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SMART MONEY

We follow the Smart Money...that is our trading philosophy

Let’s face it, most retail traders lose money. There is a wide variety of reasons for this, but here are a few of the most common ones:

1. Use too much leverage.

2. Buy high and sell low.

3. Move stop losses.

4. Do not use stops.

5. Chase trades.

6. Average into losing trades.

7. Hold onto losing trades.

8. Cut winning trades short.

9. Use too many indicators.

10. Trade randomly.

11. Do not have an actual trading plan.

12. Impatient and take impulsive trades.

13. Get fearful.

14. Get hopeful.

15. Do not treat trading like a business.

16. Overtrade.

17. Do not really have an edge.

While it may be tempting to throw yourself into the dramatic highs and lows of investing in the stock market in search of instant gratification, it is not necessarily the most profitable choice. Warren Buffett has spent his career watching investors pounce on “hot” companies, only to flounder when the market takes a plunge. All the while, he has been steadily accumulating wealth by taking an entirely different approach. His approach today is called “Buffettology” and he is part of a small group called the “Smart Money”. Let’s define what the Smart Money is. The “smart money”, or the group of winning traders that include the market makers, large institutions, banks, investment banks, hedge funds, and algorithms, rely on “dumb money” retail traders for their steady stream of profits. They are the professionals who are responsible for billions of dollars of client money, know when the broad market is ready to turn and what a certain stock is going to do before anyone else has a clue, and have massive research, analytical resources and the best information individual investors do not have. These professionals move around so much money, they tend to influence the market.

When a trader truly understands the game they are playing he/she is able to trade with confidence and consistency. Both are needed to succeed in the trading game if you want to beat the smart money. It is very important for individual traders to understand the moves of the smart money, how the large investors are positioned, when risk is perceived as high or low, the money flows and economic factors, but very few know how to follow it. If you know what to look for, you can figure out what the smart money is doing and go along for the ride.

Warren Buffett is one of the richest man in the world with an estimated worth of over 62 billion dollars. This kind of wealth is not a result of sheer luck. He has gained his enormous fortune using a very specific investment strategy, developed on a basis of long term investing. Clearly, Warren Buffet is a value investor. He looks for great companies, or “wonderful” ones as he puts it. He is not looking at hot sectors or stocks that may shoot up now, only to cool and fall later. He wants an efficient running business that has favorable long-term prospects. Since Warren Buffett has never personally penned an investment book for the masses, how does one go about learning his secrets? Luckily, many of his letters to shareholders, books that compile such letters, and insights from those close to him are readily available to the public...and there is always Google. His strategy, the “Buffettology”, evolves around the following core principles:

  • Analysis of historical financial data on each stock - excludes new companies where only a few years of financial data, however includes companies that continually increase in value over several years.
  • Search forcompanies that have a monopoly or a market edge with unique products and low competition - avoids volatile stocks and industries with stiff competition.
  • Increasing earnings which is necessary for further growth.

  • Reasonable financing – targets companies with a low debt load.

  • Simple business model – focuses on companies that do not require heavy financing to maintain or grow companies that have enough cash to self-sustain their growth).

  • Never pay a premium price – wait for a market correction or a crash to secure the margin of safety and take advantage of low prices.

  • Numerics - abide to guidelines for 1-year 2-year and 3-year returns, market capitalization, short % of float, institutional ownership, price vs. 52-week high (%), 1-year, 3-year and 5-year Return vs. S&P 500.

Fundamental Analysis - The Core of Buffettology

Buffettology is mainly based on fundamental analysis. No one knows exactly (outside of his trading circle) the complete method Warren Buffett follows to find these “gem” stocks. Our goal is to attempt to mimic his strategy, however we cannot guaranty the same results. Our investment management philosophy is strongly rooted in fundamental analysis and we believe in investing in.companies with robust fundamentals, solid core businesses, dependable management teams, a unique competitive advantage, improving or normalized returns on capital, the ability to generate significant free cash flow over a market cycle and strong free cash flow. Ultimately our goal is to uncover stocks with a value much higher than their current prices to secure a valuable profit and most importantly to protect you against any downturn. Based on our readings on Buffett’s methods, we screen stocks based on Value, Price Performance, Growth, Fair Value, Analysts Consensus and other resources; these are explained below:

Value

We screen for stocks:

  • Listed only on major US exchanges: NYSE and NASDAQ exchanges. We set the criteria to select companies with at least one hundred million dollar market cap.

