1. Adequate Size of the Enterprise

2. A Sufficiently Strong Financial Condition

3. Earnings Stability

4. Dividend Record

5. Earnings Growth

6. Moderate Price to Earnings Ratio

7. Moderate Ratio of Price to Assets

Buffett says that if you must buy a stock, make sure that the company’s earnings coupons:

1. can beat inflation
2. can beat government bond yields, which are priced to reflect inflation
3. can rise over time

So Buffett recommends that you should only buy a stock if its earnings yield (current earnings divided by its current price) is near or above yields on a long term bond. Otherwise, you are better off buying the bond.

The only time you should accept earnings yields lower than the long term bond is when the company is growing its earnings at a very high growth. But if you must wait a few years for the earnings yield to catch up to the long-term bond yield, then you are still better off buying the bond in the short term.

Inflation is essentially bad for stock prices. You have to be able to pick the right stocks at the right time.

So what are good investments?
According to Jerome Smith,

Traditional rules of money management lead to incremental destruction of one’s principal at rates exceeding dividend and interest income rates - and ultimately, the destruction of one’s capital. During a runaway inflation, the investor’s primary concern must be the preservation of his capital. With conventional avenues becoming guaranteed losers, he must seek new investments, evaluating them according to new criteria.

So what are the essentials for preserving wealth?
1. Invest in real assets like precious metals.
2. Invest in foreign currencies.
3. Don’t over-leverage. Some leverage is okay, but too much is risky. Its always good to have liquidity.

Fundamental Analysis

This type of analysis of a business involves analyzing its financial statements and health, its management and competitive advantages, and its competitors and markets. The analysis is performed on historical and present data, but with the goal to make financial projections. There are several possible objectives:
* to calculate a company’s credit risk,
* to make projection on its business performance,
* to evaluate its management and make internal business decisions,
* to make the company’s stock valuation and predict its probable price evolution.
Prediction of how the stock will move, normally for the longer term, is based on the company’s fundamentals and valuation.

Technical Analysis

This manner of playing the market assumes that non-random price patterns and trends exist in markets, and that these patterns can be identified and exploited. While many different methods and tools are used, the study of charts of past price and trading action is primary. It maintains that all information is reflected already in the stock price, so fundamental analysis is a waste of time. Trends “are your friend” and sentiment changes predate and predict trend changes. Investors’ emotional responses to price movements lead to recognizable price chart patterns. Technical analysis does not care what the “value” of a stock is. Their price predictions are only extrapolations from historical price patterns.

A Stroll Through The 7 Habits of Highly Effective People

The entire premise of The 7 Habits of Highly Effective People is that most people deal with the problems in their life in a scattershot fashion, and this scattershot fashion leads to disillusionment and disorder. Covey’s answer to this is that to be a truly effective person, you need to learn to solve personal and professional problems with a integrated and principle-centered approach - in other words, the decisions you make both personally and professionally should come from the same core set of values and ideas.

The book is really about developing that core set of values to the point where it’s easy to draw solutions to problems from them, making you a much more effective person in all aspects of life. The seven habits, thus, are ways to draw out the fundamental truths in your life and make them accessible to you at all times, so that when you’re faced with problems, you can easily solve them in a consistent and sensible fashion.

Habit 1: Be Proactive
Principles of Personal Vision

In everyone’s life, there are a multitude of events that occur every day. Out of all of these events, there’s only a subset that are actually of concern to us - the rest really don’t matter (think of things like the neighbor playing catch with his son and the ball bouncing into your yard that you notice out the front door - an event that really doesn’t matter to you). Within that set of events that are of concern is a smaller set that you actually can do anything about, your sphere of influence, so to speak. Now, where is your focus? Is it on those events that you can do something about, or on the ones that are out of your control?

The idea is don’t spend your time focusing on events that you can’t control; instead, focus on what you can control. Let’s say, for example, that you’re waiting for a very important phone call. Some people stress out waiting for the call - that’s a bad habit because you can’t control when the phone call comes. On the other hand, others simply spend their time focusing on the things they can control - the phone call will eventually come, right?

How can you achieve that? Spend a day counting the number of times you spend focusing on stuff you can’t alter the outcome of. Do you daydream about unachievable things? Do you worry about stuff you can’t affect? Cast those efforts aside and spend your time on things that you can affect.

Habit 2: Begin With The End In Mind
Principles of Personal Leadership

This chapter starts out literally at the end: imagine your funeral and what others there are saying and thinking about you. What do you want them to say? The things that you want them to say are the real core values that you care about the most, and thus they should be the ones that you focus your life’s work on, both personally and professionally.

This leads to something that I consider really worthwile: writing your personal mission statement. Can you really codify in a few sentences what your mission in life is? It seems trite, but it’s truly effective if you really spend the time to work out what it really means and actually state it in words - in writing.

