Stock Market Investing Part 6 Stock Investment Evaluation Practical Exercise | John Colley | Skillshare

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Stock Market Investing Part 6 Stock Investment Evaluation Practical Exercise

teacher avatar John Colley, Digital Entrepreneurship

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Lessons in This Class

19 Lessons (1h 22m)
    • 1. Stock Market Investing Part 6 Stock Investment Evaluation Practical Exercise 2

    • 2. Stock Investment Evaluation Practical Exercise Set Up

    • 3. What Questions do we need to ask?

    • 4. Step 1 Growth Screen

    • 5. Step 2 Profitability Screen

    • 6. Step 3 Owner Earnings Screen

    • 7. Step 4 The Economic Moat Screen

    • 8. Step 5 Capital Allocation Analysis

    • 9. Step 6 Leverage Screen

    • 10. Step 7 Share History and Buy Backs

    • 11. Step 8 Intrinsic Value Calculation

    • 12. Step 9 Current Market Data and Rule of 72

    • 13. Step 10 Margin of Safety

    • 14. Step 11 Management Evaluation

    • 15. Step 12 10k Screen and Commentary

    • 16. Step 13 Risk Evaluation

    • 17. Step 14 Investment Decision and Rationale

    • 18. Final Comments and Summary

    • 19. Stock Market Investing Part 6 Stock Investment Evaluation Practical Exercise Summary

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About This Class


Welcome to Stock Market Investing Part 6 Stock Investment Evaluation Practical Exercise

In a sense this whole course is a project as I want you to follow me through this investment evaluation exercise using the excel model provided in the project section and, in the final stage, the Investment Evaluation Score Card.

This Course offers a step by step investment evaluation which you can apply to any company of your choice.  I take you through the course evaluating Berkshire Hathaway.  Your choice of company is entirely up to you.

Make sure that you select your own company and download the financial model from the project section before you start the course.

The main steps of the process are summarised below.

Stock Investment Evaluation Practical Exercise Set Up

Welcome to this Stock Investment Evaluation Practical Exercise where we are going to apply in practice much of what we have covered in this course.  There is an Excel Model which accompanies this work and which you can download from the Resources Section.

What Questions do we need to ask?

Here we set out the process of the evaluation and explain what questions we need to ask and why they are important.  This sets the framework for our analysis in this course but note that this is only a starting point and you should feel free to extend the analysis for yourself if you wish in the future.

Step 1: The Growth Screen

This is the first step of our company evaluation.  We are going to look at the historic five year and 10 year growth and CAGR for a number of financial metrics.  Don't forget that consistency is as important as the CAGR numbers.  We will also interpret the numbers and see what we can learn from them, so this is not a purely numeric exercise.

Step 2: The Profitability Screen

In Step 2 we are evaluating the profit margins of the business and again consistency of profitability is just as important as the absolute levels of the profitability.  We discuss some of the issues raised in the context of Warren Buffett's shareholder letters and also briefly discuss what would earn the evaluation a Red Flag rather than a Green Flag.

Step 3 Owner Earnings Screen

Owner Earnings is a critical evaluation metric for Warren Buffett which is a very good reason to include it in our company evaluation process.  We need to do a little simple calculation to arrive at the number but the model does most of the work.  Again the 5 year and 10 year history is critical to our investment decision.  We also take a look at what Warren Buffett has to say on the subject.

Step 4 The Economic Moat Screen

An Economic Moat is an expression which indicates that a business benefits financially from sustainable competitive advantage.  In my view, this is an essential pre-requisite for any investment.  We explore how we can identify the Economic Moat and discuss the different types of moats which exist.  The Red Flag explanation is very clear.

Step Five Capital Allocation Analysis

Capital Allocation is the KEY job of management.  Intelligent and rational capital allocation is the basis of future profitability and shareholder returns so this analysis is important to understand.  We discuss the approach taken by Warren Buffett in the light of the market conditions of the last 10 years and discuss what this might mean for the future.

Step Six Leverage - Debt and Equity History

If a company has a strong economic moat, it should be cash generative and we should see this reflected in the company's balance sheet.  I strongly prefer to avoid indebted businesses and this screen is designed to look carefully at how the company has been finance over the past decade.

Step Seven Share History and Buybacks

We want to see whether Management have been respecting their shareholders by managing the company's equity with care.  In this screen we examine the 10 year history of share issuance and share repurchases to see how the equity has been managed.  Warren Buffett's approach to shareholder equity comes under the spotlight and we make clear what we see as Red Flags.

Step Eight Intrinsic Value Calculation

We are now going to formulate our own view on the value of the business.  Unfortunately this is far from straightforward.  The model I have provided will help you and Morningstar and Gurufocus also will provide a significant contribution to the valuation discussion.  This is at the core of our investment decision so you need to understand this.

Step Nine Current Market Data and The Rule of 72

Now we turn our attention to the current share price, the PE and PEG ratios to see how the market is currently valuing our company.  We are also interested to understand from the Rule of 72 how long we expect a number of key financial metrics will take to double, helping to frame our perspective as a long term investor.  

Step Ten Margin of Safety

Now we are going to compare our intrinsic value calculation to the market value to see whether there is the potential to invest in our company with a Margin of Safety, that is, at a price which is comfortably below our intrinsic value.  We explain how this works, the simple formula to calculate this and what a Red Flag looks like.

Step Eleven Management Evaluation

Now its your turn to do some real thinking. You will need to read extensively about the business you are considering and form a view about the management team.  I suggest some evaluation criteria in this lecture and explain when I would walk away from a deal based on the management team evaluation

Step Twelve 10k Screen and Commentary

I moved the screening of the historic 10k reports up to before the Risk Assessment as this seemed logical.  This is your chance to do some serious reading beyond the numbers we have been reviewing throughout this process.  I give you some guidance on what to do in this lecture but at the end of the day, the homework has to be done by you.

Step Thirteen Risk Analysis

Now its time to turn your thinking inward and to consider whether, throughout this process you have made any mistakes, erroneous assumptions or simply not appreciated the significance of a risk.  Be critical of your own thinking and try to make sure that you don't make a critical mistake in making this investment because of something you have missed.

Step Fourteen Investment Rationale and Decision

Now we come to the point where we need to crystallise our investment rationale and decision.  To do this we shall revisit each stage of the evaluation process in turn.  Using the Score Card I have created for you, you can add your "investment rationale" comments for each stage of the process, confirm the Red/Green Flag designation and give each step a score out of 10.  This will provide you with a very concise summary of your investment evaluation.  Follow me step by step as I do this for Berkshire Hathaway

The Score Card template and the Berkshire Hathaway Score Card are available to download in both Word and PDF formats from the project section

Final Comments and Summary

This has been a complicated, if structured, evaluation process and I want to round this off with a few summary comments to pull things together.  This is the what we cover in this lecture.

Stock Market Investing Courses

The other courses in this series may be found here on Skillshare.

The previous five parts are:

Stock Market Investing Part 1 Introduction to the Stock Market -

Stock Market Investing Part 2 Five Essential Stock Market Principles -

Stock Market Investing Part 3: Are you ready to start Stock Market Investing? -

Stock Market Investing Part 4: What do you need to know about Stocks? -

Stock Market Investing Part 5: Company Evaluation and Stock Selection -

I hope you found this really enjoyable, engaging and informative!

