te competitive advantage that one company has
    over other companies in the same industry. Tis term was coined by
    renowned investor Warren Bufett.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    97
    27). Economic Moat – Te competitive advantage that one company has
    over other companies in the same industry. Tis term was coined by
    renowned investor Warren Bufett.
    28). Equity Portfolio or Stock Portfolio – A basket or collection of stocks. A
    diversifed stock portfolio includes companies from diferent industries
    and of diferent sizes.
    29). Firm/Enterprise Value- Intrinsic value of a company taking into
    account both debt and equity
    30). Gross Margin – the total revenue (or sales) minus the cost of goods sold
    31). Gross Margin – Te proft the company makes afer the cost of its goods
    are paid for. (Gross Proft / Total Revenues)
    32). Intrinsic Value- the true value of a company without regards to its
    market value or book value
    33). Income Statement – one of the three primary fnancial statements,
    which shows the activity of a company over a period of time, showing
    both revenues and expenses
    34). Intrinsic Value – Te true worth of a company. Tere are many ways to
    estimate the intrinsic value of a company, among them are discounted
    cash fow analysis and relative valuation analysis.
    35). Intrinsic Value – What a stock is truly worth, not necessarily what the
    current stock price is.
    36). Inventories – products that will eventually be sold to a customer
    37). Interest Coverage – Te total value of the company, including the
    portion of it that “belongs” to its creditors. It is calculated by adding the
    company’s net debt to its market cap.
    38). Investment Tesis – Te basic guiding principles an investor establishes
    to justify:
65. Why he owns the company
66. What he expects to happen
67. What he sees that the market does not give the company credit for
    39). Liability – any obligation that the company owes to another entity
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    98
    40). Long-term Debt – a liability such as a loan from a bank
    41). Liquidity – Te degree to which an asset or security (stock) can be
    bought or sold in the market without afecting the asset’s price or stock
    price. Assets that can be easily bought or sold are known as liquid assets.
    42). Low Cost Advantage – A sustainable advantage driven by access to a
    unique process, location, scale, labor costs or access to a unique asset,
    which allows a company to ofer goods or services at a lower cost than
    competitors.
    43). Low Cost Advantage – A sustainable advantage driven by access to a
    unique process, location, scale, labor costs or access to a unique asset,
    which allows a company to ofer goods or services at a lower cost than
    competitors.
    44). Low Cost Advantage – A sustainable advantage driven by access to a
    unique process, location, scale, labor costs or access to a unique asset,
    which allows a company to ofer goods or services at a lower cost than
    competitors.
    45). Margin of Safety – Only purchase stocks when the market price is
    signifcantly below the intrinsic value. For example, a company owns
    land, equipment, cash and other assets that are worth $20 per share, yet
    the stock price is trading at $15 per share in the market. Buying this
    company at $15 provides a 25% discount or margin of safety.
    46). Mutual Fund – Professionally managed stock portfolio. Instead of
    investing in individual stocks yourself, you can invest money in a mutual
    fund, where professionals pick stocks for you.
    47). Market Value- the sum of the market cap (shares outstanding times total
    shares) and the debt
    48). Market Share – the percentage of a certain industry or market (e.g. the
    athletic shoe market) that a certain company’s sales are
    49). Margins – Te percentage of proft the company makes for every dollar
    of revenues. For example, a 50% proft margin means the company earns
    $0.5 of proft for every $1 of revenue earned.
    50). Market Capitalization (also known as market cap) – Total market value
    of the company’s equity. It is calculated by multiplying the stock price of
    the company times the number of shares outstanding.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    99
    51). Network Efect – A phenomenon whereby a good or service becomes
    more valuable when more people use it.
    52). Network Efect – A phenomenon whereby a good or service becomes
    more valuable when more people use it.
    53). Network Efect – A phenomenon whereby a good or service becomes
    more valuable when more people use it.
    54). Net Debt – Te company’s total debt adjusted by its cash on hand (total
    debt minus cash).
    55). Operating Expenses – the costs associated with operating the business,
    such as payroll, sales commissions, marketing, transportation, travel, and
    rent expenses
    56). Operating Income – the income afer subtracting both cost of goods
    sold and operating expenses from total revenuesOperating Margin –
    calculated by dividing operating income by total revenues
    57). Operating Margin (EBIT Margin) – Te proft the company makes afer
    paying for its cost of goods sold and the cost of salaries, utilities, and
    depreciation. (Operating Proft / Total Revenues)
    58). Proft Margins – Te ratio of profts made per dollar of revenue. Te
    higher the proft margin the better.
    59). Portfolio Manager – Te manager of a portfolio of stocks. Tey do
    extensive research to make investment decisions for a fund or group
    of funds under their control. Based on their research, the Portfolio
    Manager will buy and sell stocks.