  • Comparison between the value of a company vs. the company’s own industry. Stocks that are too expensive on an absolute basis are eliminated.

  • Companies with growing sales and earnings per share (EPS) that also show growth over the last five years. This eliminates companies that are not thriving and are more likely to be value traps.

  • Companies must be in the cheapest 20% of their industry by Price to Book, Price to Earnings and Price to Sales.

Price Performance

To separate true value stocks from value traps we study the relative performance of the stock vs. the S&P 500 over a multitude of time periods. If a stock has under performed compared to the S&P 500, it is to be eliminated.

Growth

  • We further filter those already screened companies that have growth in sales and EPS over the last five years. Among those.companies that show such growth over the last five years, we narrow down this group to companies that have sales and EPS increases from last year, thus eliminating candidates that show recent worrying signs of growth. We want to make sure that the momentum continues.

  • Additionally we look at next year’s projected earnings to determine whether these companies are expected to increase, decrease or stay flat.

Fair Value

We perform a discounted cash flow analysis to determine a company’s intrinsic value. Then based on the current price of the stock vs. its intrinsic value and factoring in the sector and market multiples, we compute the overall fair value price and compare it to the current price.

Analysts Consensus

We highlight stocks that are below the consensus analysts target prices and for which the analysts are optimistic about the companies’ future. This means the analysts think that these stocks have a value higher than their actual market prices.

Other Resources

We further dig into other information that is available to all:

  • Company’s homepage will generally have an investor relations section where one can often get investor information.

  • Company’s financial statements (balance sheet, profit & loss statement, statement of cash flow), which are provided in great details.

  • Company’s 10K (annual) and 10Q (quarterly) filings are critical to examine. This is where the management team describes the company’s competitive, financial and operating performance, as well as its management compensation structure.

  • Independent analyst research reports which can be obtained from the research pages of your brokerage website.

Never Pay Full Price

Value investing is one of the fundamental concepts related to growing wealth. If you hope to earn money over the long haul, value investing can be one way to boost your potential earnings. Value investing is all about — wait for it — finding value that is less than the stock’s current price and then buying the stock.

Remember the Margin of Safety

It is not enough to get a 10% discount on the stock you buy. Instead, our value investing strategy relies on the margin of safety. The bigger that number, the better. This is an extra buffer to ensure that if the stock does not perform like we expect, you can still take a profit. Benjamin Graham, considered the father of value investing, recommended making a purchase only when the stock was at two-thirds or less of its value. Using this guideline, when we find a stock’s price at $100, we recommend buying it for $66 or less. That way, if the stock does not perform as well as we thought, maybe only rising to $80, we are still better off. If the stock is analyzed correctly, there is a good chance that it will rise in value over time.

Patience and Persistence are Key

It is important to understand that value investing is a long-term strategy; the key is patience. If you are following this concept, you have to be prepared to stick with a stock for a long period of time. The idea is that you buy a stock that you think has long-term value and potential, and that the market does not value as it should. Then you hold it as long as you can and your patience will be amply rewarded.

When you engage in value investing, persistence helps you to stick with your plan through market downturns and difficulties. If the fundamentals have not changed, then there is a good chance that your choice will weather whatever difficulty it faces. At some point, you will sell your value stock, but only when it makes sense for your long-term plan, or if the stock has reached or exceeded the value you believe it has.

Conclusion

Value investing is a great way to invest over time. A crucial thing to remember is that, in the long run, the activities of the wider stock market are immaterial. Those who follow this strategy do not bother themselves with the laws of supply and demand or buy into the philosophy that shares are always trading at a fair value. They simply believe that the undervalued stocks they buy will in the future, return to a price that justifies their worth. As Warren Buffett once said:

“In the short term, the market is a popularity contest. In the long term, it is a weighing machine.”

There are no crystal balls in investing. There are no guarantees, but there is data, strategies and processes. We manage risk by only purchasing companies trading at reasonable valuations, and we do not chase fad or momentum names. Ultimately, we believe that the greatest rewards exist when improving fundamentals are not reflected in the current market stock prices. We are able to always keep your best interests first; we will give you no-nonsense recommendations based on our thorough fundamental and technical analysis. Ultimately, you will have the comfort of knowing that - no matter what happens - it’ll be okay.