Thank you for enrolling, see you again very soon in another course!

Best regards


Meet Your Teacher

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John Colley

Digital Entrepreneurship


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Here is a little bit about Me...

Cambridge University Graduate

I have a Bachelors and a Masters Degree from Cambridge University in the UK (Magdalene College)

Master of Business Administration

I graduated from Cass Business School in 1992 with an MBA with Distinction and also won the Tallow Chandler's prize for the best Dissertation.

British Army Officer

I spent nine years as a Commissioned British Army Officer, serving in Germany and the UK in the 1980s, retiring as a Captain. I graduated from the Royal Military Academy Sandhurst (Britain's West Point) in 1984.

Investment Banking Career

I have spent over 25 years working as an Investment Banker, advis... See full profile

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1. Stock Market Investing Part 6 Stock Investment Evaluation Practical Exercise 2: Welcome to stop market investment part six, stock investment evaluation, practical exercise. Hello, and welcome to part six of my stock market investing course. In this course, we're going to do a practical exercise in stock market investment evaluation. We're going to look at a company and evaluate it as a potential investment. My name is John Kelly. I'm an investment banker with over 30 years experience, and I also manage my own portfolio of stocks and shares. This series of stock market investing courses is designed to empower you to have the confidence to increase your wealth over the long term by having the confidence to invest in stocks and shares. So far in this series of courses, we've covered Part one, Introduction to the stock market, part to five essential stock market principles. Part three, Are you ready to start stock market investing? Part for what do you need to know about stocks? And then Part five, company evaluation and stock selection, which precedes this course and really takes on a lot of the lessons of Part five into a practical exercise in this course, part six. Then we're gonna walk step-by-step through a stock market investing evaluation process as a practical exercise. This will also in parallel form the project for the course. The course is aimed at beginners upwards, even if you have some investing, investment knowledge, you will find helpful concepts and principles, learning points to make you a better investor. Please note this is not a get rich quick scheme. This course will not contain investment mechanisms and recommendations or stop tips. It's focused on the skills and knowledge you need to become an investor speculator. At the end of this course, you will understand how to use the Excel financial model that I have provided with the course to evaluate stocks. There is also a scorecard which we will use to summarize our conclusions. The final step of the evaluation process. I hope you find this and all the subsequent parts of the course informative, engaging, and easy to follow. And I look forward to working with you the extensive knowledge base we are going to cover with the goal of making you a better stock market investor. Don't forget to follow me to make sure you didn't miss any of my courses when I publish them. So let's get started. You'll now need to decide which company you're going to analyze. Alongside my analysis of Berkshire Hathaway as I teach the course, enroll now and I'll see you in the course. So thank you for watching this video, stock market investing part six. We're going to take onboard a practical exercise in stock market investment evaluation. And I think you're going to absolutely love it. 2. Stock Investment Evaluation Practical Exercise Set Up: Let me introduce you now to the stock investment in valuation practical exercise. And this lecture is going to be explaining exactly how to set up and get ready to get started. We're going to conduct a step-by-step evaluation of accompany, which we have already identified as a potential investment opportunity. Now we've identified this company as a result of our screening for potential stocks. And in the exercise we're actually going to evaluate Berkshire Hathaway, Warren Buffett's company. Although you can run this in parallel and do it with any company, like the initial steps are to set up a folder on your computer for all the files this exercise will generate. So you know that you have them all in one place. You should start by downloading ten years worth of the companies ten K reports. And in this case, the last ten years of Warren Buffett's famous shareholder letters, as I have done here. You can find all these at the Berkshire website. The link is on the screen. On the Berkshire Hathaway website you'll find a great deal more information which I encourage you to explore in order to get to know the company and his management better. We shall do this once we've moved through the evaluation steps, Leaving the most time-consuming tasks to the end. Only if the company passes the evaluation process. I've left the detailed review of the ten k's deliberately until the last section. It's the most time-consuming. And therefore you should only complete this final task if everything else has postural screening criteria. I've created a spreadsheet for you to work with, which is available with this lecture. We should be building this spreadsheet together as we go through the lectures, I recommend that you make your own company selection and work with me through the process as we conduct our evaluation. The bright green cells in the spreadsheet or the input cells, and you can replace your company's data with that in the model. Consider this process as a starting point. I've distilled much of what we've covered in the course to a simple process as possible to make it as quick and easy as possible. And you may wish to add your own evaluation steps. It's not set in stone by any means. You may feel that you hit an unacceptable red flag at any point. That's absolutely fine. That's the purpose of the exercise. Stop. Stop there and rule out investing in that company. You won't need to go any further with that company because you've hit a buffer which is an unacceptable red flag. The 14 steps of this evaluation are shown here. We're going to work through each of these step-by-step in the process of this exercise. And then also examine and discuss our findings. The 14 steps are the growth screen, the profitability screen, the owner earnings screen, the mode screen, the capital allocation screen, the leverage, debt and equity history, common stock history and by Imax, intrinsic value, current market data and rule of 72, margin of safety, management evaluation, risk analysis, 10-K. screen and commentary, and investment rationale and decision. Let's get started. Remember, some of the information you will need will come from the ten K statements and other information from online websites such as Morningstar, Yahoo Finance and Gary focus. Welcome to Berkshire Hathaway. That's the introduction to this stock investment evaluation, practical exercise. It's gonna be very detailed and we've explained the setup. The next step is to get started with the exercise itself. 3. What Questions do we need to ask?: I wanted to start off by simply setting out the questions that we need to ask about the company evaluation. The first decision we need to make is to set the list of questions that we're going to ask about the company we are evaluating. I've showed you the 14 steps of the evaluation exercise I've set up for you. You can see them here on the screen. Let's quickly review these so we understand why they're important. And as you see, it's everything from growth margin of safety, risk analysis. But we're gonna go through these one-by-one, starting with the growth screen. As a long-term investor, we want to focus on companies with a strong history of consistent growth, growth in revenues, growth in gross profit, growth in pre-tax profit or income, and growth in net income. You will have to subjectively assess the consistency. And we will look at both 5-year and 10-year CAGR, compounded annual growth rate. The profitability screen is just as important as the level of growth. So we're looking not just at how quickly profit is great, but what's the absolute margins? And we're going to examine the gross margin, the operating margin, the EBIT margin, and the net margin. In addition, we're also interested in the return on equity and the return on invested capital. We will also check to see that the level of return on invested capital ROIC exceeds the weighted average cost of capital. Number three is the owner earnings screen. Owner earnings are an important measure of profits for shareholders, but these needs to be calculated as they're not reported. We would use the results in our assessment of intrinsic value later on as well. The mode screen is really important. We've stressed repeatedly the importance of an economic mode. This is evidence that the company benefits from some sustainable competitive advantages in its business model. This is the secret to long-term success in business. Not only will we look for financial evidence of an economic mode, we'll see how Morningstar analysts have assessed the company. We will also identify the type of aggregate economic mode as there are arranged to choose from, and there may be more than one. The capital Alice allocation screen is one of the most important management tasks. At its most simple, this is the key decision that the CEO needs to make. How capital is allocated will significantly impact future returns. It also tells us