Rule # 1 Resources

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Permalink Reply by Jeff on September 6, 2009 at 8:49am

Adrian,

Have you done any comparisons/sanity checks with your own Rule #1 calculations and those of Stock2own?

As I mentioned over on Monopolies and Moats, I'm getting back into the Rule #1 analysis game, so I've begun re-evaluating my Rule #1 analysis for GRMN (I currently hold 49 shares). When I compared my math with that of Stock2own, I came to some interesting conclusions.

1. Classic Rule #1 math equates to the "Pessimistic" results on Stock2own. Specifically a 10 year horizon in Rule #1 equals the 5 year horizon on Stock2own. I checked my formulas several times and I'm positive I'm using 10 years, yet my numbers keep matching up with their 5 year results. This is in stark contrast to their claim that "10 yr Moderate - Sticker and MOS Price are most close to the algorithm described by Phil Town."

2. I need to dig deeper into Phil Town's book some more and really work through the numbers on Stock2own (I probably look at stocks aside from GRMN too, to be certain), but I'm not convinced that the website is actually using the Rule #1 math correctly. When I follow their moderate and optimistic scenarios, I can't justify their results by applying Phil Town's results.

Maybe I'm not looking close enough, there's an error or several on their analysis of Garmin or I just don't understand Rule #1 well enough to conduct an accurate sanity check.

I'd love to use their site as my primary analysis too because of it's speed, but I have to be able to understand their math and that it follows Phil's recommendations (or where it deviates and why.)

What's your experience and opinion?

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Permalink Reply by Jeff on September 6, 2009 at 10:43am

I found Stock2own's theory section. It actually gives a pretty thorough explanation of their numbers and where they came from. While I now can understand their math, I'm still not convinced by their claim that the 10yr moderate numbers are most closely matched to Phil Town's algorithm. Stock2Own seems to take some liberties in their interpretation (which is fine) but I think that takes them away from Phil's algorithm and spins things more positively.

I think I'm following Phil's explanation in the book pretty strictly and my math is still more closely matched to their pessimistic numbers.

As an example, my numbers on Garmin are yielding a sticker price of $29.65 with a MOS of $14.82.

In contrast, Stock2Own's 10 yr Moderate Scenario yields a sticker price of $62.15 with a MOS of $31.07.

My dilemma...GRMN is currently on an upward trend and priced at $32.86 as of 9/4/09. So with my math, it's over priced and I should sell all my holdings (at a loss mind you). But Stock2own says we're still pretty close to the MOS AND the indicators are getting close to signaling another Buy opportunity.

So what does everyone think of Stock2own's moderate scenario. Do the liberties they take make sense? Or do you think I ought to stick with my math results?

Thanks, Jeff.

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Permalink Reply by Adrian on September 6, 2009 at 2:26pm

I definitely think that you should stick to your "math results", Jeff. Always better to buy on something that you understand, rather than something that you're not sure about ... I ran numbers for Apple some time ago and found a match with S2O, but can't recall if that was with their 'pessimistic' (sounds familiar) or 'moderate' scenarios. I didn't try their buy/sell indicators v. the books, but with MS Money so accessible, there's nothing wrong with going back to first principles and looking at the MS charts yourself :)

Perhaps Alex (founder of S2O) has some thoughts?

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Permalink Reply by Alex on September 7, 2009 at 1:01pm

Well, there is always a question who's numbers are correct. I can not claim that stock2own produces exact numbers as Phil Town would calculate it. However, I described all algorithms used for calculations in a very detail level. Just a brief read of it will show you the difference between Phil Town and s2o calculations. And always remember - Sticker Price, MOS Price, intrinsic value are ESTIMATES, ASSUMPTIONS, just a guide...

