Transcript S03E03 – Getting Started (Reboot Intro Part 2)

Getting Started (Reboot Intro Part 2)

Length of Audio File:  56: 48

Cameron Reilly[00: 01]: Welcome back to QAV , The reboot episode, Tony Kynaston, how are you?

Tony Kynaston [00: 09]: Very well., how are you?

Cameron Reilly[00: 11]: Very good. Thank you, mate. You’re safe?

Tony Kynaston [00:14]: Yes, Yes, very safe.

Cameron Reilly[00: 15]: Are you isolated?

Tony Kynaston [00: 17]:  Isolated? Yes, business as usual for me really? I’ve been working from home for a long time.

Cameron Reilly[00: 24]: Yes, me too seeing coming up what 15, 16 years, I think for both of us, right?

Tony Kynaston [00: 28]: Yeah. That’s right. Yeah.

Cameron Reilly[00: 30]: We’re , we’re just.

Tony Kynaston [00: 32]: Can’t go out to restaurants, but they can still home deliver, so we’re still eating well which is good.

Cameron Reilly[00: 37]: You don’t go and have breakfast in your favorite little cafe every morning the real caffeine? 

Tony Kynaston [00: 40]: I don’t know , and I’m reading the financial review online, which is hard, but I do it .Well It’s not hard, though I enjoyed the paper version.

Cameron Reilly[00: 49]: So this is episode 303 , part 2 of our Rebooted Getting Started with QAV episodes, and if you’re brand new, if this is your first time listening to podcast, I suggest you go back and listen to 301 first. What we’re doing now is we’re sort of re-recording the introduction to the whole series that we did early in 2019, just sort of not updating it really, but just trying to do a better job than we did in the early stages because as we explained last week, we’re just a little bit more fluent with the subject matter in terms of how to explain it on a podcast. So, this episode three or three is going to be picking up from where we left off in 301, 302 was a Q&A episode. People send us questions that we answer. So, we’re sort of alternating the, getting started episodes with the question-and-answer episodes. So, I mean, you can listen to this one that’s fine, but I recommend you go back and listen to 301 first and where we got up to in episode 301, I think we talked about the checklist and how you develop the checklist, where you came up with the idea from you talked about the Checklist Manifesto Book. We talked about the coffee shop analogy and how that sort of plays into explaining the checklist as we go through it, how that’s a useful tool. For me, it was a useful tool in terms of getting my head around the idea that we’re not just dealing with abstractions here, we’re actually buying shares of real businesses and thinking about it, thinking about them in terms of real businesses, like a coffee shop, something that I can grasp. And I thought where we would start today is to talk about the data services, where we get the data from, as we’re plugging it into the checklist because there’s a range of places that you can get the data from, it’s all publicly available data. I guess the place where I started was getting the financial reports from the stocks, the companies that we were looking at but I found quite quickly that was very slow and tedious.

Tony Kynaston [03: 04]: Yeah and it can also be hard according to which reporting period we’re looking at, because if we’re looking at the half reporting period, then the numbers that are readily available in some of the sources might be full year, so you have to do some manipulations as well.

Cameron Reilly[03: 21]: Yeah, because we want to be looking at sort of 12 months and a lot of cases [insudible03: 25 ], if we’ve got the half, we have to take the half year figures and then we have to go back to the last full annual report and get the last half figures and add them all up and you can do it , and I actually found it useful to start there a year or so ago because it gave me a good understanding about how much gumph is in these annual reports and to get, you said, you just you skip the first 50 pages, you just turn right to the back and get straight to the numbers and ignore the chairman statement and the CEO statement and all the fluffy stuff about, “Oh, it’s gone so great. Oh, it’s fantastic. Oh, we’re doing such a great job”. We Patting ourselves on the back and giving ourselves bonuses, you know like, yeah, yeah let me see the numbers.

Tony Kynaston [04: 10]: Yeah, exactly. Yeah. [Inaudible 04:12] with pictures of the C.E.O shaking hands with the community and [inaudible 04: 16] having staff surrounding and clapping. Yep.

Cameron Reilly[04: 21]: Because of course today you’d be like, what are you doing? You should be elbow clapping. Back to the data services., so apart from the company reporting we’ve got, I guess the data services fall into two categories in my mind, the freely available data services, and the pay-per-use data services. Now the ones that we tend to use on the show that we talk about a pay-to-play services, but there are some freely available services as well. So maybe we should do a quick review of the freely available and then we’ll get into the pay-to-play. How about that?

Tony Kynaston [04: 57]: Sure.

Cameron Reilly[04: 59]: So the free ones that I’ve used over the last year include the ASX ‘s website, Google Finance, Yahoo Finance, and Reuters. They all have finance reporting services where you can go and get sort of most of the higher-level information. Again, there’s a bit of a learning curve. You need to familiarize yourself with different tabs in each of these and where the data is and different websites tend to define certain things in different ways like net operating cash flow on one website will be a different number to net operating cash flow on another website. And I think over time, we’ve just decided, well, pick one data source and stick with it and it all should come out in the wash at the end of the day. You want to say anything more about those sorts of freely available sites?

