Transcript S03E05 – Getting Started (Part 3)

S03E05 – Getting Started (Part 3)

Duration: 49:14

Cameron: [00:08] Welcome back to QAV. This is episode 305, or as I like to think it part 3 of our introduction to QAV reboot that we’re doing early in 2020, recording this on the 6th of April, 2020. And this is actually kind of part 2 of what we started in three Oh three last week, which is the introduction to the QAV checklist. So if you haven’t heard three Oh three yet, I suggest you go back and listen to that. That’s season three, episode three is the first part of our introduction to the checklist. If you have heard that, well, this is part two, it is about another hour of walking through the checklist step by step. And this week we pick it up with column T is it the lowest PE in the last three years? Now, I think on the front page again of Stock Doctor and section five, share price Valley, you can scroll backwards and see the PE. So we want to go back six halves to get three years. Is that right?

Tony: [ 01:18] Correct. Yes.

Cameron: [01:19] We give it a score here, according to my guide here, two for the lowest, zero if it’s not the lowest and negative one, if it’s the highest.

Tony: [01:31] That’s right. Yes.

Cameron: [01:32] Do you want to talk us through why?

Tony: [01:35] Yeah. Again, it’s an indicator of value. So, I using three years was a bit arbitrary but the thinking behind it was, if you go back too far, the company could have evolved over time and the PE could have changed, but in the last three years and all things being equal, it’s probably roughly the same sort of company it was three years ago and so we can compare its PEs. And if the PE’s the lowest in that three-year period, that’s a sign of value and if it’s the highest in that three-year period is probably the sign of it being overvalued. So, we give it a check for a one or a zero or a minus one or two, I think, or a zero or minus one in the checklist accordingly.

Cameron: [02:16] Two zero and minus one yeah.

Tony: [02:18] Yeah. Thanks. Yeah.

Cameron: [02:19] So if it has the lowest PE in the last three years, it’s an indicator that the stock is currently undervalued by the market.

Tony: [02:30] Correct.

Cameron: [02:30] Alright. So, column U is net equity. This is straight up financial data you can get it stockdoc, there go to the financial statements, tab, statement of financial position and look for the equity row. Explain to us newbies what net equity means, Tony?

Tony: [02:48] Yeah. So just before I do that, so just in stockdoc, there we’re going to financial statements and then there’s a tab and we’re clicking of the one called statement of financial position brackets balance and that gives us the equity. Yeah. So, to explain what equity is, it’s technically it’s the assets minus liabilities. So, for a company to have equity, to have positive equity, it means it’s got to have more assets than it does liabilities. Assets are things like plant and equipment or the loans or property to the loans that it can be some intangibles that we’ve talked about before like Goodwill. So, if it’s bought companies Goodwill is the difference between the equity that’s buying and the price it’s paid. And so that can go into the balance sheet too. And there’s also other times there’s an intangible. So, things like the value of say a brand, if it’s a very strong brand, like some…

Cameron: [03:46] [Cross-Talking 00:03:47]. Well, some positive word of mouth, about our wives on the strip of poles.

Tony: [03:53] Yes, that’s right. So, there can be reasons why there’s intangibles, but basically, we’re looking at the total assets and we’re taking away the total liabilities. Liabilities, and the main, again, it’s going to be debt, but they’re also short-term things like supplies I have to pay, but haven’t paid yet, or also Canada is a liability.

Cameron: [04:14] And we’re going to be using this in a minute to determine the value of the assets that we’re buying for every dollar spent. So, in my mind, if I think about the coffee shop, analogy thinking what if the business costs us a hundred thousand dollars and to buy the whole thing and the net assets of the business a worth $110,000, it’s a low-risk investment because I could sell the business for parts tomorrow. Okay, good. And Gekko it, split it up, sell it for parts. And I’d make a profit, but if the net assets are only $20,000 and I have to pay a hundred thousand dollars for it, it’s a higher risk investment.

Tony: [04:53] That’s right. You’re relying more on the earnings to repay your, rather than the assets.

Cameron: [04:58] Yeah.

Tony: [04:58] In that case. Yeah. Yeah. That’s a good example. So, if the coffee shop and rented its space, it’s going to have a lot less assets than the coffee shop, which owns its space. So, they own the building that they operate from and that might actually have an effect on the valuation that we pay for the company.

Cameron: [05:15] Okay. So, column U is we ask the question, does the company have consistently increasing equity? And I think we get that from the same page that you said before, and again, it’s scrolls, so we can go right back. And how far do we want to scroll back here? And six halves again?

Tony: [05:35] Six halves again, that’s right. Again, no real science behind that. Other than it gives us a train without going back too far. Which may be distorted because the company has changed.

Cameron: [05:45] And so we’re going to give it a one for a positive and a zero for a negative here, because we’re trying to determine how well management is performing. If the net equity continues to increase steadily, they’re doing a good job. They’re building a business that’s growing, you know, has more and more equity half by half by half by half. If it’s going up and down, it’s an indicator that it’s not steady growth and there might be some problems.