The most important thing to understand is: Phil Town always suggests to use the lesser of any numbers you might have. We call it "pessimistic" estimate for only one reason - it produces very close results to the numbers Phil provided in his book, however, when I started to test it for hundreds of other securities and compared results to the numbers described in Phil Town's blog, for example, I realized, that "moderate" estimate produces much better results on the large number of analyzed securities. So, this is a bit more universal formula. Here is an example of comparison:
http://www.stock2own.com/Community_Blog.aspx?a=09260701

I also believe that in different market conditions different estimates should be used. For example, it looks that pessimistic approach works better in a bull market. In the current market conditions, moderate or even optimistic approach works better, because all CEOs and analysts are extra cautious and if you add on top of that your pessimistic estimate you probably will miss a great opportunity...

Another thing is 5 and 10 year estimates. Phil Town never mentioned 5 year estimate. However, I could find it useful and got a lot of questions when I first time introduced "5 year estimate" on stock2own.com. If you are interesting you can read the following discussion, which summarizes the questions and explains how to use it:
http://www.stock2own.com/Community_ForumThread.aspx?id=53&confid=2

Jeff, if you give me exact numbers you get for GRMN and add some comments on how you get those numbers, I will be able to figure out why we do not match and, hopefully, we can find a better way to estimate intrinsic value. I'm always open for any comments and willing to do any adjustments in order to make calculations better and more accurate.

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Permalink Reply by Adrian on September 7, 2009 at 7:35pm

Great discussion, thanks Alex!

It seems - and this is the problem with ALL 'stock picking' methods - that there is a great deal of assumption required: no GUARANTEED formula to turning lead (your cash) into gold (a winning stock position).

For example, in both Phils' case and Alex's case you need to PROJECT forward P/E ... that is, if the company is currently selling its shares at 18 times its profit (per share), who's to say whether that will continue?

In 10 years it could just as easily trade anywhere (say) between 12 to 25 times P/E, and as Alex has shown, the value that you select has a huge bearing on the outcome.

So, this is still an estimating game, BUT with Rule # 1 - and S20 - you are now left to more simple questions such as "what P/E's are this company likely to trade at?" ... questions that analysts are paid to help you answer ... rather than the 'impossible' questions like: "what is this company worth?"

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Permalink Reply by Alex on September 8, 2009 at 4:01pm

Honestly, I do not see any difference between guessing of future PE or company worth. I guess the key word is "guessing".

Talking about company worth, we can estimate an absolute minimum of company worth as a "fair market value" of all company's assets. This is not an easy procedure and requires of adjustment of each asset category in order to calculate how much money company may get from selling it's assets today. Basically, even if the company is going out of business, it still can get some amount of money by selling everything it has on inventory list. This "minimal company worth" can be used as a base for other adjustments, which may include growth projections and so on.

Estimating PE might seem a bit more attractive because we can use an industry average PE as a base and hope that company will perform at least as an average company in the industry. However, Phil Town suggests to calculate "Future PE" and just briefly mentioned industry performance counters. Anyway, I guess "Industry Average PE" may be used as a "check point".

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Permalink Reply by Ill liquidity on November 19, 2009 at 3:18pm

OK, so I watched an investools webinar today, and learned that a lot of the extra liquidity in the market is pumping up stocks to enormous PE's, I can't remember the exact stock we looked at but, the fundamentals were poor and the stock price had gone from about ~1 to ~30, just because. What I get out of this is that solid undervalued companies are a better bet for your money, i.e have higher probabilities, but are not the only way to make money, since most people have no idea about how to "value" a company properly. Investools also has a rule one search, and I made my own, and then there is stock2own to do a slightly different calc., none of these really work properly -- you have to adjust for bad years when the cause is known, as in the case of BB&T (See rule1 blog Nov 16 http://www.philtown.typepad.com/). As far as the future PE argument, that it's just a guess, maybe. But if you use the worst case and have a strong case for continued equity growth, then that would make the most sense, that the PE could continue to be in ROUGHLY the same area. What I really want to know is what to do when I have a head and shoulders pattern on a long position in a Rule1 equity and haven't got two sell signals? And what do people think about using the close over the 30D MA as a buy singnal and a close below the 10D MA as a sell signal? Thanks, Mike. PS any Canadian traders? What platform do you use? Do you self direct RRSP? I know lost of questsions, these and many more...

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