Hi, I'm Jimmy in this video
we're looking at some fears that
many investors have fears
like what if the stock market
crashes or what if I pay
too much for a stock?
Or what if I lose money in
investment or what if I miss
out on a great investing
opportunity?
Well, for that, I have three
basic rules to help ease
these investing fears.
And if we follow these rules,
whenever we're looking to get
involved in a new investment,
well, we'll be far more likely
to at least control
our investing fears and ultimately
allow us or empower us
to live the financially independent
lifestyle we all want and
deserve.
Okay. Let's start with the first
investing rule.
And this one focuses on
finding the right company and coming
up with a fair value of the stock.
So our first rule is to keep
it simple.
Now many this may sound
easy and somewhat of a generic
investing rule, but
I personally, I have found that
it takes a fair amount of discipline
to keep things simple.
Now, I think this is particularly
true when we're picking a stock
or trying to come up with a fair
value of a stock, because
oftentimes as we do our research
and we learn more about a particular
company.
Well, we want to include every
new piece of information that we
uncover about that company.
And we want that to impact our
belief of how fast
a company might grow or how
successful an acquisition might be
or ultimately how good
the company really is that we're
analyzed. So just focusing on
picking the right stock for a second
as we read about the company by
going through maybe their annual
report or through their investor
presentations or things like that.
Well, during that process
or by the end of that process,
really, we should ask ourselves
we should decide if we like the
company based on whether
or not we can explain simply
why we like the company.
If we can defined and if we
can simply explain what
we like about this business over the
long run or over our intended
investment horizon.
So if we're going to we plan on
holding it forever or for a few
years, whatever it is, can we
explain simply and let's say
under two minutes why we like
it and what we need for it to happen
with this stock, for this
to be a good investment?
If we can do that, then that
essentially becomes our investment
thesis. And by keeping it simple,
we can help. We can help drown out
some of the noise that might come
with this investment and this keep
it simple. Rule also meshes
well with the second rule.
When we're trying to come up with
the fair value of the stock and
where we buy the stock or getting
over the fear of not knowing when to
buy that or at what price to buy
it. So for that,
rule number two is to create our
own baseline rules
for when we enter a stock.
So personally, when I try to value
stock, I like to use discounted cash
flow. That's generally my favorite
version.
Basically, that's when discounted
cash flow is when we project how
much free cash flow a company will
earn over the next few years.
And then we try to determine what
that's expected to be worth today.
Then in theory, we want to buy the
stock for less than that
calculation of fair value.
Now, I did a whole video on when
to buy a stock, but for the sake of
this video, it's important
that we set our baseline
rule for ourselves.
And we want that rule to be
simple enough that maybe we could
write that rule down an index card
as to why we're investing in the
stock and at why
we're investing at this particular
price. For example, maybe
I like Apple stock and
I did a video on how to do
this kind of cash flow and I was
like a step by step guide on doing
this kind of cash flow.
And in that video, we came up with
a fair value. I used Apple as the
example, and that calculation
said that the fair value of the
stock was two hundred nineteen
dollars per share.
Well, I'm fairly confident
in that analysis.
And my personal baseline rule
is that if I'm fairly
confident in my analysis, in my
calculation of fair value, I want
a 20 percent margin of safety,
which means that I won't buy Apple
stock unless it falls 20
cent below 20 percent below
my calculation of fair value.
So I take the two hundred nineteen
dollars per share and
I multiply that by point.
Eight point eight comes from
we take the one which represents a
hundred percent. Subtract the 20
percent that I require in
order to get involved.
Multiply the point eight.
So that's really 80 percent.
80 percent of to 19 means
that I can't enter Apple stock
unless it falls below one hundred
and seventy five dollars per share.
Now here's the best part when it
comes to answering questions like
what if the stock market crashes
or what if I lose money
or what if I miss out on
a great investment opportunity?
Well, now, by keeping our process
simple and defining our baseline
rules, well, now we can just lean
on those rules.
We can essentially essentially
blame the rules.
For when when we either
get in or don't get into a stock.
So if Apple never falls
below the 175 and we don't buy
it. Well, we didn't really miss the
opportunity. Our opportunity.
Even if it goes to four hundred
dollars a share.
We weren't going to buy.
We have a rule. We're not going to
buy unless it falls below.
In this case, 175.
Now, if it does fall below the 175,
then we jump in.
What if it keeps falling?
What if the stock market's in the
middle of crashing and we jump in
and buy it and it keeps falling?
