I’m going to post up the 6 vital principles that come to us from great Rule #1 investors starting with Ben Graham then Warren Buffett then on to today’s greats like David Einhorn and Mohnish Pabrai.


These principles are timeless but have been stated in one form or another publicly for at least 80 years and yet still to this day few investors follow them.


Its hard to understand why that is; these are not fair-weather or bull-market principles.  These principles have worked to generate serious alpha returns through the Great Depression, WWII, Korean War, Vietnam and the Great Society inflation, the end of the gold standard, the great bull from 1980 to 2000 and through two huge bubbles that crashed the market in the last decade.


These are principles to invest by.  Learn them well and violate them at your own risk. Here is the first one:


Principle #1: Stay Rational

Easier said than done when you are investing real money.  Money you can’t afford to lose tends to be ‘hot’ or emotional.  Pro gamblers try to avoid sitting down with more than they can afford to lose but anyone investing all of their own hard-earned money is always sitting down with more than they can afford to lose. Fear of losing more than you can afford to lose tends to make the mind go irrational.  You start guessing.  You can’t tell the difference between a good idea and a bad idea.


Investing decisions are not life and death decisions (unless you’ve embezzled $100 million or so) but still, remaining rational in the face of intense emotions is an art that is learned in the trenches.  They don’t teach this at business school because they can’t generate real emotions in a classroom setting.


Practice Rational Investing

Staying rational is an art that the best investors in the world have learned.  They have the ability to separate their emotions, block them off and operate on pure reason.  If A, then B.  If B, then C.  Therefore, if A, then C.  Using our rational mind is a huge advantage in a marketplace that dominated from time to time by irrationality covered over with Modern Portfolio Theory.  MPT says that the market is a roulette wheel which never remembers the last spin, all professional investors are solidly rational and, therefore, price is value.


I’ll write more about irrationality in the future but for now suffice it to say that were it not for the occasional irrationality of otherwise brilliant fund managers sheltered and comforted by MPT, we’d all of us be out of luck trying to beat the market. Fortunately, its in the nature of the beast for a fund manager to do irrational things; principally to sell something at a significant discount to its actual value.


Price is Not Value

A corollary of ‘Rationality’ is that price is not value.  Price is only what you pay.  Value is what you get no matter what you paid for it.  Pay too much and you’ll never have excess alpha returns.  But buying value on sale requires an intelligent human to do the irrational thing and sell it when its on sale.  The good news for us is that fund managers rarely hold stocks for longer than 3 months.


If a company is having an issue that may take longer than a few months to solve, an issue that calls their near-term future earnings into question, fund managers will begin to sell.  Uncertainty is anathema to the Big Guys.  Hampered as they are by size to react to unforeseen events and by their Ivy League MPT education, we can forgive them their hair-trigger launch for the exits, particularly since their loss is our gain if we stay rational.


Rule #1 Investing Tip

This is the key to Rule #1 type investing.  In a nutshell, we buy fear and we can’t unless someone is afraid.  That someone is a fund manager who in the face of any uncertainty begins to sway like a too-tall tree in a too-big wind.  We little guys just have to remember that  “A is A”.  Its obvious.


Well-educated fund managers all studied this tautology in their survey philosophy courses.  But fund managers forget that “A is A” if they aren’t in the classroom and the tautology is structured as “value is value”.  If the future earnings are reasonably intact despite the problem, value is still value and it most certainly isn’t the same thing as price, no matter what the siren call of Modern Portfolio Theory is whispering in the fund manager’s ear.


To get the other 5 Principles NOW click the button below to download my FREE 6 Principles to Market Crushing Investing and become a Rule #1 Investor today. Now go play.

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About Phil Town – Phil Town is an investment advisor, hedge fund manager, two-time NY Times best-selling author, ex-Grand Canyon river guide and a former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence. You can follow him on google+, facebook, and twitter.

  • Will Regan

    Hey Garrett, long time no time…
    I still read the blog from time to time and felt I needed to chime in on what I feel is an important and often overlooked fact….
    You can get a much higher annualized credit selling monthly puts and or calls than you can selling LEAPS. if you do the math and add up what you could receive doing 12 monthly’s vs. a one year option or LEAP the difference is quite staggering. If you add monthly compounding to that it can really make a huge difference. You can even take it a step further and do weekly’s on some equities. Once again the math is quite impressive.
    The theory you present is sound and excellent. Adding monthly or weekly premium just makes it that much sweeter of a strategy.
    Happy Capitalism

  • Thanks for the plug, G!

  • Mickey,
    I’ve been there…multiple six figure losses.
    So I understand and you know how true it is when I say you can learn the hard way or save money and learn from someone who can teach you how to do it Rule #1 Style.
    We’ve had some Rulers suggest a few books. I’ve never found one that I like. Everything I’ve learned that’s made me money was from mentors.
    The more books I read, the more confused I got because nobody was showing me HOW to make money the way I do now.
    I can teach someone Butterfly’s, Strangles, Straddles, Ratio Debit/Credit Spreads, Naked Puts, Covered Calls, Vega Trades, Calendars…but all that is just information and noise if you don’t know your 4M’s.
    And you really don’t need all that stuff. It has a place but not really for Rule #1 Investors who are Value Investors using fundamental and technical analysis to determine the Value of a company.
    What’s really missing in ALL, 100%…of these books is the 4M analysis that goes into our Rule #1 Investing.
    And that’s the part that requires the most effort and training.
    Mickey, when Phil advertises his next Rule #1 Transformational Investing Seminar in Atlanta, make sure you get a seat. You’ll get a 3 day course in Rule #1 Homework and see how Phil thinks about investing in a company, how we reduce our risk via numerous valuations and drive down basis with dividends and buybacks to reduce our market risk.
    To Your Wealth!

  • Mickey

    Since this is Phil’s blog I would like to recommend some good reading on options. But I am not sure if Phil is ok with recommending someone else book?

  • Mickey

    I have not studied with Jeff or any of the other Rule #1 courses. I learned the other way as you describe in the school of hard knocks by loosing multiple six figure amounts. However through reading, learning, and applying Rule #1 I have stayed rational and made it back.
    I would like to attend seminars and some of the courses that you mentioned, I just need to scrape the time and money together to get there. I do not think I will be able to attend the upcoming Atlanta event.

  • Rulers,
    It’s been a long time…historically, a very long time, since we’ve had a nice 10% correction in the markets.
    I would presume that’s because of the Fed, Bank of Japan, Bank of England and the European Central Bank all printing in one form or another:
    Here’s some facts:
    The S&P 500 SPX has gone well beyond the time in which it typically endures a correction or worse (the 500 has advanced for 32 months without a decline of 10% or more, versus the average of 18 months since 1945). In addition, valuations on trailing and projected Operating and GAAP (also known as “As Reported”) earnings per share, are equal to their long-term averages.
    We’ll get a correction…and when we do…when it finally arrives, be ready with your homework done so you can know the VALUE of your Rule #1 Company.
    To Your Wealth!

  • Excellent Mickey!
    Good, rational thinking!
    Mr Market is open and the first company I looked at today was Panera. That $150 floor is holding.
    Panera isn’t at a price that I’d consider a deep MOS.
    However, I do like them at $130 or below based on a PE Multiple, future EPS GR, new store growth and share repurchase. This morning I tried to build a case how Panera could drop below $130 based on current TTM of $6.73…and staying FLAT or even dropping by Jan 2015 or Jan 2016 and I just couldn’t build a case where Mr. Market would price them that low of a multiple for any extended period of time.
    I’m mostly trading for cash flow around BP and some other companies I’ve mentioned on the blog…like DeVita Healthcare and John Deere…which are all backed by Warren Buffett.
    Are you a graduate from Jeff Town’s classes – since you mentioned you’re doing some cash flow trades?
    I think over the last three years, I’ve done ZERO, zilch, nada – speculative cash flow trades.
    Instead I do many cash flow trades around the companies I’d like to own. In fact, I don’t mind being temporarily overloaded in my portfolio with a company if I know “The Story” and it meets my 4M Criteria.
    It’s my “win, Win, WIN” scenario…I try to place myself in a position if the stock goes up, down or sideways the outcome is acceptable. One direction may be preferred, but ALL are acceptable.
    That simple investing philosophy has made Rule #1 Investing fun and profitable.
    Regarding short-term…sometimes I do a month-to-month thing but most of the time I’m selling Jan 2015 and Jan 2016 contracts. Even cash secured PUTs can turn profitable in a short time if the price pops up – you can close contracts out early, take 1/3 to 1/2 of the profit in 1, 2 or 3 months rather than wait till expiration – sometimes – if not, you better like whatever obligation you sold!
    All this is certainly advanced stuff and I’d highly encourage anyone who wants to learn more to seek out Jeff Town’s Rule #1 Course.
    The way I figure it, is if you try to learn options on your own, you can…and you’ll pay a few thousand making stupid mistakes along the way. But if your pockets are deep enough, you’ll learn.
    You can plug into Jeff’s course and have fun while you’re learning and SAVE yourself money. My goal would be to have my investing education paid from what I’m learning in the course.
    To Your Wealth!

  • Mickey

    I do not have anything allocated long term right now with the market at all time highs. I am only doing cash flow trades short term. I am really focusing on a hand full of companies on my watch list that I understand and pass the Meaning Moat and Management test. I currently have three with PNRA at the top. I also appreciate Phil’s comment. Anytime I invest I always ask myself if that investment deserves to stay. If not I sell it. As you say I always play devil’s advocate. I will go back and check and see if there is anything I missed in reading about the story and double check my valuations. I just returned home from work today so I will see what I can find about the big drop today. I am going to go back and do some more reading and see what I can find before I spend more time posting why I like the story of PNRA. I will save that for another post.

  • Mickey / Rulers,
    Panera’s taking a nice drop today at the open…down 2.8% so far.
    I thought it might be a good time to use Panera as how I’ve learned to “Begin With The End In Mind” when it comes to investing and capital allocation.
    I didn’t pull the trigger on PNRA last week or even today. There are a couple of reasons…here’s two of them.
    1) I had money allocated to other investments
    2) It’s less risk to me if I allocate money and basis reduction option strategies on the few companies I already own than aggressively trying to find another new investment.
    I love Panera and have posted about them frequently over the years. But like hedge fund manager Eddie Lampert how he just invests heavily in very little…focused!
    I’m staying true to my strategy and focusing on my “Just One” company…stuff that is so bullet proof that I don’t have to worry about the day to day market fluctuations and I can aggressively trade around those companies to either take shares or create cash flow.
    Phil mentioned on the blog “Invert” your “Story.”
    This is something we do as his students and Rule #1 Investors.
    What you want to do is make the case WHY Panera deserves to be discounted. Be your own devil’s advocate. What’s wrong with Panera NOW and attempt to prove that Panera’s problems are real, long-term…prove that the 4M’s are all negative and that there is too much risk in this. If your best arguments are truly pathetic, then your case FOR investing in PNRA becomes stronger.
    I think Panera’s problems are short-term. However, like building a home, it may take some time before the project is complete. And with the Market at all times highs and clearly overvalued in general, we are well, well, well overdue for a 5% and 10% correction. Thank you Fed and ECB.
    If Panera dropped from $150 to $110, would I have the funds to celebrate at my good fortune as I’m buying more or would I run out of money before I found a bottom?
    Because at $150 a share, it won’t take long for most investors to run out of cash buying more on the way to a bottom.
    If I felt that my downside risk were greater than my upside short-term potential, I’d probably employ a strategy something like this in my account:
    1) Begin with the end in mind:
    If all I have is $100,000 to invest, then I’d have to be willing to own about $60,000 worth of Panera if the price never drops below 150…that’s 400 shares.
    2) Allocate capital appropriately:
    Buy 100 shares today for $152.72 or $15,272.
    3) Aggressively reduce basis in the event I’m not at a bottom.
    Sell the Jan 2015 $155 CALL for $10.00 per share.
    Sell the Jan 2015 $150 PUT for $11.00 per share.
    This sets me up to make money if the price goes UP…I won’t get fully allocated AND I’ll have immediately capped my profit…but if the price is above $155 on Jan 17th 2015, then my profit is
    $2,100.00 on the PUT / CALL option premiums I collected and
    $228.00 on the share price going from $152.72 to $155.00.
    Total Return: $2,328 on a $15,272 investment is a 15.2% ROI and an annualized ROI of 25.1%.
    (Yeah, I know some readers are saying the ROI is wrong because you have the PUT out there that you have to cover. I get that. It’s a cash on cash ROI and Rule #1 Coaches are teaching it like this. In some accounts, equity can cover the PUT.)
    There are advantages and disadvantages to this strategy.
    What I like about it is:
    1) I made money…no violation of Rule #1.
    2) If the price goes LOWER, I’m in a good basis lowering position to take another 100 or 200 shares by doing the same or some similar strategy.
    Now lets assume the price dropped perfectly to $150 on Jan 17, 2015, and we take another 100 shares for $15,000
    What’s my basis look like now in the future if Panera goes lower?
    We bought 100 shares at $15,272. But I Sold the CALL to reduce basis on that 100 shares, so my basis is $145.27
    We got PUT 100 shares at $150 strike…$15,000. But I Sold the PUT to take those 100 shares at an $11 discount. So 150 – $11 -‘s 139.00
    Now we own 200 shares.
    Our basis is $139 + $145.27 / 2 =’s $142.13
    Our investment is now worth 200 shares x 142.13 =’s $28,427.
    Whenever I’m investing initially in a company, it’s all about Building the Foundation…lowering RISK, lowering BASIS and ALLOCATING Capital. I’m not looking for the price to go up. If it does, then I didn’t get fully allocated and I made SOME money. And then I have the Rule #1 Conundrum…I made money and I have to find another low risk, Rule #1 Company on sale. That’s not easy and may take time.
    …This is how I think about this stuff…I begin with the end in mind. I have to be able to look at this and say, “Ok, what’s the VALUE? And do I understand this company enough to buy more of it below $142? I have 200 more shares to allocate before I’m “all in” with my intended goal of owning 400 shares. Where’s the FEAR? Is this a temporary problem? I READ everything.
    **** Capital Allocation next to Valuation is probably the next most important thing in managing your own money. ****
    If in Jan 2015, Panera is below $142, I have to be able to understand why Mr. Market is giving such a discount. If I get it wrong, I could easily wipe myself out financially.
    That’s why I don’t do this stuff solo…I bounce ideas and questions off my Rule #1 buddies and the blog. No deal is so great that you can’t take a few days to study, read and ask questions.
    Had I bought WFM, this is how I would have begun the process. It’s a relatively low risk way to start entering a position.
    Manage your risk and the returns will come.
    To Your Wealth!

