How To Really Succeed In The Stock Market

So I thought I would share the value investment process that I utilize for my stock valuations. I have been studying hedge fund analysis and Buffetology for quite a while, and I am constantly reforming my opinions. So far I have had reasonable success with both the portfolio I publish on here and the portfolios I have traded prior.

DISCLAIMER: I am discussing methods not individually how to do them. Google them. This is a long process that requires a lot of time. But, it will pay off in the long run provided you can master them.

There is no one way to valuate a company

Businesses are very complex components to evaluate. In many cases, they are subdivided into many subsidiaries and complexities, not only this but there is usually a fair bit of accounting trickery that can be done to ruin a value investors forecast.

In order to do this we are up against buildings of Wall Street Analysts and "quants" as well as billionaires who have been succeeding in the market for decades. These people for centuries have been looking for a "magic formula" to give them an edge. They still have yet to find one. So I doubt you will.

Before we actually get started I will explain why technical analysis along with so many other tools are not viable.
Who are the most successful people in the stock market? Answer: Value Investors, Quantitative Analysis

Anyone interested in quantitative analysis I would recommend looking into Renaissance Technologies, a hedge fund that specializes in analysis tons and tons of data in the market and forming sophisticated trades from that. It has performed phenomenally since inception (its also said to house the most PHDs).

For value investors I need only list the name of Warren Buffett and Berkshire Hathaway.

The Value Investment Process

If you don't know, value investors aim to minimize risk and maximize return in the long run. As Seth Klarman says, would you flip a coin to double your net worth? Probably not. So why should you in the stock market?

Value investors do this by creating a Margin of Safety. The Difference between the current market capitalization and the actual value we find the company to be worth. Value investors also believe the value of the company is equal to the cash flow the business will generate for the rest of its' lifespan.

We aim to build models to try to accurately forecast the future of the business' earnings and free cash flow. When doing this we look to reduce risk by making conservative assumptions and finding a large margin of safety.

When I properly value a company it takes a week - month. I spend 100+ hours building my models and valuing the company. It is not a quick process. The stock market isn't a quick game though.

It is bipolar in nature in the short term, but in the long term it is a calculated process. Unfortunately I would not be able to thoroughly condense all of this research into one article so I would urge you to read my other post which will walk you through how you can learn value investing from scratch.

Investing is more of an art than a science and with that there are many different views, opinions and assumptions people take about how to do it and the stock market in general. This is my take on it and it has benefited me well so far in my short timespan (I don't have much of an online track record though ).

Finding a value investment
I look for investment opportunities by either trial and error, news or a combination. A stock screener can be helpful to identify businesses with high margins of safety that trade below their liquidation value.

P/E ratio and Dividend Yields are relics of old investing. They have many floors such as one time dividend payouts and accounting gimmickry. At best they offer an inaccurate snapshot of the actual business which is what were trying to find.

As a private investor (which most of you on this forum are) you should not feel pressured into making bad investments / trades. You should be looking for the best of the best. Sure about 9/10 businesses you look at are shitty. But 1000 hours of work to find a great trade is better than 100 hours of work to find a "goodish trade".

Value investments can often be found through "special situations" which are when corporate action is taken to affect the future revenue of the company. These are often in the news. Another great place, is to be a contrarion; go against wall street. We must also acknowledge George Soros' "Theory of Reflexivity" which is that the markets opinion of the stock may actually become the stocks value. This is where activist investing can also be exploited. There are many other ways but these are the ones I have had most success with.

We are the ones who should be there to correct Mr. Markets bipolar when he makes a wrong move for whatever reason.

Quantitative Analysis #1: Discounted Cash Flow + Liquidation Valuation

Once you have found the stock you want to analyse we must break it into what it actually is which is a business. We do this by discounting the cash flow of its future earnings to forecast what it will earn from now until its' end (or the universes). Then we can find a rough intrinsic value. This IS NOT AN ACCURATE FORECAST. You are placing many assumptions into this calculation. These assumptions greatly affect your model. If anything this is just an "appetiser" into the company. It seperates the bad from the good and great.
Reminder: you should compare your DCF results to what the current market cap of the stock is. This will give you the Net Present Value.

Before you give up on a bad business find the liquidation value. This is not an easy task either. Will all the assets be sold under fire sale conditions or over a longer period of time? That is up to you. It is your "worst case scenario" that you should look at and consider. Be conservative.

Now if once you have done this and you have a bad business both with DCF and Liquidation Value you should just move on. If you have found a decent margin of safety or even a great one It is time to progress.

Fundamental Analysis #2: Intangible Fundamentals
You should look for intangibles that could add good value to the company. For example, the brand of Coke is worth alot; it is intangible however.

To do this, read news articles about the company, any other media. Read conference calls, company reports. Become an expert in understanding the business.

After that look at the management. What decisions have the made? What are there plans? Are they being replaced? You should constantly ask questions like this at the stock you are valueing.

Review your quantitative analysis #3: Are the current assumptions good assumptions?
Do not add intangibles to the DCF or liquidation value. Instead, with your new knowledge of the company adapt your assumptions to what you think about the company as a whole. Do not get optimistic because you have done so much work so far. Be realistic.


Optional:The Bigger Picture #4: Whats happening in the sector and market that will affect the company?
Now we are at the point where you can "speculate". But remember, you shouldn't. You should instead consider the possibilities in your model of the company. What if the interest rates will be raised? What if Brexit does actually happen? Will your company still be in a good position?

To answer these, we need to do 2 things; look at the bigger macroeconomic market currently.
Don't bother forecasting macroeconomics you won't be able to. I would really recommend instead trying to answer various outcomes like this and adding this to the model. This requires research and continued quantitative analysis.

You should be consider various views and then weighting them based on their likelihood. You don't have to mathematically do this. You just have to be aware that your margin of safety assumptions and your so called "risk valuation" may be wrong.

The Portfolio

You should look now look at macroeconomics and risk aversion as the portfolio in its entirety. You should look at sufficient diversification as well as other means of diversifying risk through portfolio allocation by sector, industry and market as a whole.

DONT SPECULATE ON MACROECONOMICS. Instead consider outcomes that may affect your portfolio and your asset you are interested in.

Buying
You should be buying incrementally over a long period of time!!!!!! You should not go "YOLO" in. You should buy into a company over a period of weeks and months. If the stock goes up, dont buy more. If it goes down, reevaluate and reconduct your analysis. Look back on your model. Then buy more once you have decided. You should always consider your portfolio as a whole. I am not going into that in this post however.

Thank you for reading. Expect many edits to happen as I wrote in a hurry. By the way is there anyone interested in having a debate on the forums about whether or not technical analysis is bull shit?