Tony Kynaston [06: 02]: No, you’ve summarized it well. I think where they started to give us a hurdle was in terms of trying to get a financial health score for companies. So, we could certainly get all where the numbers from their reporting pages, things like earnings per share and net equity and those kinds of things. But occasionally we have problems with the earnings per share because sometimes it was pre-abnormal or after abnormal so there can be some differences. But the big problem, I think that most of our listeners have was how do I replicate financial health that we find in some of the paid subscription services? How do I do that from the free ones? And we have talked about that in detail on a couple of our prior episodes, I think episode four in season one, I think went through it and we redid that one again too and one of the more recent seasons and I think we even found that one of the services we using has changed the way it reports, so even getting difficult to use that. But you can put together a checklist yourself that looks at things like how much did the company has and compares it to equity and how quickly it can liquidate the things and pay off its debts, that kind of thing So go back and listen to those in detail if you want to do it by hand. But I think you and I, me definitely historically, and I think you have to now come to the conclusion, we’re better off paying an annual subscription to a service and getting it all in an easily to slice and dice, a service that lays it all out for us.

Cameron Reilly[07: 39]: Yeah. I mean, it’s a fairly time intensive. And if you’re trying to do, particularly, if you’re trying to analyze a lot of companies relatively quickly using a lot of these freely available services, it’s just going to chew up a ton of your time. Now, if you’re a full-time investor, great. If you’ve got eight hours a day to do that, then that’s fine and dandy, but it’s probably better things to do with your life, it depends on what you think your time is worth. So, there are these pay-to-play services and a couple of the ones that I’ve toyed around with in the last year is a service called QuickFS. It’s out of the US and they have an Excel plugin where they will sort of automatically fill out the spreadsheet for you. They’ll pull the latest data down and I thought that was a great idea for a while, but I found at the end of the day, there were way more coding and way more problems with it than seemed to be worth the time and effort. It was cheaper than some of the other services put maybe a quarter to a third of the price, but for the amount of dicking around, I had to do to get it to correlate with your numbers. It just wasn’t worth it at the end of the day. There’s an Australian site called Share Analysis that we do use, it is currently free, again, talking March 2020 here, they’ve had a lot of technology challenges in the last year. They’ve been up and down like a bride’s 90 so they’re a little bit unreliable. They, replat formed, I think they got acquired by another organization and they seem to have had a lot of technology issues for the time being they’ve sort of got a free trial that just keeps going. You have to re-sign up to the free trial, I think every 30 days, but until they bed down the technology, it remains free. But of course, the site that we both use for the majority of our data now is Stocked Doctor, and now Stock Doctor Lincoln is the parent company it’s been around for a long time. Do you want to just give people sort of the high level pricey on Stock Doctor?

Tony Kynaston [09: 58]: Yeah, sure. So, Lincoln Indicators is the parent company because it was founded by a guy called Dr. Merv Lincoln, who did his Ph.D. on looking at what kind of ratios between cash flow statements, profit and loss statements, and balance sheets he could find that were common to companies that went bankrupt. So, he did some regression testing over the Australian share market. I think he did it probably in the seventies or eighties. So up until that period, and he came out with these holes, the ratios of things that were common to companies that went bankrupt and then he flipped around and said, well, let’s score every company based on these ratios. And if they score well against these, then they’re healthy and the higher the score on these ratios, the healthier it is. So that’s how Stock doctor was formed, his son took over the business and turned it into a software program. Originally, they used to send us a disk and you put the disk into a computer and load it up locally, but now it’s all available in the cloud, which is a lot easier as well. But I think it’s a great tool because you cannot only get the benefit of their financial health scores, but you get very easy access to data, which is really useful and plugging those numbers into our checklist.

Cameron Reilly[11: 14]: So people can check that out. I think they do have a free trial go to stockdoctor.com.au if you want to have a look at that and then I think there’s a couple of weeks free trial and then you’re on a membership it’s about $1,600 a year or $142 a month.

Tony Kynaston [11: 36]: If you do sign up, mention Cameron’s name so you could get a discount on the future subscriptions, but we’re trying to get some leverage with Stock Doctor. So, we can, if they see enough people signing up from our podcast, then they will try and negotiate a deal for our members forward.

Cameron Reilly[11: 54]: Yeah, a deal. And one of the things that we’d love them to do is build a QAV filter into the product to make it easier for our listeners to go through our process. You don’t have to build at the moment, every all of us have to build our own filter. And we’ll sort of explain how to do that, but it would be a lot easier if they would just make that a feature of their product to QAV filter. So that’s the service we’ll be using as we run through a little bit of share analysis, but mostly Stock Doctor’s. We run through them this and we’ll explain how to use it, where to find the data. But if you’re brand new and you’re getting around your head around this, it’s going to be easier for you. If you go up to Stock Doctor and take out a free trial, I think while you work your way through it. All right. Well, Tony I think we should get into walking through the checklist. 

Tony Kynaston [12: 50]: Yes. Absolutely. 

Cameron Reilly[12: 51]:  Well for those of you that are brand new, go up to the Q.A. V website qavpodcast.com.au, and if you’re a QAV club subscriber go to the portfolio and checklist tab on the menu, and you’ll be able to download the latest version of the checklist, which is an Excel spreadsheet, grab the, it’s called the stock doctor version up there, download that if you want, and you can walk true. Otherwise, if you’re not a QAV club subscriber yet just build your own. I guess you can do that, just walk through and make your own spreadsheet. We’ll walk you through all the data points and it’s not a bad exercise actually to build your own. That’s how I did it when we started off, because I wanted to understand it and I find if I build things myself, I tend to understand them better. Well, once you open up the spreadsheet, you’ll see that the first half a dozen columns are so basic stuff that the stock code, I like to put the name of the company in there so I know what an AQG or an SSG is. I just throw in links to the A.S.X and Google news and a Stock Doctor link in there just for easy access If I’m going back to it at a later date and I quickly want to check some data. Then column F is just the last analysis date, last time I did the analysis so I know when I did. And then the column G is the period end date, that’s when they close off their financial year or the reporting period that we’re looking at anyway. So, there’ll be full years, half years, and some companies because of where their headquarters are on weird financial year periods, not your usual, June and Decembers. And it’s good to know that because it helps me understand where the data is at.