  • Mike M.

    The main concern with PNRA is an issue with through-put at restaurants during peak hours. Being able to efficiently move the line is key. This is a high class problem to have. It is solvable. They are considering adding kiosks to help order input accuracy and timeliness of service. This will help. They are also focusing on cleaning up their menu to remove fake ingredients in favor of natural. This, of course, is part of the larger trend in food these days. PNRA and CMG are best in class in this space.

  • Mickey: Dig deep and don't forget to INVERT your Story and particularly this part: If Mr. Market is selling it cheap (you are saying its on sale, right?) then why is he selling it cheap?  There has to be a reason.  If there is no reason, keep digging.  There is a reason.  Your job is to find out what it is and then determine if the reason is short term or long term.  If its short term then indeed this might be on sale.  If its long term or you can't figure it out, my unsolicited advise is to avoid owning it.  Never own anything you don't understand well enough to know why Mr. Market has incorrectly priced it.

  • Mickey

    I did two valuations. I have an MOS price of $156 and sticker at $220. I also did an 8 year PBT of $125. With the recent pull back and new buy back program just announced that should reduce basis even further. I hope it drops some more where I can sell more puts at 125 and 100 strikes.

  • Rulers,
    Mr. Market hits all time highs…”The Tools” are all green and the Shiller PE is 26.23 and the S&P 500 PE is 19.46.
    You just can’t fight the Fed…or the European Central Bank.
    With the Fed trying to taper, the ECB is trying to replace what the Fed is trying to decrease.
    I hate all this market manipulation and money printing.
    To Your Wealth!

  • Mickey,
    Do you mind sharing why you think Panera is a good value at your adjusted basis should you get PUT the PNRA stock?
    Was it because of the GuruFocus article or did you do additional valuations?
    Thanks for sharing if you have time.
    To Your Wealth!

  • Mickey

    I have had PNRA on my watch list for a long time. I have considered starting a position after reading the article the you posted from Dr. Paul Price. Thanks for that by the way. Doing some more reading on PNRA this weekend and found out the board authorized a new $600m share buy back program. I wanted to share as I think that is why the quick bounce and $150 is probably a new floor. I am going to start my buys with a 100 shares and selling 1 contract of the Jan 2016 150 puts for about $17.

  • Thanks Brian.  Good points, both.  Sears and K-Mart are dealing with the fact that the US main street consumer is deleveraging and therefore consuming less.  While the Tiffany consumer is back, the little guy isn't doing as well and that translate into fewer dollars going to the mid to low-end stores and that translate to some wicked price cutting competition.  Low Price is only a Moat if you have the low cost locked in.  Sears and K-Mart didn't and that makes life in a recession a day to day struggle for survival. 

  • Rulers,
    Phil brought up a SIGNIFICANT FACT about BP vs XOM regarding “oil equivalent” to his students a long time ago.
    Out of respect for those who are invested in Phil’s mentoring, I don’t bring up significant investing facts that I only learn from Phil’s Tuesday night classes.
    But now that Phil posted that on the blog, it was really fascinating to me. I never picked up on it when reading about BP and XOM – Nor had I read anyone mention it in the Seeking Alpha articles.
    Phil’s really good at looking at those 10K’s and extracting the important stuff.
    BP is well ahead of Exxon when it comes to replacing the oil that they’re taking out of the ground. Exxon is basically saying, “Well, we’re not as good at replacing the oil that we’re selling as BP is at finding and replacing it. So we’ll use natural gas as an equivalent amount of energy that the oil we ARE NOT replacing.”
    BP’s MOAT is in offshore deep water drilling…all the big guys do it, but BP is the best at it. Try to take a Billion Dollars and bust BP’s MOAT…you can’t do it with a Billion.
    Of course, the courts are still after BP. The way I figure it is in a worse case scenario – suppose BP has to pay out $80 Billion in fines starting tomorrow.
    Well, it will probably take them about 3 years to pay then we’ll finally have that behind us.
    If that’s the case, BP would tank, I’d buy more at $35 and in 20 years, I’d have a lot of my retirement tied up in BP…and I’d be fine with that!
    What I think BP will do is drag, delay, stall…this thing for 20 years through the court system. And in 20 years, that $80 Billion probably won’t even be traded in US Dollars!
    To Your Wealth!

  • Brian

    I wonder if those position reductions were by choice or forced by the need for capital to plow into the blackhole that is Sears’ retail operations. Lampert has committed himself to revitalizing Sears and tacked away from the real estate divestment plan many investors hoped for. It will be interesting to see if he can bring Sears back to life before he runs out of capital.

  • Brian

    One more quick lesson on book value BP taught me. In 2012 and 2013 they were selling off their assets (book) to raise funds for a possible settlement or just to streamline the business by divesting “non-core” assets. The reality is that most of the assets they divested sold for more than their listed book value because they were valuable to other companies in their industry. Contrast that to Buffett’s purchase of Berkshire Hathaway the textile company where he was hardly able to give away the textile machinery and forced to sell it at a fraction of book value. “Zombie value” is a good starting point but some industries tend to be more facilitating to the sale of all or parts of a company than others so make sure “zombie value” can actually be realized in the real world if you’re going to create a valuation based on it.

  • The website has the correct number of shares for the BP ADRs on the Stock At A Glance page but the Details page shows a wrong number.  The correct number of shares is about 3.5 billion for the ADRs.  The 2012 number on Details is correct but the 2013 number is using the British shares of 20.5 Billion and is wrong.  We're working to change it with our data provider.
    Einhorn (and I) think the true Z is in the $70-$80 range.  Only the value of Proved deposits is calculated and that at cost.  At $100 per barrel oil, the value is much, much higher.
    If you are looking at oil stocks you have to read the 10K for BP and XOM back a few years and get an education in how oil is put on the books.  You'll notice, for example, that XOM has a lot of 'oil equivalents' in its assets … meaning its finding a lot of natural gas and liquids instead of oil … and its putting that on its books as equivalent when its only equivalent energy, not value.
    If you're going to buy an oil stock (or any stock for that matter) you have to read a lot to get to be a bit of an expert in the industry.  Its part of the 4Ms: Meaning, and its probably the most important part … like being in shape is basic to playing football well.  Its not the game but you can't play the game without it.  That's what Meaning is to the 4Ms; basic and fundamental.  From there you go on with that base to studying the durable Moat and the Management team and then the MOS.
    So enjoy the reading, guys.  My wife, Melissa goes to sleep nearly every night with me reading her off with 10Ks.  They are amazing sleeping pills.

  • Rulers,
    Whole Foods took a nice pop up today too from that $37 floor and is currently trading at $40.85.
    If you were a buyer at $37.50, that’s an 8.9% return in a few days. I’m curious if there will be some traders out there that will take their profits and give this another shot at hitting $37.50.
    Next quarter, I’ll be watching and definitely reading to see what the analyst ask during the Q&A as last quarter’s was very interesting to read. If it dumps again after next quarter, then I might be a buyer.
    As I mentioned in a previous post, I wasn’t sure if I believed in Management’s ability to reach their Free Cash Flow goals. They kind of remind me of Southwest Airlines….there was a time when Southwest Airlines was the low fare niche market. We became victims of our own success when United, Delta, Northwest, Continental, American Airlines…all either consolidated and/or declared bankruptcy to compete.
    I truly believe Whole Foods is going to be around for 20 years. I’m just not confident that they can grow at 15% to 18% as the analyst believe.
    Plus, I just don’t shop there because we don’t have one near us. I love eating healthy, but I don’t need to spend a fortune to do it. And even though “Whole Paycheck” has that incredible experience, I can buy healthy foods from our local farmers market.
    If Whole Foods had dropped to about $25 to $30…I’d probably be all over it buying shares because I could justify a lower amount of Free Cash Flow in the event times get tough and WFM can’t grow as fast as they say they will. In the end, I just wanted a larger MOS.
    To Your Wealth!

  • Rulers,
    Eddie Lampert is one of the hedge fund managers I follow. He manages over $2.1 Billion dollars.
    …and is presently invested in just 4 companies – Sears, AutoNation, Lands End and Gap.
    You can learn something about investing from Eddie Lampert.
    For example, He likes retail…that’s his focus and circle of influence. It’s a good lesson to Invest In What You Know!…MEANING.
    I’ve lost 6 figures multiple times investing in stuff that was outside my circle of influence…and my CONTROL.
    Lampert likes to focus on what he knows and invest heavily when he does. With returns well over 20% per year, he’s a Rule #1 Investor to follow.
    Here’s a summary:
    Lampert is the founder of RBS Partners, L.P., a private investment company, and the Chairman of Sears Holdings Corporation (SHLD). Since starting RBS Partners, L.P. in 1988 at the age of 25, he has racked up returns averaging 29% a year. He is #68 on the list of Forbes 400 Richest Americans.
    Like Warren Buffett, Lampert targets mature and easily understandable businesses that have strong cash flows.
    He focuses on a company’s ability to generate large amounts of cash over the long haul. Unlike Buffett, Lampert
    is less focused on the management team of potential because of his willingness to implement changes in the companies in which he has invested. Lampert has significant experience investing in the retail arena.
    Lampert’s been reducing his position in AutoNation (AN) now for several quarters by about 20% and Gap (GPS) by almost 60%.
    I’ve been waiting to see where he’s going to be deploying more capital.
    To Your Wealth!

  • Good Morning Rulers!
    The only time I’m doing a Zombie Valuation on a company is if it’s a “Special Situation”
    Take JC Penny for example – that was a company that if you believed in the turn-around story, you’d really want to know the Z-Value.
    Regarding BP’s Zombie Value – it’s not really important to me because their advertised Book Value is about $40 per share. And with the stock trading at $50 and with a goal of $30 Billion in Free Cash Flow for 2014, I know that Mr. Market isn’t going to offer this up at Zombie Value.
    When BP was spilling it’s guts all over the Gulf…definitely a “Special Situation” and that would be a good time to check the Zombie Value.
    Seems like Panera had some good news and Mr. Market has given them a little pop off that $152 floor. Trading today at $159.
    To Your Wealth!

