32 Rules of Investing
1. The business being invested in must fall within your “circle of competence”. In other words, it must be of a nature which can be easily understood. “The business must be so good, that an idiot could run it, and it would still work.”
2. The business must have a consistent operating history.
3. The business must have favorable long-term prospects – i.e., sharp growth rates in the future.
4. In addition to having the stable business economics stated above, management must also be evaluated. Management must be rational.
5. Management must be sincere with its shareholders.
6. Management must resist the “institutional imperative”.
7. The business must also have stable financial tenets. The key financial ratios (debt/equity, current ratio, etc…) must be satisfactory.
8. The business must consistently produce high returns on shareholder’s equity (book value) – e.g., above 15%.
9. The business must be able to grow its book value (shareholder’s equity) at a satisfactory rate over the long-run.
10. Return on total capital (net earnings/total capital) must be consistently high – e.g., above 15%.
11. The business must be able to consistently grow its revenues and net earnings year-over-year at a satisfactory rate – e.g., above 15%.
12. The business must have either high profit margins or high inventory-turnover or both.
13. For every dollar retained within the business, the business must create at least one dollar of value in the marketplace. The “value-added” by retained earnings should increase the market value of the company.
14. The various price ratios, like the P/E and P/S ratios, of a share in the business must be in single-digits to low-teens.
15. The business should preferably trade below book value, so as to provide a margin of safety in the unforeseen event of a bankruptcy or liquidation.
16. The business must always be trading below intrinsic value – i.e., the business must be undervalued in the market.
17. If the entire company isn’t worth buying at the current market price, than a single share must also not be purchased.
18. The business must be in an industry in which little (if any) competition exists, so as to allow the business to reap monopoly-like profits.
19. Insiders of the business (i.e., top management) should preferably have a reasonable ownership of the company’s shares.
20. The company should preferably be repurchasing shares on the open market.
21. Little institutional ownership of the company’s shares is preferred.
22. A business that possesses the “must-haves” in the list above, but has been overly sold and shorted within the market will make for an excellent investment.
23. The business must be bought when the best buying opportunity exists – i.e., when the purchasing of the business makes “business sense”.
24. The business should preferably rely on “intangible assets” (like patents) and services rather than a product mix.
25. The business’ goods/services must be of a (strong) nature which would allow them to be consistently priced above inflation. In other words, the business must have pricing power over its goods/services.
26. The business should preferably be of a nature that requires little in the way of R&D, so as to pass on all excess profits to shareholders, kept for reinvestment within the business, or used towards the purchase of other whole or partial interests in above-average enterprises.
27. The mindset of top management must be such that if it cannot reinvest retained earnings in a profitable manner, then it must return the earnings to its shareholders in the form of dividends – rather than placing the earnings in sub-par investments.
28. The business must be of a nature which can be maintained without much in the way of operational costs. For example, maintenance costs must be so small that most of the earnings can either be retained or paid out as dividends without damage to the business.
29. If the business being invested in is known to be bidding for the acquisition of another business the target must:
i) also possess strong business economics
ii) be within the businesses’ “circle of competence”
iii) not be overpaid for above and beyond its estimated intrinsic and book values.
iv) have a business-model of related nature to the parent, e.g. a drug company should not buyout a sneaker manufacturer, as the conglomerate form-of-business can sometimes lead to sub-par results. However, certain corporations, as Berkshire Hathaway and Proctor & Gamble, have proven themselves otherwise.
30. Be very cautious if the business in questions has recently announced news of a merger with another company. Mergers have proven to result in poor performance and below-average returns -- at least in the first few years proceeding the merger -- in most historic cases.
31. If the business being invested in is said to have been targeted for acquisition by another firm, then an arbitrage position of potentially high return may exist. The bid price by the acquiring firm must be satisfactory though.
32. Invest only in arbitrage positions know to have a fixed “closing date”. To do so otherwise is to take on unnecessary risk.
2. The business must have a consistent operating history.
3. The business must have favorable long-term prospects – i.e., sharp growth rates in the future.
4. In addition to having the stable business economics stated above, management must also be evaluated. Management must be rational.
5. Management must be sincere with its shareholders.
6. Management must resist the “institutional imperative”.
7. The business must also have stable financial tenets. The key financial ratios (debt/equity, current ratio, etc…) must be satisfactory.
8. The business must consistently produce high returns on shareholder’s equity (book value) – e.g., above 15%.
9. The business must be able to grow its book value (shareholder’s equity) at a satisfactory rate over the long-run.
10. Return on total capital (net earnings/total capital) must be consistently high – e.g., above 15%.
11. The business must be able to consistently grow its revenues and net earnings year-over-year at a satisfactory rate – e.g., above 15%.
12. The business must have either high profit margins or high inventory-turnover or both.
13. For every dollar retained within the business, the business must create at least one dollar of value in the marketplace. The “value-added” by retained earnings should increase the market value of the company.
14. The various price ratios, like the P/E and P/S ratios, of a share in the business must be in single-digits to low-teens.
15. The business should preferably trade below book value, so as to provide a margin of safety in the unforeseen event of a bankruptcy or liquidation.
16. The business must always be trading below intrinsic value – i.e., the business must be undervalued in the market.
17. If the entire company isn’t worth buying at the current market price, than a single share must also not be purchased.
18. The business must be in an industry in which little (if any) competition exists, so as to allow the business to reap monopoly-like profits.
19. Insiders of the business (i.e., top management) should preferably have a reasonable ownership of the company’s shares.
20. The company should preferably be repurchasing shares on the open market.
21. Little institutional ownership of the company’s shares is preferred.
22. A business that possesses the “must-haves” in the list above, but has been overly sold and shorted within the market will make for an excellent investment.
23. The business must be bought when the best buying opportunity exists – i.e., when the purchasing of the business makes “business sense”.
24. The business should preferably rely on “intangible assets” (like patents) and services rather than a product mix.
25. The business’ goods/services must be of a (strong) nature which would allow them to be consistently priced above inflation. In other words, the business must have pricing power over its goods/services.
26. The business should preferably be of a nature that requires little in the way of R&D, so as to pass on all excess profits to shareholders, kept for reinvestment within the business, or used towards the purchase of other whole or partial interests in above-average enterprises.
27. The mindset of top management must be such that if it cannot reinvest retained earnings in a profitable manner, then it must return the earnings to its shareholders in the form of dividends – rather than placing the earnings in sub-par investments.
28. The business must be of a nature which can be maintained without much in the way of operational costs. For example, maintenance costs must be so small that most of the earnings can either be retained or paid out as dividends without damage to the business.
29. If the business being invested in is known to be bidding for the acquisition of another business the target must:
i) also possess strong business economics
ii) be within the businesses’ “circle of competence”
iii) not be overpaid for above and beyond its estimated intrinsic and book values.
iv) have a business-model of related nature to the parent, e.g. a drug company should not buyout a sneaker manufacturer, as the conglomerate form-of-business can sometimes lead to sub-par results. However, certain corporations, as Berkshire Hathaway and Proctor & Gamble, have proven themselves otherwise.
30. Be very cautious if the business in questions has recently announced news of a merger with another company. Mergers have proven to result in poor performance and below-average returns -- at least in the first few years proceeding the merger -- in most historic cases.
31. If the business being invested in is said to have been targeted for acquisition by another firm, then an arbitrage position of potentially high return may exist. The bid price by the acquiring firm must be satisfactory though.
32. Invest only in arbitrage positions know to have a fixed “closing date”. To do so otherwise is to take on unnecessary risk.
posted by Raphael Blogger at
9:32 AM