    60). P/E Ratio – One measure of how expensive a stock is. In general, a high
    P/E suggests that investors are expecting higher earnings growth to be
    high in the future. A low P/E can indicate either that a company may
    currently be undervalued or that the company’s profts are expected to
    decline.
    Te price-earnings ratio can be calculated as:
    Market Value per Share (Stock Price) / Earnings per Share
    or
    Market Capitalization / Profts
    61). Property, Plant, & Equipment – the long-term physical assets owned by
    a company, including land, buildings, furnishings, and machinery
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    100
    62). Price to Book – A ratio used to compare a stock’s market value to its
    book value. It is calculated by dividing the current closing price of the
    stock by the latest quarter’s book value per share.
    63). Profts – Proft is the money a business makes afer accounting for all
    the expenses. Regardless of whether the business is a couple of kids
    running a lemonade stand or a publicly traded multinational company,
    consistently earning proft is every company’s goal.
    Net Profts = Total Revenue – Total Expenses
    64). Profts – Proft is the money a business makes afer accounting for all
    the expenses. Regardless of whether the business is a couple of kids
    running a lemonade stand or a publicly traded multinational company,
    consistently earning proft is every company’s goal.
    Net Profts = Total Revenue – Total Expenses
    65). Retained Earnings – income generated by the business that has been
    reinvested in the business, rather than distributed to owners in a
    dividend
    66). Revenue – Te amount of money that a company actually receives
    during a specifc period. It is referred to as the “top line” because it is
    the total amount of sales before you start to factor in the costs of the
    business.
    67). Revenue (or Sales) – the total amount generated by sales to customers
    68). Return on Invested Capital – A calculation used to assess a company’s
    efciency at allocating capital under its control to proftable investments.
    69). Return on Capital – Return on Capital is a useful metric for comparing
    proftability across companies based on the amount of capital they use.
    70). Return on Equity (ROE) – Perhaps the most useful fnancial metric or
    all, it is used to compare a company’s profts based on the total capital.
    Return on Equity = Net Income / Shareholder’s Equity
    71). Revenue – Te amount of money that a company actually receives
    during a specifc period. It is referred to as the “top line” because it is
    the total amount of sales before you start to factor in the costs of the
    business.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    101
    72). Return on Equity (ROE) – Perhaps the most useful fnancial metric of
    all, it is used to compare a company’s profts based on the total capital.
    Return on Equity = Net Income / Shareholder’s Equity
    73). Statement of Cash Flows – one of the three primary fnancial
    statements, which shows all the sources and uses of cash over a period of
    time
    74). Stock – Stock is a unit of ownership in a company. When you buy a stock
    you become a shareholder, which means you own part of the company.
    75). Switching Costs – Te inconveniences that dissuade a customer from
    switching to a competitor’s products. Te negative costs that a consumer
    incurs as a result of changing suppliers, brands or products. Although
    most prevalent switching costs are monetary in nature, there are also
    psychological, efort- and time-based switching costs.
    76). Stock Market – Te market in which shares of publicly-held companies
    are issued and traded, either through exchanges or over-the-counter
    markets. Also known as the equity market, it provides companies with
    access to capital (money) in exchange for giving investors a slice of
    ownership in a company.
    77). Switching Costs – Te inconveniences that dissuade a customer
    from switching to a competitor. Te negative costs that a consumer
    incurs as a result of changing suppliers, brands or products. Although
    most prevalent switching costs are monetary in nature, there are also
    psychological, efort and time-based switching costs.
    78). Shareholder – Any person, company, or other institution that owns
    at least one share of a company’s stock. Shareholders are a company’s
    owners.
    79). Stock Ticker or Symbol – An identifer (usually from 1 to 4 letters
    for US companies) for a stock. Tis symbol is the name under which a
    company’s stock trades in the stock market.
    80). Shareholders – Owners of company stock.
    81). SWOT Analysis – A comprehensive analysis of a company’s Strengths,
    Weaknesses, Opportunities and Treats.
    82). Shorting a stock – Borrowing against the shares of stock, you proft
    when the stock price goes down.
    YOUNG INVESTORS SOCIETY . STOCK INVESTING 101
    102
    83). Switching Costs – Te inconveniences that dissuade a customer
    from switching to a competitor. Te negative costs that a consumer
    incurs as a result of changing suppliers, brands or products. Although
    most prevalent switching costs are monetary in nature, there are also
    psychological, efort and time-based switching costs.
    84). Ticker – Te abbreviation that a company is listed on the stock
    exchange. For example, Google has the ticker GOOG and Apple has the
    ticker AAPL.
    85). Valuations – A way to gauge how expensive a stock is. Commonly used
    methods are the price of the share relative to earnings per share (P/E
    Ratio) and the price per share relative to the book value per share (P/
    Book ratio). Te higher the valuations, the more growth you need to
    justify the investment.
    If you enjoyed this post don’t forget to like, follow, share and comment!