Tony: [06:15] Yeah, that’s right. And if you remember that, well, where as an owner of the company, you’re a part owner of the company, equity is our asset. So that’s what we’re buying. And if you think about it, what we’re trying to do is to have a company which gives us a good return on equity and therefore that equity should be growing. So, it can also be a sign of a company with a bumpy return on equity number or a low return on equity number as well.

Cameron: [06:40] Right. Well, column W then is for, in my spreadsheet, I just copied the share price over again. It’s only there to be used as an easy reference for the next column, which is column X. Which asks what the net equity per share is, or NEPS, N E P S, NEPS also known as book value. Is that right, Tony?

Tony: [07:08] Yeah. So that we’ve had some discussion about whether it’s also called net tangible assets per share, but I think we stick to book value or NEPS is probably a good way to go.

Cameron: [07:17] So this is another calculation sell. Basically, I’m taking the net equity figure that we just came up with and dividing it by the share price. And this is again, is telling me, you know, for every dollar that I spend, how much equity I’m actually getting.

Tony: [07:33] Yes, correct. So ideally you want to pay a dollar for a dollar as equity per share but no more than 30% above net equity per share.

Cameron: [07:41] So this comes in the next column. So, column “Y” I asked the question is the share price less than the NEPs. It’s a score cell. So, it gets one for a yes. Blank for a no. Why blank for a no Tony?

Tony: [07:56] Well, again, it’s one of these boosts things because plenty of companies won’t be trading at their net equity per share value. It’s a fairly rare occurrence, but if they are, it’s a thing we want to give an extra score on the checklist for.

Cameron: [08:10] But we don’t want to penalize them if they’re not.

Tony: [08:12] So, that’s right. Otherwise, you’re penalizing most of the market.

Cameron: [08:15] Yeah. And then column Z is the price to book ratio. Another formula, this one is the share price minus NEPs divided by NEPs. This is giving us a ratio for the next column, column AA which is the question that you were indicating a few seconds ago. Is the share price less than 30% above NEPs, the net equity per share? This is another score cell. Now this is what you’re saying, ideally, we don’t want to pay any more than 30% above the share price. This is more safety margin stuff. Why the 30% figure is that, is there any science behind that or is it more black magic?

Tony: [09:05] It’s not black magic. It’s another steal from Warren Buffett who has always said that he would be interested in buying back Berkshire Hathaway shares if he thought that they were trading at less than 30% of book value.

Cameron: [09:19] And did he say why 30%? Is it just about risk margin?

Tony: [09:25] I think he actually did. I’m just stretching my memory here, but I think it was partly risk margin, but partly also that can be again, because of all the intangibles, et cetera, it can be a difficult thing to nail down book value if you draw right down into it. So just giving himself a bit of a buffer there.

Cameron: [09:44] A buffer to Buffett. Oh, we’re on fire today, Tony.

Tony: [09:52] We’re in sync, aren’t we?

Cameron: [09:56] Buffer, part of being… Oh, Jesus, it’s gold. Okay. So, safety margin here. So, if we were spending a dollar no if we’re going to buy a dollars’ worth of equity, we don’t want to spend much more than a $1.33. Again, it’s just about minimizing the risk. How much are you paying for this thing? You don’t want to overpay. When I was with you in Sydney a week or so ago, you were talking about buying a car and how you like to negotiate price before you buy anything. And you said, shares are exactly the same. And you know, we’ve said this a lot of times, but it’s worth repeating. There’s two parts to QAV there’s quality and there’s value. That’s what the QAV stands for. If people haven’t worked it out yet quality and value, and you want to buy good quality stock, but you don’t want to pay too much for it because I’m going, okay. So, the car analogy is going buying a Mercedes-Benz. You don’t want that’s worth; I don’t know. Let’s say a hundred grand. You don’t want to pay 500 grand for it. Why would you do that? Why would you pay five times what something’s worth? That’s ridiculous. When it comes to shares though, people quite often don’t have the mindset of determining the intrinsic value of the share. So, they will quite often over pay for something.

Tony: [11:16] Yeah. And look, I think there’s a school of thought in investing that paying anything for quality is to do a good investment because you know, the company will keep going up and its share price will follow and over time you get your money back. I don’t subscribe to that and I don’t think anything’s worth over paying for even if it’s the best company on the share market.

Cameron: [11:35] Well, it’s one of my favorite quotes is from Howard Marks at Oaktree. He says, figure out what something is worth and then try to buy it for less.

Tony: [11:44] Exactly.

Cameron: [11:46] And I think he also says buy shares like you buy everything else when it’s on sale.

Tony: [11:51] Yes. Yep.

Cameron: [11:52] Which is of the discipline of investing value investing, right. Is only buy it when you can get a good deal.

