What Is A Good Price To Free Cash Flow Ratio Book Review – Why Are We So Clueless About the Stock Market?

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Book Review – Why Are We So Clueless About the Stock Market?

No idea about the stock market? If so, or if you are unsure, Mariusz Skonieczny’s book is for you. Why do we have no idea about the stock market? is a short 150-page read that focuses on the principles espoused by some of the world’s most successful investors. MagicDiligence recommends the book for both new investors and experienced investors who want to “get back to the basics.”

The first few chapters of the book cover a fact that is often lost in the noise of following technical trends and macroeconomic predictions: underneath the stock is a business, and the outcome of that business determines the outcome of investing in stocks, relative to the long term. Skonieczny briefly explains what a business is and then talks about how a business creates wealth for its owners. For publicly traded companies, these owners are equity investors. I liked how the book follows the passe example of the lemonade stand, starting with “why start a stand”? The answer, of course, is to achieve a better return on investment capital that can be achieved through alternatives such as a savings account. The author then goes through the factors that can erode these returns on capital, especially competition, and how the existence of an economic moat protects against this.

Later chapters cover other points investors should consider, such as diversification, broader economic trends, IPO investing, and more. MagicDiligence finds the most useful of these chapters to be those on valuation, along with a number of discrete examples from a real company. Mariusz has a slightly different method for valuing stocks than the traditional free cash flow discounting method. However, it is done similarly. An investor using his method should use a range of expected growth rates, estimate the trailing P/E ratio, assign a required yield (discount rate) and also estimate the dividend payout ratio over a 10-year period. Using them, two components of the final return can be determined: the capital value of the share and the dividends paid. Add these two together and you get the stock price target. By using a target range, you compare to the stock’s current price to see if there is a significant margin of safety. If there is, buy it.

These examples are also very well documented – the graphics in the book can easily be converted into a spreadsheet. Skonieczny even provides a little help by providing a “normal” range of discount rates, as well as using historical data to assign other values. I liked this approach. Although the discounted free cash flow (DFCF) method is theoretically the correct way to value a stock, this method focuses on evaluating potential returns in real life. DFCF does not actually adjust for stock market realities such as average P/E ratios that vary by industry or relative dividend payouts that vary among companies.

Another chapter that I found particularly interesting describes in a short but complete way how such large, well-respected companies as Fannie Mae (FNM), Freddie Mac (FRE), AIG (AIG) and Long-term Capital Management can fail within of several weeks. . While The Magic Formula singles out financial companies like these, it’s absorbing to read about how quickly debt can destroy these companies. The explanation of leverage, why companies use it and the dangers of using it was exceptional.

Mariusz Skonieczny clearly shares many of the same influences as MagicDiligence. Why are we so oblivious… it exactly matches Magic Formula Investing (MFI) using return on invested capital to determine what is a good deal and what is not. But the durability of that quality requires competitive advantage analysis, which both this book and MagicDiligence believe is best explained in two books by Pat Dorsey (The Little Book That Builds Wealth and Five rules for successful investment in shares) through factors such as regulatory barriers, unique assets and economies of scale. MFI’s valuation shortcut, following earnings yield, can also be enhanced by forward-looking examination as in the book. If the earnings yield is ultimately not sustainable, or if the earnings yield is not outside the realm of historical valuation, the stock may not be so cheap. These types of analyzes protect Magic Formula investors from buying into “value traps.”

In the end, the book’s brevity may be its greatest asset. Oft-quoted investment novices like Ben Graham Security analysis, are frankly a very long and mostly boring read, the salient points of which have been extracted and effectively compiled into a number of shorter books, including this one. Keeping the focus and not getting too technical, Skonieczny presents only the important parts of a successful fundamental investment. For beginner investors, this is a very good example. Seasoned value investors may not find much new material here, but it’s still a good refresher to stay the course.

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