  • Joe M.

    I agree with your calculation. Google Finance incorrectly lists 18,466.07 million shares outstanding. That’s where I went wrong.

  • Mike G.

    Phil S.,
    You’re using the British shares outstanding. You have shares outstanding as 20.43 billion but the shares you should be using in your calculation are 3.4 billion.
    According to BP’s website, 1 ADR equals 6 ordinary BP shares. If we divide the 20.43 billion BP ordinary shares by the conversion rate of 6, we get about 3.4 billion ADR shares.
    BP zombie value using MSN Money:
    Equity: 129.080 (bil)
    Goodwill (aka cost in excess): 12.168 (bil)
    Intangible Assets: 21.696 (bil)
    Shares Outstanding: 3.4 (bil)
    129.080 – 12.168 – 21.696 = 95.216
    95.216 (bil) zombie value divided by 3.4 (bil) = $28 per share.
    Just another side note to help you…. Cost in excess is pretty much the same thing as Goodwill.
    You have intangibles listed as 34.22 and cost in excess (Goodwill) as 12.181 but that 12.181 is included in the 34.22.
    In other words your are double subtracting the cost in excess of 12.181 in your calculation.
    Gets a little confusing but if you hit the drop down arrow next to “Goodwill and other intangibles” in the Balance sheet at MSN Money, you may get a better understanding of what I’m saying.
    Hope this helps

  • Brian

    I come up with around 31 which matches what gurufocus lists as their tangible book value.
    Total Equity (129 billion) – (Goodwill + Intangibles [34 billion])= 95 billion in tangible assets
    Divide by 3.072 billion shares outstanding per Think or Swim
    $31 per share in tangible book which makes sense since their listed book value including goodwill and intangibles is $38.
    Gurufocus’ free screener lists tangible book value when you type in a ticker but it makes sense to take a look at the balance sheet yourself to see how much the company is carrying in goodwill and intangibles in relation to other assets.
    As to Einhorn’s valuation. BP is in the top 5, perhaps top 3 of oil and gas majors and makes money. If it’s selling for less than tangible book something is probably wrong with it as we saw with Macondo.

  • Phil S.

    Thanks Joe, but doesn’t help in understanding how I can semi-accurately calculate this myself. If you come up with a $5 ZVPS, I come up with $12, and Einhorn thinks it’s $70 – why the huge disparity?

  • Good discussion.  Zombie is indeed modified by any 'non-real' item in assets like goodwill, cost in excess, intangibles ….  And how the assets are valued by the accountants is important.  For example, real estate GAAP accounting requires that it be placed as an asset at cost less depreciation.  Companies like Alex Baldwin in Hawaii own huge chunks of land that was acquired in the early 1900's and is on the books at those costs.  Read the small print of the 10k for an education if the Z value is important in your valuation model.

  • Phil S.

    I used the information from your website. Would that have been the ADR or British shares?

  • Be sure that for BP we are all using the ADR shares, not the British shares.  BIG difference.

  • There is a right price for COH but be careful.  Their management team is trying to change the very nature of the company.  That changes the story considerably because it adds uncertainty.  And no question that the brand is damaged and going down-scale.

  • Joe M.

    Most balance sheets list intangibles in two line items: intangibles and goodwill. Your formula doesn’t account for liabilities. An easy formala is:
    Tangible Book Value=(Total Equity – Intangibles – Goodwill)/shares outstanding
    These parameters are available in Google Finance.
    For BP I get about $5 per share. There are many accounting factors besides intangibles that can mask true book value. For example, when a company like BP buys back stock at a share price greater than the stated book value it further reduces the GAAP book value. What is also in effect with BP is much of their land assets are worth more than the carrying value. Without access to “the books” its difficult to know for sure what this is worth. David Einhorn believes their assets are worth about $70 per share.

  • Apparently I can’t do math – but still only comes out to 12.69/Share.

  • Phil S.

    Question on Zombie Value – what I have in my notes about how to calculate is
    Assets – Intangibles – Cost in Excess = Zombie Value. Take the Zombie Value / Shares outstanding to get Zombie Value per Share.
    As Far as BP is concerned, I remember seeing Mr Town do this and came up with somewhere around $40/share. I’m running this with the current numbers and am only coming up with $4/Share.
    Total Assets = 305.69 (Bil)
    Intangibles = 34.22 (Bil)
    Cost in Excess = 12.181 (Bil)
    Shares Outstanding = 20.43 (Bil)
    Are my calculations incorrect or has the Zombie story changed that much for BP?

  • Sue

    Coach couch couch couch couch couch couch couch couch couch ????? History has been amazing, anybody have any convictions on where the puck is going??? Price has really come down…

  • Hi there Anne!
    Let’s see…first in this example, we bought 400 shares at $50.
    Then IF the price dropped below $50, our second tranche of 400 shares would be $2.80 for the PUT and $2.35 for the CALL…add that up and we get $5.15. So $50 – $5.15 =’s a basis on the second tranche at $44.85.
    Now in our perfect world example, IF BP were at $49.99 on Jan 17th 2015, then we’d get PUT the 400 shares and our CALL would expire worthless allowing us to keep a total of 800 shares.
    Our basis is now on 800 shares…400 at $50 and 400 at $44.85 =’s average of $47.43 basis.
    Here’s how I look at investing…When I’m buying a company, I’m in my accumulation phase. It’s like building a foundation for the house. I’m not expecting to make any money building a foundation for a house because the house isn’t finished yet.
    It’s the same with “getting allocated” into a company. In the beginning, I’m just trying to get all the money allocated into the investment slowly. Once I’m “out of the green zone” price, then I’m done buying shares. That’s when you wait and let your MANAGEMENT Team do what they said they would do each quarter – grow the company’s widgets, increase sales, yada, yada, yada.
    By the way, the above example is actually called a straddle.
    Now, in the beginning of an investment, you’re looking at getting allocated and lowering basis. All your focus is on lowering your risk and getting whatever amount of shares you can before the price goes above your Margin of Safety.
    In such an example, if BP goes above $50, you’ll have still made money, but you’ll have capped your profits. And that understandably drives a lot of value investors just nuts. Why do all this homework, just to have your shares called away?
    I understand the pros/cons of that position. But sometimes, it does make sense to lower your risk and turn your strategy into a basis lowering strategy rather than a growth strategy of waiting for the price to go up when you’re not fully allocated.
    Remember how we want to place ourselves in a win/Win/WIN situation…if stock goes up, down or sideways we’re fine with the outcome even if one may be preferred ALL are favorable outcomes.
    So with this example of BP, if it goes lower, we’re ok with that because we’ll lower basis and get more of it…and we’d still have $40,000 more to invest should it go even lower.
    If BP stays flat, then maybe we don’t get more shares, but we’ve still lowered basis on what we do own.
    If BP goes up, we’ve certainly capped our profits, but at least we still made money.
    The hard part of course is when something goes down and buying more of it at a better price. You have to be able to determine if the reason it went down more is rational or irrational. MOST of the time Mr. Market is RATIONAL – like WholeFoods…I think Mr. Market has this priced fair – certainly not at a great discount.
    Look at Cliff (CLF)…taking another beating. I have a friend who was invested in CLF but finally couldn’t stomach the news any longer and finally bailed with a significant loss.
    A few years ago I bought a company at $13 dollars. It eventually dropped to $4.00. I was sitting on a big loss. But once I finally did my homework, I could see where I had failed initially and because I had so much more experience later in life doing some simple VALUATION analysis, I could look beyond the price and finally see THE VALUE.
    Once I saw that, I bought a lot more shares. In a matter of weeks, I went from a big fat loss to a nice profit thanks to stockpiling.
    But that took big golf balls to do…and you have to KNOW your 4M’s.
    It’s been a long flying day as you can see. Time to get to sleep.
    To Your Wealth!

  • Anne (iloveangels)

    Thanks Garrett!!!
    In your example above, if we were PUT the BP, our basis for those 400 shares would be about $45 a share, right?
    As we would be obligated to buy it at $50, but we received $2,060 (round down to 2000).
    We received per share: 2000/ 400 = 5.
    Cost Basis is then: $50 – 5 = $45.
    Am I understanding this correctly.
    All the Best to You!
    :) Anne

  • Garrett

    BP is one of my “Just One” and for now, we seem to be stuck in a narrow trading range from about $48 – $51 while Russia does their thing and BP comes out with their next quarterly earnings numbers.
    When I see those kinds of short-term trends, that provides me some basis lowering opportunities using cash-secured PUTs to buy more shares and covered calls.
    This is a low risk, no leverage strategy for me and my goals. And there are numerous ways to do things, but this one is pretty straight forward.
    I’ll use some current numbers simulating a fake $100K account and one basic assumption is that BP is a 4M Rule #1 Company to you and you love it at $50 per share or less.
    I’ll begin with the end in mind…In this example, I want to own $80,000 of BP in this fake $100,000 account.
    Suppose we own 400 shares at $50 already for a $20,000 investment and we’d love to own another 400 shares at any price below $50 for a second tranche or “chunk” to lower our basis.
    Here’s something I could do.
    I could sell the Jan 17, 2015 $50 PUT for $2.80 per share or $280 per 1 contract (each contract is 100 shares). If I sold 4 of those contracts, I’d immediately have $280 x 4 =’s $1,120 in my account. Now I’d have the obligation to buy an additional 400 shares of BP at $50 with a basis of $47.20 ($50 – $2.80 =’s $47.20)
    The next thing I could do is sell the Jan 17, 2015 $50 Call for $2.35. If I sold 4 of those contracts, I’d collect $2.35 per share and $940.00.
    Total collected: $940 + $1,120 =’s $2,060.
    This is a 10.3% ROI based on BP shares being above $50 on Jan 17th 2015. However, annualized the return is 16.49%.
    If that happens, then you only had a $20,000 investment but you did make money.
    And in a world of zero percent interest rates and 2.5% Ten Year Treasury Bonds, something like this might be a much better outcome for a retiree trying to find yield.
    Plus, BP is providing about a 4.5% dividend yield.
    If BP breaks well above $50, then you’ll have made money, but didn’t get allocated all that you wanted. And then you’ll have to find another place to allocate all that cash sitting around in your account.
    On the other hand, if BP breaks lower, you’ve got a great basis starting out on a company that is at least $36 per share based just on the amount of proven oil reserves.
    More on this later! Time to fly!
    To Your Wealth!

  • Anne (iloveangels)

    Thank you Mike G.
    I love this type of information.
    All the Best to You! :) Anne (iloveangels)

  • Mike G.

    I wanted to share a blog by a guy named Shane Parish that I’ve been reading a lot lately. This blog came to my attention from John Mihaljevic of the Manual of Ideas after I noticed he was retweeting (sharing) a lot of Shane’s blog posts.
    Shane is an investor who received an MBA from a college he doesn’t mention. He strongly feels that he “became stupider in the end” from his education and now he is a on a mission to educate all his readers on how to think thoughtfully and to share the wisdom he has learned.
    He is a huge follower of Munger and Buffett so I thought it would be ideal to mention on this blog.
    The website is: http://www.farnamstreetblog.com/
    Here is a post I suggest reading:
    And an interview from Forbes for fun:

  • Sal

    ready for next post

  • Garrett

    I’ve traded in and out of PNRA…been watching and reading a few things. Here’s an article from GuruFocus on Panera – I think you can read it without having a subscription.
    I’m crazy busy this week…Hope to be more on the blog when I get a moment to compose some Rule #1 thoughts.
    To Your Wealth!