The chapter goes through several exercises for teasing out the meaning, but it really all comes back to that funeral scene at the beginning. What will your family say at your funeral? What will your coworkers say? What about your friends? What about people in the community? What do you want them to say about you? That’s your mission.

Habit 3: Put First Things First
Principles of Personal Management

Most things that we do each day can be divided up in two different ways: they’re either urgent or not urgent, and they’re either important or not important. Obviously, in our lives, we wish for the things we do to be important, but we’d also like for them not to be urgent, because urgent things cause stress. So, ideally, an effective person focuses on things that are important but not urgent.

Covey goes a long way with this central idea here, pointing out that we should strive to do this in all aspects of our life, no matter which hat we’re wearing at the moment: worker, parent, spouse, volunteer, and so on. Then, within each of those roles, one should define specific goals that they wish to accomplish, important short term ones. For example, in my role as a parent, I might have a goal of taking my son to the park this week for two hours.

Once you’ve defined a couple of goals for the upcoming week for each of your roles, literally schedule them in. Add these things to your schedule and don’t let anything interfere with them. Because these items are not urgent, you have some flexibility on when to do them, but because they’re important, you must schedule them and keep it on the schedule. He even gives a sample weekly planner page to make this easier. I think this is a fantastic idea and I’m using it to a degree with my 101 goals in 1001 days project.

Habit 4: Think Win/Win
Principles of Interpersonal Leadership

My wife took a course on the seven habits a while back and her reaction to it was that it was full of business buzzwords that didn’t really apply to her life. I now realize that almost every example she used to illustrate that came from this chapter.

Yes, the whole “win/win” business-speak came from this chapter, but that doesn’t mean the idea is bad or flawed. Instead, take it as a fundamental way to see all interpersonal relationships. Is there a way where you both can come out ahead at the end of an interaction? If there is, that’s usually the best road to take, and that’s the real value of the whole “win/win” thing.

I tried some of the exercises from this chapter, and the one that really stood out to me was to think about a relationship in my life that wasn’t in a “win/win” state. I wrote down every notable aspect of the situation from my perspective, then tried to do the same from her perspective. Doing that brought me fairly close to seeing a win/win solution, so I went and had a talk with her, and things were quickly repaired. It really does work.

Habit 5: Seek First To Understand, Then Be Understood
Principles of Empathic Communication

This is probably the habit I’m worst at because I often fill in the blanks unnecessarily when talking with people, which is an incredible no-no. Instead, an effective communicator really tries to understand as much information as possible about the situation before providing a solution.

Covey offers a great example of this in the middle part of the chapter, when he outlines a discussion with a teenage boy that goes terribly. The problem is that they’re speaking to two completely different things: the boy is having difficulty expressing his problem, while the parent is already trying to guess at the solution.

What can be learned? Don’t stab at solutions until the full story is told. If someone comes to you with a situation, hear them out; often it requires the full story and some questions before the correct plan of action is revealed. This means listening and attempting to see the situation from the speaker’s perspective, not just your own.

Habit 6: Synergize
Principles of Creative Cooperation

Although I expected this chapter to be similar to the buzz-speak of the fourth habit, this one actually turned out to be much more worthwhile, because it’s about dealing with the people that tick you off and turning that into something beneficial.

I’m as guilty of it as anyone else: I simply fail to get along well with some people, even people that I ought to get along with for the benefit of both of us. The real key to doing it is to identify what exactly about that person makes them beneficial, and also the specific traits about them that cause you not to like them. Once those are clear, how can those traits be used all together, perhaps along with your own, to make the situation better?

My wife and I do this in parenting. I often find our son’s socially anarchical toddler behavior to be humorous, so when he drops his pants or tries to ride the cat like a pony, I often am forcing myself to suppress laughter and thus can’t really make it clear that it’s the wrong thing to be doing (if he does something truly wrong, though, I’m just fine); on the other hand, I’m much better at reading to him than my wife is and I appear to be his primary language teacher. So we synergize: she focuses on social areas while I focus on reading and language building.

Habit 7: Sharpen the Saw
Principles of Balanced Self-Renewal

This final habit focuses on the need to do things that renew you in several different ways: physical, mental, spiritual, and social/emotional. Quite often, we get so caught up in the day-in and day-out business of life that we rarely step back and spend any time focusing on taking care of ourselves.

Covey ties this in with the third habit and encourages the reader to identify ways to really renew oneself in each of those areas, then literally schedule it in and stick to it, because it’s important but not necessarily urgent. For example, if the physical nature of things is what’s dragging you down (some extra weight, or a general malaise), schedule time to get some exercise two or three times a week and stick with it. If you’re feeling mentally drained, schedule a period of time to relax and let your mind float onto something outside of your normal thoughts (like a book or a movie) or even just meditate. And so forth.