Tony: [12:01] Yup. Everything’s a value investing if you look at it that way but a lot of people don’t on the share market for some reason. For all sorts of human psychology, we’ve talked about before, like their mates have made money out of investing in a tech stock, so they don’t want to be left behind. So, they go and buy it too. All sort of mistakes I made within the first year of investing.

Cameron: [12:20] The fear of missing out, greed, emotion is what drives the market. So, we’re trying to be more scientific than that.

Tony: [12:28] Correct. We’re trying to take the emotion out.

Cameron: [12:30] So column AB, what is the earnings per share? Now this is straight up financial data. We get it on stockdoc in the financial statements page, under profitability, financial statements, financial metrics, profit. You first have financial metrics profitability. It’s got an EPS and it’s expressed as sense. Yes. Do you want to explain that I’ve got a note here that it tells us something about how well they’re investing their equity?

Tony: [13:05] So, earnings. Earnings per share is I think we spoke about it before. It’s the earnings part of the PE ratio. So, it’s how much profit is the company making divided by its share price or profit per share, divided by its share price and that gives us earnings per share.

Cameron: [13:19] Okay. And as I said, we’re grabbing that number here because in the next column AC, we’re going to figure it out, we’ll look to see what analysts are saying the future earnings per share is and we can get this from two places. Stock Doctor has a future earnings per share sometimes for some businesses, depending on the size of the business. Sometimes it doesn’t Share Analysis. Also share analysis.com also has a future EPS prediction in there. And the way that I’ve learned to understand this is because you don’t try and become an expert on macroeconomics or on the economics of a particular industry or sector or business, you don’t spend a lot of time drilling deep down into who their competitors are and what their R and D is like and where they’re leading the market and all that kind of stuff, which some people do particularly full-time analysts do that kind of stuff. What you do is go and look at well, those professional analysts who do understand the sector and do understand what the company is doing and where they’re putting their money, what did they think the future earnings per share is going to be? And I’ll just take that. I’ll take the summary of a consensus from a number of analysts. And I’ll use that as my shorthand calculation.

Tony: [14:43] Correct. And just one more thing I’d say is that oftentimes the analysts are doing a shorthand calculation because they’re using the guidance from the company as well. So, most companies, most large companies will say, we think our earnings per share next year is going to be X, Y, or Z or within the range.

Cameron: [14:58] Wow. What do these analysts get paid to do then? Just like read what the company says and republishes it.

Tony: [15:05] Thank you. Thanking of new ways of securing how to invest so you can charge more fees. I don’t know.

Cameron: [15:10] Stripper poles. Wonder if they’ve considered that?

Tony: [15:15] They’ve already registered badabing.com.

Cameron: [15:19] Yeah.

Tony: [15:19] Someone has.

Cameron: [15:21] Way ahead of us. Okay, so that’s column AC again. So, in Stock Doctor to find the future EPS, I should make a note of that. Is that in the same place where we got up before under profitability, they just have the estimate for the next period.

Tony: [15:41] Correct? Yeah. And I usually just take the next period. So, like Stock Doctor sometimes we’ll have two periods going forward, so this year and next year but I just shouldn’t like just take the next period and the same where Share Analysis it’ll have probably two years of forecast, but I just take the next step forecast period.

Cameron: [15:58] Okay. So then in column AD I want to work out another formula. This is the growth of the earnings per share. So, the future earnings per share, subtract the current earnings per share, and then divide that result by the PE. Now you’ve told me before that this little formula is something that you borrowed from Peter Lynch; he reverses it. He calls it the PE over growth or the PEG ratio. And ideally, we want the growth of the earnings per annum to be close to the PE. Why is that?

Tony: [16:35] Well, Peter Lynch always thought that was the true intrinsic value for a company. So, taking into account its growth and what you’re paying for it now, he thought when they were equal, that was the right price to pay. I’d have to go back and reread his book to understand why that was the case. But basically, what he’s saying is that you can pay, I guess, in a broad sense, he’s saying you can pay more for a company that’s growing quickly and you should pay less for a company that’s growing slowly. So that for the PE to be equal, sorry for the PE over growth to be equal to one. Then if the growth is only 10%, the PE should be 10. And if the growth is 20%, then the PE should be 20. So, it’s basically saying you can pay more for a growing company.

Cameron: [17:18] Okay. So, in the next column, AE. We asked the question is the growth over PE higher than 1.5? If it’s a, yes, it gets a one. If it’s no, it gets a zero and if it’s a negative result, it gets a minus one. Why the 1.5 number?

Tony: [17:39] Yeah. So again, I’ve probably inverted Peter Lynch’s number here, but if you do it the other way around, he’s looking to buy things that are less than one. So, I think from memory, he was saying 0.7, five. So basically, if you’re PE is 10, but the company’s growing at 20%, that’s a Bali. So, you’re not paying very much for that growth. I came across it more recently in a different presentation from a stockbroker and they inverted it and used 1.5. So that’s what I’ve adopted in my checklist.

Cameron: [18:12] So in essence, we’re using this to determine if the company’s earnings are growing faster than the price to earnings ratio?