much about the quality and the rationality of the management team. Leverage the debt and equity history comes next. A company with an economic mode and sustainable competitive advantage should be highly cash generative. As a rule, we want to avoid companies which have substantial debt. This is particularly the case as we are leaving a decade of cheap money where balance sheets have been loaded up with debt to fund share by banks or for acquisitions. This, for me, is a simple green flag, red flag issue. The common stock history and buybacks. If companies are generating high levels of cache and management cannot find strong economic projects to apply it to, then share buybacks are a great way to grow the value of the company for existing shareholders. It's also very tax efficient. Note we want to see this done with surplus cash and not dead intrinsic value. Note that we're paying no attention to the market valuation of the company so far. Now we're going to form our own view on the valuation by calculating the intrinsic value for ourselves. Unfortunately, this is not straightforward. We will cover a range of different options, discount and growth rates. The current market data and the rule of 72. Now we bring in the current market price, the price earnings P0 and the peg, the price endings to growth ratios for review. We also take this opportunity to apply the rule of 72 to find out when we might expect some of the key financial metrics to double. The margin of safety combines our calculation of intrinsic value with the current market value to enable us to interpret whether the company is currently undervalued or overvalued by the market. The margin of safety is a critical investing metric and you should always be aware of what it is before you make an investment. In the management evaluation, we want to be sure that we're investing in a business with a management team who is focused on creating value for its shareholders. We will therefore review management, compensation, integrity, transparency, and rationality. Much of this information comes from the company's reports and press releases, as well as external commentary on the company. Risk evaluation. We need to ask ourselves what might go wrong with our investment thesis. This is your opportunity to check whether your assumptions and conclusions make sense. It's a double-check to ensure that we are not rushing ahead and making an investment where the head is ruling the heart. The heart is ruling. Behead. The 10-K. screen and commentary. Well, if you've got this far without identifying any red flags, then you can sit back and spend an hour or two reading through all these ten K reports do downloaded, focus on the reports from the management rather than the numbers. Now, you're looking to understand the story of the business, the decisions good and bad made by the management team, and how this affects your view of the company over the next ten years. Finally, we come to our investment rationale and decision. The final step is to establish if you want to make an investment and if so, why? I will not discuss the level of your investment is that it's entirely up to you and your personal circumstances. The investment rationale is just as important as the screening. You need to have a view as to why the company will continue to flourish into the future. This then is our process. These are all questions. You may have more questions and have more analysis that you would like to do. That of course, is completely fine. You should devise a company evaluation process that works for you. I would hesitate to suggest shortening this process. As I think the steps we have included are all important. That's a run-through of the questions I think we need to ask. And it gives you a framework and sets you up now for the detailed evaluation of the businesses that we're going to look at. 4. Step 1 Growth Screen: The first step of AI evaluation exercise is the growth screen. Just as a reminder, before we get started, our evaluation in all these lectures is focusing on Warren Buffett's company, Berkshire Hathaway. Although of course, I would be very much encouraging you to select your own company and work with that in parallel with the course. The first step is to input the growth data into our spreadsheet, which I have done for Berkshire Hathaway. This is what the data looks like in the spreadsheet which you've already downloaded. We can focus on our results, which is shown here. It's important that you interpret what you see. You just don't take the numbers, you want to understand them. The first observation I would make is that our CAGR uses 2020 as the final year, which of course was significantly impacted by COVID. You can see a significant drop in revenues and profits between 20192020. You will need to factor this understanding into your interpretation. The results in 2018 look surprisingly poor. Why is this? In the shareholder's letter of that year, Buffett explains the 20.6 billion loss from reduction in the amount of unrealized capital gains that existed in our investment holdings. Sounds very curious, doesn't hit. This was entirely due to a change in gap, which is the accounting standards, which require the company to report the net change in unrealized investment gains and losses on stocks held by the company. Which of course four, if Berkshire Hathaway is a very substantial amount of money, It's important given that bunch of Hathaway is a portfolio of a $170 billion, that you understand the impact of this gap rule going forward from 2018, the 10-year record shows a consistent record of steady growth, which is a major plus when evaluating growth in a business, we now understand the impact of the gap will change and the impact of COVID, neither of which are fundamental issues for the company. The gap changed and forget is unrealized. Gains or losses. There's actually no change to the business itself. Earnings per share growth from Morningstar of 12.72% is a good figure to illustrate the Rule of 72. If we divide 72 by 12.72, the result will tell us how long it will take for EPS to double. The answer in this case is 5.66 years. This is a really useful tool for investors to understand and use. We'll cover the Rule of 72 in detail later in this evaluation process. While the growth figures are not off the scale, they are very respectable. Don't forget, the company is huge and mature. There are no red flags at this stage. The next step is to quickly check through the reports or any comments or insights about growth. I want to try to inform myself and be able to better interpret these numbers. One of the factors which is immediately apparent in the shareholder's letters is that banks are Hathaway can only report its dividends from its investment portfolio rather than its proportionate share of owner earnings, which is significantly understating the real value being created by its investments. This point is clearly illustrated by this extract from the 2018 shareholder's letter. Dividends received 2.966 million. 2.966 billion. Share of retained earnings is 6.8307 billion, more than twice as much. The 2015 annual report, Buffett sets out his recipe for future growth. This highlights the benefits of reading and researching. It's worth quoting in full. And I quote, The managers who succeed Charlie and me will build boxes per share intrinsic value by following our simple blueprint of constantly improving the basic earning power of our many subsidiaries, further increasing their earnings through bolt-on acquisitions, benefiting from the growth in our investees. Repurchasing Berkshire shares when they are available at a meaningful discount from intrinsic value and making an occasional large acquisition management. We'll also try to maximize results for you by rarely if ever, issuing boxes, shares. I think that says it all as a growth blueprint. What would a red flag look like? Well, either inconsistent growth fast one year, slow or negative than eggs, or very slow or growth below five per cent per annum perhaps would be a cause for serious concern. So now we have a set of acceptable figures, but we also understand management's plan for future growth. On this basis, we can conclude that our growth evaluation is positive and give it a green flag. Next up, we're going to take a look at profitability. That completes step one of our growth screen. And you can see by putting in these numbers and interpreting what they're telling you, you can understand the historic growth of the business over a long period of time. And that gives you confidence for the future. 