HEWITT HEISERMAN JR. [email protected] The Earnings Power Chart and Earnings Power...

HEWITT HEISERMAN JR.

www.EarningsPower.com

[email protected] Earnings Power Chart and Earnings Power Staircase are property of Hewitt Heiserman Jr.

All rights reserved. Copyright 2008

Presented to Bryant College

April 10, 2008

Ben Graham and the Growth Investor

mailto:[email protected]

22

Preface

Why We Have to Be at the Top of Our Game

3

Which Asset Class Is Better Value Today?

Stocks: Bonds:

S&P 500: 1355

S&P earnings (TTM): $6610-year Treasury: 3.52%

S&P 500 earnings source is Barron’s. Market data as of Apr. 9, 2008

4

Stocks Better Value Than Bonds—P/E Basis

Stocks: Bonds:

21x (1355/$66) 28x (1/3.52)

P/E Misleads If Economy At Inflection Point

6

Real 10-Year P/E: The Stock-Bond Gap Narrows

Stocks Bonds

S&P 500

Real 10-Year Earnings (avg.)

Bond yield (10-year Treasury)

1355

$59

3.52%

P/E 23x 28x

Source: IrrationalExuberancecom, EarningsPower.com

Repetitive Cycles of Enthusiasm and Despair

88

Will History Repeat?

Peak Trough Contraction

Date

10 Yr. P/E S&P Date

10 Yr. P/E S&P Years

S&P

CAGR

6/1901 25x 239 12/1920 5x 74 19.5 -6%

9/1929 33x 383 6/1932 6x 74 3.75 -36%

12/1968 22x 635 7/1982 7x 238 13.6 -7%

4/10/2008 23x 1355 ? ? ? ? ?

55-Yr. Avg. 300bps Above Current 3.52% Yield

10

If 10-Year Reverts, Then Bonds Offer More Value

Stocks Bonds

S&P 500

Real 10-Year Earnings (avg.)

Bond Yield (55-year avg.)

1355

$59

6.44%

P/E 23x 16x

As the cost of money rises, corporate earnings and P/E multiples get punished

11

We Need to Be at Top of Our Game

If market reverts to “generational” trough P/E’s of 5x-7x, expect tremendous loss in wealth or time; either we have i) explicit bear market of 430 today or ii) decade of flattish S&P while earnings catch-up.

We do not have benefit of P/E expansion ca. 1982-1999, when it climbed to 44x from 7x and produced a 13% CAGR.

Introduce Earnings Power 1-2-3 Process to help you navigate choppy investment waters

Resources:

Prof. Robert Shiller’s website:

http://www.irrationalexuberance.com/

To view the Real 10-Year PE Data, click here:

“One can access an Excel file with the data set (used and described in the book) on stock prices, earnings, dividends and interest rates since 1871, updated.”

http://www.irrationalexuberance.com/

http://www.irrationalexuberance.com/shiller_downloads/ie_data.xls

1313

Section I

The Growth Trap

1414

Many Ways to Make Money on Wall Street

Net-net

Sum-of-the-parts

Risk arbitrage

Catalyst

Activist

Short selling

Technical analysis

Growth

1515

Growth Stock: Company with Rising EPS

EPS to $1.42 in 1999 from $0.07 in 1990

1616

Benefits of Growth Investing

Defer capital gains taxes, so your principal compounds faster

Save money on commissions, bid-ask slippage costs

Trade less, which improves investing results

No “exquisite timing” required; you can build a position over

many years

Asymmetrical risk-reward. Worst-case, investment goes to zero.

Best-case, multiply your capital several-fold. $10,000 in

Microsoft in 1990 grew to almost $1 million over next ten years.

1717

But Beware of the Growth Trap

0%

2%

4%

6%

8%

10%

12%

10-Year Avg. Annual Real Returns for S&P 500, 1926-9/2007

Highest P/E (growth) Lowest P/E (value)

Source: Jeremy Grantham, GMO, Oct. 2007

1818

Three (3) Obstacles Confronting Growth Investor

1. Poor earnings quality

GAAP income statement has four (4) structural limitations. So just because a company is profitable in the traditional sense of the word does not mean that it has authentic earnings power.

