Rule #1 Finance Blog

With Investor Phil Town


Phil_town_100 Every once in a while someone gets the hang of Rule #1 Homework on the first try. Read on.

Phil Town,

"Knowledge is power"  Francis Bacon

My 17 year old son and I heard you at a Get Motivated seminar in Corpus Christi, TX earlier this year.  He had wanted to learn about stocks since he was very small and I had put it off since they scared me–lack of knowledge breeds fear.  I had placed my faith in mutual funds. 

You opened my eyes and I took my son with me to the Investools seminar and they opened our minds to consider investing.

You emphasized practicing our trading before we invested REAL money.  Investools pushes you to move quickly.  I chose to follow your advice.  I pre-ordered your book and audiobook. While waiting for the book and CD to arrive, my son and I practiced with paper trading.  It didn't go very well and we were puzzled.  We thoroughly enjoyed the Investools seminar and using their website but we weren't getting the results we wanted or expected.  (Thank you again for the recommendation of practice, practice, practice!)

Okay, my favorite Icon on Investment,  I think I have found my first wonderful company and I want the teacher's approval or re-direction.

I seem to know a lot of people with asthma and I understand that
medical equipment like nebulizers and such are crucial but I want to
avoid drug manufacturing companies.  I found a company that makes stuff
to help people breathe (Resperonics RESP). 

It sounded like a good
company but the numbers just weren't there for the Big Five.  I
jockeyed between Investools and Yahoo Finance looking at competitors. 
I found Resmed Inc. RMD.   It isn't quite the same as what I was
initially looking at.  It specializes in sleep disordered breathing
devices.  I still get it though–when people can't breathe, they need
help and this helps them. 

I prowled around the company website and
found that I liked the way things sounded: 

"The S8 launch completion
coincides with ResMed's second business award this year. In recognition
of ResMed's technological innovation, superior marketing strategy, and
business results, Frost & Sullivan recently named ResMed the 2005
Company of the Year for Patient Monitoring. The Award recognizes
ResMed's outstanding performance in education, product innovation,
strategic planning, market development and exceptional execution, which
has driven ResMed's strong revenue and market share growth and, more
importantly, enhanced the quality of life for thousands of patients
worldwide. Earlier this year, ResMed received the Frost & Sullivan
Product Quality Leadership Award for its superior product quality and

I read selected parts of the 10K and that sounded like good business strategy to me.  The board looked to be a good mix of backgrounds in engineering and
finance.  The CEO is also the founder of the company and has devoted
his career to this type of research. 

Now for the Big Five.  Here are the numbers I came up with using Investools, MSN and your calculators.

  • ROIC   16.2
  • Sales Growth Rate   29.05
  • EPS    41.93
  • Equity Growth Rate  29.09 (I am shaky on this one.  I couldn't make
    heads or tails of this on Investools Balance Sheet so I went to MSN and
    used your calculator.)
  • FCF   35.27

I thought that the Sticker Price would be higher but the Sticker Price
I get from the Investools Valuation screen is $56.36, so my MOS should
be $28.18.  The current price is $44.01, so I watch it until it hits my
MOS or better. (?)

Thank you, again.


Here's my critique of Catie's homework:

Let's look at your homework on RMD:

First thing is you got a HUGE thing right and I don't know if you know
you did.  You found a business that has a CONSISTENT financial

What I do immediately when looking at a new biz is look at the Balance Sheet to see if Equity is growing consistently.  It is.  Every
year it goes up. 

Then I look at Debt and it's going down. 

Then I go to
the Income Statement
and see if Sales and EPS are both going up
steadily.  They are. 

Now I look at Free Cash Flow.  Bumpy but not

Now ROIC — over 10% and not going down. 

OK.  This has
consistency.  This is CRITICAL to being able to predict the future.  If
the past is all over the place, then we're going to have to be real
smart like Buffett to figure out what the future is. 

So yes, this has
consistency in its history.  That tells me there may be a MOAT here
somewhere.  But what is it?

This is a consistent earner (like one of Tony Soprano's best boys) so
we want to know more about it.  What is the moat?  How does this
business protect itself?  Remember the five kinds of moats?  (Look'em
up!)  Tell me which one this has… if any.  No moat, end of story.
Good moat plus good numbers to verify it and I wanna know more.

Knowing more means it's time to dig in on the numbers and find out if
that consistent growth that is obvious just from looking at the Sale,
EPS, Equity and Cash lines for the last ten years is growing at the
same rate, at a faster rate or at a slower rate. 

So we have to do the little
calculation for 10 years, 5, 3, 1.  And then decide what growth rate
we're happy with.   Then when we do our Sticker Price analysis we can
decide whether to use our estimate or the analysts.

Assuming that the analysts estimate is lower than historical (and it
looks like it is at first blush) and that the historical PE is lower
than the Rule #1 PE (and that looks like it is, too) then I agree with
your Sticker Price and MOS.  Nice job.

And accurate conclusion: We want to start buying at a 50% discount or
thereabouts to the Sticker Price.  In this case, as you point out, the
Sticker is at $56 so the MOS that you identified at $28 is also
correct.  And as you point out, the price is $44.  Too bad we didn't
find this one a year ago when it was priced at $28!  But you found it
now and now it goes on your Watch List to see if there isn't some bad
news sometime either in the economy, the sector, the industry or the
business that drives out the bulls for a while and lets us in with a
nice big MOS.

So you did it right.  First try.  Congratulations.

Oh, one more thing.  I'd say that out of 10 trades in a good Rule #1
stock, in any given year, 60% of them will lose slightly (2-5%) or have
a zero return.  40% will have a postive return.  Maybe 2 will have a
very positive return.  Stock prices are subject to great emotion: fear
and greed.  Stocks that move, move suddenly and aggressively. 

Our job
is to be there for the days that the aggressive move is up and to be
outta there on the days when the aggressive move is down.  Don't be
discouraged by having your first efforts not make money.  Remember Rule
#1 and if, at the end of the year, you have not lost money, then I
assure you, you have the skill set to make money big time when you get
it right.

Now go play!