5. Step 2 Profitability Screen: Step two is our profitability screen. We're now going to evaluate the profitability of banks or Hathaway. We can use the revenue and profit figures from step one to calculate the margins. This is the raw data from the spreadsheet. We can debate acceptable margins for a mature business such as bath chair Hathaway, 15% EBIT margins and 14% average net margins are more than acceptable. We can also see that berkshire Hathaway is ROIC exceeds its cost of capital WACC. Again, the picture is one of consistency, which is very important. We are aware of 20172020 as potential outliers. But across the board, the profitability screen gives us confidence the 2018 gap change makes the operating earnings margin the most relevant profitability margin as it is not distorted by this gap rule. A quick check through the shareholder letters to see what Warren Buffett has to say on this topic is important. Up to 2018, Warren Buffet measured performance on the basis of increase in book value per share, 2021.43610%.721723 thousand in 2018, we know about 0.4%. Compounded annual game between 19652018 was 18.7%, which isn't incredibly impressive track record. These figures on their own are strongly positive from an investor perspective. However, in 2018, He moved away from this metric for two reasons. The greater proportion of wholly owned businesses rather than investments which are not marked to market. And so whose value is understated in Book terms was the first reason. The second reason is that he expected that the company would be a significant purchaser of its own shares below their assessment of intrinsic value, but above market value would itself increased book value per share. Note the unusual level of candor and honesty from the chairman on this point. Lesson to be learned from this consistent profitability is the power of retained earnings, which Buffett highlights in his 2019 shareholder's letter. And it's a lesson worth emphasizing him. If it Quotes John Maynard Keynes and explaining the benefits of retained profits. This highlights the long-term benefits of retaining and re-investing earnings, which compounds growth. We've already explained the importance of compounding and Buffett is highlighting how this can benefit investors when profitable businesses reinvested earnings every time the quote is, well-managed, industrial companies do not, as a rule, distribute to the shareholders the whole of their earned profits. In good years. If not in all years, they retain a part of their profits and put them back into the business. Thus, there is an element of compound interest. Keynes's italics, operating in favor of a sound industrial investment. Whichever companies you are assessing, consider if there's a better way to evaluate long-term profitability than we using in the spreadsheet for this exercise. What does a red flag look like? Well, apart from the level of profitability, which is obvious, the consistency of the track record is key. If the profits record is erratic, it is unlikely that the company has a wide economic moat and therefore would not pass my evaluation. I'll conclusion is that profitability is good to strong, so it gets green flag. Next, we're going to take a look at owner earnings, which will also help us with our intrinsic value calculations later in this valuation process. That's step two, the profitability screen. We want to see a good level of consistent historic profitability in the business to give us the confidence that the company can continue to deliver that level of property profitability and that level of consistency going into the future. 6. Step 3 Owner Earnings Screen: Now we come to step three, which is our owner earnings screen. Calculating owner earnings is important to get them valuable earnings metric. And one which we shall use later to calculate one method of intrinsic value. We should also see in this lecture what we can learn from Warren Buffett himself, for whom this is a fundamental metric. We've started from net income and added. We've started from net income, deducted capital expenditure and added back the depreciation and amortization charges. Most online resources will provide the last five years history for free. We've also calculated the ten year record and the margin against revenues. The five and 10-year averages are 9.612%.65 per cent, respectively. The 10-year history is consistent growth with the 20182020 results already explained. These figures and the growth rates will feed into our intrinsic calculations later. You should also be aware from reading the shareholder letters of buyer Warren Buffett, that puncture Hathaway owns two businesses which are asset heavy and which will require investment in excessive depreciation and replacement costs. Understanding this can help you interpret the owner earnings numbers and understand why berkshire Hathaway is CapEx exceeds depreciation and amortization and significantly, but these are only two out of 70 businesses. We have already seen the importance of owner earnings versus dividends in companies where at Berkshire Hathaway holds a minority investment. There is no reason why you cannot apply the same methodology to companies you hold in your portfolio and then measure them over time to see how they grow. In the 2020 shareholder letter, buffet highlighted the Berkshire Hathaway held 281 billion of marketable stocks, I E, minority positions. He again reminded us that Berkshire Hathaway could only report the share of dividends, not owner earnings. But he explained the benefits of owning owner earnings very clearly. Those under unrecorded retained earnings are usually building value. Lots of value for bulk share. Investees use the withheld funds to expand their business, make acquisitions, pay off debt, and often to repurchase their stock. An act that increases our share of their future earnings. As an aside, I also want to quote buffet on the value of being an investor who can select the best companies for investment, which of course is the purpose of this course. Of course, you didn't really need reminding. Owning a non-controlling portion of a wonderful business is more profitable, more enjoyable, and far less work than struggling with 100% of a marginal enterprise. Another lesson from the 1980's annual report stresses the importance of owner earnings. This approach would impact our management assessment later. It's also an excellent principle for you to judge the quality of management and how they allocate your owner earnings. Buffett says, although our form is corporate, our attitude is partnership. What does a red flag look like? Low-level of earnings would be concerning. As a rule, I prefer to avoid very capital-intensive businesses as these are expensive to maintain. Capex significantly in excessive historic investment, DNA would earn a red flag for me in puncture, although it has these two capital-intensive businesses. But the cost of this CapEx, it doesn't get anywhere near far enough to cause me any concern. Conclusions are therefore positive for owner earnings and it gets a tick in the green flag box. So we can move forward. The next screen is to evaluate economic modes. So that's a look at older earnings. And you've got the spreadsheet and you can put your data into the model and see what you come up with, whether your business that you're evaluating and a green flag or a red flag. 7. Step 4 The Economic Moat Screen: We now come to step four, which is the economic moat screen. We already understand the importance of economic moats from previous discussions. These indicate that the company has a sustainable competitive advantage, or indeed more than one. This is the mode screen data from the financial model which I provided you with. The first step in the mode screen is to see how Morningstar have classified our company, in this case Berkshire Hathaway. The economic mode here is rated as wide, which is the best possible rating the morning style can give it. This is a significant plus and I would go so far as to say that if there was no moat than the red flag on this issue could be enough to end our evaluation exercise. What have you identified for your company? Next, we can examine the ratio of free cashflow, operational cash flow minus CapEx to revenues. Any margin above 5% is an indicator that there is an economic mode. The result for Berkshire Hathaway is encouraging. The 10-year average is 8.96 and the five-year average is 9.85. The strong net margins are also encouraging. The next discussion is more subjective. What type of economic moat does Berkshire Hathaway benefit from? There may be more than one, particularly in a conglomerate business like bark to Hathaway. I think straight off we can say the Berkshire Hathaway benefits from significant scale efficiencies, particularly in its insurance businesses. I think boxes moat goes further than this though. Firstly, Barker is a collection of wholly owned and minority owned businesses. And we know that one of buffets key criteria is only investing in businesses with a strong mode. We can reasonably conclude from this that most, if not all of the businesses within bulkier have their own modes, even if the nature of these vary. The second doc, economic mode, which is related to scale, is the way that Buffett and Munger control capital allocation. This enables them to provide benefits to their subsidiaries in the form of capital strength, which is particularly important in insurance businesses. From this, it follows that the aggregation of the float, the customer premiums held within the different insurance businesses can be allocated strategically and not on a piecemeal basis. These factors help to explain why Morningstar allocates puncture or wide moat rating. What does a red flag look like? Well, this is very simple. No economic moat equals red flag. The economic mode may be wide or deep, but there really has to be one that is non negotiable in mind evaluations. The next screen we're going to take a look at is how Berkshire Hathaway allocates his capital. That's step four, the economic mode screen. It's a really critical, very straightforward, but really critical screen that your companies must pass. My opinion, if you're going to seriously consider them for investment. 