2. Competitive advantage wanes

Successful companies attract imitators. This is good for consumers, bad for owners.

3. Premium to intrinsic value

We predict by extrapolation, so growth stocks often get pushed beyond real worth.

1919

Section II

Obstacle #1: Poor Earnings Quality

2020

The GAAP Income Statement

To create comparability, all companies follow generally accepted accounting principals (GAAP)

Robert’s Rules of Order for corporate America When you open an annual report, 10-K or 10-Q and look at

financials statements, that’s GAAP Many investors take GAAP at face value; they think EPS is “hard”

number, like…

…height of Fenway’s Green Monster (37 feet)

2222

But EPS is a “Soft” Number

GAAP income statement has four (4) structural limitations A dollar of earnings for one company’s may not be comparable to

a dollar of EPS from another company, or for same company from one year to next

2323

GAAP P&L’s Four (4) Structural Limitations

1. Investment in fixed capital is ignored, so when capital spending is greater than depreciation the company may be profitable on GAAP basis but short cash.

2. Omits investment in working capital, so when receivables and inventory grow faster than payables and accrued expenses the company may be profitable on GAAP basis but short cash.

3. Intangibles like R&D, advertising, employee education are expensed even though the benefits will last more than one accounting period.

4. Stockholders’ equity is free even though owners have an opportunity cost.

2424






25

Notes on Capital Spending

Fixed capital is buildings, trucks, telephone networks, etc. When a company buys fixed capital, it spends the cash today but

for accounting purposes depreciates outlay over asset’s expected useful life. Depreciation enables companies to match current sales with current expenses, and future sales with future expenses

If capex is greater than depreciation, a company makes investment in fixed capital. Investment in fixed capital is a use of cash. This cash outlay has to come from somewhere; e.g. checking account, liquidate other assets, borrowings, or stock sales. Will investment produce higher future sales, cost savings?

Beware of capital-intensive companies. The 20% with highest capital spending growth lagged market by 1.5% a year during 1973-1996, while lowest 20% beat market by 1% a year. (Paul Sturm, Smart Money, June 2005)

TheStreet.com (TSCM)

2727

Structural Limitation #1: Investment in Fixed Capital

TheStreet.com (TSCM)($mls) 2007

Capital spending (real cash they spent in 2007)

- Depreciation (a noncash charge in GAAP P&L)

= Investment in fixed capital

$5

3

$2

2828

Expensing Investment in Fixed Capital Usually Reduces GAAP Earnings

TheStreet.com (TSCM)($mls) GAAP Expense

Net income (inc. $3M of depreciation)

- Fixed capital investment

= Adjusted net income

$31

n/a

$31

$31

2

$29

2929

Sidebar: Are Acquisitions a Capex Equivalent?

TheStreet.com (TSCM)(millions) GAAP Expense

Net income

- Fixed capital investment

- 20% of 2007 Acquisition ($30/5 years)


$31

n/a

n/a

$31

$31

2

6

$23

Acquisitions are 1) a use of cash, 2) a substitute for capital spending, and 3) their payoff is uncertain. Depreciate deals over 5 years.

3030






31

Notes on Working Capital

Working capital assets include receivables, inventory, other current assets (but not cash, marketable securities); working capital liabilities are payables, accrued expenses. Working capital is WCA - WCL

While it is good to have more assets than liabilities, when working capital increases from one year to next, this is an investment in working capital

Investment in working capital is use of cash that does not appear in GAAP income statement. Still, like fixed capital investment, it has to be financed somehow

A profitable company can suffer liquidity squeeze if it can’t collect receivables and/or sell inventory in timely manner

Crocs (CROX)

3333

Structural Limitation #2: Investment in Working Capital

Crocs Inc. (CROX)($mils) 12/31/06 12/31/07

Working capital assets:

Receivables

Inventory

Total WC assets

Working capital liabilities:

Payables

Accrued Expenses

Total WC liabilities

Net working capital

Investment in net working capital

$66

86

$152

$44

31

$75

$77

$153

248

$401

$83

57

$140

$261

$184

3434

Expensing Investment in Working Capital Usually Reduces GAAP Earnings

Crocs Inc. ($mils) 2007

Net income

- Investment in working capital


$168

184

$(16)

3535

Sometimes WC is a Source of Cash

Blue Nile (NILE) ($mils) 2007

Net income

- Investment in working capital


$17

(14)

$31

A negative investment in working capital is wonderful; it’s like having a job that pays you today for work you will do in two weeks.