Tony Kynaston [14: 58]: Yeah. If I can just bite in there too. Sorry, Cameron just told me the six monthly versus 12 monthlies. So, companies in Australia report twice a year, once in, well, they have to report by the end of August or the end of February, depending on the period. Stock Doctor will say whether the reports that you’re looking at are annual, so they represent the 12-month period for the company or interim, which is six monthlies, but in Stock Doctor, they add the current six months to the prior six months. So, you get a rolling 12 months, which is useful. So, we don’t have to do that calculation ourselves.

Cameron Reilly[15: 38]: Very good. So, then we get to column H, where the data starts, and in my spreadsheet now Tony, column H does the share price have a positive trend for sentiment chart? This used to be a little bit later on in the checklist, but I’ve just moved it to the front of the checklist because we decided a little while ago that if the answer for this question is negative, then we stop. This is a go-no-go breakpoint for us in the checklist. So, let’s talk about sentiment, Tony.

Tony Kynaston [16: 21]: Yeah. So where do I start? So, it’s basically the wisdom of the crowd. So, we’re trying to see whether or not people are buying or selling the stock and whether they have some confidence in it, just from looking at the share price graph. That might sound a little bit counter-intuitive to value investors because they either don’t necessarily like looking at graphs and they tend to be fundamental analysts. So, they’re looking at the numbers and then the share price will take care of itself. I have a lot of sympathy, for people who think that way, but I use the sentiment on the share price graph, it’s a bit of an insurance policy. I don’t want to hold a stock where the share price is dropping too quickly and I only want to buy stocks where they’re going up, their share prices going up. So that’s roughly, the theory behind it. And I remember listening to a podcast years ago by a gentleman who said that all he did to invest was he looked to the share price graph and if it was going from the bottom left of the page, the top, right of the page he bought, and if it was going from the top left to the bottom, right. He sold. And there’s a lot of wisdom in that, I think. If you are a value investor and you think you have a compelling score on a company, and you think it’s well below its intrinsic value and even though the share price is going down, you can still buy it.

But I don’t do that because typically what you have to do is to wait for it to bottom out and then start to come back up and I’d rather buy it on the way back up and then use my money for something else in between, which is more profitable. So, having given that sort of overview of where I’m coming at it from, I guess a macro level, how do you measure sentiment? How do you know what’s happening with trends? Because sometimes we’re looking at graphs and the share prices all over the page, it’s going up and down. And I didn’t come up with this solution, but I did download a package or 10 or 15 years ago that talked about a three-point trend line as a way of analyzing stocks. And there are plenty of moving averages and investors who use moving averages out there who use them to create, buy or sell signals. And this is just one of those ways of doing it. Stock Doctor has their own one, which they call SDMax, which is Stock doctor, I’m not sure what the Max stands for, basically, it’s looking at the short-term movements and the share price over the long-term movements. So, for example if in the last, Stock Doctor users to use in the last two years that the share price has been going up, but in the most recent period it’s going down, they’ll use it as a trigger to say that there has been a technical breach and you might want to think about selling. So how do I do it? First of all, I use a five-year monthly graph, and I think that’s pretty important. I think three-point trend line analysis and other trend line analysis can work over different time periods.

But if you use one, which is too short it can be very volatile, so you’re buying and selling a lot, which can be expensive in terms of paying capital gains tax, but also expensive in terms of paying brokerage as you get in and out of a share. So, I take a longer-term view, so five years, and I use the monthly graph. So, I’m not looking at weekly moves or daily moves or whatever. And then what I do is, if I’m looking at whether something should be sold, I’m going to find the lowest point on the graph in that five-year period and I’m going to take the next lowest point to the right of that lowest point. And I’m going to use a ruler or a straight edge to join those two points up and then I’m looking for the time that the share price drops below that line. And so basically what I’m saying is that if you think about shares and even in the index, they generally trade in peaks and troughs, so in a range.

So even though they’re going up or down, they generally testing a high point and a low point within a band, and we’re looking for times when they move out of that range on the way up all the way down to really say that people have had enough and they’re selling out or they’re buying in because there’s new people buying into the share price and its trading outside of its downtrend. So, on the way for shares that are going up, we’re looking for a break that goes down and per shares are the going down, we’re looking for a break that goes up. So, we reverse the procedure for shares that are going down in terms of looking for a time to buy-in. We’re taking the highest point on the way down, then the next highest point to the right of that, we’re drawing a line. And when the share price goes above that line, it’s a buy signal because there’s more buying than selling in the share price. Is that clear Cam? Do you have any questions or comments?

Cameron Reilly [21: 23]: Yeah, let’s just take those line drawings a little bit more slowly, and if people are confused about this and a lot of people always are, it’s hard to grasp without having a visual guide, go up to our website again and go to the videos page and you’ll see a number of videos that I’ve put up there over the last few months that will give you a visual step-by-step demonstration on how this works, which makes it a lot easier I think. So that’s qavpodcast.com.au/videos, but just again, in terms of when should it be sold, so we’re looking at drawing a line between the two lowest points on the five-year monthly chart, and if the share price, and then you draw that line all the way to the right, to the current date and if the price drops below that line, we sell? when to buy we’re taking the highest point and then drawing a line to the right of the graph through the next highest point? 

Tony Kynaston [22: 26]: Yes. 

Cameron Reilly[22: 28]: And we’re waiting for the share price to get above that line before we buy back in.