8. Step 5 Capital Allocation Analysis: Instead of five, we're going to take a look at the capital allocation analysis. This analysis, we're going to take a look at the capital allocation strategies of management over a ten-year period. The fundamental role of the CEO and the board is to allocate capital. And this analysis will put them under the spotlight. This information is taken from the consolidated cash flow statement of the company. You will have to tailor the categories to fit the company you are analyzing. But this will tell us a great deal about the priorities of management and what you can expect from them in the future. In the case of Berkshire Hathaway, the company does not pay dividends. The company frequently buys and sells minority holdings as investments. The numbers are negative because these are net cash outflows. Share buybacks are normally listed in the cashflow statement is acquisitions of treasury stock. This is what our data looks like in the financial model. The results are interesting to nearly 40% has been invested in capital expenditure. This suggests that Berkshire Hathaway is actively improving the businesses that it owns. Twenty-five percent is being spent on acquisitions and twenty-five percent on investments, but only 9% has been spent on share buybacks. Although from Buffett's comments recently, we expect this to be higher in the future. This reflects the market conditions of the past ten years. The equity markets have been very strong. Berkshire Hathaway has had plenty of investment opportunities, but fewer acquisition opportunities. The equity market bubble valuations of 20202021, I've seen even fewer investment opportunities and an increase in share buybacks by bulkier Hathaway. These figures, of course focus on neon cash investing activities and do not reflect unrealized investment gains. In 20 twenties letter to shareholders buffet admitted boxer made no sizable acquisitions and operating earnings fell 9%. This of course was the pandemic. Yeah, we did though, increase boxes per share intrinsic value by both retaining earnings and repurchasing about 5% of our shares. This share buyback program costs $24 billion and can be seen in the spreadsheet. I am personally very enthusiastic about Mr. buffets capital allocation skills by not paying dividends on which we would, as shareholders would have to pay tax. He retains the money in the business to continue to grow the business. If you don't set any shares, that growth, capital gain is tax-free until you do. What would have red flag look like? I've already said that I'm not keen on very capital-intensive businesses with a very high proportion of capital is allocated to CapEx. I would be nervous. The normal course of events. I'm not keen on very acquisitive businesses, particularly if this is funded with debt. You have to understand the nature of the company and intelligently interpret the numbers that you see. In summary, the capital allocation analysis is positive and raises no red flags. The next screen we're going to look at is the leverage screen in the next lecture to check to see how this capital was funded. That's the capital allocation and analysis. We're really checking to make sure that the management is doing its job that is allocating capital intelligently, rationally, because that capital allocation is what is going to drive future profits and future returns to shareholders. 9. Step 6 Leverage Screen: Now we come to step six, which is the leverage screen. In our discussions, we identify that businesses with sustainable competitive advantages are cash generative. Wide moves should equal positive cash generation. We therefore prefer to see companies with surplus cash rather than those funded on high levels of debt. This is what this screen is going to examine. Take a look at your company's balance sheet. We are going to extract cash and cash equivalents, current and long-term debt, shareholders equity, and net cash flows from financing. This is the dataset for this screen from the financial model that I provided you with. It is worth commenting in regard to Berkshire Hathaway, that it has a liability on its balance sheet, deferred tax liabilities. This represents the capital gains tax, which would be due for payment if the company is sold all its investments, as long as the major investments are held. This amounts in effect to a loan from the federal government from which the company continues to benefit. In the notes to Berkshire Hathaway accounts, the company splits out selected financial data for the past five years, which is very helpful. We can see the split of the dead between the three main businesses. Insurance, railroad utilities and energy, finance and financial products. Not surprisingly, the railroad utility and energy business, which is the most capital intensive, accounts for around 60, 60% of the dead. These are largely regulated businesses where future cashflows are reasonably predictable. And debt finance to cover the necessarily high CapEx is entirely appropriate. Significantly in the notes to the accounts you will find this disclosure. Bark share does not guarantee any debt borrowings or lines of credit of B NSF, THE, their subsidiaries. This means from an investor's perspective, much of this that has no recourse to the parent company, which is highly positive. We can see throughout the decade under review that net cash has always exceeded net debt. A healthy sign of financial strength. The ratio of debt to equity shareholders funds has been very stable, around 30%. We know the railroad businesses require debt funding. We also understand that the insurance businesses are very cash generative if you include the float. This makes the financial structure very well-balanced. Review of the net cash flows from financing shows us whether the company has been raising debt to finance the business. The data shows this is not the case. The 10-year net total of all financing activities practically sums to 0. Our inclusion of shareholder equity enables us to check the 10-year CAGR, which is a very healthy 10.91%. The Rule of 72 shows this is doubling every 6.9 years. One final check is to see what rating Morningstar attributes to boxers financial strength. As you can see here, it is graded a. In summary, it is clear that berkshire Hathaway is very conservatively finance. Cash generation is strong, as you would expect from a collection of businesses endowed with their own modes. What would a red flag issue look like? A combination of poor cash flow and high debt-to-equity above 50%. I am wary of any company which has been through a private equity buyout and then being returned to the market, often saddled with high leverage. Normally as a result of restructuring the balance sheet to pay dividends to the private equity house. Another issue of concern which has been common in the past decade has been companies buying back shares funded by debt. This has been easy to organize as interest rates have been very low and debt markets liquidity very high. This has lead to reductions in the number of shares of common stock in the market. An increase in the EPSC earnings per share, often followed by a share price increase. The main beneficiaries of this strategy have been the senior management who share option compensation is often measured by increases in earnings per share. It is possible for companies with flat revenue, profits and cash flow to nontheless increase their share price. And EPS through this mechanism. Read the annual reports very carefully when you see this going on. This brings us very conveniently to the next topic, share history and biobanks. Having established that the company is not financing with debt, we need to see how profligate or not the company has been with its equity. This is particularly important where companies are regularly acquisitive. That step six, the leverage screen, we're very happy with the conservative financing of Berkshire Hathaway, and we're very happy to give it another green flag. 10. Step 7 Share History and Buy Backs: Let's take a look now at step seven, the share history and buybacks. This is a relatively straightforward screen. We want to understand whether the company has been issuing shares or buying them back. Highly acquisitive companies may use their shares to grow them by paying for their deals in shares. As a long-term strategy, this is not to be encouraged. Far better to pay with cash from the balance sheet Providing is generated from the business. Debt fueled acquisition strategies are also to be avoided. If the company has surplus cash, then share buybacks are a tax efficient way to return money to shareholders. And the one I personally prefer. As already mentioned, some companies borrow to fund share by banks. This may help CEOs achieve their earnings targets, but broadly speaking, it is not in the best interest of shareholders. This approach has unfortunately been very popular in recent years, but may not be so in the future as interest rates increase. The data for Berkshire Hathaway looks like this from the financial model. As we can see, over the past ten years, Berkshire Hathaway has been a net buyer of its own shares. The majority of these had been repurchased in the last two years from the available data. Reading of Warren Buffet shareholder lets us makes it clear that he is extremely protective of Berkshire Hathaway shareholders and uses the equity very rarely for deals. The strong cashflow of the businesses allows him to use the company's cash. This is a very strong point in his favor and makes a review of this particular screen very straightforward. An illustration from Buffett shareholder, let us illustrates my point perfectly. In 1993, he purchased disastrously decks tissue for Ford, had written $33 million in stock. This is his comment on the results. The fact that I gave boxes stock to the sellers of Dexter rather than cash. The shares I used for the purchase are now worth about $5.7 billion. As a financial disaster. This one deserves a spot in the Guinness Book of World Records. The lesson he draws some stock-based acquisitions is neatly summarized a few lines later. The intrinsic value of the shares you given an acquisition, must not be greater than the intrinsic value of the business you receive. What does a red flag look like? Well, debt funded share buybacks and high levels of share issues to fund acquisitions. It's very simple. This neatly brings us to step eight in our analysis. Intrinsic value. That's a look at share history and buybacks. It tells you an awful lot about how management treat and view shareholders and what they put in terms of the interests of shareholders, whether they put those interests first. And it's something which you really need to look at and ideally get a handle on whether the management has been issuing loads of shares or weather much better. They've been buying them back from the cash generated from the company. 