Tony: [18:24] Yeah. Well, the PE doesn’t grow as so much, but we’re trying to find, like I said before, a company that’s growing at 20%, but it’s P is only 10%, so it’s fast growing, but we’re not paying as much for it as that growth would indicate we should pay for it.

Cameron: [18:39] Right. But yeah, what I meant to say is that it’s growing faster than what the current PE is, so the current PE isn’t taking into account the future growth.

Tony: [18:50] Yes, that’s right, correct.

Cameron: [18:51] Effectively.

Tony: [18:53] Yes. Correct. Again, another nature of value.

Cameron: [18:56 ] Yeah. So, it’s saying we think this business’s earnings are going to grow, so the PE will grow the PE a year from now will be different to what it is today but if we can buy it today at that price, and it’s not factoring in what the earnings are going to be a year from now, we’re getting it at a good price.

Tony: [19:19] Correct. Yeah. It’s cheaper.

Cameron: [19:20] That sounded convoluted but I understood what I meant.

Tony: [19:24] I as just going to say, I think one thing that might be becoming clear to people who are listening to us is that we don’t just have one way of valuing a company. And, spoke about this before, I have found that there is no one KPI or no one metric that is a great indicator of quality or value. What we’re trying to do is built almost like a radar map of all different things that are pinging. And then if they ping on a number of different fronts, whether it’s book value or book value plus 30% or growth over PE all those kinds of things, then the score goes up. So, we’re not really focusing on one way over any other way.

Cameron: [20:05] You’re like a doctor, that’s listening to their chest, taking their temperature you know, listen taking their heart rate, doing some blood analysis, blood work, sticking your finger up their coy to check the prostate. You know, you’re, you’re fondling, you’re squeezing, checking. You’re doing a full checkup.

Tony: [20:28] That’s right? Yes. Just like a doctor.

Cameron: [20:31] I’m nearing 50, I’ll be 50 the end of the year. So, you know, getting the old prostate exam is front of mind. I’m sorry to disturb people who had to visualize that, not looking forward to it. Or maybe, or am I? I don’t know.

Tony: [20:49] I can take you out the back of the bedaubing and give on a filler.

Cameron: [20:54] Do you charge extra for that? Okay, so column F. So, we’re getting to the end here, let’s push through if that’s okay with you, if you’re up for it.

Tony: [21:07] Yep, sure.

Cameron: [21:08] I mean, pushing through not the, rectal exam.

Tony: [21:12] Not the proctology.

Cameron: [21:15] Column IF intrinsic value number one. Okay. So, this is where we get down to brass tax. And we’re trying to, this is we mentioned the discounted cashflow in a recent episode which is something that Buffett, people like him use to determine what they think the value of a company is. And we’ve talked about the fact that you have this calculation called an intrinsic value. We do two of them, it’s sort of an estimation or a shortcut of heuristic to achieve sort of the same thing as doing a full DCF calculation. Our IV number one is the current earnings per share the current EPS divided by 19.5%, which is one of the hurdle rates that we look at. This took me a long time to get my head around. Can you explain what a hurdle rate is Tony?

Tony: [22:09] Yeah, sure. So, when we’re talking about discounted cash flows, the hurdle rate is the discounting factor. So, it’s basically saying that if I’m going to buy the coffee shop and I’m going to project out into the future, what it’s currently earning I’m going to discount that future cashflow for two reasons. One because there’s risk and two, because the money of the day in the future is not worth what the money is now. So, I think we spoke before about if I agreed to give you a thousand dollars in 10 years’ time, how much would you pay for that contract now? And you can take into account the risk of me not being around in 10 years’ time or having a thousand dollars to pay you. And also, the fact that a thousand dollars in 10 years’ time might be worth $700 now, or 600 or 500 or whatever. And so again, trying to put some science around it, the hurdle rate is the you use to discount the future cash flows. I use 19.5% in this first IVF calculation because that’s what my long-term return has been in the market. So, I’m looking for stocks that I want to add, which are getting better than that hurdle rate. It’s a very small sample set, but if they do achieve that sort of metric, they’re really worthwhile looking at.

Cameron: [23:30] And so one of the things that I want to point out to people too, is that quite often the current share price will be above pour IV figure. And we may still end up giving it a by writing because as you’ve explained to me in the past, this is just, again, one measurement. It’s not necessarily a go, no go like the sentiment is it’s not the be all and end all. It’s just one more data point that we’re looking at. Ideally, we would like to be able to buy the share for what our intrinsic value is or less but if it’s above that today, that’s not necessarily a deal breaker.

Tony: [24:14] No, and that’s right. It’s partly because the particularly IV number one is a very, very high bar just counting the earnings per share into the future by a high hurdle rate means it’s got to be in deep value before you buy it. And that’s great if it happens, but it may, we don’t want to necessarily roll companies out that don’t quite meet that hurdle rate.