Tony Kynaston [22: 36]: Yeah. And I just want to add that, because we’re recording this in March, 2020, most of the share price graphs are going to have a very obvious cell signal, some don’t but the majority do, and you can see the share prices just dropped off a cliff and certainly have breached through the three-point cell lines. And you can also see that it’s too soon to buy because the share graphs are still going down and they will take up at some point and we’ve had market rallies that have gone on and petered out in the last couple of weeks. They haven’t really been, buy signals for us. What we’re really trying to wait for is we really want to see sentiment turning, not just people dipping their toe in the market or trying to get to the bottom. We really want to see sentiment turn, and that’s when we need to see a break in the downtrend whereas the share price gains momentum on the way up.

Cameron Reilly [23: 31]: And I guess the point I want to make to people here is you don’t believe in forecasting, you don’t believe in trying to time the market. What you do is look at individual stocks, you at, in this particular column, we’re looking at the market sentiment for that particular stock. It’s only the first step in 17 data points that we’re going to go through, but we are not trying to time the market. We’re just looking to see if the share price has support or not.

Tony Kynaston  [24: 06]: We are kind of timing the market, but not in the classical sense .We’re using the three-point cell line has a bit of insurance, almost like a stop loss for us to say the market’s collapsing, let’s get out. And we’re using the three-point up line to say, look, no markets are on its way back up, now it’s time to buy. That’s it in a very broad sense. So, we are in a way timing the market for sure.

Cameron Reilly[24: 31]: We’re not trying to guess what’s going to happen with the market, I guess is what I’m saying when.

Tony Kynaston [24: 37]: No. We’re letting the market tell us really.

Cameron Reilly[24: 38]: Yes, you wait for the data to tell you when to sell and when to buy, you’re not trying to predict,  maybe the predictive, it’s not predictive timing. It’s a database timing. Yeah.

Tony Kynaston [24: 49]: Yeah. And like, as I think I’ve said before on the podcast, if anyone was any good at prediction, economists would be billionaires and they’re not good. They’re at telling us what happened, not what will happen and likewise, almost any sort of forecast that will be wrong as much as they are right It’s just the fool’s game so we wait for the [inaudible 25: 10]

Cameron Reilly[25: 10]: It’s flipping a coin. 

Tony Kynaston [25: 11]: It is, yeah. And especially in times like this, how on earth could you ever forecast when the lockdown will finish, whether there’s going to be reinfections in China with the stimulus packages are going to be enough, et cetera, et cetera, you just can’t forecast it.

Cameron Reilly[25: 28]: The lockdown is going to finish anywhere between two weeks and six months, depending on who you list, if it’s  Scott Morrison versus Donald Trump. 

Tony Kynaston [25: 33]: Yeah, exactly. 

Cameron Reilly[25: 35]: Now I just wanted to also mention that there’s a, like a number of aphorisms around this that you’ve mentioned to me over the last year. We mentioned one on an episode today as well another episode we did Charlie Munger, Warren Buffett’s longtime partner talking about, I think you said it’s time in the market, not timing the market that’s important, but these guys like the Warren Buffett’s, the Charlie Mungers who have been doing this for 60 years, extremely successfully, they’re in the same camp as you, right? They don’t believe in trying to guess what the market’s going to do?

Tony Kynaston [26: 13]: No, that’s correct. They don’t, they know it’s a Mr. Market as manic-depressive. Look, I appreciate Charlie’s advice to stay in the market and I also think that if any of our listeners are uncomfortable with the three-point trend line, they can stay invested and ride things out. I just found, especially after the GFC that I would have done better if I had a stop loss on the way down and why did the things on the way up? So that’s why I use the three-point trend line now. So, it is going a little bit against what Charlie says in terms of I am trying to time the market on the way down and back on the way up. But if anyone feels uncomfortable with that, then sure, go fully into the market all the time. I’d advise if you’re getting into the market now though, that your dollar cost average that you don’t just buy everything on one day and think you pick the bottom because that’s really the essence of what Charlie’s trying to say is you can’t pick the top or the bottom.

Cameron Reilly[27: 08]: Yeah. And we did a video last week where we were using the G.F.C and I think CBA is an example, global financial crisis from 2008, we looked at a chart of what happened with CBA. And you explained if that was playing out today where you would have sold and where you would have bought back in using three-point trend lines as your signal and how you would have, by using that avoided the majority of the downturn and picked up on the majority of the upturn. So, if people are again, trying to see why you do this, go and have a look at that video, “when to buy back in” video, I think it’s called on a videos page. So, with this one, we’re doing column H if the stock is exhibiting positive sentiment, we give it a two and if it’s negative sentiment, it gets a minus one. And in fact, as I said before if it’s negative sentiment, we just stop right there. Don’t! Do not pass go, do not click 200, unless you are learning the QAV process you want to do the checklist just for experience. That’s great, but just don’t forget at the end of it, regardless of what happens with the score, it’s filed on the sentiment. So, we would not buy it regardless of what happens to the rest of the numbers when it’s in negative sentiment.

Tony Kynaston [28: 36]: Correct, yes.

Cameron Reilly[28: 37]: Okay. So that’s a go-no-go decision. Now, the next column is asked a similar question, Is there a recent positive upturn? Explain your thinking behind that, Tony.

Tony Kynaston [28: 52]:  Yeah. So, it might be easier for people to have a look at this in reverse. So, is there most of the share price graphs on the market at the moment or stocks on the market at the moment are displaying a recent negative downturn? So, in other words, has the trend line been broken in the last six months? What we’re looking for in terms of the checklist is for a break on the upside. And if that’s happened, it’s really a signal to start buying in. So, we give it an extra point in the checklist because I expect that that’s the start of a run. And I guess more often than not, that’s a great time to buy and we get most of our returns at that kind of time.