3636

Structural Limitation #2: Investment in Working Capital

Blue Nile (NILE)($mils) 12/31/06 12/31/07

Working capital assets:

Receivables

Inventory

Total WC assets

Working capital liabilities:

Payables

Accrued Expenses

Total WC liabilities

Net working capital

Investment in net working capital

$2

15

$17

$67

7

$74

$(57)

$4

21

$25

$86

10

$96

$(71)

$(14)

3737






38

Notes on Intangibles

Intangible growth-producing initiatives are R&D, advertising, and employee education. We call them “intangibles” because we can’t weigh, touch, or measure these assets, in contrast to fixed capital

Companies invest in intangibles to boost revenue, charge higher prices (brand value), cut costs, improve productivity, etc.

But GAAP says intangibles are expenses, not assets. Thus, GAAP earnings for “brain” companies are not comparable to “brick” companies

“Increased R&D led to both improved operating performance and superior stock returns,” per study of 8,300 companies over 50 years. (Source: Journal of Finance, 2004, Vol. 59)

When we capitalize intangibles we are not eliminating the cost. Instead, we are deferring it to a later period. This is the “matching” principle of accrual accounting: align current sales with current expenses, future sales with future expenses

Google (GOOG)

4040

Depreciation Intangibles Over Expected Useful Life Usually Increases GAAP Profits

Google (GOOG)($mls) - 2007 GAAP Depreciate

Profit before R&D

- R&D

= Operating income

Increase (%)

$7,204

2,120

$5,084

$7,204

1,316

$5,888

16%

4141

Structural Limitation #3: Intangibles are Expensed

Google (GOOG)($mls) 2005 2006 2007

R&D (GAAP) $599 $1,229 $2,120

Depreciation period 3 3 3

Depreciation $200 $410 $707

Year 1

Year 2

Year 3

Total

$200

132

$410

200

132

$707

410

200

$1,316

Depreciation period is the useful life of the asset. If you depreciate over three years, then you need three years’ worth of R&D.

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43

Notes on Stockholders’ Equity

All companies financed by combination of debt and equity

Debt comes from banks, bondholders; equity from owners via retained earnings (GAAP profits minus dividends)

Debt an expense but equity is free. Why? Noncash cost; also, different owners have different required rates of return.

But GAAP-profitable company may destroy value if you expense owner opportunity costs.

Playboy (PLA)

Playboy’s Stock is No Miss April

4646

Structural Limitation #4: Stockholders’ Equity

Playboy (PBA)($mls) - 2007 GAAP

(equity free)

Expense Equity

Pre-Interest income (EBIT + investments)

- Interest - Debt Only ($115)

- Interest – Debt & Equity ($283 x 7.1%)

= Pre-tax profit

$12

5

n/a

$7

$12

n/a

20

$(8)

If the accounting treatment for equity is same as debt, then pre-tax profit turns into a pre-tax loss

47

Estimating Playboy’s Interest – Debt & Equity (1/2)

Avg. 2 Years

1

Capital Weighting

2

AT Cost

of capital*

1x2

Wtd. Avg. Cost of Capital

Debt*

Equity

Total

$115

168

$283

41%

59%

100%

2.8%

10.0%

1.2%

5.9%

7.1%

*Pretax cost of debt = $5 million/$115 million = 4.3%; after-tax cost = 4.3% x (1-35%) = 2.8%. Cost of equity = 10-year Treasury + 500 bp, or minimum 10%.

48

Estimating Playboy’s Interest – Debt & Equity (2/2)

Playboy (PLA)($mls) 2007

Total Capital

X Wtd. Avg. Cost of Capital

Interest – Debt & Equity

$283

7.1%

$20

The more equity a firm employs as a percentage of total capital, the less money it makes if you think equity has a cost

49

Summary

Structural limitation… As a result…

1. Omits investment in fixed capital

Company may be profitable on a GAAP basis but run out of cash if capex is much bigger than depreciation

2. Omits investment in working capital

Company may be profitable on a GAAP basis but run out of cash if it can’t collect on receivables, or if inventory doesn’t sell

3. Intangibles are expensed

Penalizes forward-looking companies investing for higher future sales, earnings

4. Equity has a cost The more equity a firm employs as % total capital, the less intrinsically profitable it is

50

How Do We Fix These Structural Limitations?