  • Garrett

    The following article by Seeking Alpha Pro Contributor, “Early Retiree” created a lot of dissension and angst among many of his followers. It’s titled “Do Dividends Add Shareholder Value? What Buffett Says.” – this one generated dozens of comments and opinions!
    I read EVERYTHING by “Early Retiree” as he appears to be an awesome student of investing and “Buffettology.”
    He’s made me money by helping me do some of the hard homework – and in investing, if you ain’t cheatin’ you ain’t tryin’!
    What I mean by that is you should absolutely be looking at what the great Value/R#1 investors out there are buying or selling. That’s how I found my investments in companies like BP, IBM, DeVita Health Care and John Deere for example.
    I completely agree with “Early Retiree’s” position regarding if a dividend increases shareholder value…many times a dividend DOES NOT increase shareholder value.
    I hope you take the time to read his article and the subsequent comments as part of your Rule #1 Homework this week.
    Subsequently, you should read his EXCELLENT follow up article and comments here:
    “When Cutting Dividends ADDS Shareholder Value”
    One of my Rule #1 Wealth Building buddies jumped on the opportunity in BWP (Boardwalk Pipeline Partners) as mentioned in the above article. I saw the opportunity, but had money allocated in other places and did not participate in that low risk investment – nor did I mention it on the blog – sorry about that – I guess I was wrapped up in my own investments at the time.
    Anyway, I hope you all take the time to read both articles and the 200 comments along with them. If you do, I think you’ll add another notch to your R#1 Investor Education.
    To Your Wealth!

  • Garrett

    Just to clarify for our Newbie Rulers…we all want to double our money every 5 years or sooner – a 15% annualized ROI.
    When it comes to “Beating the Index” we’re typically talking about the S&P 500.
    This is the holy grail of all mutual fund managers. However, my goal isn’t to “Beat the Index” but rather to just get “Absolute Returns”
    In 2008/2009 when the S&P 500 just tanked and many people lost 40% of their money selling at the bottom, it really doesn’t matter if you “Beat the S&P 500” and only lost 30% of your money…it still really stinks, right?
    There are investments out there where our return OF CAPITAL is more important than our return ON CAPITAL!
    How many times do you wish you just didn’t lose money? I have too many to list!
    I manage several accounts. One of those accounts is my Southwest Airlines 401K Plan where I can buy individual companies and sell cash secured puts/covered calls. My goal in that account isn’t to “beat the index”…rather it’s just to invest heavily in a few select R#1 Companies and achieve 10% or more annualized returns. If I can do that and continue to contribute as we’ve been doing, we’ll have certainly secured our financial future in 21 more years when I retire.
    Don’t stress out so much about the S&P 500 getting a 30% ROI in a year…and feeling like you missed out on something because you only got a 15% ROI.
    I’d gladly take a smaller ROI than the S&P 500 if I did it with less risk, less stress, more sleep and KNOWING THE VALUE of what I own than just owning “The Market”
    But if you can’t make the commitment to becoming a Rule #1 Investor, then owning “The Market” may be your best strategy for wealth accumulation.
    To Your Wealth!

  • Garrett

    Tom / Jerryjrk…
    Shoot an email to Michelle at support@ruleoneinvesting.com…put something in the headline like “Garrett said contact you” so that it doesn’t get lost to far in the dozens of emails she gets.
    If you don’t get a follow up by the end of the week, let me know on the blog and I’ll give you Cory and/or JP’s phone number. They can talk to you in more detail about what Phil has going on and if they think you’d benefit from participating in his classes.
    To Your Wealth!

  • Tom

    On a related matter I’ve been waiting for half a year now to get access to Phil’s online classes on Tue/Thu *without* having attended all the face to face workshops. Anyone got an update on that? Last time Phil wanted to consider to think about my request.
    I’ve got an interesting question: since we all know how hard it is to beat the index for a long period of time, would you rather put all your money on an index or invest it in a value investment guru stock of one of the top 10 gurus with a proven track record?
    I’m seriously considering it.

  • jerryjrk@kuhn01.com

    To Phil’s students,
    I have been thinking of paying for one on one with Phil for a while now. I know there is a fee to learn from him.
    My question is will Phil teach me how to get my fee back right away. And teach me a whole lot more?
    Is it worth it?

  • Joe M.

    That’s a good interview. Thanks for sharing. I found it interesting that she said Buffett does not DCF for his valuation.

  • Sal

    He has 110 Billion in the stock market. berkshire will always own a heap of stocks, but it’s true he prefers elephants in his zoo

  • Rulers and Phil Town,
    I present the MDW reading material for your guilty pleasure:
    Alice Schroeder Q&A about Warren Buffett. It has so many golden nuggets. And I hope it serves you all well, like how many of you have helped me here on this board.
    There was a question regarding if the investing world is harder today and her response is very interesting:
    aliceschroederThe Snowball[S] 6 points 14 days ago
    Is investing easy? It’s gotten a lot harder because so many people are value investors now. With a small amount of money you can hunt among the nano caps and that market is less efficient. Also, one thing that is clear is that really good investments jump out at you; they’re obvious. I spent tons of time on Wall St doing models of minutia that didn’t matter at all. It’s a few big things that determine whether something will succeed or not. That said, investing requires a really strong stomach. A mispriced bet, to quote Charlie Munger, is normally misplaced because the consensus thinks the company’s got a problem or has reached its limits of scale. So to be successful, you have to be able to understand herd mentality. The battle over Herbalife is a very interesting real world application of this. On valuation, Herbalife is one of the most attractive stocks… holy cow. So the question is do you believe Ackman’s thesis, or do you go by valuation.
    PS. I get a kick out of reading “To Your Wealth” on every Garrett’s post!

  • Tom

    I like the Priceline products like booking.com as it’s easy, convenient and mostly the best price. Bought them last year for less than 1000, valued it at 1300, sold it at 1300 (slightly before the peak) and made roughly 30% (USD killed me a bit though). They have a tiny moat, but CTRP (same thing for China) is catching up and seeming to be the new internet booking darling. As with every tech company the last couple of year, you don’t know how long it’s valued correctly. So better be sure or don’t even invest in it and put your money in an index.

  • Garrett

    Great post…I’ve read that before and it’s good to be reminded. Take BP just as an example. If you’re a little guy, you could have killed the markets just dancing in and out of BP using a combination of option strategies and owning shares while trading between $40 and $50 over the last year or more.
    Warren also said this:
    If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.
    Quoted in Amy Stone, Homespun Wisdom from the “Oracle of Omaha” ((June 5th 1999, business week)
    To Your Wealth!

  • In 2007 Warren Buffett said:
    “If I were working with a very small sum – you should hope this doesn’t happen – I’d be doing almost entirely different things than I do. Your universe expands – there are thousands of times as many options if you’re investing $10,000 rather than $100 billion, other than buying entire businesses. You can earn very high returns with very small amounts of money. Everyone can’t do it, but if you know what you’re doing, you can do it. We cannot earn phenomenal returns putting $3, $4 or $ 5 billion in a stock. It won’t work – it’s not even close. If Charlie and I had $500,000 or $2 million to invest, we’d find little things we could do, not all of it in stocks.”
    The interesting point he made was “I’d be doing almost entirely different things than I do.”. It almost means to say his current holdings and style would not be effective at smaller amounts of money (Less than $10 Million). It makes sense because at his current size, he’s only looking to buy whole businesses than stocks. Owning stocks does little for his performance but rather he’s shooting to buy the whole whale. We as small investors get to own a piece of a company via stocks, but we don’t have the capacity to buy the whole thing.

  • Tuna, Doug, Jerryjrk…fellow Rulers …
    Had to cut myself short while I was quickly trying to respond about COH.
    After COH’s poor quarterly performance, the old floor around $47 is gone and we’re finding a new floor.
    Back around September of 2013, I did some homework on COH and based upon their Free Cash Flow, I found them to be a great price at $45.00. I was a trader and was Selling PUTs at $50 and below in my non-retirement account.
    All that is no longer true today.
    Today’s Free Cash Flow is HALF of what it use to be. March 2013 FCF was $205 and March 2014 is $109…YUK!
    That’s a HUGE RED FLAG and enough for me to know that “The Story” has changed and time to “Get Out”…but I have a CALL I bought…and that’s going to be a $2,000 loss I suppose in Jan 2015…like I said, I rarely buy CALLs and I did it in my wife’s IRA because I believed in MANAGEMENT. The $2,000 dollar loss is negligible but none the less, a lesson learned in the risk of buying a CALL.
    The other thing that doesn’t make sense when reading some of the Seeking Alpha Bullish articles on COH is that they “pay a dividend”…yeah…but where are they getting the cash to do that if Free Cash Flow just dropped like a bomb?
    MANAGEMENT is borrowing the money! YIKES! You can see it in their financial statements…it’s “RULE #1 page 171 Accounting!”..remember how Phil wrote what GM Management did to their shareholders?
    I got out of COH last year in my non-retirement account – but I was about $1K under water on the COH call I bought in my wife’s account. It wasn’t as obvious then as it is today that COH has some serious MOAT and MANAGEMENT problems. Now I’m just going to suck up the $2K loss most likely on the CALL I bought because COH has little reason to go above $50 by Jan 2015.
    I see the FEAR Mr. Market has with COH. I think Mr. Market is acting RATIONAL and has this one correct!
    To Your Wealth!

  • Not talking about the business fundamentals of COH, but I can’t find price value currently with COH today. I feel that COH’s current price is too high for any margin of safety.

  • Garrett

    Last year I bought a tiny bit of COH in two accounts. It wasn’t a “just one” company for me and after I got rational, I sold out in one of the accounts for a small profit.
    In my wife’s IRA, I did something with COH that I rarely do. I bought two calls that cost me about $2,000 and expire Jan 2015.
    I fully expect that to be a loss now…well I’ll have to finish this story later and why I’m absolutely not a fan of COH…the jet just pulled up and it’s time to fly.
    To Your Wealth!

  • Doug

    Hi Jerry ,
    Thanks very much for posting a question – gives us all a chance to learn.
    Looks like you have an early start on your review of COH. And you’ve posed a question: “Can anyone tell me why or why not this is a good company to consider buying soon?”
    Honestly, probably the best way to support you is to pose a few questions in return. And offer a few sources you might use to continue your research.
    1. MEANING: What meaning does COH have to you? Do you know this company and industry and where it is headed? Sources: Seeking Alpha, 10-k filings, Yahoo Finance, Coach web-site, competitor web-sites.
    2. MOAT: Can you describe COH’s moat (Brand, Secret, Toll, Price)? Is that moat still intact? Sources: Review the Big 5 numbers, Annual Letters, industry trade magazines.
    3. MANAGEMENT: Is management shareholder friendly? Sources: Read earnings call transcripts, Google and Wiki the CEO and management team, review Forbes/Fortune etc. articles, review the 10-K for compensation plans.
    4. MOS: Is there a Margin of Safety? You have a good start here. Question now is this: after doing the “M” research above, are you personally comfortable with your growth and PE estimates?
    Certainly not trying to be evasive; rather, I’ve learned as a maturing Rule#1 investor that a Margin of Safety calculation only makes sense in the context of all 4 M’s. (Each “M” is an ingredient to the cake– and just looking at the MOS is like eating the flour without mixing in the other ingredients of the batter).
    So perhaps you could do a bit more 4M research on COH and post your findings for further input from the Ruler community. (as an aside, when looking at COH, you may want to dig into their new design leadership and timing of new product launches this year. And carefully understand COH’s competitors and what they are doing or not doing).
    Don’t Stop Believin’,

  • Rich

    An article on Seeking Alpha has an interesting take on the eventual reversion to the mean for the S&P 500. The author uses prior year dividends to forecast the time frame for the eventual decline in the stock market. As Rule #1 investors many of us have been waiting as so many of our top choices are fairly valued or overvalued. If the author ends up being correct, we may not have much longer to wait.

  • jerryjrk@kuhn01.com

    To any of Phil’s students please,
    I just calculated the sticker price and MOS for Coach.
    I used 16% as growth rate & 21 avg PE, got STICKER OF $84 and MOS OF $42.
    I also used 14% growth rate & 21 avg PE, got sticker of $67 & MOS OF $33.
    Both are a little conservative, i have yet to read the 10-K and find out the story why it’s down. But the number look pretty good on Coach.
    Can anyone tell me why or why not this is a good company to consider buying soon?
    Thank you very much for any input.

  • Thanks for sharing this lovely post genuinely loved it.