Cameron: [24:41] Right. So, in my spreadsheet, people will see that the next column AG is just the current share price copied over from earlier again, just for easy reference, because column AH asked the question is today’s price below IV number one? If it’s a, yes, it gets a one. If it’s a, no, it gets a zero. So again, not the end of the world, if it is below the IV, but it just, it gets a score if it does just all adds up at the end of the day.

Tony: [25:15] Yeah.

Cameron: [25:15] The next column AI is intrinsic value number two. Again, it’s a formula, but in this case, we take the future EPS that we grabbed earlier from Stock Doctor, or you can get it from Share Analysis and we divided by a different hurdle rate, the market hurdle rate. And this is one that I think tricks a lot of people up Tony. So, and in fact, as somebody pointed out to me earlier that in the first time when we first did our getting started episodes, I screwed this up the way I explained it. And it took until now for somebody to point that out to me. So, I don’t know what everyone else has been doing when they listened to it, just when right over their heads, maybe. But why don’t you explain the second hurdle rate, the future IV2 hurdle rate?

Tony: [26:00] Yeah. So, IV two hurdle rate users what’s often called the market hurdle rate. So again, it’s a norm in accounting to user a risk premium for stocks of 6% and then to add in the long-term interest rate, which is currently 0.25%.

Cameron: [26:18] Sorry. Can I just, is Norm in accounting like Scotty from marketing? Is that, should we like Norm in Cheers? No, what’s up Norm? My nipples it’s cold outside. What should… Sorry, please keep going.

Tony: [26:34] Oh, that’s okay. No, I think there’s some science behind it, way back when maybe a hundred years ago that someone said, look, if I’m going to buy stocks rather than bonds, I want to pay less for the stocks and the bonds. And that risk premium is being calculated as 6% for a long time. So, most fund managers in the market will be using 6% plus the long-term interest rate. So, 6.25% is the current hurdle rate, which is commonly used.

Cameron: [27:03] So let’s explain the long-term interest rate. This is the RBA cash rate?

Tony: [27:08] It is. Yes, that’s right. And it’s generally the right that applies to a 10-year government bond.

Cameron: [27:16] Right. So, okay. That’s why that’s important. So that’s what I could get for a bond, nothing effectively right soon to probably go to zero. Yeah. And I want to get at least 6% better than that. If I’m going to take the risk of investing in stocks.

Tony: [27:36] Correct. That’s right. Compared to putting your money into bonds. Yep

Cameron: [27:39] Column AJ asked the question is the share price below IV number two again, so before it’s a, yes. It gets a one. If it’s a, no, it gets a zero. In some cases IV, two will be blank because the EPS. Sorry, the future EPS will be blank. We can’t get one. I find this is quite often with smaller companies that don’t have analysts looking at it.

Tony: [28:07] Correct. Yes. And that can be a good thing for us because if we found a company which the analysts haven’t found yet, because it’s too small as it grows, if it scores well on our checklists, we’re hoping for it to grow. Then as it gets endless, starting to report it, report on it, then we get more investors buying it and that drives the share price up.

Cameron: [28:28] Yeah. So, it’s not necessarily a bad thing.

Tony: [28:31] Correct. Yes.

Cameron: [28:32] Column AK asks the question is IV number two, more than twice the current share price. If it’s a, yes. It gets a one. If it’s not gets a zero, if the FEPS is a blank, so is this. Why do we have this question in there, Tony?

Tony: [28:48] Yeah. Again, it’s an example of a company selling with a price, which is at extreme value. So, if we think the value of the company is a dollar per share by error IV is saying that it’s 50 cents, then it’s again, an indicator of it probably being very undervalued.

Cameron: [29:09] Column AL asks whether or not it is a start stock on Stock Doctor gets a one for a yes. Zero for a no. And a Star Stock is basically a health rating from Stock Doctor. Right?

Tony: [29:25] Correct.

Cameron: [29:25] And you can tell if it’s a Star Stock, because when you go to the first page for that company on the Stock Doctor, if it is it’ll have stars beside its name.

Tony: [29:36] Yeah. And they use three stars from memory. So, we need to be careful here. So, if it’s a Star Stock, it gets a one, but they also have a Greenstar, which is called a borderline star growth stock. So that’s a stock, which is almost a Star Stock. And they have a purple star, which is what they call a star income stock. So, it’s a stock which pays a good yield and it’s also has a good quality score. So, I give star growth stocks a score of one and 0.5, if they’re borderline or star income stocks.

Cameron: [30:08] What color is the star growth? Can you remember?

Tony: [30:11] It’s gold.

Cameron: [30:13] Right. So, borderline gets a 0.5.

Tony: [30:18] Yeah. So, I’ve got BHP open in front of me at the moment. It’s a borderline plus a star income stock. So, we would score it 0.5 plus 0.5 or one.

Cameron: [30:27] Oh, it gets a 0.5 for star income too.

Tony: [30:30] Yeah.