Do we re-build income statement to 1) expense investment in FC, 2) expense investment in WC, 3) depreciate intangibles, and 4) expenses stockholders’ equity?

We could, but then we create other problems; e.g., we penalize companies that are investing in FC, WC. Also, who is arbiter of cost of equity? (Elvis still alive, some think.)

No single income statement is cure-all. Instead, let’s add the strengths of two alternate P&L’s that have been devised in recent years to our analysis…free cash flow and Economic Value Added

5151

Metric Wars: Which Alternate P&L is Best?

Free Cash Flow Economic Value Added

Adjustments 1. Expenses investment in fixed capital. 2. Expenses investment in working capital

3. Intangibles depreciated over useful life 4. Stockholders’ equity is an expense

Goal Self-fund? A company does so when it produces more cash from ongoing operations than it consumes.

Create value? A company does so when it produces a return on capital that is greater than its cost.

52

Not this Ben Graham

53

This Ben Graham!

5454

Benjamin Graham (1894-1976)

Graduated #2 in class from Columbia in 1914 at age 20, then offered teaching jobs in English, mathematics, and philosophy departments

Instead, went to Wall Street. Nearly ruined by speculation before devising “margin of safety” strategy of buying companies selling at two-thirds of net working capital after subtracting all liabilities Then made 20% a year for two decades.

Taught popular investing class at Columbia 1928-1956 Warren Buffett’s teacher, employer, and friend Turned class notes into Security Analysis (1934). The Intelligent Investor

published in 1949. Goal to take advantage of “Mr. Market’s” occasional manic personality Helped found CFA program in 1960s “Wanted to do “something foolish, something creative and something

generous” every day.” Gave presents to employees on his birthday, “figuring that he was the lucky one”

5555

The Intelligent Investor: Graham’s Two Types

“The defensive (or passive) investor will place his chief emphasis on the avoidance of serious mistakes or losses…”

Pessimistic commercial banker Expenses investment in fixed and

working capital because they are uses of cash; also, who knows if investment will pan out

“The determining trait of the enterprising...investor is his willingness to devote time and care to the selection of securities …more attractive than average”

Optimistic venture capitalist Intangibles expensed over useful

life because they are key driver of higher future sales, earnings; also, equity is an expense because stockholders have opportunity costs

Source: The Intelligent Investor (Harper & Row, 1973)

5656

In Honor of Graham…

Personality Pessimistic commercial

banker

Optimistic venture capitalist

Income statement

Defensive

(free cash flow)

Enterprising (Economic Value Added)

To learn more

Cash Flow and Security Analysis, Hackel and Livnat

The Quest For Value, Stewart

5757

Case Study: Enron Corp.

Per-share GAAP earnings up 9 of 10 years ending 2000

During the ’90s, total return 1,415% vs. 383% for S&P 500

One of Fortune’s “10 Stocks to Last the Decade” (August 2000)

Board of directors rated among U.S.’s five best

5858

Step 1a of 3: Three Income Statements

Enron Corp. year ending Dec. 31, 2000 (millions except per-share)

Income statement Defensive GAAP Enterprising

Revenue

- COGS, SG&A, other

- Investment fixed capital (#1)

- Investment working capital (#2)

- Intangibles (#3)

- Interest expense (#4)

- Other

- Taxes

Total expenses

Profit (loss)

$100,789

98,836

3,555

1,071

0

838

(1,093)

684

$103,893

$(3,102)

$100,789

98,836

n/a

n/a

0

838

(215)

434

$99,893

$896

$100,789

98,836

n/a

n/a

72

2,609

(55)

765

$102,228

$(1,439)

Source: Company reports, EarningsPower.com

5959

Step 1b of 3: Quality of Profits

6060

Step 1c of 3: Earnings Power Chart

6161

Enron: A Second Look

2000 was a record year for revenue, net income; total return +89% vs. -9% for S&P 500