  • Mickey,
    I’m not a fan of PCLN as an investment…obviously, Mr. Market loves them. But consider if you Sell a PUT on a company such as PCLN it could easily represent over a $100,000 investment if you don’t know exactly what you’re doing…and I’m just mentioning that for Rulers that are new to all this.
    The primary reason why I’m not a PCLN investor is because I don’t quite understand their MOAT.
    I rent cars rather frequently because we travel a lot for various reasons and I simply go to Kayak.Com and let them sort out the best price on the internet for me.
    I have no problem making Cash Flow trades, however, I do them on companies that I don’t mind owning the shares or being temporarily overweight in my portfolio for that company.
    I did that this month on a company I own. I didn’t care if I took the shares or made the cash flow or if the price dropped well below my Bull Put Credit Spread. Either way, I was fine with it.
    So that’s how I primarily invest as long as “The Story” has not changed. I try to put myself in a win, Win or WIN situation – if the stock goes up, down or sideways…I’m fine with it for my goals. One outcome may be preferred (WIN) but all outcomes are favorable (thats the little “win” or the slightly bigger “Win”
    Many people do cash flow trades on the indexes and I understand why. However, I’m not in a position where I need to leverage up like that and speculate if the SPY, QQQ…etc….is going to hit my trade.
    Today I flew with a fellow pilot that is only investing in hard, tangible Gold/Silver physical bullion and farm land. We had a great time sharing insights on an 8 hour flight.
    To Your Wealth!

  • Mickey

    Has anyone looked at Priceline PCLN during the recent selloff? I have a MOS price of $600 based on a $43.60 TTM EPS 28 historical PE and 15% growth which is conservative based on analysts estimates. I have not done an 8 YR PBT or DCF valuation yet. But I am considering selling some puts and was wondering if anyone else was making some cash flow trades with the decline?

  • Thanks guys for the feedback on the recent posts.
    I’ve got friends who bought LNN and VMI. I haven’t done extensive homework on them, but they seem like well run companies.
    Regarding AGCO…I looked at them before buying John Deere and I liked my 100 year history of John Deere, the predictability, share repurchase, dividends, retained earnings, MOS…and Buffett owns some.
    Had Buffett bought AGCO, I would have considered that in more detail. But I’m not as think as smart I am…so I like to know that there are other investors on Buffett’s team that can crunch the numbers better than I’m able and have access to the CEO to ask the tough questions.
    To Your Wealth!

  • Jess

    Great post Garrett. Ever since you posted about DE I did my own research and got the same numbers as you. While researching the industry I came across AGCO who is a much smaller player in the industry but has performed very well. They are growing over seas in the coveted Brazil, Russia, and China markets. Unlike Deere, they are exclusively in the agricultural business meaning they don’t sell construction or mining equipment.
    While they are not quite Deere, the do offer several different product lines which I think makes them a good alternative if some people can’t afford the Cadillac of farming (Deere). They are also a major player in grain storage systems which is actually where a lot of the poor yields stem from in developing countries because they can’t get their crop to the market quick enough before spoil.
    Their dividend is not as large as Deere’s which should be expected, but they have consistently grown it.
    They have grown BVPS at about 13% consistently over the past 3, 5, and 9 year periods but even with a 10% conservative GR I have a MOS around $40. Currently they are trading at $54 which below they 8 year payback time value around $75.
    I view AGCO as an interesting growth play in good long term sector as you have pointed out. With the Russian/Ukraine conflict still playing out, it may present a Rule 1 Event for buyers to get in at a level they normally couldn’t.
    Stay tuned.

  • Martin

    I’m with you on that one. I bought LNN @ 76 as well. I would be happy to even see it below 80 so I can sell a $70 put. But no such luck seems like it hasn’t been below 85 or so in awhile.

  • Hey Garrett,
    very good post on John Deere!
    It reminds me of a LNN (Lindsay) buy last year. Lindsay is a Company in the irrigation market – two companies are holding 70-80% of the whole market, Lindsy and Valmont (VMI).
    I bought a first Tranche at 76$, hoping it will fall to <70 or maybe to 60$, but it never happens.
    LNN is a just one company for me, but it flies under the radar of big Investors.

  • Rulers,
    John Deere posted Q2 Quaterly Earnings and I’m reading the free transcript available at Seeking Alpha along with their investor presentation slides.
    I bought in to John Deere at $80 last year and immediately lowered basis by selling PUTs that were never “put” to me and posted some of that Rule #1 Homework for others to see where I was finding my Margin of Safety. Basis was quickly reduced with a rising stock price, increased dividends, share repurchases and basis lowering option strategies.
    I researched today what some of the analyst were saying about the time I was buying. The following was typical on August 14th, 2013 after earnings were reported:
    “It was a good quarter but longer-term we expect fundamentals to weaken in North America for agriculture,” Larry De Maria, a New York-based analyst for William Blair & Co. who has the equivalent of a sell rating on Deere, said in a telephone interview this morning. “The peak probably just happened.”
    He was wrong…by a lot. I was hoping people would SELL Big Time and drop the price to $60…no way…no such luck. It barely dropped below $80 at the time I was buying. And there was plenty of reasons why it just didn’t make sense from a dividend yield and PE Multiple why DE wouldn’t drop below $80.
    I wish I knew more about why analyst Larry De Maria was suggesting a “sell” rating. It just didn’t make sense to me.
    Today, after announcing decreased sales forecast, the price dropped from $93.61 before earnings to $91.05 at this time. But there were still other good things in their earning report.
    Last year, If I had $100,000 to invest in John Deere, I was buying $25,000 at $80 and ready to buy $75,000 more all the way down to $60. Bummer I never got all I wanted.
    I don’t know if DE will hit $80 again. It would be difficult with their dividend increases and recent share repurchases.
    DE’s share repurchase has MANAGEMENT’s basis at about $60.00. That’s a pretty amazing value and the same number I came up with as a phenomenal price to own DE should it have dropped below $80 last year.
    Now, I know these analyst are a lot smarter than I am when it comes to financial academics, but my experience has taught me that the most simple VALUATIONS like the ones we typically teach in Rule #1 and Payback Time work just fine for moms and dads without MBA’s.
    A 5th or 6th grade mathematical education is all I’ve ever needed to come up with all the Valuations I’ve ever needed to determine my MOS price. Those simple Valuations work pretty darn good when supplemented with a basic understanding of the Balance, Income and Cash Flow statements. Wrap that up with a fundamental understanding of your business (MEANING), its MOAT and whether MANAGEMENT is looking out for their shareholders. Do that and Rule #1 Investing is stress free.
    In addition, understanding how Dividends and share repurchases (when Management buys shares at proper valuations) can reduces our market risk, may help us stay rational while Mr. Market is changing the price of our company on a daily basis.
    John Deere is a “Just One” company for me primarily because I understand our 7 Billion earthlings are going to grow to an estimated 9 to 10 Billion by 2050. And the last time I checked, all of them need to eat. And sadly, with millions of people starving, John Deere has plenty of opportunity to grow. (My opinion is that starvation is a result of corrupt government and not the result of a lack of our planet’s resources or our entrepreneurial ability to feed the world)
    John Deere will be worth a lot more in 21 years when I need to live off that dividend income than it is today. That’s all I know for certain. But I also know that there will be bumps in the road over the next 21 years and during those bumps, I can buy a few more shares or lower basis.
    Reading the transcripts and seeing MANAGEMENT write out their GOALS and how they’re doing over the next 5 years to achieve them is compelling evidence that they know what they’re doing even when they decrease their sales forecast for 2014.
    I can rest assured that Cash Flow is still flowing at a predictable rate and those dividends will continue to increase just like MANAGEMENT has done for over 10 years.
    To Your Wealth!

  • Brian

    I’m curious what others think of Alibaba. Superficially it seems like the antithesis of a Rule 1 stock; an IPO, Chinese internet company,probably a lot of hype surrounding the IPO which will drive the price up pretty quickly. That said, it has a massive competitive advantage in an already enormous and still growing market. Furthermore its a relatively straightforward business model that doesn’t require a lot of capital to keep going which is reflected by their incredible margins. Ultimately its still a little early since the IPO price hasn’t been announced but I’m interested in what others think about it.
    Here is a pretty good summary/estimate of Alibaba’s value-
    And a follow up on a way to avoid the IPO and have a stake in it through Yahoo. The sum of the parts valuation used here is appealing because even at relatively conservative valuations for the actual IPO Yahoo still provides a decent margin of safety.

  • Rulers,
    Good morning…earnings season is still upon us and I’ve been diligently reading several earnings call transcripts.
    During these quarterly updates, as a Rule #1 Investor, I’m reading to make sure that MANAGEMENT is doing what they said they would do.
    After a few quarters or years of doing this with one of your companies, you’ll develop an enormous understanding of your industry and trends.
    Lots of Rulers get especially nervous during earnings because the stock price can gap down significantly if analyst don’t see their anticipated Revenue and Earnings numbers met or exceeded.
    This daily swing in the stock price is called “Market Risk” and it probably does more than anything else to increase what Phil calls the “Emotional Rule of Investing”
    Dad and I were talking about Market Risk and more specifically about Exxon. He inherited Exxon from his mother many, many years ago.
    How does a Rule #1 Investor eliminate or reduce Market Risk?
    One way is to reduce our basis via share buybacks and dividends.
    Dad really doesn’t care what happens to Exxon in a big market sell off. His wealth in Exxon isn’t tied to the daily price fluctuations because he’s had almost 20 years of dividend increases and share buybacks. That’s a great place to be and I intend to be in the same place 30 years from now with my current investments in BP and other great Rule #1 Companies.
    Since Buffett has made Exxon one of his largest portfolio holdngs, let’s look at Exxon over the last 10 years and see how our Market Risk has been reduced if we just bought and held 10 years from today’s date at a price which would have been $35.88.
    Using Phil’s Tools, I can look at how many shares outstanding we had from 2003 to 2013.
    2003: 6.57 Billion
    2004: 6.40 Billion
    2013: 4.34 Billion.
    Now I’ll plug those numbers into my Excel Sheet and determine my historical Growth Rate for 10, 7, 5, and 3 years.
    And I see that Exxon has been buying back shares at about 4% per year.
    If Dad bought Exxon 10 years ago and he had the ability to do what I just did, he would have been able to forecast with some accuracy how his Market Risk would be reduced by 2013.
    Year 1 $34.44
    Year 2 $33.07
    Year 3 $31.74
    Year 4 $30.47
    Year 5 $29.26
    Year 6 $28.09
    Year 7 $26.96
    Year 8 $25.88
    Year 9 $24.85
    Year 10 $23.85
    $35.88 – $23.85 is $12.03. That’s a significant reduction in Market Risk, wouldn’t you agree?
    But wait…there’s more! We also have a reduction in basis via increasing dividends. Phil’s tools are a great asset for quickly getting this information and pasting it into my Excel Sheet.
    2003: 0.98
    2004: 1.06
    2013: 2.46
    And I see that XOM has grown it’s dividend about 9.5% per year.
    So if dad bought 10 years ago today, at $35.88 here’s how his basis is reduced via dividends:
    Year 0 $0.98 div $35.88 basis 3% Return
    Year 1 $1.07 $34.81 3%
    Year 2 $1.18 $33.63 3%
    Year 3 $1.29 $32.35 4%
    Year 4 $1.41 $30.94 5%
    Year 5 $1.54 $29.39 5%
    Year 6 $1.69 $27.70 6%
    Year 7 $1.85 $25.85 7%
    Year 8 $2.03 $23.83 9%
    Year 9 $2.22 $21.61 10%
    Year 10 $2.43 $19.18 13%
    We’ve reduced our Market Risk by Exxon increasing our dividend.
    Now let’s see how we’ve done with our buy and hold strategy from 2003 to 2013 with a hypothetical $100,000 investment.
    May 14th, 2003: $100,000 / $35.88 =’s 2787 shares.
    May 14th, 2013: 2787 shares x about $102.55 =’s $285,806
    That’s $185,806 profit over 10 years. I know my ROI is less than 15% because that’s less than $200K (two doubles) over a 10 year period.
    If we grow $100,000 over 10 years at 11.07% we’d have $285K or our $185K profit. Dad is fine with that for his goals…because he’s also received a dividend check every year. Let’s look at that:
    How much money did Exxon give dad back in dividends over our 10 year period from 2003 to 2013? For this, I like to go back to Phil’s Tools and see what the div was during that period.
    We take the dividend payout of Year 1 at $0.98 cents per share and multiply that by the number of shares we own – which in our example is 2787 shares. 2787 shares x 0.98 cents =’s $2,731.26 cents. Year 2 our dividend was $1.06 and that times 2787 shares $2,954.22 and we’ll keep adding this up for 10 years…
    Year 1: $2,731.26
    Year 2: $2,954.22
    Year 10: $6,856
    Total Received: $48,131
    Now let’s add that $48,131 to the $185,806 profit =’s Total $233,937 profit.
    What’s the 10 year annualized growth rate of a $100,000 investment growing to $333,937? Taking out the financial calculator and I see it’s about 12.8%.
    Every investment has to be based on its own merits and your goals. Dad doesn’t have any market risk in XOM anymore after 20 years. He’s happy to receive a dividend check that supplements their retirement.
    And dad doesn’t have to sell his stock either to get that cash flow. It’s kind of like paying off the mortgage on a rental property and now all the cash flow from the renter is going to you instead of the mortgage payment.
    When you think about reducing Market Risk, just like Warren, you’ll find your path to prosperity and comfort in your retirement years!
    To Your Wealth!