Cameron: [30:32] Okay. And this is basically just again, giving is we’re taking advantage of the fact that there are analysts at Stock Doctor that have delved down deeply into the financials and the prognostications. They’ve gone beyond the proctology exam. They’ve done put it in an MRI machine. They’ve done ultra sounds and they’re giving it a rating away going. Yep. Thanks very much. We’ll use that. Whack it into our calculations.

Tony: [31:09] Yeah. So, I spoke before about Merv Lincoln’s working to companies that go bankrupt and how he came up with a list of ratios to measure the financial health of companies. So, there’s the Star Stock process goes one step further, and it’s all laid out on the front page of the, of Stock Doctor. So obviously the company has got to have strong financial health. They, I think from memory, they look at things like whether earnings per share growth is going up by 8% or more from memory. So, they’re looking at growth. They’re looking at the outlook that may be where they score, whether it’s going up or not. They look at the dividend yield for a star income stock criterion. From memory, they’re looking at return on assets above 8%. And I think return on equity. Yeah. I’m not sure what the score is. Maybe 12%. Anyway, all these numbers are outlined in Stock Doctor and you can look it up if you like. They have their own version of the sentiment check, which is, there is the max that they look at. Yeah. And so, it’s not just the financial health of the company, it’s a few other metrics that they put into their checklist and give stocks a Star Stock, or a borderline stock rating.

Cameron: [32:24] Right. And then we go over to our old friends, Share Analysis, shareanalysis.com. And we look to see what they’ve giving it for their own health rating and where they use a system ABCs, I think Ds and also, numbers.

Tony: [32:48] Correct. Yeah. So, the letter, I think from memory is the strength of the balance sheet and the numbers that the strength of the profit and loss statement. And so, you’re looking for A ones, A twos, B ones and B twos has been the highest quality and the Share Analysis universe.

Cameron: [33:06] So if it gets an A one, A two or B one or B two on Share Analysis, it gets a one. If it doesn’t, it gets a zero. You can find this on Share Analysis. You go to the summary page, look at the first two graphs, quality and performance. These ones, the A, and one’s the number, see where if it gets an A one, A two, B one or B two. Column AN ask, what is the Stock Doctor current intrinsic value? This is another financial data page. This is again, section five on the nine golden rules page. And I think we use either the Lincoln valuation or the consensus valuation here.

Tony: [33:51] Yes. We give preference to the Lincoln valuation if it’s available but Stock Doctor only gives all income valuation for its Star Stocks. Also, they borderline ones in their Star Income Stocks. So, if it’s not part of that set, then they don’t give a valuation. And we use the consensus valuation, which is also available on start-stock. I’m sorry to Stock Doctor.

Cameron: [34:12] Right. So, this appears as like a little heat map, like?

Tony: [34:18] Correct. Little graph. Yep.

Cameron: [34:20] And the big number in the middle under fair value. That’s the figure that we’re looking for.

Tony: [34:25] Yes, that’s right.

Cameron: [34:27] So, we take that valuation and I throw it into the spreadsheet. If you don’t have Stock Doctor, I think you can use, if you go over to Yahoo finance, you’ll find that they have a consensus estimate as well for some stocks.

Tony: [34:44] Correct.

Cameron: [34:44] If Stock Doctor doesn’t have it and you don’t want to use the Yahoo finance one, we just leave this cell blank.

Tony: [34:53] Yes, that’s right. As we said before, for smaller companies, we sometimes don’t get an evaluation on them.

Cameron: [35:00] So he doesn’t get penalized if we don’t have one, it’s just like, it doesn’t add to a total score.

Tony: [35:04] Correct.

Cameron: [35:05] But then in column AO, I asked the question is the current share price beneath the Stock Doctor intrinsic value, same sort of ideas, our own intrinsic values? Again, it gets a one for a yes. Zero for a no. But if the previous cell was blank in that we don’t have an IV, then we leave this one blank as well. Similar process column AP what is the Share Analysis current intrinsic value? This is another financial data sale. You get it on the value versus price tab on Share Analysis. Again, if they don’t have an IV leave the cell blank. And the next column, AQ asks is the current share price beneath the Share Analysis intrinsic value? One for a yes, zero for no. Blank if it’s blank, if they don’t have one. Column, AR asks is the intrinsic value on Share Analysis, going up in the future? You can find that on Share Analysis on the same value versus price tab. Then we get to the column AS which asks is the financial health from Stock Doctor stable or increasing? We get this on the financial health box on the home page, the nine rules page, Tony?

Tony: [36:28] Yeah. So, on the nine rules page, you’ll see a series of bar charts. If that gets too hard to read it, shouldn’t boot. Sometimes it can, you can go into financial statements and again, on the financial metrics page, you’ll see it in the first row of that page in quite bold color-coded scores with a financial health rating of strong or otherwise, and a little number behind it in the brackets, which is actually the score it gets when you run it through those mobile and can metrics.

Cameron: [37:04] Right. So how do we tell if it’s stable or increasing using just section one here, strong. It’s a BHP has got a big strong in the circle,

Tony: [37:16] Correct.