But then management declared bankruptcy in December 2001 after admitting 1997-2001 earnings were overstated; biggest U.S. corporate failure to date

Stock falls to pennies from high of $85 21,000 employees lose their jobs, pensions Despite GAAP profits, Enron does not possess authentic

earnings power according to the Earnings Power Chart

6262

Section III

“Just Four Types of Companies”

6363

Lower-Left Box: Enron

6464

Upper-Left Box: HealthSouth (HLSH) (down 83% from $30 peak in mid-1998)

6565

Lower-Right Box: Krispy Kreme Donuts (KKD) (down 88% from $50 peak in mid-2003)

6666

Coal Mine Canary

Defensive: Enterprising: Both:

Autozone (’92-’99) Bethlehem Steel (’96-’00) Allou Health & Beauty (’98-’02)

Centennial Technologies (’93-’97) Boston Market (’93-’97) Bombay Company (’91-’94)

CML Group (’92-’97) CKE Restaurants (’95-’97) Enron (’96-’00)

EDS (’00-’02) Crown Cork & Seal (’95-’00) Polaroid (’95-’00)

Fine Host (’95-’96) HealthSouth (’96-’01) Sunbeam (’93-’98)

Gap, The (’96-’02) Ikon Office (’93-’98) Warnaco (’94-’99)

Gateway (’97-’01) Rite-Aid (’95-’00) Xerox (’96-’00)

Krispy Kreme Donuts (’02-’04) Sherwin-Williams (’91-’00)

Lucent Technologies (’97-’00) WorldCom (’97-’01)

Measurement Specialties (’98-’01)

Tyco (3/00-12/01)

United Airlines (’94-’01)

Source: EarningsPower.com

6767

Upper-Right Box: Wrigley (WWY) (up 41% 1998-2002 vs. –9% loss for S&P 500)

6868

How to Use the Earnings Power Chart

1. Source new ideas. “Long” prospects in upper-right box; “short” candidates in lower-left box.

2. Monitor current portfolio. Which of 4 boxes is company in? Why? Are gains in GAAP confirmed by higher levels of defensive, enterprising profits? If not, why? Is there a tight or loose fit between GAAP and defensive, enterprising profits? What is long-term trend?

3. Competitors. If your company’s competitors are weakening, your company may be next.

4. Customers. See #3.5. Test management candor, realism. Do they say they had

“good year” but company moved in lower-left direction? (See Enron)

69

“Enron’s performance in 2000 was a success by any measure….Our talented people, global presence, financial strength and massive market knowledge have created our sustainable and unique business.” – Ken Lay and Jeff Skilling

Tripe from Enron’s Last Annual Report:

7070

Key Points:

The Earnings Power Chart fixes the four (4) structural limitations of the GAAP income statement

Regardless of size, industry, or capital structure, all companies are situated in one of Earnings Power Chart’s four (4) boxes

Which box are the companies you own in? Why? The Earnings Power Chart is like looking both ways before you

cross the street; it provides a margin of safety. There are companies in the lower-right, lower left, and upper-left

boxes that will be great stocks. But life is short and our capital is limited. So unless you have a compelling reason, stick with upper-right box. These “twice-blessed” companies have the authentic earnings power that Wall Street prizes.

71

Source for an Earnings Power Chart Spreadsheet:

n.b., I did not make this spreadsheet so user beware. Also, do not ask me questions about this SS as I use my own proprietary version.

http://www.filespace.org/Sand101/IETC1.2.zip

http://www.filespace.org/Sand101/IETC1.2.zip

7272

Section IV

Hallmark of Profitable Growth: The Earnings Power Staircase

7373

Microsoft ca. 1990’s: Authentic Earnings Power + Earnings Power Staircase

$10,000 grows to almost $1 million

7474

Apollo Group: $10,000 grows to $78,000

7575

Apple: $10,000 grows to $106,000

7676

Cisco Systems: $10,000 grows to $631,000

7777

Chico’s FAS: $10,000 grows to $73,000

7878

Dell Computer: $10,000 grows to $1.3 million

7979

First Cash Financial: $10,000 grows to $86,000

8080

Garmin: $10,000 grows to $44,000

8181

Google: $10,000 grows to $51,000

8282

Paychex: $10,000 grows to $257,000

8383

Quality Systems: $10,000 grows to $70,000

8585

Not All Great Stocks Are Staircase: $10K to $200K

8686

Section V

Best Stock: 1997-2006

The winner is: Hansen Natural

88

$10,000 grows to $2.6 million

89

Authentic Earnings Power + Earnings Power Staircase

9090

Section VI

Putting It Altogether: The Earnings Power 1-2-3 Process

9191








Our Case Study: American Eagle (AEO)