  • Rulers,
    Panera’s been getting a little punishment from Mr. Market. I’ve been watching it since earnings came out and we’re testing that 2 year floor right at $155.00
    Rarely does PNRA sell for a multiple less than a 22 PE. Right now the PE is about 23.4.
    In order for PNRA’s PE to drop to 20, and it’s current TTM Earnings being $6.73 that would be a 20 X 6.73 =’s $134 price…that’s a pretty big discount for PNRA.
    PNRA’s getting some competition…still profitable…but Mr. Market isn’t getting that 20% Growth Rate that they’ve been use to seeing.
    Quick look on Phil’s Tools using TTM earnings of 6.73 and a 15% GR / 30 PE gives us about a $200 Sticker and a $100 MOS. The problem here is, PNRA has NEVER really reached it’s sticker price before it’s gotten sold off.
    A little more homework required on this one before I can get a good VALUE on PRNA.
    To Your Wealth!

  • Moncho

    I would be upset with management too if I was a KO holder. I don’t have the greatest writing style but this article, http://www.gurufocus.com/news/258337/crony-capitalism-and-the-oracle-of-omaha, sums up my basic thoughts on the subject.
    The best line in the article was, “All Buffett had to do was to check the “No” box on the proxy statement.”
    I do give Warren credit though, he has to balance personal and business ethics on both sides of the fence as a shareholder and CEO. That has to be difficult.

  • Rulers,
    Whole Foods closed today at $39.64, up slightly since it’s 20% drop on their earning report.
    While I was out doing some springtime yard work, I found myself pondering Whole Foods and how I’ve become a more rational investor over the last 10 years.
    I suppose there was a time when I would have jumped on Whole Foods after the market dumped it the other day.
    However, now I ask myself some simple questions that make investing a lot easier and much less emotional. Many times, that means I’m missing out on some nice little trades…but I don’t worry about that anymore because I’ve learned to like the certainty of Rule #1 Investing.
    Here’s some of the questions I asked myself that led me to pass on buying or trading Whole Foods.
    1) What’s the VALUE?
    I think Mr. Market has this one correct. In fact, as I said in a previous post, I wouldn’t be surprised if Mr. Market dropped it to $30 per share based on a lower PE around 20.
    I valued WFM based on their ability to produce Free Cash Flow over an 8 year period based on a $39 stock price.
    Since I’m not confident that WFM’s can produce that $900+ FCF, I passed.
    2) If I had $100,000 to invest in BP or WFM at today’s prices, which company offers less risk and more certainty?
    For me, the choice was BP based on my belief that Management will reach their goal by end of 2014 of producing $30 Billion in Operating Free Cash Flow and continue to grow their dividend. If they do that, then I have a significant MOS buying BP at $50 or less.
    3) What do people need more of in their life – oil/natural gas or Organic Food? Again, BP wins with oil/nat gas.
    At 44 years old, I only have about 21 more years to keep working at Southwest Airlines. As Phil shares in Rule #1, our goal is a 15% ROI. As a little investor, if our goal is 15%, then we should be able to double our money…20 years / 5 years =’s 4 more times.
    Sometimes it helps to step back from the daily prices and market volatility and just let your investment in a company grow over 20+ years.
    For example, a $100,000 investment in BP today, may easily be worth over One Million in 21 years with dividends reinvested. That’s only a 12% annualized return. Sometimes when you think about that, it just kind of takes the noise and stress of investing away and lets you “Go Play!”
    For my wife and me, we don’t even need to achieve that kind of an ROI to provide a comfortable retirement – Obviously, I want the highest ROI with the least Risk I can achieve.
    But we have a MOS in our goals…So I’m a boring investor…if we get 10% annualized returns over the next 21 years, we should have plenty saved up for retirement.
    Remember, once you KNOW the VALUE all the FEAR goes away.
    To Your Wealth!

  • Anne (iloveangels)

    Thank you every one for teaching me more about Buffett and what happened and why in the voting…
    I realize I perhaps didn’t know the whole story… and could have been much too hasty in my judgement… so… so sorry to Warren if this was the case… I just pray things work out best for the share holders.
    All the Best,
    :) Anne

  • Jess

    Buffett is not on the Coke board, his son is. Check out this link with the annual meeting notes http://ify.valuewalk.com/wp-content/uploads/2014/05/222892108-2014-Berkshire-Hathaway-Annual-Meeting.pdf (if this doesn’t work you can find it on Value Walk)
    It’s a great read overall but the first question relates to the Coke compensation issue. Once again, I think the stock options are ridiculous but they are across the landscape. It’s a loophole in accounting practices that somehow doesn’t show up on the bottom line immediately.
    If I owned Coke I would be much more upset at Management then Buffett.

  • Moncho

    Buffett doesn’t have to worry about becoming an activist investor to show his disapproval. All he needs to do is liquidate in one fell swoop or at least threaten to.
    The way I figure it, if you are an investor and have a seat on the board, are you not already and an activist investor???

  • Jess

    Buffett abstained his voting interest which is his way of publicly disagreeing with the compensation plan without ostracizing Coke management. Buffett was on the board and voted against the ridiculous bonuses that Salomon Bros were paying and that created a mutiny between him and the management in place. Buffett and Berkshire’s M.O. is acquiring (or partially acquiring through stock in Coke’s case) wonderful companies with wonderful management that stays in place to steer the ship that he feeds capital when necessary.
    At the annual meeting this year Buffett was grilled pretty hard regarding the Coke stock options and he still disagreed with them, but he did point out that the dilution of the shares is not nearly as bad as has been reported. He also stated that he has and will continue to discuss the issue with Coke management, but he will do so in a more behind the scenes way. Buffett and Munger are both strongly against activist investors and do not want to be perceived as such for future partnerships.
    Buffett’s son is on the board for Coke but is not included in the compensation package that is being scrutinized. Buffett also pointed out that while the board is theoretically in place to steer the company, this rarely happens at the board level and are generally handled by sub-committees and to buck the committees is rare.
    I agree that the compensation plan is ridiculous (as is most of corporate America at this point) but I don’t think Buffett deserves the amount of criticism he’s receiving.

  • Mike M.

    I have a different take on it. he initially wasn’t aware of the plan. he reviewed it and voiced his concern which will have the effect of causing Coke to change the plan. remember the plan was approved but nothing has been implemented. Warren doesn’t need to put on an Ackman like show to get the result he desires.

  • Anne (iloveangels)

    Hi Garrett!
    Yes, I agree. I like your attitude very much: I hope Warren realizes he made a mistake and redeems himself.
    All the Best to You and Your Loved Ones,
    :) Anne

  • Rulers,
    Just got some emails from some friends regarding WholeFoods and we had a brief discussion about their FCF. Here’s an excerpt of what I sent:
    I’m just not sure how much FCF WholeFoods can generate. Read multiple Seeking Alpha articles, quarterly transcript and two articles on them in yesterday’s WallStreet Journal. I think WholeFoods is still overpriced based on their $1.50 EPS with a $39 / $1.50 =’s 26 PE. Kroger and other stores are biting into WFM niche and are at a 14 PE. If I wanted to buy WFM at a 20 PE then I’d have to see the share price at 20 x $1.50 =’s $30 – which I think is a FAIR price and could see Mr. Market eventually dropping to that price as things stay the same or worse. I don’t necessarily see WFM at a fire sale MOS price.
    Bottom line is WholeFoods was even quoted in the WSJ as “whole paycheck” for their exorbitant prices. WFM has to drop prices and we just don’t know by how much. And since I don’t know, I’m reluctant to buy.
    However, this is a lot like the Starbucks situation when SBUX was at $25 per share and everyone was (and still is) selling coffee. I’m still shocked that SBUX has thrived and perhaps WFM can emulate their success. But given what I know about BP, CF, DVA, ZINC, DE IBM, etc…WFM isn’t worth risking what I know versus what I’m unsure. I’d rather invest in what I already know than invest in WFM.
    That’s just me and my goals. And again, when times get tough, – as they will again when the next financial crisis happens – I want to be invested in oil, commodities and the farming industry to feed the growing population of 7 billion to 9 billion.
    With current FCF at $931 Million and $39 share price, we’d need an 11% GR for an 8 Year FCF Payback Time based on their market cap. I don’t know if FCF will grow, flat or decrease over the next few months/years – so as of now, I’d consider that be a bit too risky for me to jump in on WFM when I have other companies that have more MEANING to me and whose future is more certain.
    Enter Current FCF $931
    Enter FCF Growth Rate for Calculations 11.0%
    Enter Market Cap $(14,500.00)
    (Market Cap is a negative number since it’s cash out)
    Payback Time Free Cash Flow
    Market Cap
    Current Year $931
    Year 1 $1,033 FCF
    $(13,467) Market Cap
    Year 2 $1,147 FCF
    $(12,320) Market Cap
    Year 3 $1,273 FCF
    $(11,046) Market Cap
    Year 4 $1,413 FCF
    $(9,633) Market Cap
    Year 5 $1,569 FCF
    $(8,064) Market Cap
    Year 6 $1,741 FCF
    $(6,323) Market Cap
    Year 7 $1,933 FCF
    $(4,390) Market Cap
    Year 8 $2,146 FCF
    $(2,244) Market Cap
    To Your Wealth!

  • Rulers,
    Dad owns Coke. So I watch it too. Recently Coke’s been under the microscope for MANAGEMENT’s compensation plan which angered shareholders.
    Buffett is Coke’s largest shareholder. But..
    Buffett failed us all on this one. There’s a few Seeking Alpha articles and recent interviews where I just get ticked off for him rolling over like a dead fish towards MANAGEMENT and NOT telling them to knock the crap off…and the fact that he has relatives on Coke’s board.
    When Buffett could have made a difference and stood up for shareholders, EVEN WHEN HE DISAGREED with Coke’s compensation plan, he FAILED to vote and encourage other shareholders to do the same.
    Shame on you, Warren. I hope you live long enough to redeem yourself from this disgraceful error in leadership.
    To Your Wealth!

  • Yeaha, WFM!!
    This is a great company, i love them. I enjoy good nutrition and really like organic food. WFM is making the world a little bit better with their products. And the share price is down 19.4%!
    It is a great c… Is it really a great company??
    Emotions are flying high, and this perfectly fits to Phils topic: STAY RATIONAL!!!
    What is WMT´s Moat?
    In his books, Phil mentioned a secret moat. The secret of processing easily perishable fresh food.
    Is this moat intact? – I think it is not. Other companies can process this food very well, too, and enter the market.
    Amazon is trying to find (and I think they will) a way to sell this products online.
    A brand moat? Yes, WMT has a big brand moat.
    But brand moats are weak. And they get easily crushed by price, especially if products don´t have a “unique selling proposition” like food.
    A price moat? No – WFM don´t compete on price. As John Mackey said, they did not lower prices the way they could do.
    But he said that this is a possible way, even if it declines their profit margins.
    For me it is very hard to do a good valuation for this company at the moment. Even with 20% price drop, WFM has a P/E of 25, and is selling with a premium. Is it worth this premium?
    With the “normal” valuation methods – DCF / MOS, PBT earnings, PBT free cash flow, Zombie Value etc. I get a price below 30$ (22$–28). And even if the price would drop below 30$, I can´t say (at the moment) if this is a good price for this company.
    For me it is a great company! But staying rational, it is not a wonderful company to invest in.
    Like to hear what you are thinking.