Cameron Reilly[29: 31]: So if there is a positive upturn, it gets an extra one. If it doesn’t, we just blanket, we don’t. So, we see with some of our scores that will just be a blank. That means we’re not, it doesn’t get counted in the overall. So stock isn’t being penalized If it doesn’t get a positive here, it just doesn’t get doesn’t get a positive boost. Yeah, a kicker.

Tony Kynaston [29: 57]: Yeah. So, some things we’re looking for things which boosts the score rather than take away from the score, because if a share isn’t an upswing anyway, there’s no point penalizing it, because it’s probably in the right place to buy. It’s just that we think it’s a better place to buy if it’s just recently happened.

Cameron Reilly[30: 13]: All right. So, column J is net operating cash flow. This is where we start to actually look at financial data. And the rationale here, as I understand it is because from your perspective, cash is King. We’re looking for businesses that are performing well and you believe the best indicator or at least one of the best indicators for that is how much cash the business is generating.

Tony Kynaston [30: 40]: That’s right. I mean, cash is King, you’re, right? And Warren Buffet has spoken a lot about using what he calls free cash flow and you can get that in Stock Doctor as well on there’s quite a strong correlation between free cash flow and operating cash flow. But just to give it a quick summary. We’re looking at the money coming in through the front door list the cost of collecting that money. Buffet takes it a bit further and he starts looking at whether the company is putting enough aside for providing for investment in the future for CapEx replacements, and maintenance, and things like that. And you’re paying down of debt and investments that it’s likely to need to make in the future. And let’s say, if you go through those other lines in the cash flow report, you get the free cash flow.

Found over the years, even though there’s a correlation between the two but I preferred operating cash flow because it’s the highest line in any of the accounts that the company reports and a company that we’re required under the law to report an operating cash flow statement, a profit and loss statement, and a balance sheet. And what I found over time is that the further you go down those reports, the more it comes, not guesswork, but the more, it becomes a management decision as the, as to what figures get put in there. So, for example, what do I mean as we said before, Buffet’s trying to work out in getting to free cash flow, whether enough money has been set aside for depreciation on the current assets or amortization of things like Goodwill. And that’s a bit of an educated guess sometimes because unless you’re very close to the company, you’re very close to the industry.

You don’t know whether they need to replace the bulldozers at the mine next year, or whether they can wait until the year after. And, and some of these things are subjective. So, if you kind of follow that line of logic, then sometimes other things are subjective and there’s been very big cases of companies which have exploded in a bad way because of the accounts being almost doctored by the management to make them look good. You know, things like Enron even Al Dunlap who work in Australia, for Kerry Packer for a while was found to have a front-ended sale and reduced his inventory. So, there are lots of leavers and a manager can pull between those through three accounting statements to make themselves look good, or to suit their purposes, whether they have to, like, they may decide that they’re going to reach their bonus early, easy this year.

So why don’t we put some provisions on the balance sheet? So, we’ll reduce the profit a little bit so that it makes it easier for us next year to withdraw those provisions and spend them against some costs. And our P and L will look better next year. So, all of these kinds of things are available to managers, and I’m saying managers are crooked in some cases they are, but it’s human nature to try and present yourself in the best light or to maximize your income, which for a manager is often tied to the performance of the company. So, what I found was operating cash, being at the top of the statements was the hardest thing to manipulate. And so that’s why I use operating cash as the driver for my valuation.

Cameron Reilly[34: 09]: I guess, as we go through this, Tony we should tell people where to find this data using Stock Doctor with the graphs before if you go to Stock Doctor, you see there’s the little menu tab up the top. I tend to use the one, that’s got a little picture of it like a white board on it with a graph on it, advanced charting. And I go through and do my five-year monthly, use the chart style of align. But for this one, the net operating cash flow, we go to the second tab and Stock Doctor financial statements?

Tony Kynaston [34: 47]: Go across the top line and click the statement of cash flows tab.

Cameron Reilly [34: 52]: And then it’s just the top line on there, the first row here operating cash flow.

Tony Kynaston [34: 58]: Yep and just be careful of the units. The units are above the column. In most cases, it’s millions, but sometimes it’s thousands and sometimes it’s just dollars. So just be careful of that too.

Cameron Reilly[35: 11]: Okay. So, there’s nothing else that we need to be. We just grabbed that number out of that column and sticking the latest column and stick it in.

Tony Kynaston [35: 20]: Yeah. Just, you said something just before I wanted to just ask you about for share price sentiment, I just go to the front page of stock doctor and I don’t go into advanced charting.

Cameron Reilly[35: 30]: Oh, okay. You just eyeball it from there.

Tony Kynaston [35: 34]: I can keep, yeah. I keep that page set to five-year monthly, and I can eyeball it from there.

Cameron Reilly[35: 40]: Moving right along then on our checklist, the next column would be column I, which is shares on issue. How many shares they have out there available to be bought? I always struggle to find that on Stock Doctor, tell me where I find that one again. I think it’s on this front page too, isn’t it?

Tony Kynaston [36: 00]: No. So, I get back into financial statements and it’s on the first tab that opens when you get into financial statements down the bottom where it says liquidity, is the subheading.

Cameron Reilly[36: 11]: Fully paid ordinary shares.

Tony Kynaston [36: 14]: Correct. Yeah, and again, be careful of the units and B.H. Ps case it’s millions, but again, sometimes it’s not, it’s hundreds of thousands or units.

