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Stock Investing 101

www.younginvestorssociety.org

STOCK INVESTING 101

Copyright © 2016 by Young Investors Society

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Young Investors Society

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www.younginvestorssociety.org

LESSON 1: THE SEVEN GOLDEN RULES OF INVESTING ............................................................................3

Introduction ................................................................................................................................................................3

ARE YOU AN INVESTOR? ......................................................................................................................................3

SECTION 1 ....................................................................................................................................................................5

Who are Investors? ......................................................................................................................................................5

Starting Early ...............................................................................................................................................................6

WHAT DOES IT REALLY MEAN TO INVEST IN THE STOCK MARKET? ..................................................7

SECTION 2 ...................................................................................................................................................................9

BEATING THE MARKET ........................................................................................................................................9

QUESTIONS TO CONSIDER: ...............................................................................................................................10

SECTION 3 .................................................................................................................................................................11

THE SEVEN GOLDEN RULES ..............................................................................................................................11

LESSON 2: THE VALUE OF A STOCK ..................................................................................................................16

Introduction ..............................................................................................................................................................16

SECTION 1 ..................................................................................................................................................................17

WHY DO STOCK PRICES FLUCTUATE SO MUCH? .....................................................................................17

MR. MARKET ..........................................................................................................................................................17

SECTION 2 .................................................................................................................................................................19

WHAT IS THE VALUE OF A BUSINESS? ............................................................................................................19

SECTION 3 .................................................................................................................................................................24

UNDERSTANDING THE TERMINOLGY ..........................................................................................................24

THE "GO-TO" WAY TO VALUE A BUSINESS: P/E RATIO .............................................................................25

LESSON 3: WHAT MAKES A GOOD BUSINESS? ..............................................................................................27

Introduction ..............................................................................................................................................................27

SECTION 1 ..................................................................................................................................................................28

HOW DO I KNOW IF A COMPANY IS A GOOD BUSINESS? .......................................................................28

SECTION 2 .................................................................................................................................................................30

WHATEVER FLOATS YOUR MOAT ...................................................................................................................30

Types of Economic Moats ......................................................................................................................................30

LESSON 4: FINDING STOCKS TO INVEST IN ..................................................................................................41

Introduction ..............................................................................................................................................................41

SECTION 1 .................................................................................................................................................................42

HOW DO I COME UP WITH INVESTMENT IDEAS? ...................................................................................42

SECTION 2 .................................................................................................................................................................44

STOCK SCREENS ....................................................................................................................................................44

IS THE COMPANY GOOD? ..................................................................................................................................45

TABLE OF CONTENTS

IS THE COMPANY GROWING? ..........................................................................................................................45

IS THE STOCK CHEAP? ........................................................................................................................................45

THE S&P 500 & THE DOW JONES: ....................................................................................................................47

SECTION 3 .................................................................................................................................................................48

RESEARCH REPORTS: ...........................................................................................................................................48

GIVING DUE DILLIGENCE ITS DUE ................................................................................................................49

LESSON 5: LEARNING TO SPEAK THE LANGUAGE OF FINANCE ............................................................52

Introduction ..............................................................................................................................................................52

SECTION 1 ..................................................................................................................................................................53

WHY DO COMPANIES PREPARE FINANCIAL STATEMENTS? .................................................................53

WHO USES FINANCIAL STATEMENTS? ..........................................................................................................53

WHAT ARE THE THREE FINANCIAL STATEMENTS? .................................................................................54

THE BALANCE SHEET ..........................................................................................................................................54

SECTION 2 .................................................................................................................................................................56

THE INCOME STATEMENT ................................................................................................................................56

THE STATEMENT OF CASH FLOWS ................................................................................................................57

SECTION 3 .................................................................................................................................................................59

HOW DO I FORECAST REVENUES OF A COMPANY? ................................................................................59

HOW DO I FORECAST MARGINS OF A COMPANY? ..................................................................................60

COMPANIES ............................................................................................................................................................63

APPENDIX A: SELECTED FINANCIAL STATEMENTS .................................................................................64

LESSON 6: THE INVESTMENT THESIS .............................................................................................................73

SECTION 1 .................................................................................................................................................................75

WHAT IS AN INVESTMENT THESIS? ...............................................................................................................75

SECTION 2 .................................................................................................................................................................78

LESSON 7: INTRINSIC VALUE ..............................................................................................................................82

SECTION 1 .................................................................................................................................................................84

SECTION 2 .................................................................................................................................................................86

Determining the Intrinsic Value of a Company ...................................................................................................86

!

e Discounted Cash Flows method .....................................................................................................................86

SECTION 3 .................................................................................................................................................................89

!

e Relative Valuation Method ..............................................................................................................................89

Two Primary Valuation Options ............................................................................................................................92

GLOSSARY OF TERMS ............................................................................................................................................93

5

LESSON 1:

THE SEVEN GOLDEN RULES OF INVESTING

W elcome Young Investors! It is our goal to make you master investors. Many of the lessons you will learn have been used by successful investors over several generations. You will notice that a recipe for success is easy to follow but is actually followed by few. Let's start with a question:

ARE YOU AN INVESTOR?