Well, this is the key to this whole
rule working.
If we know why we
invested, then all we have to do is
to continue to challenge our
why we're investing in this stock.
So are we take our simple investment
thesis and we say, has
anything fundamentally changed
about why we want to invest in this
stock? So if the stock we bought it
one seventy five and it continue to
crash, maybe it's down to 150 on
twenty five.
Well, fine, maybe we
can jump in and buy more.
If the fundamentals of what
we like about the company hasn't
changed, then perhaps
this is a bigger opportunity to buy
more of this stock.
So maybe we invested in Apple
because we believe that Apple has a
strong brand and they have a very
loyal customer base
and that loyal customer base
is willing to pay a premium for a
very good product.
If that hasn't changed, then I'm
guessing that the current loss that
we're experiencing is just
temporary.
OK. So that's rule 1 and 2 where
we want to keep it simple and we
would want to define our own
baseline set as set of rules
as to when we buy the stock.
Now, Rule 3 looks to tackle
the fear of, well, how do I
know that I have the right stock
price at all in our Apple example?
Well, my calculation of the fair
value was two hundred nineteen
dollars.
How can we be reasonably
confident that that that is a fair
valuation?
And for that, our third rule
is to start with the group
or basically to start with consensus
estimates. What we're trying to come
up with our fair value of a stock.
So anyone who is it who's seen
any videos that we've done, any
company analysis videos where we use
this kind of cash flow may
know that I like to
use consensus estimates for
what expected free cash flow
is going to be going up the next
couple of years.
So starting with consensus estimates
is what I mean by starting with the
group right now as an example
on Yahoo! Finance.
Apple has 40 analysts
that are estimating what, 20, 19
earnings per share will be and 41
analysts estimating how what revenue
should be over the next year or two.
Well, we can use
these projections as a starting
point for our own projections.
Now, I'm not suggesting that we need
to stop here, but we
all know that analysts can be wrong.
But if we start there and then we
adjust their estimates
based on the research that we
do. So we start with them, as we
say. You know, I see why they're
doing it, but I think it's going to
be a little better, a little bit
worse. Well, I'm a little bit more
conservative. What doesn't work out
that well? Well, we can adjust those
numbers accordingly.
This is a lot better way of doing it
than trying to model out the
entire business to come up with
revenue estimates or profit
estimates or free cash flow
estimates. Now, I learned this
a few years ago.
I went to an analyst training course
that was put on by the director of
training for Morgan Stanley's
global research team.
And he once said to me
something along the lines of
the more complicated that our
valuation method is, the
more likely that something will go
wrong. Warren Buffett said something
similar to this about when he was
talking about valuing a stock in one
of his shareholder letters where he
said, I would rather be vaguely
right than precisely wrong.
So in my mind, all of
this points towards keeping the
why we buy a stock.
Very simple.
And though when we buy the stock
very simple by following our
predetermined set of rules
and then we start with consensus
estimates and only make adjustments
to consensus as necessary.
This should really help our job
much easier when it comes to what
stocks we buy.
Where do we buy it?
Because at the end of the day, our
job is to find great investments
and help each of us achieve our own
financial independence.
So if you find yourself
getting stuck on coming up,
the fair value of stock.
Well, like I said, personally,
I prefer using the discounted
cash flow technique and I've got
a link below and our box
should pop up towards the end of the
video that will send you over the
discounted cash flow video.
I think that's a good place to go
to.
But if you prefer
if you prefer to focus more on the
margin of safety side of things,
well, then head over to a video
where we talk about when to buy a
stock.
And that should be the next video
you watch. If you're unsure if
you're a bit nervous about when to
jump in and actually buy it.
But the key to this whole thing for
all of us is to recognize
that any estimates of
fair value are just
that. Their estimates that we.
Came up with even in the Apple
example I used to 19,
maybe Apple's not really worth to
19, maybe it's worth to 10, maybe 20
to 30 these.
That's why we add a margin of safety
to this whole thing, because if it's
worth to 10 or to 30 or to 19,
if we buy it at one seventy five.
I'm fairly confident we're going to
do OK over the long run.
Now, I do think it makes sense
for us to continue to watch
each of our companies and continue
to challenge our investment thesis.
But if we adopt these three
rules, I think this will go a long
way towards easing some
of our investment fears and help
us achieve the financial
independence that is the purpose
of investing.
So thank you very much for sticking
with me all the way into the video.
I really appreciate it.
And I'll see in the next video.
Thanks.