11. Step 8 Intrinsic Value Calculation: Now we come to a very interesting screen indeed, which is the intrinsic value calculation. Calculating the intrinsic value of the company. We are forming our own view on the value and not just following the market. It does come with some complexities which need to be explained and understood. This is what our model data looks like. Don't be put off. I'm going to take you through it step-by-step. We're going to discuss these numbers in detail to better understand the intrinsic value. We can start this process by taking a look at what Morningstar and guru focus have to offer. It's important that you understand the assumptions behind their numbers. Morningstar offers a fair value, which is shown on their homepage for the stock. Here we can see that Berkshire Hathaway a shares are valued at $480 thousand each. Note, this is the correct figure. Buffett has never split the a shares. Give me a focus, offers two bases for calculations. Earnings per share and free cashflow. In both cases, they take the trailing 12 months, the TTM values, which is the most recent possible starting point. The given focus model is a two-stage DCF incorporating a growth stage and a terminal stage. Each stage is ten years, but the growth rate is different, assuming a maturing and slower growth. The terminal stage. The model we are using has a 10-year DCF growth stage, but then we are using a perpetuity calculation, dividing the value by the weighted average cost of capital, the WACC to get a terminal value. This demonstrates how complex and apparently simple calculation can be. Let us review the results. The GUI focus DCF, using earnings per share of $55 billion, incorporates growth rates of 11.9% and then 4%, a discount rate of 8%. And this calculates an intrinsic value of one trillion, three hundred and twenty-five billion, two hundred and forty one million dollars. The GUI focus DCF uses a free cashflow of 19 billion, growth rates of 9.9%, then 4% and discount rate of 8%. This comes up with intrinsic value of 400 billion. Model uses a discount rate of 10%. Growth rate of 8%. Weighted average cost of capital of 6.545 per cent. Our calculations use owner earnings, net income, and free cash flow. These are all figures which we have input earlier in the model. The discounted value and terminal value are added together to produce an intrinsic value for Berkshire Hathaway, using the three different cashflows. If we use the GUI focus, earnings per share trading 12 months and free cashflow trailing 12 months. Figures in our model, we get similar values to the guru focus model. Similar but not the same. If we take the average of all three cash flows and the average of the two cashflows from the GUI focus values, we get much closer. Nine hundred and seventy, three billion and eight hundred and fourteen billion. The guru focus DCF calculator averages 862 billion. What conclusions can we draw from this? The computation of intrinsic value is very complicated and can be confusing and contradictory. I think the owner earnings or free cashflow or the right cashflows to use. You will have to be very careful with your growth rate and discount rate assumptions. Terminal value is very sensitive to the level of weighted average cost of capital and makes up a substantial portion of the total value. What does a red flag look like? Well, any value materially below the current market value is at least a hold signal. If the intrinsic value of market value remain out of line, you may never be able to invest without breaching the margin of safety rule. Our values indicate an intrinsic value is significantly above the current market price. This provides a significant margin of safety and supports a potential investment. We therefore Award this session and other take in the green flag box. The next section, the next screen will consider the current PE and PEG ratios and look more closely at the rule of 72. So this is a complicated one to handle. The good news is that Morningstar and guru focus do the calculations for you. But you should be able to do them for yourself and understand the assumptions behind any calculations that you use. Coming up with your own intrinsic value calculation and understanding what you believe to be the value of the business is however, critically important. 12. Step 9 Current Market Data and Rule of 72: Now we come to step number nine and we're going to look at the current market data and the rule of 72 in a little bit more detail. To this point, we have paid relatively little attention to the current market data. The purpose of the analysis up to this point is to form your own view on the company. Before you look at the market data, we have touched on margin of safety in the last lecture when looking at intrinsic value. And we will look at that more closely in the next screen. While I have little interest in PE ratios, except for what they can tell you about historic trends. I find PEG ratio is more interesting. We would also discuss and review the Rule of 72. This is what the data looks like in our model. Starting with the PE and PEG ratios, the easiest way to find these is to simply look them up on GU focus and you can see where to find them on the screen here. The price earnings to growth ratio, PEG ratio, is a stock's price earnings ratio divided by the growth rate of its earnings for a specified time period. Anything below 1 suggests that the market is fairly valuing or undervaluing the stock. Above 1. The market is valuing the company above a level appropriate for its level of growth. As we're interested in the long-term growth, It's worth checking the PEG ratio. In my opinion. The Rule of 72 is also interesting for what it tells us about the long term growth prospects. The rule of 72 is a quick and easy formula to estimate the required number of years for an investment to double. You can use the rate of interest on the investment. You can also apply the rule to the CAGR growth rate to see how long the metric being measured will take to double. We can apply this to revenues, 9.34 years, net income 6.70 years, owner earnings 6.31 years, and free cashflow 7.270 years. The average of these four matrix is 7.40 years. This is encouraging but still relatively conservative growth. What would a red flag look like? I would be concerned if the peg ratio is significantly above 1 and would probably not invested over 2, maybe wait for a market correction. As a long-term investor, I would want to see a doubling of key metrics within ten years or there may be better opportunities elsewhere. This obviously means looking for growth above 7.2%. We have now done much of the hard work. Next, we will take a look at what our intrinsic value and the market value can tell us about the margin of safety should we consider making an investment? So that's a quick look at the market data and the rule of 72, we're bringing in the share price, the PE ratio, the PEG ratio, and seeing what it tells us about how the market is valuing the business today. Completely separate to our view on valuation, which we calculated when we calculated the intrinsic value. 13. Step 10 Margin of Safety: We now turn our attention to step ten, the margin of safety. Let's quickly refresh what we mean by a margin of safety. This is a term which was a central tenet of Benjamin Graham's Intelligent Investor strategy. It's also consistent with Warren Buffett's rule number one of investing. Don't lose money. Rule too, by the way, is never forget rule one. The formula is one minus the current market price divided by the intrinsic value. This means you should only buy a stock when it is significantly below your calculation of its intrinsic value. Benjamin Graham recommended a margin of safety of twenty-five percent. We have identified that the intrinsic market calculation is not straightforward. In fact, it's quite complicated. And you would have to make your own judgments about the results. Here we see three of the four metrics with a positive margin of safety, even if the Morningstar fair value is marginal. What does a red flag look like? Well, if all your margin of safety calculations are strongly negative, it suggests that if all other screens are positive, then you may have to wait for a correction in the share price or an update or improvement in the economics of the business before investing. It's not on its own and automatic red flag, you have to use your judgment here. The next criteria we're going to discuss is the management evaluation. One of the most subjective criteria of all those we have discussed so far. That's the margin of safety. It's not a difficult calculation you're taking or intrinsic value and comparing it to the market value. And ideally, your intrinsic value is higher than the market value, and therefore you're buying in below your intrinsic value. And that's what the margin of safety is telling you. 14. Step 11 Management Evaluation: We come now to step 11, which is our management evaluation. We've worked through most of the numbers and