Cameron Reilly[36: 23]: Right? So that’s a fairly easy one to fill out in the spreadsheet. You just grabbed the number and you throw it in and obviously, some of the people will see that some of the data points that we’re looking at on the spreadsheet is just grabbing raw data from financial statements or from Stock Doctor. And some of them require an assessment, and a score for how it’s doing. So, this is just a data point, how many shares they have, and that is going to become important because the next column. Column L is how much cash per share the business is generating. And I have it in my spreadsheet just dividing the net operating cash flow by the number of shares on issue, gives me how much cash per share they’re generating. I guess that’s, that’s a good one to talk about the coffee shop analogy, Tony.

Tony Kynaston [37: 20]: Yeah. So, if we say that rather than saying cash per share, but just how much cash is the coffee shop generating. So, we know in terms of operating cash flow if we’re using the strict accounting definition, it’s how much money is coming in from selling coffee and food, less the cost of collecting that money. So, it’s the, probably the wages of the staff who are doing that collecting. Fairly simple calculation but if we were saying, a partner in the coffee shop, and there was a say,10 partners in the coffee shop, we’d have to divide that operating cash flow up according to the number of shares. And that’s where we get to our share of the cash flow coming in.

Cameron Reilly[38: 03]: And let’s talk about why we want to know that. My understanding is if I’m going to pay, if we’ve got a coffee shop and I’m going to pay a hundred thousand dollars for the coffee shop where we’re starting to work out, how long is it going to take before the business is going to bring in enough money to neutralize the outgoings that I had to fork up with to buy the business in the first place?

Tony Kynaston [38: 31]: Yes, that’s right. So, whilst, acknowledging it’s a rough and ready calculation because we’re not taking into account any of the other profit and loss items like depreciation and how often we have to turn over the cappuccino machine and things like that, but a rough and ready calculation of how long will it take for me to get my money back.

Cameron Reilly[38: 53]: And  this is trying to minimize our risk here. Buffet talks about a safety margin and a buffer, or we’re trying to do here is determine what level of risk, if it’s going to take me two years for the business to nominally return, my initial investment, that’s very different to a business that might take 10 years or 20 years, or when you look at some technology stocks, 50 years to return my investment.

Tony Kynaston [39: 26]: Yeah, and if you were tempted to pay 50 years for a coffee shop, you’d want to have a fair idea it was going to grow. maybe it was a franchise of five coffee shops and you were going to franchise it out to be a hundred or something like that. But if we’re just buying the regular run of mill down the road, coffee shop, then yeah, we want to have a quick return on our money basically.

Cameron Reilly[39: 47]: I mean, for 50 years that coffee shop would want to have a little room out the back where I got additional benefits over and above the coffee. Coffee with a happy ending, that’s what their coffee shop would have to be happy, ending beans. So, I’d call it. 

Tony Kynaston [40: 01]: The Bada Bing

Cameron Reilly[40: 02]: The Bada Bing?!  Did you say?

Tony Kynaston [40: 06]: The Bada Bing, I said Bada Bing. The Bada Bing is a great name!

Cameron Reilly[40: 09]: Quick! let’s go trademark the Bada Bing strip joint with coffee is basically Pole dancers and coffee and mobsters at the back it’s a Sopranos as reference for people who’ve never watched the Sopranos.

Tony Kynaston [40: 25]: Well I was going to the front coffee shop and not the back.

Cameron Reilly[40: 29]: I thought their wives would be on the poles [inaudible 40: 31] cost. Just get the wives in there on the poles.

Tony Kynaston [40: 35]: Well, if you’re paying 50 times earnings, maybe you need to

Cameron Reilly[40: 42]: All right. So that’s our cash per share column. K is the share price pretty obvious you get that from well, Stock Doctor will tell you what the current share price is. You can also get it from the A.S.X website or Yahoo Finance or any of those other websites. And then column L is another calculation, I call it cell type formula; the same as the cash per share cell type. This one of course is we’re taking the share price and dividing it by the cash per share figure that we had before. And this is to work out exactly what we were talking about. How long is it going to take to generate enough cash to neutralize my investment. 

Tony Kynaston [41: 23]: Correct. Yes. And we’re looking for a number which is equal to six or less than six. So, we want our investment paid back within six years or no more than six years.

Cameron Reilly[41: 35]: And that’s column M. Column M is, the price per share, divided by the cash per share, less than seven, six or less. And then we give it a score too, if it’s a positive zero, if it’s a negative. So, let’s explain that Tony, what’s this magic number seven? I know that one is the loneliest number that you’ll ever know, two is not as bad as one, but it’s the loneliest number since the number one, by the time I get up to seven, I think that’s polygamy. By the time you get up to seven, you’re a Mormon. Where did you come up with? Why is seven important?

Tony Kynaston  [42: 14]: Yeah, so I once read a book about investing and it was covering a guy who ran a company called Cap Cities, which was a TV station in New York, upstate New York Capital Cities. I think it was called, but it’s always referred to as Cap Cities. And he went around buying up other TV stations but would never pay more than six times operating cash flow for them. And eventually, it grew into one of the big networks. I think it was AB.C in the U S and that was his metric. So, I’m again, unashamedly stealing from someone else. But what we’re trying to do is, people often talk about, for example, the P ratio, the price to earnings. So that’s doing the same calculation we have, but they use the earnings per share rather than the operating cash flow per share. And then they’ll, come out with a high number in terms of their targets. So oftentimes they’ll use a number, which is less than the market average, which is around 14 which is the PE of the market long-term. And so, they’re looking for companies which are less than that. We’re higher up in the profit loss and operating cash flow statement than earnings per share we’re at operating cash flow. So, our ratio has to be less than 14 and so I arrived at six. I also found two that basically if we, without putting a number on the door, if we use sort of did error analysis of all the companies and then rack and stack them, starting at the lowest price to operating cash flow, we had more than enough to get on with, by the time we get to six. So, I kind of approached it from a number of different ways.