When I was growing up, my family used to devote Sunday afternoons to such tasks. Everyone would take two hours to do something mentally invigorating, like reading a book or doing a puzzle, then everyone would spend two hours doing something physically invigorating, like working in the garden or running or something. It wasn’t as formal as that description, but every Sunday afternoon, it was part of the routine, and it’s something I look back on with fondness as it really helped me recharge and shape my life.

Value Line.

These are the ratios he is considering, and how to find the information in Value Line:

• Book Value: (Total Assets - Intangible Assets - Total Liabilities) / Outstanding Common Shares ; This is found directly on the right side of the Value Line page, titled Book Value per share.
• Debt/Equity: Total Liabilities / Shareholders' Equity ; Not provided directly by VL, a simple calculation using Total Debt (listed under Capital Structure) and Shareholders' Equity (on the right side) reveals the ratio.
• Working Capital: Current Assets - Current Liabilities ; Found directly on the right side of the page.
• Current Ratio:  Current Assets / Current Liabilities ; Not directly provided, the requisite figures are both found under the Current Position section on the left.
• Net Quick Asset Value:  Current Assets - Inventory - Current Liabilities ; Not directly provided, the information is found in the Current Position section.
• Quick Ratio:  (Current Assets - Inventory) / Current Liabilities ; Same as previous ratio.
• Net Net:  Current Assets - Current Liabilities - Long Term Debt ; Simple calculation of Working Capital (found on the right) - Long Term Debt (also found on the right)
• Net Net Current Assets per Share:  Net Net / Outstanding Shares ; Common Shares outstanding is found on the right side of the page. 
• Price/Earnings Ratio:  Found at the top of the page
• Profit Margin:  Gross Profit / Total Sales ; Listed as Net Profit Margin, found on the right side.

Overall, Value Line is an excellent source for the average individual investor seeking to do some research before purchasing. 

My screening criteria:

• 10 Yr Sales Growth Rate
• 5 Yr Sales Growth Rate
• 1 Yr Sales Growth Rate
• 10 Yr EPS Growth Rate
• 5 Yr EPS Growth Rate
• 1 Yr EPS Growth Rate
• Book Value Growth Rate

All these growth rates had to be greater than 10%. As you can see, I have left out the cash flow growth rate. Phil Town states that this is the least important one as the company may deploy all its cash during a growth spurt. So I would prefer to look at this criteria on a case by case basis.

I also added the following liquidity ratios as criteria to ensure that the business is not growing due to debt:

• current ratio > 2.0
• quick ratio > 2.0
• debt-to-equity ratio < 1

And lastly, in my initial screen, I used the PEG ratio to determine if the business was selling at an attractive price. This time, I decided to not use the PEG ratio. That way, I could get a look at all the wonderful businesses. Instead, I decided to sort my list in order of the earnings yield.

The earnings yield is the current EPS divided by the current price. We can use the earnings yield to determine which stocks are selling at a discount.

Sharpe Ratio

Developed by William F. Sharpe, this calculation measures a ratio of return to volatility. It is useful in comparing two portfolios or stocks in terms of risk-adjusted return. The higher the Sharpe Ratio, the more sufficient are returns for each unit of risk.

Taking Stock
I implemented many of the suggestions I received from our financial planner and have made a few tweaks since then. A review of the investment holdings of several personal finance writers yesterday gave me a chance to take a look at where we stand today. The small investing experiment that began about seven years ago is now worth a little more than a quarter million dollars and is relatively well diversified as you can see below:

29% - Vanguard 500 Index (VFINX) – Large Blend
14% - American Century Equity Income (TWEIX) – Large Value
13% - Vanguard Small-Cap Index (NAESX) – Small Blend
11% - American Century Ultra (TWCUX) – Large Growth
11% - Vanguard Total Bond Market Index (VBMFX) –
6% - American Century Intl Growth (TWIEX) – Foreign Large Growth
5% - Vanguard High-Yield Corporate Fund (VWEHX) –
4% - Oakmark International (OAKIX) – Foreign Large Value
4% - Vanguard REIT Index (VGSIX) – Real Estate
3% - Dodge & Cox International (DODFX) – Foreign Large Value

What the heck are Bollinger Bands? Created in the 1980s by John Bollinger, they are the plots two standard deviations above the moving average, two standard deviations below the moving average, and the moving average itself. It’s measures volatility because the standard deviations will increase with increased volatility, i.e. the bands will widen. When the moving average isn’t as volatile, the bands will shrink. Below is a chart from Investopedia that charts the bands of one stock and the moving average is for 21 days.

Image from Investopedia

So, how do you read it? As the price moves closer to the upper band, the more the stock is more overbought; as it moves closer to the lower band, the stock is more oversold. Being oversold may indicate a buying opportunity as the price has been depressed, perhaps below its true value; the opposite if it’s overbought. Simplistically, how some people use it is that when the price is below the moving average, they wait until it hits the lower band to buy. When they have the stock and the price is above the moving average, they will wait until the price hits the upper band to sell.