Cameron: [37:16] Is that stable or increasing?

Tony: [37:18] Go below there, so it says L score June 15 to December 19. And we’re looking at the last two columns here, which is the last two scores for the HP.

Cameron: [37:29] It says distress.

Tony: [37:31] No, I’ve got strong

Cameron: [37:32] Above that. It says distress.

Tony: [37:34] Yeah. Sorry. It does. Doesn’t it? I don’t know why it’s saying that, but it’s strong.

Cameron: [37:38] It’s strong. So again…

Tony: [37:40] Probably goes for above the last column it says December 19 strong.

Cameron: [37:43] Strong. Yeah. It says distress above it, but we’re looking at those bars…

Tony: [37:49] Sorry, I know why that is it’s because if we went to a company where it was the stress, the column would go all the way up to touch the distress.

Cameron: [37:56] Oh, I see. It’s strong.

Tony: [38:00] Yeah. For some reason, a healthier company is a lower score.

Cameron: [38:04] Oh, I see. Right. Okay. So, how do we score this then? So, I’ve got for increasing. We give it a two for stable. We give it a one. Anything else is zero. If it’s just strong, strong, strong, strong, strong, we say that stable?

Tony: [38:24] Correct. That’s a one.

Cameron: [38:27] Right and if it was just going from weak to strong, that’s increasing.

Tony: [38:31] Yes. And we’re just doing the last two reports. So, in this case, June 19 and December 19.

Cameron: [38:39] Alright. So, column AT asks is the CEO or a board member, a founder. This is another score cell gets two for a yes. Zero for a no. This I believe is because Warren buffet has often said that he believes companies where the founder is either a CEO or is still active on the board will often outperform other companies. Is that correct?

Tony: [39:04] Correct. That’s right. Yeah. Yep. No, yeah. There’s nothing like having skin in the game. So, we will, I mean, yes, it’s great if it’s a founder, but we’ve someone else’s on the board or in the company that has a very large shareholding we’ll also score that too as a founder.

Cameron: [39:18] Now on Stock Doctor, up in the little menu, there there’s a little picture of a silhouetted person wearing a tie. That’s the corporate details tab. If you click on that, you’ll see the current directors and management, and then we’re looking at the percentage under ordinary securities, the percentage of the company that they own. Yeah?

Tony: [39:40] Yeah. Correct.

Cameron: [39:43] How big a percentage does it need to be to determine whether or not they’re a founder we’re looking at sort of 20% or more?

Tony: [39:50] No, I’d actually go lower. It’s a good question. I’ve gone as low as 5%. If I think that that the person was a founder and they’d been diluted over time then I’ll go down to 5%, but probably around 10%, it’s a good number because maybe the company may well have grown a lot in the company and they own, and may well have had to have down to achieve that growth too.

Cameron: [40:15] Right.

Tony: [40:15] It’s often times are requests from institutional investors for the founders to sell down, to improve liquidity in the stock.

Cameron: [40:22] Okay. So, again, they get a two for a yes. Zero for a no. So, column AU then is the sum of the scores. So, we’re adding up all of the score cells. If it’s a blank and obviously we don’t add it up and their bid in column AV we count the number of checklist items that got a score, ignoring the blanks. That’s a null result because in column AW we want to come up with a checklist score, which is where we’d take the total score divided by the number of checklist items and this gives us the quality score of the stock. And ideally, we want this to be higher than 75%. Why 75% Tony? Is this a magic to that number?

Tony: [41:14] No, that’s black magic.

Cameron: [41:18] Black magic.

Tony: [41:18] Yeah, look, interestingly enough that was something I used to look at, but it’s probably gone by the wayside now because if a company scores less than that, I’ll still buy it if it’s cheap which we’ll get to in a minute when we multiply the quality score by the price operating cashflow.

Cameron: [41:37] Yeah. So that’s the last column. Column AX, well kind of the last column. This is where we give it a QAV score. This is where the rubber meets the road. We take the checklist score from column AW divided by the price to cash flow number, which was column L price to cash ratio and that will give us a number. If that number is greater than 0.1, it’s a buy. If it’s less than 0.1, it is not a buy.

Tony: [42:19] Correct.

Cameron: [42:20] You want to explain why 0.1 is the magic number there, Tony?

Tony: [42:25] Yeah. Again, black magic. No, so in the past when what we’ll do probably next is to talk about ranking these companies in order of their QAV scores. So, I won’t get to the QAV score, rank all the companies I’ve scored and then start to buy the ones with the highest score. And it just, I mean, it just seemed to be that I was, you know, I had too many companies when I started to get down into anything less than 0.01. Oh, sorry, point one. So that’s really where it’s come from. The reason why I have done that is because, why I’ve used the score of 0.1 is because if it’s the reporting season and I haven’t analyzed all the companies yet, because they haven’t reported, but I come across some of the score more than 0.1, I’ll buy them straight away rather than waiting for the whole reporting season to finish, and then racking and stacking all the scores and buying down the list. So0.1 is just an easy thing to remember. And it’s also about where we start to have enough companies in our portfolio.