Cameron Reilly[43: 57]: And the guy I think was Tom Murphy?

Tony Kynaston [44: 01]: Yes. 

Cameron Reilly[44: 02]: It sounds familiar, yeah and it’s like Warren Buffet is the big fan of his right? I think the book might have been the outsiders was that the book?

Tony Kynaston [44: 10]: It was yes, it was. Yes. Thank you. Really that’s the book.

Cameron Reilly[44: 14]: That’s why I’m here. Tony. I’m your other memory? Actually, I just quietly Googled cap cities, guy, Warren buffet, Warren buffet once said most of what I learned about management, I learned from Murph, Tom Murphy. I just kicked myself because I should have applied it much earlier. He said, 

Tony Kynaston [44: 34]: Right. 

Cameron Reilly[44: 35]: So, if people want to go read their book, I haven’t read that one yet, but I should make a point getting my hands on. Okay.

Tony Kynaston [44: 42]:  That’s really good. 

Cameron Reilly[44: 43]: So, it’s just guidance again, is if I understand it, it’s just risk management?

Tony Kynaston [44: 48]: Yes, that’s right. So, like you said before, if we were paying six times operating cash flow for the coffee shop, we expect to get our money back after six years. And obviously you want that to be as low as possible. So, when we come to ranking companies, the lower that price to operating cash flow the better.

Cameron Reilly[45: 07]: Because it’s pretty hard to predict. I mean, we bought a coffee shop in the suburb and people were still going to be drinking coffee seven years from now, probably, but what’s going to happen to trends in coffee shops?  are baristas going to have like long square beards, short beards, Hitler mustaches. Are they, is it going to be jazz? Is it going to be like, we don’t know what happens in the suburb? We don’t know. Things can change a lot. The longer the timeframe, the more things can change. Yeah.

Tony Kynaston [45: 36]: More importantly, another coffee shop could open up across the road and take half our buses.

Cameron Reilly[45: 41]: With, with stripper poles at the front at the butter bean.

Tony Kynaston [45: 45]: Yeah. So, we want our money back as soon as possible before the risk and can destroy our business.

Cameron Reilly[45: 53]: I’m just googling that the Bada Bing. Yeah. Somebody already got it thebadabing.com see we’re Tony too late, story of my life back short stay late. Actually. I’m normally too early, 10, 15 years too early. Or I spent seven years writing a book, four years, making a film released in both just as a global pandemic hits the world and everything goes into meltdown like hell.

Tony Kynaston [46: 22]: If You want the book, let me know when you’re going to read it.

Cameron Reilly[46: 26]: Yeah. Yeah. You don’t believe in forecasting, except if Cameron’s doing something stay right away from it. Yeah.

Tony Kynaston [46: 37]: Yeah. It’s going to be missed time completely. Yeah, 

Cameron Reilly[46: 40]: Column P dividend yield again, straight-up financial data on Stock Doctor, I get this from on the homepage Nine golden rules is the homepage on Stock Doctor. And then down in the past financial performance module, whatever you want to call it that they have there.

Tony Kynaston [47: 02]: Yeah. So there’s in fact, there’s two years. Did they give you what they call the dividend yield percentage and then the gross dividend yield percentage.  So the gross is simply taking into account that when you get paid a dividend in Australia, you get a franking credit as well. So it’s basically adding 30% to the dividend, but we’re just looking at the basic dividend or dividend yield number.

Cameron Reilly[47: 23]: Right? Why don’t we want to use the gross one?

Tony Kynaston [47: 25]: Well, we can, but I think we just have to change the metrics that we use. That’s all, the cutoffs, 

Cameron Reilly[47: 32]:  Why? 

Tony Kynaston [47: 34]: Well, we’re going to say that the dividend yield has to be greater than the mortgage rate so that we can all want what banks charged for mortgages so that we can buy stocks. It’s an advantage to be able to buy stocks and have the dividends pay off the interest if you want to gear against stocks , so that’s the basic test. If we then took the gross number you might want to just, well  you probably could keep it at the store above the bank yield. No, the problem would be is that you’d have to wait longer to get your tax return back, to get your claim, your franking credits to service that debt. So for example, if we had a company which was yielding 3% and the gross stuff from out on that was 4% and the mortgage rate that we’re using as our benchmark is 4%. We might say it’s worth buying, but it would take us probably, you know, 18 months to service the debt, which would probably give us cash flow problems. 

Cameron Reilly[48: 29]: Yeah. Okay. Now you’ve talked about the reason why we have this there. I assume this leads into sort of  the potential upside for the stock. If it pays out a dividend that’s higher than the mortgage, right? There’s going to be a lot of retirees that might like this stock also. It’s good for people that are leveraging their portfolio. Like I know that you have done in the past, but I just want to be clear about this because we’ve had some people who’ve listened to the show who get confused about this. They make the assumption that you care about dividend income and at least up until this point in time, it’s not that you care about dividends. You don’t, you’re not buying stocks for the dividend. You just see this as a potential one particular indicator of potential growth for the stock

Tony Kynaston [49: 22]: And helpful. I think that’s the other important point is that the boards of companies will have to be very certain that they can maintain a dividend once they start paying it because companies , they share prices are marked down very heavily. If they have to withdraw a dividend or lessen it. So yeah, basically it’s a sign of stability in the earnings of a company. 

Cameron Reilly[49: 44]: Yeah. Good point. Okay. So moving right along column Q is the question is the dividend yield higher than the mortgage rate? This is how where we score them for their dividend yield. They get a one for a positive and a zero for a negative. Now, where do we determine what the mortgage rate is? We just go to a bank site, like the N.A.B. 