Are you a spender or an investor? Pop Quiz. Ready. Go.

Question #1

I'll give you $100 today or a new Mercedes next year? Which one will you take? A) ! e cash B) ! e car C) Why are you even looking at other options, you'd be crazy not to take the car!

Question #2

I'll give you $100 today or $100 next year. Which one will you take? ! ink about it... A) ! e cash today B) ! e same cash tomorrow C) Of course you wouldn't wait! What's the point? You wouldn't get anything in return for waiting. In one minute we've narrowed down whether you are an investor or a spender. You're a spender if you don't get a return. You're an investor if the future is worth somewhere between $100 and a new car. ! e question of whether you will invest is really just a question of how much you believe tomorrow can o " er. How much could the future be worth for a bit of sacri # ce today? ! at is the key question that every investor asks themselves....

Introduction

6

QUESTIONS TO CONSIDER:

1. How much cash would you be willing to give up today in return for a

promise to receive $500 5 years from now from that investment? $50? $100? $300? $450?

2. What does a low number ($50) say about you? What does a high number

say about you ($450)?

YOUNG INVESTORS SOCIETY . STOCK INVESTING 101

7

SECTION 1

Who are Investors?

T he truth is that WE ARE ALL investors. When we hear the word investors, we may think of a high- $ ying Wall-Street banker in a blue-pin striped suit. ! at is certainly one type of investor, but so is the business owner, the family trying to save for their kids' college, and the college student trying to scrape up enough quarters to eat dinner. We all need to manage the money we make, and we all hope to end up with as much money as possible. ! e question of building wealth in your life will really boil down to two questions?

1) Are you able to save each year?

2) When you save, where do you put the money?

Hypothetical

Let's assume you're 20 years old and just took a job as a # reman, your childhood dream (what kid doesn't want to be a # reman, right?). Your salary is meager, but you make the goal to save $1,000 dollars per year and put it in a retirement account. You work and save for the next 50 years until you retire. Does it really matter where I put that money, I mean it's only a thousand bucks a year? Well you have a couple of options, let's evaluate.

1). !e savings Account (otherwise known as the

"Under the Mattress" approach). ! e easiest and "safest" thing is you could just put the money in cash. Nice and safe! It will never go away and it won't go up and down.

Average Annual Return: 0%

Amount Accumulated in 50 Years: $50,000

2). Bonds or Real Estate. Most people say that they get

most of their retirement funds from investing in their home and watching it increase in value. Or investing in bonds. Both of these options will grow in line with in $ ation, which on average is about 3% per year.

Average Annual Return: 3%

Amount Accumulated in 50 Years: $116,000

YOUNG INVESTORS SOCIETY . STOCK INVESTING 101

8

3). !e Stock Market. Scary, right? It goes up and down. !ere are times

when it can decline by 20% in a short period of time, inducing panic and scary headlines. But over time, the stock market grows with how fast corporations grow. In every ten year period, the stock market earns you

8-10% returns. In fact, over the last century, the S&P 500 (the largest 500

companies in the US) have returned 9.8% per year. Average Annual Return: 9.8% Amount Accumulated in 50 Years: $1,359,199 So does it really matter where you put your money? Uh, yeah! It makes all the di " erence in the world. In fact, the more money that you can put in the stock market early, the more the magnifying e " ect of "compound interest" or "compounding" can work in your favor. "Compound interest is the eighth wonder of the world" -Albert Einstein Now, I know what you're thinking. If going from 3% to 10% return gets me an extra million dollars, what does getting a 20% return do? Warren Bu " ett, the legendary investor, for example earned 30% return over a period of 30 years. (called the famous "30/30").

4). Beating the Market. !is isn't easy, it isn't for everyone, but let's say you

take a few hours per week, and you do your homework, and invest in some exceptional companies through the stock market, and earn an extraordinary 20% return per year. ! is is a very high return (even 12% per year is quite a feat) but let's just assume you're really good at # nding great stocks.

Average Annual Return: 20%

Amount Accumulated in 50 Years: $109,826,119 (Yes, that's over $100 million dollars) ! at's a huge fortune for a # reman saving just $1k per year. So, now you know why you heard your dad's friend bragging that he "beat the market" on his investment portfolio last year. ! e di " erence between 3% and 10% may seem small, but it makes all the di " erence in the world towards building wealth.

Starting Early

Compound interest is a powerfu l e

" ect, and the EARLIER you start investing the more it will work for you. Consider the example above with the # reman, but instead of starting to save at 20 years old, instead he starts to save at 40 years old. Instead of retiring with $1.3 million he will retire with only

YOUNG INVESTORS SOCIETY . STOCK INVESTING 101

9 $190k. Look at the results below assuming he invests in the stock market:

Started saving $1,000 per year at