Table Of ContentG O O D
S T O C K S
CHEAP
Value Investing
with Confidence
for a Lifetime
of Stock Market
Outperformance
KENNETH JEFFREY MARSHALL
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Copyright © 2017 by Kenneth Jeffrey Marshall. All rights reserved. Except as permitted under the United States
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He picked the right girl.
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CONTENTS
PREFACE vii
ACKNOWLEDGMENTS xiii
INTRODUCTION xv
PART I
FOUNDATIONS
CHAPTER 1: The Quiet Outperformer 3
CHAPTER 2: Why Stocks? 7
CHAPTER 3: Price and Value Are Different 15
CHAPTER 4: Measuring Performance 19
PART II
THE VALUE INVESTING MODEL
CHAPTER 5: Understanding the Business 29
CHAPTER 6: Accounting Is a Language 39
CHAPTER 7: Capital Employed 51
CHAPTER 8: Operating Income 65
CHAPTER 9: Free Cash Flow 71
CHAPTER 10: Book Values and Shares 79
CHAPTER 11: Past Performance 85
CHAPTER 12: Future Performance 97
CHAPTER 13: Shareholder- Friendliness 115
CHAPTER 14: Inexpensiveness 129
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vi CONTENTS
CHAPTER 15: Price Drives Risk 147
CHAPTER 16: Misjudgment and Misaction 151
PART III
MAINTENANCE
CHAPTER 17: Portfolios and Selling 165
CHAPTER 18: Endurance 173
CHAPTER 19: Generating Ideas 175
CHAPTER 20: Differences Among Value Investors 183
CHAPTER 21: Preservation 187
GLOSSARY 191
BIBLIOGRAPHY 207
NOTES 209
INDEX 215
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PREFACE
First, my goofs. I failed to sell my Coca- Cola Company shares when
they spiked past $80 in 1998. That price suggested that every man,
woman, and child on earth had just pledged to drink a bathtub full of
soda a week for life. And I knew that that hadn’t happened.
Worse was Nike. I started selling it at $67 per share in 2010, con-
cerned that its price- to- book ratio had swelled past three. But I knew
that the treasured swoosh logo was carried on the company’s balance
sheet at precisely zero. Nike’s earnings and stock price have both
soared since then.
Lest my blunders be limited to consumer goods, in 2011 I passed
on pipe manufacturer Mueller Industries. Its stock price had dipped
following a drop in housing starts, a cyclical condition that always
ends. And not only did I know that, I knew the company so well by
that point that I probably could have installed one of its copper elbow
fittings myself. Mueller’s operating income went on to double, and its
stock split.
These are some atrocities perpetrated by your author. And there
were more. Sometimes I did something wrong, and other times I
failed to do something right. Some were errors of commission, others
errors of omission. But none of them has cost me much. They were
more about upsides forgone than losses suffered.
That’s a charm of value investing. It instills in one a caution that
occasionally produces the unnecessary abstention, the premature
sale, and the unjustified hold. But it flags disasters incomparably. For
every triumph missed, a hundred disappointments are avoided. And
that’s a virtue of the discipline, not of the practitioner. It’s available
to anyone. But few ever pick up on it.
Of course, few ever pick up on just investing. They simply won’t
get it. They won’t see a contribution made to a retirement account, or
a deposit made at the bank, as part of a deliberate process of growing
vii
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viii PREFACE
wealth. They won’t view the commitment of capital today as a way
to gain a larger claim on civilization’s goods and services tomorrow.
Even if they buy stock in listed companies, they may not be invest-
ing. They may be merely speculating. I define speculating as the
purchase of something now in the hope that it can be sold at a higher
price later, with no consideration as to why that may be possible.
Versus investing, nothing could be more different.
Of those who do understand investing, only a fraction ever get
value investing. I define value investing as acting on the observation
of a clear difference between price and worth.
Of the few who get value investing, only a fraction ever teach it.
We could all fit in an elevator. Our lot is small because there’s scant
encouragement in academia to pursue the discipline.
Value investing is a subject of simplifications and approxima-
tions. It disdains the Greek letters and exactness that masquerade as
a scientification of capital management. It champions the back of the
envelope over the spreadsheet. It doesn’t spotlight theoretical acumen,
quantitative wizardry, or other hallmarks of professorial achievement.
As such, it’s no sure route to tenure.
So what you get in me is a subset of a subset of a subset: an inves-
tor who is a value investor who teaches value investing. Expect twists.
I am not starting a fund. I state this because a common—and
valid—reason for writing is to give potential investors insight into
one’s thinking. My motivation comes from a different place. I have
seen enough people act against their economic interests that I want
a book to throw at the next flare- up. Perhaps the page will triumph
where the conversation did not.
This book is about what I do. It’s entirely my opinion, a distillation
of what I see as the best practices in the discipline. It reflects my par-
ticular approach. Several parts of this approach are nonstandard. For
example, I hold stocks for the long term. I don’t use leverage. I don’t
sell stocks short. And my portfolio is concentrated, never containing
more than a dozen names, and usually far fewer.
Other bona fide value investors act differently. They may churn
their holdings monthly. They may borrow, short, or diversify. They
would write different sorts of books.
In the end, it doesn’t really matter much what my peculiarities are.
Value works. Once one has committed oneself to some incarnation
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PREFACE ix
of a value strategy, the long- term results are likely to be good. The
impact of inflections is on the margin.
Consider the way I calculate return on capital employed, a com-
mon metric that we’ll cover. For the numerator, I use operating
income. But many don’t. They use net income, or earnings before
interest and taxes. There’s spirited debate on these different takes.
But in context it becomes banter among the knowing. It’s like beach-
front homeowners comparing views. All the views are good.
One of the better lessons from my undergraduate economics
classes was the difference between principals and agents. Principals
hire agents to help them accomplish something. Agents are thought
to possess special skills, connections, or other attributes that qualify
them to assist.
In finance, an example of a principal/agent pairing is a high net
worth individual and a registered investment advisor. Other examples
are a hedge fund limited partner and a general partner, or a retail
investor and a mutual fund manager.
This book is primarily for principals. It’s firstly for people man-
aging their own money. It will have little to say about how to satisfy
regulators, communicate with outside investors, or other topics of
interest only to agents.
Of course agents are also principals. They have their own port-
folios, and often take stakes in the pools of capital that they run. In
addition, the best agents run clients’ money as if it were their own. So
this book is useful for agents, too. But know that it is the principals
that I put first.
Most readers will enjoy diving into the processes outlined in this
book. But some won’t. They’ll find them too demanding, or tedious.
That’s not a bad finding. It helps some people see that they’re
unlikely to stick with the value approach over the long term. That’s
important, because the long term is what’s required to achieve real
outperformance. Those turned off should instead consider low- cost
index funds. These are truly useful innovations that have performed
satisfactorily. They’ve actually beaten the returns of many otherwise
high- functioning people who venture into stock picking.
Those who discover value investing tend to do so via one of two
routes: trauma or exposure. Trauma, alas, is far more common. It’s
losing money—or not making enough—via some other strategy.
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