now it's time to take stock and to consider the management and to evaluate whether they are management team we want to invest alongside. This task really is open-ended and relies on you reading extensively about the company. We can review some objective criteria that compensation arrangements, management's integrity, transparency, and rationality. And these are all hurdles that we want them to be able to jump over. The management's compensation information can be found in the Form DEF F4 for US listed stocks. The information in the UK companies in the back of the report and accounts. This will tell you about their cash, salary, their options, and the restricted stock grants. You can find Berkshire Hathaway depth 14, the link shown below, or simply, as I did just Google it. Integrity is something that you know, when you see it all, you see it being abused. Does management own up It's mistakes? Is it candid about events when they don't go to plan? Does management provides you with enough information to evaluate the business? Some management accounting reports and accounts are very difficult to follow and written quite deliberately so you don't really understand what's going on. Is the content of the ten K and the annual report helpful or obstructive. Is Matt management's behavior rational? This is another one that's hard to explain. But as an example, companies that inflate their earnings per share with debt fueled share buyback programs? Not in my view rational. It may however be helpful for their share option incentives. Of course. Having read every one of Warren Buffett shareholder letter since the early 1970s, it is easy to give Buffet to Charlie manga and the rest of the Berkshire Hathaway management, a clean bill of health. And to take the green flag box. And I strongly recommend that you read these letters as an object lesson in how to understand a very high-quality management when you see it. Red flag would be appropriate if you leave with the feeling that you would not buy a used car from the CEO? I can think of one or two, but I didn't want to be defamatory. I regard this as a total deal breaker and I won't invest in businesses if I feel that the management doesn't pass this screen. The next screen we're going to consider a risk assessment of our investment thesis to ensure that we are acting with rationality and intelligence. That's the management evaluation. It's really down to you to do your homework and do as much reading as you can and form your own view as to whether the management that you're looking at is one that you'll be happy investing alongside. 15. Step 12 10k Screen and Commentary: Now we come to step 12, which is the ten K screen and common tree. Yes, if you are expecting the risk analysis in this lecture, then don't worry, it's coming up. But I decided to move the 10-K. screen up one step. If you've got this far and remain enthusiastic about the investment potential of the company, then it's time to roll your sleeves up and do some serious reading. I've kept this step until near the end because it is probably the most time-consuming and it would be a waste of your time if the company throws up red flags during the evaluation process. I recommend going back at least ten years, but go back further if you want. I went back to the early 1990's to read up on Berkshire Hathaway. It's also worth considering reading the reports of some of the company's competitors. Pick up and read business biographies that great, or books about the market, which will serve to further inform your position. Insured, you really cannot do too much reading. While the numbers will tell one story, often the management's report, we'll put a new light on matters such as the company inflating its earnings with additional debt. Partially disguise because it also had strong cashflow but weak revenue growth. Again, if anything you see causes you concern, either read further, step back and wait, or reject the business as a potential investment, but do take stock and think about it. We will test our own rationality and intelligence in the next lecture, the risk assessment, which is up next. So that's Step 1210 K screen and commentary. It's a brief lecture because the work you need to do is very time-consuming and essentially obvious. And I can't really give you much more of a steer on it other than to say, go and read those ten k's for at least ten years in the past to see what's being going on. And then form of you. 16. Step 13 Risk Evaluation: Step 13 is our risk evaluation. This is where we're going to step back and take a critical look at all the assumptions we've made and see if they still make sense. By now, you should be framing your investment thesis as to why you might like to make an investment in the company you are evaluating. But wait, we need to conduct a risk analysis. It is time to ask yourself, what can go wrong? Because remember, it, something can go wrong. Often, it will. You confident in the assessment of the business. If you consider a SWOT analysis, strengths, weaknesses, opportunities, and threats, can you identify any risks that you have not yet considered? One of the ways to challenge this is through an understanding of behavioral finance. Behavioral finance could be a section of lectures on its own. Maybe it will be one day. But the key question you have to ask is, have you miss appraise the company because of your own mental failings and limitations, have you made assumptions? It is easy to fool the fool as they say, and nobody is a bigger fool than you. Or indeed, I remember that when it comes to investing, patience is a virtue. You do not have to act or buy right now. You can just wait and see how things turn out. The do nothing strategy is perfectly acceptable. I've referenced Warren Buffett throughout this course and here's some tips to summarize how you should approach risk evaluation following the Master. Don't forget the first rule of investing. Don't lose money. No, your circle of competence. Be patient and disciplined. Be fearful when everyone is greedy and greedy. When everyone is fearful. Look for good companies with an economic mode and high sustainable returns on capital. Avoid leverage and debt and make your own opinion first, third, rely too much on the opinion of other people. A red flag is difficult to define for this screen. Anything you come across in your reading about the company or articles written about it may cause you concern. Is management considering a major acquisition has recently been a change of the management team. Has there been a significant adverse development in their markets at home or abroad? Have one of the competitors come out with a disruptive new product. These are just examples. You need to put your objective thinking cap on and see what you come up with. The final step in our evaluation process is to make the decision to invest or not to invest. We also need to understand why we're proposing an investment. And we should discuss that in the next lecture. That's the risk evaluation is really down to you to decide. If you've missed something. Have you made an assumption which is wrong? Are you depending on an outcome which is highly probable or improbable, but depending on something to go right for you, in order to make your investment work. Whatever it is, you need to be very objective about your thinking in this screen. And really be prepared to criticize your own thinking to see if you've missed something. 17. Step 14 Investment Decision and Rationale: We now come to the final step in our investment evaluation process, which is the investment decision and rationale. It's now time to take stock of what we've learned about our company and to see whether we can make a positive case to ourselves to invest. To assist you with this, I have created an investment evaluation scorecard. We should revisit each step of our evaluation process, confirming the green flag, red flag. We're gonna make summary notes about each stage. And if you wish, and I will, you can give each screen a score out of ten, which you can use at the end for future comparison with other stocks. The idea is that you can print this out and put it in a file. This will enable you to understand in future why you took the view of the company that you did. You will understand why you either bought the stock or not. The scorecard is available to download in both Word and PDF formats from the resources section, downloaded, making a copy for each company, and then follow me step-by-step as we complete the scorecard. Step one, the growth screen, I've awarded this nine out of ten. We know revenue growth has been affected by the COVID pandemic. But still the 10-year net income, CAGR is 10.75%. If you exclude the COVID year of 2020, it's 18.9109% and EPS growth is over 10% at 12.75%. This is a strong track record for such a large and mature accompany. It's important, of course, to interpret the impact of the 2020 results on the CAGR as it's the denominator in the formula calculation for the compound annual growth rate. Step two, profitability, where I'm giving this eight out of ten, net margins have been very consistent. Apart from the 218 the 2018 gap adjustment, both ROIC and ROE return on equity has been strong and consistent as well. We have double-digit margins over 510 years. You should also bear in mind buffets 50 year track record of outstanding returns as well. Long-term compounding effect well highly benefit the profitability returns going forward. In step three, owner earnings, I wore this nine out of ten. Now we know the railroad in utility businesses offer great long-term growth, but with substantial investment, albeit on a non-recourse basis where the debts concerned, we