Sunday, October 28, 2012

Investment Framework

Corporate profit as % GDP
Government debt as % GDP
Market Cap As % GDP
Wages as % of GDP
Interest Rate and Baa and AAA Corporate Bond Rate:
Inflation Rate:
VIX Level:
Shiller S&P P/E
By the traditional value method, a snapshot of the S&P500 shows a current multiple of 15x (based on trailing 12-months earnings), which is not overly expensive in historical terms. But the Shiller PE which is based on a 10-year moving average of earnings to smooth out the impact of an economic cycle, shows an expensive historical 24x.
Value Line Meadian P/E
Leading Sectors

Big Picture:
1. What could make this company bankrupt in 10 years?
2. Risks, especially the hidden risks.
3. Which side of the value pendulum is the current price at?
4. What makes the stock misvalued and how do I know that I possess superior knowledge than the other side of the trade?
5. What have caused the price of the stock go up and down in the past (short term, medium term and long term)?
6. Current valuation using various measures depending on the nature of the business.

Framework and Steps:
1. Business and Background.
a. Overall Business.
b. Segments.
c. Leadership.
d. Operating Metrics.
e. Historical Development.
f. Risk Factors.
g.10 year historical record.
h. Profitability
i.Long-Term Debt.
j.GAAP-Non-GAAP Consideration.

2. Current Valuation:
a. Recent 10K and 10Q, normalize earning and calculate free cash flow.
b. Current implied multiple of Price/Normalized Earnings and Price/FCF, P/S
c.Ratio and Trend Analysis: A/R, Inventory, is FCF in line with Eanings.
d.Accounting irregularities.
f. Is BV per share growing?
g.Capital Expenditure.
h. ROA, ROE.
i. Net Current Assets
j.Opportunity cost: What about valuations of other companies in the same basket.

3. MOS Calculation:
a. Project earnings and FCF out 7-10 years.
b. Apply a 15-18 multiple on earning and 9-12 multiple on pretax FCFs.
c.Discount them back to today.
d. Margin of Safety calculation.

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