Tony Kynaston [50: 13]: Yeah, that’s what we’ve been doing. Yep. There’s probably websites out there like Canstar, which gives us the whole range of mortgages. They will often have very cheap mortgages in there. I tend not to use that because I don’t think people can necessarily always borrow at those rates depending on their circumstances. So, yeah. I tend to go to the bank of values, which is A and Z and check its benchmark. They call it interest plus  capital repayment mortgage for 25 years and use that principle plus interest, sorry.

Cameron Reilly[50: 47]: Column R is the price to earnings ratio. The PE first thing everyone learns when they start dabbling in the share market is the PE. Now this is straight up financial data. We can get this off of Stock Doctor. Let me see. Is it on? Yes, it’s on the home page section five on the home page.

Tony Kynaston [51: 16]: Is it really? Okay, let me have a look. I normally go to the financial statements. Oh yeah. It is that you’re right. Okay.

Cameron Reilly[51: 25]: Yes. So it gives us, the P.E  gives us a number of figures. David. We just got the industrial average PA the market average, P.E we just want the Stripe PA here, the latest number now. Well, let’s talk about the P.E Tony from memory you’ve said in the past that it’s a little bit like price to cash, kind of an indication for how long it will take for the business to provide enough earnings to neutralize our purchase price. But the concept of earnings is a little bit fluffier than net operating cash and can be manipulated in the financials.

Tony Kynaston [52: 01]: Correct? Yeah. That’s exactly why I use operating cash and operating cash to share price as the ratio, rather than the price to earnings ratio.

Cameron Reilly[52: 12]: I’m trying to pull up. I know I’ve got a quote from Charlie Munger somewhere about this. He says, I think that every time you see the word E.B.I.T.D.A, you should substitute the word bullshit earnings.

Tony Kynaston [52: 30]:  And E.B.I.T.D.A Earnings Before Interest and Tax and Depreciation and Amortization. Yeah and let me give that context. A lot of the internet companies will use that as their earnings line, because they’re not making any money at the actual earnings per share line. So they say, Oh, we’re not making any money at the normal E.P.S line. So our P.E ratio looks bad, but don’t use that line because we’re growing , use the Earnings Before Interest Tax and Depreciation and Amortization.

Cameron Reilly[53: 04]: Yeah. So if it’s bullshit earnings, why do we have it in the checklist?

Tony Kynaston [53: 09]:  E.B.I.T.D.A? We don’t,

Cameron Reilly[53: 12]:  We have the P.E which uses earnings are there when they. What’s the earnings used in P.E, is it the E.B.I.T.D.A?

Tony Kynaston [53: 21]: No, it’s lower down, its earnings per share. 

Cameron Reilly[53: 24]: Oh, okay. Right. 

Tony Kynaston [53: 25]: So, E.B.I.T.D.A is before interest tax depreciation, amortization and E.P.S is after all those things. 

Cameron Reilly[53: 32]: Okay.

Tony Kynaston [53: 33]: Yeah. That’s okay we don’t use the P in terms of a direct indicator of whether a stock is  the right price or not. We use the P trend, which I think you’ll talk about in a minute. Why don’t you?

Cameron Reilly[53: 47]: Well, we do give it a score. If the PE is less than the yield and you’ve told me in the past that it’s just an observation that you’ve made with your aggression testing. It’s an indicator of value?

Tony Kynaston [54: 04]: Yeah, exactly. So again, if you think of a company paying out a dividend it’s, going to have the view that they can keep doing that going forward. And if the P is less than the yield, then it’s going to  be cheap. So we’re seeing a company which has all likelihood of continuing to pay a dividend, which means of all likelihood it’ll be in business. But you can buy it on a PE of less than the yield. And the yield is probably going to be around four or 5%. So the PE is very, very low.

Cameron Reilly[54: 33]: Okay. And so this is column S for the checklist is the P.E less than the dividend yield. We give it a one for a positive and zero for a negative.

Tony Kynaston [54: 42]:  Now we give it one for a part of it and a blank. If it’s not, again, it’s one of these boosts that we do.

Cameron Reilly[54: 49]: None of my checklist, we don’t earn it, we give them.

Tony Kynaston [54: 53]: We should.

Cameron Reilly[54: 56]: We give it a one or a one, all blanks. I got to love a blank stare. You’re right. It’s a blank typo. 

[Outro] Cameron Reilly[55: 03]:  Well, that’s where we’re going to leave episode 303 folks. We actually kept going, I think we recorded for another hour to finish the checklist explanation, but you don’t want to see, I know we’re recording this in the middle of the coronavirus lockdown of 2020, but you don’t want to sit here and listen to this for two hours. So we’ll put out the next area of that next week. I think we’ll do episode 304 in between, which will be another Q and A episode and then we’ll be back to finish off the Check List Analysis next time. Of course, if you’re listening to this in the future, first of all, how did we go? Did we survive the coronavirus? Let me know, send me an email. And secondly, I’ve, well, obviously you did. If you’re listening to this and secondly, you can just skip around then listened to the 301, 303 and 305 and you’ll get the whole getting started introduction episodes or you can go and listen to the episodes in the middle as well. I’m not the boss of you. I can’t tell you what to do , do whatever the hell you like. Don’t look at me like that do what you want.

But If you are new to this, just remember, as we always say, we are not financial advisors, don’t take anything you hear on this show or as financial advice. We’re just teaching how Tony thinks about investing, maybe right for him may not be right for you. So please, before you make any investment decisions, go see your financial advisor. Stay safe, be nice to each other, we’ll see you week.

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