  • JasonD

    Here is an analysis done by my fiance, Anne. I feel she did an excellent job digging but would like some other feedback on it. This analysis was done pre-earnings.

    Company Overview

    • Supermarket chain specializing in natural/organic foods

    • First opened 1980; 350+ stores in the USA, 9 in the UK.

    • Mission: to promote the vitality and well-being of all individuals by supplying the highest quality, most wholesome foods available. Since the
      purity of our foods and the health of our bodies are directly related to the purity and health of our environment, our core mission is devoted to
      the promotion of organically grown foods, healthy eating, and the sustainability of our entire ecosystem.

    • “Natural” quality standards needs to be met: minimally processed foods free of hydrogenated fats, artificial flavors, colors, sweeteners,
      preservatives, and others listed on “unacceptable food ingredients” list. They don’t sell meat/milk from cloned animals/offspring, even though FDA
      has ruled them safe to eat.

    • Recognition/Awards

    • America’s first national “certified organic” grocer

    • #3 on the US Environmental Protection Agency’s list of “Top 25 Green Power Partners”

    • Fortune’s “100 Best Companies to Work For” every year since inception 2007; 2013 “Retailer of the Year,” Fortune’s “World’s Most Admired
      Companies,” Fortune’s “100 Best Companies to Work For in America,” Ethisphere’s “World’s Most Ethical Companies,” Forbes’ “America’s 25 Most
      Inspiring Companies,” USA Today’s “America’s Top 10 Fastest-Growing Retailers

  • Store management/structure

    • 365 Everyday Value product line

    • WFM does majority of purchasing at regional/national levels to negotiate volume discounts. Regional store managers are focused on local/unique
      products that meet quality standards to ensure a neighborhood feel. Some regions have an employee known as a “forager” whose sole duty is to
      source local products for each store.

    • Portion of store budget goes toward employee development/evaluation. Each team member has access to “Whole Foods Market University, an online
      information portal that connects employees to the core values of the company and further knowledge about products. When someone’s hired,
      they’re assigned a mentor. >> However, whenever I shop there, they don’t look very happy?!

    • Little/no advertising. Relies on word-of-mouth and social media.

  • Causes

    • Plastic bags. 1st US supermarket to commit to completely eliminating disposable plastic bags. They have 100% recycled paper bags or reusable
      bags. 5-10 cent refund with BYOB.

    • Humane treatment of animals. Global Animal Partnership’s 5-Step Animal Welfare rating system standards for cattle, pigs, chicken, turkey.

    • “Whole Trade Guarantee” is a purchasing initiative emphasizing ethics/social responsibility of products from developing worlds – fair prices
      for crops, environmentally sound practices, wage/labor conditions for workers, premium product quality. Goal published in 2007 to have at least
      ½ of its imported products from these countries fully certified by 2017.

  • Criticisms

    • Wild Oats acquisition. Feb 2007 announcement, FTC allowed, Aug 2007 WFM officially acquired. July 2008 Federal decision reversed decision to
      allow merger. 2009 WFM agreed to sell. 2010 officially sold.

    • Mackey posted on Yahoo boards under “rahodeb” about WFM stock during the time they were going through federal complaints challenging WFM’s
      acquisition of Wild Oats Market Inc. The issue raised numerous legal questions, but the SEC cleared Mackey of any charges in 2008.

    • WFM uses “natural” as a marketing tool, that they’re a big box retailer more concerned w/ competing against other big boxes rather than
      ethics/sustainability. They’ve done well expanding the organic market, but at the cost of local foods, regional producers/distributors.

    • CA vs. WFM 2008 lawsuit claiming WFM sold natural body care/household cleaning products that tested high for a cancer-causing chemical,

    • Health care controversy: John Mackey claimed WFM insurance plan is a viable alternative to “Obamacare.” Notable for its high deductibles, and
      mental illness is not covered. Mackey opposes universal coverage, saying, “A careful reading of both the Declaration of Independence and the
      Constitution will not reveal any intrinsic right to health care, food, or shelter. That’s because there isn’t any. This ‘right’ has never
      existed in America.”

  • Charts and possible explanations

    • Steady decrease from Jan 2006 – Dec 2008. <<What happened in 2006? WFM annual reports only go back to 2007. How do I find 10Ks from
      2006?>> 2007-2008 is the Wild Oats and Mackey’s secret postings on Yahoo boards issue.

    • Steady increase from Jan 2009 – Oct 2013.

    • Steady decrease from Nov 2013 – present. Seeking Alpha article says it’s due to lower earning estimates for 2014, cannibalization effect of new
      store openings (but this should have happened every year, why is it affecting it now?) and the recent announcement of Walmart and Wild Oats
      deal. This possibly isn’t such a bad thing for the direction of the company, and could be a positive opportunity for investors. However, with
      the increased interest for more natural/organic foods (US organic food industry is expected to grow 12% in 2014), and other stores being more
      mindful of this (Walmart & Target plan to open lines of organic items, announced April 2014), the days of 20% industry growth may be in the
      past. WFM market share is decreasing but only because the organic market is so quickly growing.


    • I completely support a company who has health as a major focus. Natural is something I definitely subscribe to and consciously strive for, though
      my standards are not so strict as to only consume organics. Price point is a big determining factor with food for me, along with being “natural.”

    • My food habits evolved from Paleo to include a broader, mostly-natural, healthy diet. Though I don’t shop at Whole Foods often (bc of price), I
      like that the brand is so prominent and that they promote natural foods. It’s a good thing in the broad spectrum of America’s diet.

    • Whatever the case, I believe that a good healthy foundation will provide for a long life in this industry. WFM has already been around for 35+
      years, and I don’t see it going anywhere anytime soon.

    • Most grocery stores, especially Publix with their GreenWise section, seem to be expanding their organic/natural section of products. This is the
      future of grocery stores, and Whole Foods seems to be ahead of the curve, possibly leading the industry.


    • Brand Moat – (WFM was the example of “brand moat” from Phil Town)

    • Building a national brand

    • Self imposed quality requirements that other stores do not subscribe to (54% of groceries at Walmart are deemed unacceptable for sale at WFM)

    • Leader for natural foods movement

    • Consumer Edge survey claims WFM boats the best brand loyalty of any grocery retailer.

  • Identify a moat by looking at 5 numbers. We want it to be > 10% per year for the last 10 years

  • ***Note: All these numbers are calculated using MSN Money numbers bc 2013 Rule 1 numbers are WRONG?!***

    • ROIC: 10, 7, 5, 3, and last year averages are 10.1% > 9.3% > 10.5%> 12.6% > 14.1%.

    • All are above 10% consistently, and they’re either holding steady of going up. The hiccup in the 7 yr avg (9.3%) is below 10% but it could
      be attributed to the 2008 crash.

  • Sales growth rate: compounded sales growth rates for the last 9,7,5,3,1 years are 14.4% > 12.7% > 10.2% > 12.8% > 10.4%

    • The numbers fluctuate a little, but they are all solidly above 10%, so I’m not worried yet. They don’t even seem to be decreasing all that
      much, as it’s pretty steadily 12-10%.

  • EPS growth rate: compounded EPS growth rate for the last 9,7,5,3,1 years are 12.5% > 11.2% > 29.1% > 28.1% > 16.7%

    • The numbers fluctuate, but are all far above the 10% minimum that we are looking for. Not a problem here.

  • Equity growth rate, aka Book Value growth rate (BVPS growth rate): compounded book value growth rate for the last 9,7,5,3,1 years are 11.8%
    > 11.1% > 14.2% > 14.7% > 1.6%

    • Book value is the bottom line of the company. It’s how much the company is worth right now if it were to cash out, and is completely
      adjusted for all expenses/costs.

    • The last year (from 2012-2013) had a 1.6% increase, which is really low compared to the compounded values of 11-14%, but it’s still a
      positive number. The company worth just did not increase in value too much from 2012 to 2013, just like it didn’t from 2007-2008 (2.3%) and
      2008-2009 (7.8%) but those all evened out in the compounded rates. Not too worried about this.

    • Liquidation value (aka zombie value): Book Value (3.878 billion) – Intangibles (744.0 million) = 3.134 billion total, or $8.43/share

  • Free cash flow growth rate (OCPS): compounded operational cash flow per share growth rate for the last 4,3,1 years is 31.3% > 17.7% >

    • Free cash flow seems to be decreasing, but it’s still high above the 10% minimum that we want. The cash flow is just growing slower, but
      it’s hard to tell bc there are only 5 years of data for this. Also, sometimes as companies grow larger, it’s harder to keep generating so
      much cash flow. Not too worried.

  • Average of 4 Growth rate numbers (10 years for all except 4 yr for OCPS): 17.5. Safely over 10%.

  • Debt. Reasonable amount is able to be paid off in 3 years. Divide total long term debt by current free cash flow.

    • Balance sheet: Long term debt (most recent 2013 is 31.0 million) divided by Cash flow sheet: Net cash (most recent 2013 is 201.0 million) = Can
      be paid off in 0.15 years.

  • Competitors [Because numbers for WFM is so great and all over 10%, I feel confident in not going too deep into market cap, net earnings, moat
    score, revenue, and % net earnings for competitor comparisons. We’re only looking at high level comparisons for WFM’s main competitors.]

    • KR Kroger – looking at market cap, they are a much larger company. They sell more than just natural/organic foods. This is probably the biggest
      competitor for WFM.

    • SFM Sprouts Farmers Market – smaller company, really new. They are not so much a big worry bc they have two major hurdles: WFM and KR.

    • Fresh Market


    • John Mackey, co-founder & co-CEO (Walter Robb is the other co-CEO since 2001)

    • Barron’s list of the world’s best CEOs (30 top corporate leaders who excel in not only profit/stock price growth, but leadership strength and
      industry stature)

    • 2009: John Mackey acknowledged that the company had lost touch with its natural food roots and would re-attempt to reconnect w/ the idea that
      health was affected by the quality of food consumed.

    • He set his annual salary at $1 w/ no cash bonuses or stock option awards from 2006, stating that he’s reached a place in his life at age 53 where
      he no longer wants to work for money, but the joy of work itself, and to better answer the call to service that he feels in his heart.

    • He’s instituted an executive pay cap at the company.

    • Strong anti-union views, believing that they facilitate adversarial relationships btw management and labor.

    Margin of Safety

    • Looking at all the compounded growth rate numbers, equity seems to be pretty smooth: 11.8% > 11.1% > 14.2% > 14.7%. Analysts for Rule 1
      are predicting 16.3% but I’m going to stick with a conservative 15.0%

    • If 15.0% (conservative), sticker price is $45.00, MOS is $22.50

    • If 16.3% (analyst prediction), sticker price is $54.72, MOS is $27.36

    • Current price is $50.35, so right now we’re still far off that.

  • Payback time is acceptable at 8 years (should be a max of 8 years).

  • Our future PE number should stay between the Low/High PE ratio. 30 is between 8.6-52.1 so we’re ok.

  • Rulers,
    This following was just emailed to me from my friend and fellow Ruler that I’ve mentored over the years. He just emailed me about WFM and without his permission, I’m posting it here because it’s well worth reading:
    Betsy and I did the whole30. All natural diet for 30 days so needless to say we were shopping at WFM weekly.
    What we noticed was that their all natural, organic, fruit and vegetables were more expensive, but we understood why. In addition the grass feed beef, pastured raised chicken, and wild caught seafood was more expensive. Again we understand the why.
    Here’s what I found interesting, much of the fruit and vegetables are conventionally grown, meaning not certified organic and are in most cases the same fruit and veggies that we could find at our local Giant or Safeway super market and military commissary. My Pete’s coffee was marked up 75 % from the mil commissary and 16% from a normal grocery store. I know I should probably go to the commissary, buy a case of Pete’s and go sell it in the giant parking lot until someone tells me I can’t.
    Where am I going with this ? I am concerned about their moat. I observed people in the store buying the regular fruits and veggies and regular meat. I think many people go to WholeFoods and think they will be eating all natural and organic if they buy their food at what is known as the all natural and organic supermarket. A college roommate of mine who also shops there (and invests on his own) also notices the same thing. We both ended up buying only what we needed at WholeFoods and then going to the cheaper stores to buy the rest. If we are doing this how many other people are too ?
    In our cases we are driving to WFM and passing other supermarkets on the way so it’s a no brainer. I get if some people buy everything at WFM for the convenience but a 16-100% mark up on the same product would seem to eventually deter customers once they catch on. Yes some of their regular fruit was marked up 100% from giant.
    I love the store, love the company, but I am weary of their moat. Seems like every other grocery store could do the same thing and in fact the Safeway near us has revamped the store and now has a huge natural food selection along with all those supposedly healthy snacks. The ambiance is more like WholeFoods as well.
    WholeFoods is still the place to go for all natural, organic veggies, fruits, meats, poultry and fish. They have the largest selection and in some cases are the only place we could find certain meats and free range chicken products. They also have a great bakery and deli section. I just wonder how long people will continue to put up with the high prices for the same products that they can find in other stores.
    My 2 cents from our observations.
    To Your Wealth!

