Estimated Growth Rate Formula Using Dividend And Return On Equity Book Review – Why Are We So Clueless About the Stock Market?

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Book Review – Why Are We So Clueless About the Stock Market?

Are you ignorant about the stock market? If so, or if you’re not sure, Mariusz Skonieczny’s book is for you. Why are we so ignorant about the stock market? A short, 150-page read that focuses on principles espoused by some of the world’s most successful investors. MagicDiligence recommends the book for both new investors and experienced investors looking to “get back to basics.”

The first few chapters of the book cover a fact that is often lost in technical trend following and macro-economic predictions: the bottom line of a stock is a business, and the results of that business determine the results of investing in its stocks. long run Skonieczny briefly explains what a business is, and then talks about how a business creates wealth for its owners. For companies listed on public exchanges, those owners are stock investors. I like how the book follows the passing example of a lemonade stand, starting with “Why start a stand?” The answer, of course, is to earn better returns on investment capital, which can be achieved through options like savings accounts. The author then goes through the factors that can reduce these returns to capital, especially competition, and how the economic gap protects against this.

Later chapters cover other points investors should consider, such as diversification, broader economic trends, IPO investing, and more. MagicDiligence found the most useful of these chapters on valuation, complete with many discrete, real-company examples. Mariusz has a slightly different method for valuing stocks then the traditional discounted cash flow method. Although it is done in the same way. An investor using his method must use a range of expected growth rates, estimate the trailing P/E ratio, determine the required rate of return (discount rate), and also estimate the dividend payout ratio over a 10-year period. Using these, one can determine two components of the final return: the capital cost of the stock and the dividends paid. Add these two together and you get a target stock price. Using a range of targets, you compare it to the current stock price to see if there is a significant margin of safety. If there is, you buy.

These examples are also very well documented – the graphics in the book can easily be turned into a spreadsheet. Skonieczny also provides some help by providing a “typical” range of discount rates, as well as using historical data to assign other values. I like this approach. While the discounted free cash flow (DFCF) method is a theoretically correct way to value stocks, this method focuses on estimating real-life potential returns. DFCF does not adjust for stock market realities such as average P/E ratios varying per industry, or relative payouts of dividends varying between companies.

I found the next chapter particularly interesting, a brief but thorough description of how large, respected firms like Fannie Mae ( FNM ), Freddie Mac ( FRE ), AIG ( AIG ), and Long-Term Capital Management can collapse in a matter of weeks. . While the magic formula specifically screens out financial firms like these, it’s absorbing to read about how debt can quickly destroy these companies. The explanation of the financial benefits, why companies use it, and the dangers of its use were extraordinary.

Mariusz Skonieczny clearly shares a lot of influence with MagicDiligence. Why are we so ignorant… Magic Formula Investing (MFI) is exactly the same as using return on invested capital to determine what is a good business and what is not. But sustaining that quality requires an analysis of competitive advantages, which is well explained in two books by Pat Dorsey, both this book and MagicDiligence.The Little Book of Wealth Building and Five Rules for Successful Stock Investing) through factors such as regulatory constraints, unique assets, and economies of scale. An MFI’s short-cut for valuation, trailing income yields, can also be improved by a future-oriented examination, as in the book. If recent earnings yields are unsustainable, or if earnings yields are outside the range of historical valuations, the stock may not be that cheap. These types of analyzes are the magic formula that keeps investors from buying into a “value trap.”

In the end, the book’s brevity may be its single greatest asset. Commonly cited investment primers like Ben Graham’s Security analysis, obviously, are very long and often boring reads, the main points of which have been extracted and effectively compiled into several short books, including this one. Maintaining focus and not being too technical, Skonieczny presents only the critical components of successful fundamental investing. For beginner investors, this is a very good primer. Seasoned value investors won’t find much new material here, but it’s still a good refresher to stay on course.

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