know the owner earnings are understated due to gap reporting of minority investments. They only taken the dividends. They didn't take in the share of owner earnings. But still the nine-year CAGR, taking the 2020 years out is 18.69%. These are really great earnings for such a large business. Step four, the economic mode, this is an easy ten. Morningstar gives the company a wide rating, which is great. But we've also discovered that each business has its own economic mode, both the owned businesses and the minority owned businesses. This is very reassuring on a collective basis. Step five, capital allocation. Again, I've given this ten. Buffett, among them are the masters of capital allocation. I've been doing this for over 50 years. And the fact that they handle this on a centralized basis is another big plus. Step six, leverage, again, ten out of ten. We know there's leverage used in the railroad, in utility businesses. These are regulated businesses and the debt is non-recourse, so that's fine. The company has huge cash reserves which are implied applied to investment and to the business highly intelligently because it's all done on a central basis. And debt is actively avoided. Again, very happy with the leverage situation. Step seven, shares and biobanks. Well, Buffett, on record as being very conservative with equity. He always prefers to make acquisitions with cash. And he's now stepping up the share buybacks in a significant way, particularly in the last couple of years. I'm very happy that the management, again, to treat the equity with a great deal of respect. Step eight, intrinsic value. I've only given this seven out of ten. This is complex and to a degree contradictory. Morningstar gives it a fair value of 480 thousand. My model calculations are more positive, but the results from guru focus are contradictory. So I'm having to be a little bit cautious with this one. On Step nine, market data and the rule of 72, I've given this nine out of ten. The, both the PE ratio and the PEG ratios are very positive. They are very modest. And I'm very happy with those. The rule of 72.47 years, but we've seen that that's likely to be conservative. So the market data is not giving me any cause for concern. Margin of safety. Our model shows a margin of safety of 40 per cent. This is supported by the P and the PEG ratios which are low. Morningstar is more conservative and Gary focus is ambiguous. Hence the eight out of ten. For step 11 management, well, it has to be at ten for Buffett, I'd score both him and Charlie Munger 11 If I could. Compensation tick integrity, absolutely Transparency, totally rationality, absolutely straight forward. He's so rational and logical and systematic. I absolutely loved what he does. So yes to all those, management gets ten out of ten. Step 12, the 10-K. screen, again, ten out of ten. If you read Buffett's shareholders letters as I have, you'll see that he continually explains what's going on. He owns up when things don't go right, or if he's missed doing something. And he's very critical of his own performance. So that's exactly what I want to see from the ten k's when you read them and you get this set strong sense of confidence in the management. Step 13, risk analysis, nine out of ten. Well, I'm not quite sure. I haven't again, at nine, to be honest, the market cap at the moment is 720 billion. Of that investments are 310 billion. The cash equivalents are a 143 billion. You then you've got this amazing stock of businesses, which I'm sure individually, if you worked out the value for the more would be considerably more than that. Hence margin of safety. The management is fantastic. There's a 50 year track record and I'm very confident in my mind with any swot analysis. So all in all, I don't have any further concerns arising from my reappraisal of the investment risk. Step 14, the rationale rash investment rationale. Ten out of ten, I struggle to think of a better balance of quality businesses and management. This is not, of course, a trading stock. This is a long-term value compounding investment. And as such, I'm very happy to decide that if at least within the hypothetical confines of this exercise, this would be a yes on the investment decision. Of course, please note this is an educational process that is not an investment recommendation. This step-by-step review of our evaluation process, I think, is a very useful exercise. We can reconfirm our conclusions from each of the screens. The scoring is a useful direct comparison tool, but other investments and the report will go into her my investment file and be reviewed periodically. You can download the completed review from the resources section. In the final lecture, we will address some final comments and summarize this evaluation process. That's it, step 14, investment decision and rationale. I hope you appreciate the logic with which we've approached this, the systematic way we've gone about it and the framework, but it leaves you to work with with other companies in future. 18. Final Comments and Summary: This evaluation process has been reasonably complicated, so I want to leave you with a few final comments and a summary. Firstly, congratulations on getting this far with the stock evaluation exercise. If you followed it step-by-step, line-by-line, I think you would have to put a lot of working, but you would have gotten a lot of good value out. You will recall that I set out this list of investment screens and analysis right at the beginning of this exercise. If you've reached this stage with your analysis, then your company has passed the tests and you have a series of green flags. You now have to make the key decision to invest or not to invest. However, before you do this, you need to consider why you think this is a good investment decision. What this amounts to is coming to some conclusions about the analysis we've been doing. Starting with the big picture, are you confident that you can see the company you want to invest in continuing to flourish and grow over the next ten years. If we look at companies like Berkshire, Hathaway, Apple, or Microsoft, how do you think they will do by 2032? What about companies like Meta, Facebook, tesla, or Google? I didn't have a crystal ball and I don't expect you to either. If you happen to have one, I'd be very happy to borrow it. But this is the view you are trying to develop. Our analysis has considered the financials in detail, growth, profitability, balance sheets, strength and risk. We have challenged the quality of the company, looked at his operational strengths, economic modes, and risks. All the sums up our view about the quality of the company. We have gone further and study the management for the intelligence and rationality. We have read extensively the information provided over a decade by the company. We have challenged ourselves in our risk assessment. Evaluation has been deliberately bottom-up. We're studying businesses with a view to taking a small part ownership in the business. Your investment rationale must be focused on the business and not on some macro investment theme or trend. The final screen, we pulled everything together with the scorecard to come up with a measurable view on the investment opportunity. Of course, it's all based on your judgment, but it is a reusable framework for every investment you want to consider. At the end, the decision is yours. Make it on the basis of analysis and intelligent appraisal of information. Decide why you do or do not want to make an investment. And don't forget, you can always defer your decision until something changes in the future. You don't have to act now, follow this process and framework. Use this as a checklist, keep your scorecards and review them from time to time. I cannot guarantee the results, but it's far better than throwing darts at a metaphorical dartboard. Don't be afraid to develop the evaluation process and model in further ways that suit you and your investment style. I hope you found the exercise testing, but nonetheless enjoyable and instructive. Those are my final comments on this whole evaluation exercise. I've designed this process to make it thorough but comprehensible, logical, and structured, and easy to follow. And I hope you found it so. 19. Stock Market Investing Part 6 Stock Investment Evaluation Practical Exercise Summary: Now we come to the end of the course, the summary of my stock market investing course part six, which has been a stock investment evaluation practical exercise. Firstly, congratulations on completing Park six of my stock market investing course. I hope you found it informative, engaging, and of course enjoyable. The next step is now to complete the course assignment. You will find the financial model which goes with the course if you haven't already done so in the project section, use this to conduct your own stock investment evaluation exercise using a company of your choice. Just funded the course lectures step-by-step. In part seven of my stock market investing course, the final part of the course, we're going to discover how to conduct a ten minute preliminary screen of a potential stock market investment. For this, I've created a simple spreadsheet model, my stock screen calculator, which also forms the project for the course. So it's very practical and very hands-on. Make sure you click on the Follow button so that you get notified when my new classes go live. Thank you for taking this course and I look forward to seeing you again in stock market investing part seven. I'm John Kali, That's been part six of my stock market investing course. I hope you're getting a huge amount out of this, and I'll see you very soon in part seven.