9393

Highlights

Mall-based retailer with 926 stores in U.S., Canada Three concepts: American Eagle, aerie, and Martin + Osa HQ’d in Pittsburgh Founded 1977 Ranked #2 “coolest brand” among 12-19 year olds “We compete on trend but not ahead of trend.” Schottenstein family with AEO since 1980; owns $750 million of

stock. One of 10 best stocks for decade ending 2006

9494








95

Step 1b of 3: Earnings Power Staircase

96

Step 1c of 3: Earnings Power Staircase

9797








9898

Step 2 of 3: Competitive Advantage

“Strategies, skills, knowledge, or resources” that differentiate a business from its competitors

If a company has a competitive advantage, it probably has authentic earnings power and may even forge an Earnings Power Staircase

Warren Buffett says competitive advantage is “moat around the castle.” Wider the moat, the more protected the castle

Use the Quality of Profits and Earnings Power Charts to gain insights into whether company has competitive advantage

The more durable the competitive advantage, the longer we can project above-average growth in Step 3, Valuation

9999

Morningstar’s 4 Types of Competitive Advantage

Types Examples

1. Low-cost provider Wal-Mart, Dell (?)

2. High-switching costs Paychex, Microsoft

3. Intangibles (e.g., patents, mindshare, locations, addictive product, management, employees)

Pfizer, Starbucks, International Speedway, Berkshire Hathaway, Altria (Philip Morris), Best Buy, Disney

4. Network effect eBay, Chicago Merc

Most Competitive Advantages Wane over Time: Who Is Building the 13-Corkscrew Version?

101101

American Eagle Has “Mild” Competitive Advantage?

Competitive advantage Examples

1. Low-cost provider no

2. High-switching costs no

3. Intangibles (e.g., patents, mindshare, locations, addictive product, management, employees)

Jay Schottenstein is long-time board chair; and family’s interests are aligned with outside stockholders. But not the most durable competitive advantage.

4. Network effect no

If no competitive advantage, keep your forecast period short

102102








103

Take Analyst Forecasts With a Grain of Salt

“There is no persistence in long-term earnings growth beyond chance….growth forecasts are overly optimistic and add little predictive power.” (Source: The Level and Persistence of Growth Rates, Louis K.C. Chan, Jason Karceski and Josef Lakonishok)

David Dreman: The average error was 44% annually, based on 500,000 quarterly estimates of more than 1,500 companies between 1973-1996. (Source: Contrarian Investment Strategies, Dreman)

104

Step 3 of 3: American Eagle’s Intrinsic Value

Low Medium High

This Year Earnings -4% -4% -4%

Next Year Earnings 7% 10% 13%

Earnings Years 3, 4 & 5 7% 11% 14.3%

Earnings Years 6-10 3% 4% 5.6%

Earnings Terminal Period 3% 3% 3%

Share Count – annual growth -1% -1% -1%

Intrinsic value (inc. net cash) $36 $41 $47

Weighting 40% 35% 25%

Wtd. Avg. Intrinsic Value $40

105

Valuation: 5 Margins of Safety

1. Cost of equity (discount rate) is 10%2. High growth = consensus; Low, Medium growth is

50%, 75% of High3. Growth in years 6-10 is 50% of years 1-54. Intrinsic value estimate 40% based on Low Growth,

35% on Medium, and just 25% on consensus. 5. Buy when companies sells at 50%-70% of intrinsic

value, depending upon quality of earnings and durability of competitive advantage

106

American Eagle’s Price-Intrinsic Value (PIV)

Stock price

Intrinsic Value

= PIV

$17

$40

43%

Authentic earnings power on sale: At $17, you get $1 of intrinsic value for $0.43.