Cameron: [43:32] One of the things that we haven’t spoken about, I guess and we should point out to new listeners is you, don’t like to have more than about 20 stocks in your portfolio at any given time.

Tony: [43:43] Yeah. Correct or at least start off that way. Sometimes it grows a bit bigger than that. Sometimes it’s at the moment. It’s much less than that. Yeah. So that’s, again, just a rule of thumb. What tends to happen, the more stocks you have, you tend to get a smoothing of your returns. So, you’re not going to get, you know, sort of punch the lights out returns. If you have a lot of stocks, you’re going to probably start to track the index closer than what you would, if you had a small number. And that just makes sort of common sense that if you have one stock in your portfolio went up and it went up more than the market, then you’re going to beat the index and not correlate to the index. Once you get to about 15 to 20, then you’re starting to have enough that makes it manageable, but also gives you something which you canso if something does really well, I can still have a meaningful impact on your total portfolio returns.

Cameron: [44:39] Right. And you found that by making the cutoff 0.1, it just tends to narrow down the list to the best 20 or so companies.

Tony: [44:51] 20 or 30. Yeah, exactly.

Cameron: [44:54] Yeah. Alright and then really all that’s left is, if it gets a buy, we often talk about the fact that you want to look at what the average trading volume is because for you and people like you, that are dealing in large sums of money, you don’t want to get stuck buying too much of a company that has a low trading volume, because it might be hard to get out if you want to get out at a later point.

Tony: [45:23] Correct. And it also might be hard to get in. So, unless you’re very, very patient and buying small amounts of shares, you’re driving the price up on the way in and driving it down on the way out.

Cameron: [45:33] Right. And you want to speed, what is it about no more than 10% of the average daily trading volume?

Tony: [45:42] Yeah. I’ll go as high as 20.

Cameron: [45:43] Right.

Tony: [45:43] But that’s about it. Yeah. You don’t want to be too much above that,

Cameron: [45:47] But for those of us that aren’t yet dealing in millions of dollars of buys and sells, probably not an issue.

Tony: [45:55] No, but which is one thing we do though with the QAV portfolio is we look at companies and score them and put them in the portfolio, regardless of their average daily transaction value but some of them are pretty small. So even if you’re only trading in tens of thousands of dollars, you still want to pay attention to that average trading value, average daily trading value, just to make sure you’re not going to flood the market either way, you know?

Cameron: [46:23] Alright. Well, that’s the checklist overview, Tony.

Tony: [46:25] Whew, man. That was a long podcast.

Cameron: [46:29] I’ll break that into two.

Tony: [46:31] Okay.

Tony: [46:33] Yeah. That was long but was good. So, we’ve gone through that in detail now. Again, if you’re a QAV club subscriber, go up to the checklist page, you’ll be able to download shortly, if not already, by the time you listen to this, the getting started manual where I’ve taken everything that we’ve just talked about and sort of condensed it down to the main points into a written document that you can look at as you’re doing this. So, you don’t need to try and, you know, find the spot of the podcast where we talked about what a price to cash ratio is every time you can just look at a written description, good luck with that. If you have any questions, email me, cameronreilly@gmail.com. And I can throw your questions into next week’s episode whenever that may be like. It doesn’t matter when you’re listening to this, it’ll be in the next episode is what I’m saying. And again, as I’ve said before, happy if it doesn’t worry about the fact that we may have answered questions before you, we’re not worried about repeating ourselves, because if you don’t understand that there’s probably hundreds of people that have just started listening, who also don’t understand it and rather than me having to completely repeatedly say, go back and listen to this episode or that episode, we can just keep covering. We can keep covering it over and over again. And I think anyone listening, it doesn’t matter how many times they’ve heard you talk about it as a subject get bored with hearing you talk about it again. Right? So, it’s one of those things that we can just keep going over the basics, the fundamentals repeatedly, because it just sinks in every time, I hear you talk about it a little bit more.

Tony: [48:06] Yeah. Good point.

Cameron: [48:07] Alright. Well good. Thank you, Tony. We’ll be back next week. Good luck with your investing’s. Stay safe, Tony, stay isolated. I don’t want you to catch the virus. I don’t care if I catch it, but I don’t want you to catch it. So, no golf. You’re banned from golf until we’re through this. Just get one of those like virtual golf things that I see in Hollywood movies, like get a room of the parlor, put a sheet up on the wall. Put the projector, smack the ball into that and get by,

Tony: [48:37] Right. Yeah, that would be good. Well, I might play golf if they keep the golf courses open in new South Wales. That’d be good. It’s good to get out. Yeah,

Cameron: [48:47] No. Well, you’re only allowed to play by yourself though just…

Tony: [48:51] Correct.

Cameron: [48:52] Or you and a priest. Okay. Cheers Tony.

Tony: [48:55] Thanks Cameron. Bye.

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