  • Here’s what I can gather from Whole Foods “Strategic Guidance” …and this is where I think MANAGEMENT failed to communicate their plan and why they are getting whacked.
    The following statements are cut and pasted verbatim.
    1) “We are having our game, evolving, differentiating, innovating and improving our value while cutting our cost.”
    2) “we are investing in technology to meet and connect with our customers where they are whether physically, digitally or both.”
    3) “We have several pilot projects in process including click and collect, direct delivery, payment at food venues using square, a mobile app, affinity program and expanded access to our e-store from just the holidays to year round.”
    So that’s the opening remarks and WFM strategy. When I read that, I think, huh?” There’s a lot of fluff in that strategy.
    I compare that to BP’s strategy and 10 point Plan. BP has a goal…creating 30 Billion in Operating Free Cash Flow and beyond…and here’s exactly how we’re going to achieve that…and then they lay it all out and show you where that $30 billion is going to come from. Whole Foods didn’t do that at all.
    My opinion is that Whole Foods MANAGEMENT wasn’t paying near enough attention to their competition and is now staggering a bit trying to see what happened. They have some work to do and Wall Street doesn’t have time to wait for them to figure it out. So they dump them and invest their money somewhere else.
    Good for us because that creates opportunities. But before we do, we have to KNOW where WFM is going.
    To Your Wealth!

  • …and the Q&A beating for Whole Foods continues..
    Kate Wendt – Wells Fargo: …”does your guidance include any spending for more advertising or marketing around what you are doing on price because it seems to us like that’s part of the problem, people have no idea what you are doing?”
    Co-CEO Jeff Mackey sums it up in the last statement:
    John Mackey – Co-Chief Executive Officer:
    “For a long time, put this whole thing in competitive perspective. For a long time, Whole Foods Market was this small niche. I remember many years ago, talking to venture capitalists and early as a public market, as a public company. Their belief was that this was — they wasn’t even sure it was a viable niche, wasn’t even sure that this had any legs at all. One guy said you guys are a bunch of hippies selling to other hippies. And yet we’ve grown continuously for many, many years until one time our market capitalization in the last year was the highest of any dedicated food retailer in the United States.
    Our tremendous success has created more competition. And that’s the way capitalism works, so we have, what we thought was a niche and we still think it’s a niche. But it’s just gotten to be a very big niche and in some ways it’s gone mainstream. So there’s a lot more competition, a lot more entrants into the marketplace as well as conventional supermarkets copying and imitating a lot of what we’re doing.
    Whole Foods Market does not want to engage and as you say, we don’t want it to become a commodity where we’re trying to just compete on the basis of price. That’s not what we want to do. Instead, we are upping our game in terms of differentiation, innovation, service, quality and overall experience that we give to our customers. You can see this if you go into many of our new stores. And we’re opening, I mean, we have 114 stores we’ve announced and we’re finding more and we just approved a bunch more stores today before this meeting.
    So, we’re rapidly increasing our growth and we’re opening tremendously good stores that we think will set us apart from our competitors and we are a very-very creative, innovative company. So at the same time, we have to recognize that we have more competition going after us, kind of, on the margins on certain well known brands and products and we can’t ignore that. We have to meet that challenge head-on and we are doing that.
    At the same time though, we’re continuing to differentiate. We’re continuing to innovate. We continue to upgrade the experience that we’re giving our customers. We think it’s a good strategy and that’s why we’ve gone for the first time and laid out how we see the next five years happening because we want our shareholders, as we always want our leadership at Whole Foods to understand where we’re getting to. I can tell by some of the questions on the call that people may not agree with our strategy and of course, people are free to make their own decisions about whether this is a good strategy or not.
    But we want to be as transparent and as honest and as open with our shareholders as we possibly can be. This is where we’re heading. This is what we’re going to do. And I think Whole Foods has a great track record, not maybe every single quarter in the last 35 years but if you look at the long-term trends, we deliver what we say we’re going to do. And this is what we’re going to do in the next five years. So there you have it.”
    Where’s the FEAR?
    Mr. Market is afraid that Whole Foods is going to have to compete on price with every other food market out there that is trying to offer more organic foods to their customers.
    The Analyst are not convinced that Whole Foods can do this. They don’t believe in Whole Foods strategy which wasn’t clearly spelled out in the transcript.
    Instead of giving guidance, MANAGEMENT gives “Strategic Guidance” which really didn’t give the analyst any comfort on exactly how they are going to compete in what has become a very competitive price environment.
    Here’s what Jeff Mackey said:
    “Returning now to our updated outlook for fiscal year 2014 and our longer term strategic view of the vision of the business, we were overly optimistic in our ability to compare against the record breaking results we have produced for the last few years, particularly in light of the rapidly changing competitive landscape and our ongoing strategy around value.
    We’re resetting expectations for this year and for the first time, laying out our strategic vision for the next several years. This is not guidance, but rather a framework around how we intend to manage our business over the intermediate term.”
    Whole Foods is growing. But the analyst are sold on Jeff’s future for WFM.
    Jeff says:
    “we expect to increase our sales by $11 billion, approaching $25 billion over the next five years. It took us 34 years to cross the $11 billion mark. We are moving aggressively to take advantage of the tremendous growth opportunity. And with 56 new leases signed over the next — over the last 12 months, we now have a record 114 stores in our development pipeline.
    We expect to end the year approaching 400 stores and cross the 500-store mark in 2017. Over the longer term, we see demand for 1,200 Whole Foods Market stores in the United States alone.”
    These transcripts use to cost big bucks to get. Now, thanks to SeekingAlpha they are FREE and an invaluable source of information for the Rule #1 Investor.
    This is where you have to dig deeper. You have to be able to put a VALUE on WFM and then figure in your MOS. If things going forward are not going to be like they were in the past, we need to adjust our growth and earnings. And we have to figure at what multiple we’d be willing to pay to have that growth.
    Lots of number crunching to be done here if you’re a fan of Whole Foods. Whole Foods is worth something. They aren’t going to go bankrupt. So what you need to figure out is how low can they go and how much are you willing to buy IF it goes lower.
    To Your Wealth!

  • Rulers,
    I’m reading the Whole Foods Earning Transcript Call available on SeekingAlpha.com
    Some of these analyst are pretty ticked off…fun to read too!
    Here’s an excerpt during the Q and A:
    Operator: Thank you. We’ll go next to Ken Goldman with J.P. Morgan. Please go ahead.
    Ken Goldman – J.P. Morgan
    Thanks. I have to admit, I’m surprised by what I perceive to be a constructive tone on this call. You’re telling us that our estimates for the next couple years are significantly too high. Your stock’s down around 14% after hours. One of the questions I’ve been getting lately is does Whole Foods management appreciate that the world has changed and there’s a lot more competition out there?
    I’ve got to be honest. I’m not really hearing anything that’s suggesting management is taking this situation as seriously as some investors want you to. There’s a lot of talk about what’s going, not a lot to talk about what it takes to win the change market. I’m really just curious what are you doing differently versus a year ago other than taking your cost down which I think the market’s telling you may not be enough anymore?
    John Mackey – Co-Chief Executive Officer
    Well, we’re lowering prices. We’re making investments on price. We’re cutting expenses. And we’re…
    Ken Goldman – J.P. Morgan
    You’ve been doing that for years. You’ve been taking price down for years. I mean, it’s hard to understand.
    John Mackey – Co-Chief Executive Officer
    No, we haven’t. I mean, if you look at we had rising gross margins for the last five years. So we haven’t been investing in price as aggressively as we probably needed to do. So we’re going to be investing more aggressively in price going forward while continuing to take our expenses down and continuing to innovate and differentiate. That’s our t strategy. We’ve laid it out. So there you have it.
    Ken Goldman – J.P. Morgan
    All right. Thank you.
    To Your Wealth!

  • Rulers…Whole Foods Get Whacked Big Time!
    By the way, Nice commentary on BBBY. Because of the way I like to invest, BBBY isn’t a “Just One” company for me, however, I’d certainly be comfortable trading around it with smaller amounts of money – likewise, COH falls into that category for me too.
    And here’s an interesting Story…Whole Foods just tanked from $48 to $38.
    Is WFM on sale?
    Imagine for a moment that this is your “Just One” company and you loaded up in Feb 2012 and now more than two years later, you just watched your portfolio tank overnight.
    This is where you’ve GOT TO KNOW your company. I read the quarterly earnings transcripts on all my companies along with the free articles in Seeking Alpha.
    Some people are going to buy WFM today, but since I haven’t been following “The Story” I’m not ready to buy a bunch of shares.
    But I am sitting in a hotel room today and I’m going to figure out what caused Mr. Market to punish WFM and see if there’s an opportunity here.
    To Your Wealth!

  • Ryan C.

    Hey Christian,
    Some other Items to consider with regards to BBBY:
    • Share buy back program
    ○ $2.5 Billion
    ○ Complete by 2015
    ○ Authorized in Dec 2012
    ○ In Q4 2013 purchased 7.5 Million shares for $532 million ( or $70.93 avg share price)
    ○ 86% of cash flow to repurchase program over last two years.
    ○ Have decreased number of shares by 24.7% over 9 years
    ○ Increase (investors) share worth by 2.7 % per year.
    ○ $1.1 Billion left
    2014 projections
    • 30 new stores (could indicate solid growth potential)
    • Renovations and repositioning
    • Operations funded from internally generated sources (which we definitely like)
    Z value = 3867.49 – 483.52 = 3383.97
    $15.8 ZVPS
    I think this is an interesting story, and I’ll be doing more research on this one…
    Happy Hunting

  • Hi Joe,
    you are right. I thought he he focuses on few Investments, and did not proof it.
    And if a guru Investor buys a stock, it is not a criteria for us to buy it, too.

  • Joe M.

    Careful following Greenblatt. He believes in diversification. He will by a large basket of companies with high ROIC and low P/E. He will admit that some of those companies may underperform. His portfolio, according to Gurufocus, has 950 stocks. Check out his first book, “The Little Book that Beats the Market”.
    I think it’s better to following investors who have concentrated holdings.

  • Garrett wrote as a last comment “COH and BBBY are still getting hammered pretty good”.
    Let´s have a short look at BBBY!
    Share Price had a hard drop down to 60$. There is a lot of fear that this Company is slowing down growth, and that Amazon has a huge Impact on sales.
    So you have to know if this is true, and what BBBY will do in future. That´s Rule#1 homework.
    Let us jump to the valuation…
    1. dicounted cash flow based on earnings
    EPS ttm: 4.81
    Growth Rate: 9.7% (Analyst growth rate)
    P/E: 19.4
    –> Sticker Price: 58$
    –> MOS-Price: 29$
    It is no buy at 60$, or?
    2. Payback-Time (based on earnings
    –> The 8 year Pbt is 60$
    It is getting interesting, let´s have another payback-time valuation.
    3. Payback-Time (based on free-cash flow)
    FcF-Growth Rate is 19.20% (10 years) and 13.40% (5-years.
    Market cap: 12.65 bil.
    The Company has 1 bil. free cash flow, that is our starting Point.
    With the 13.4% growth-rate (stay conservative), we get a payback-time –> 6.5 years!!
    This is great, 6.5 years PBT on free cash flow.
    And by the way, Joel Greenblatt is buying this Company.
    Maybe it´s worth to invest some work in BBBY.

  • Joe M.

    Swing, not sing

  • Joe M.

    Many times a fund manager may want to buy when the market is down, but his/her investors pull money out of the fund and force their hand. The opposite is true in a bull market. Investors pile in cash and say, “sing you bum,” if the manager is holding cash.