107

American Eagle’s Expected Return

Expected Return = ($40 - $17)/$17

= 134%

• The lower your price-intrinsic value (PIV), the higher your expected return (ER)

• Portfolio management: Rank all your companies by ER, from high to low. Does the company you are thinking of buying offer a higher ER than the lowest-ranked company you own? If not, then why buy it?

108

Sell Discipline

• Earnings quality: Quality of profits permanently deteriorate

• Loss of competitive advantage

• Stock climbs to intrinsic value

109109

Summary

Why “Ben Graham and the Growth Investor?”

What’s Your Process?

“It al starts with a well-defined process that is executed with a high degree of discipline.

“There are a lot of smart people in the investment business, but not very many of them are consistently successful.

“We think the reason is that not many of them have a truly well-defined process and are truly disciplined in executing it.

Source: “He Recruits Managers with Passion and Focus For Stocking-Picking Teams,” Wall Street Journal, Nov. 7, 2005

111

Avoid “Growth Trap” - Use Multiple Margins of Safety

“Next Microsoft” won’t be cheap on a Ben Graham net-net basis.

To protect against “miscalculation or bad luck,” include multiple margins of safety in your well-defined process: 1) seek out authentic earnings power, 2) look for a durable competitive advantage, and 3) buy at a discount to intrinsic value

Bonus Material for Bryant College:

- Useful Writing Tips

113113

Useful Writing Tips

1. Its vs. it’s “Its” = possession. Example: “its dog”

“It’s” short for “it is.” example: “It’s exciting when my stocks double in an afternoon”

2. Show me, don’t tell me

No: “U.S. Global Investors went up a lot in 2006.

Yes: “U.S. Global Investors went up 338% in 2006”

3. No “quite’s” or “very’s”

No: “It’s quite/very hot here in Las Vegas.”

Yes” “It’s 92 degrees in the shade here in Las Vegas”

4. No adverbs No “I honestly believe…,” or “I personally think….”

5. Key info at beginning of sentence, then cite source

No: According to data from TowerGroup, more than half of all U.S. investors make fewer than five trades per year. (TMF, 1/30/07)

Yes: More than half of all U.S. investors make fewer than five trades per year, according to data from TowerGroup,.

and please! Don’t send a cover letter explaining how much you admire Warren Buffet. Buffett has 2 “t’s”

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It’s Earnings That Count (McGraw-Hill, 2004)

Challenges conventional wisdom that company has “earnings power” just because EPS keeps rising

Introduces Earnings Power Chart to find conservative growth stocks for long-term capital gains

Foreword by John C. Bogle, founder and former CEO of The Vanguard Group

Endorsed by Charles W. Mulford, Tom Jacobs, Thornton Oglove, Morningstar’s Mark Sellers, Robert L. Rodriguez, Arne Alsin, Jim Rogers, John D. Spooner, Kenneth L. Fisher

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Biography

Hewitt Heiserman Jr. conceived the Earnings Power Chart and the Earnings Power Staircase, which are featured in his book "It's Earnings That Count" (McGraw-Hill, 2004). He also writes a column on earnings power for RealMoney.com. Heiserman graduated from Kenyon College with Distinction in History, and also received the Faculty Award for Distinguished Achievement. Heiserman is a member of the Boston Security Analyst Society and the CFA Institute. Heiserman's work on earnings quality has appeared in TheStreet.com, BusinessWeek, CBS MarketWatch, Business 2.0, Better Investing, The Motley Fool, Complete Growth Investor, Barron's, and the Haverford Trust Company Adviser. Heiserman has spoken to the New York Society of Security Analysis, the Boston Security Analysts Society, Fidelity Management an Research, the Babson Investment Management Association, the American Association of Individual Investors, and Complete Growth Investors on "Ben Graham and the Growth Investor." Heiserman is a finance instructor for Gerson-Lehrman Group. He is a trustee for a land conservation group. To learn more, visit www.EarningsPower.com

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[email protected]

www.EarningsPower.com

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HEWITT HEISERMAN JR. [email protected] The Earnings Power Chart and Earnings Power...

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