Appendix I: The Elements of Quality-Driven Value Investing
Book Serialization | Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises
Welcome to Appendix I of my next book, Quality Value Investing: How to Pick the Winning Stocks of Enduring Enterprises.
I am writing the book on Substack Finance as part of the QVI Newsletter and look forward to subscribers’ support and feedback as we produce the manuscript in real-time.
Appendices appear in the back matter of a nonfiction book as supplemental information of an explanatory, statistical, or biographical nature. The author includes an appendix to benefit readers, which would otherwise break up the synergy of the main body content.
Appendix I provides a summary of Quality Value Investing, the book, for future reference or review by those who have read the entirety of the preface and chapters.
Appendix I
The Elements of Quality-Driven Value Investing
Independent book summaries are commonplace, so I’ve included a built-in review and reference feature for those who have read the entirety of the preface and chapters. —David
Preface: Invest in Current Wealth and Present Value
Subject Matter: Uncover fundamental investment value. For example, Quality Value Investing uses a proprietary analysis to inspire readers to build and maintain portfolios of the shares of quality companies purchased at value prices.
Summary:
QVI’s proprietary checklist-driven approach to stock-picking generates an actionable investment thesis on why a targeted company and its stock rate a buy, hold, or sell.
As a result of his renewed approach of investing solely in a company’s current wealth and a stock price’s present value, the author transitioned from an underperforming, near-sighted stock trader to an alpha-achieving, far-sighted company investor.
Everyday retail investors often build portfolios to finance their life’s essential milestones, such as buying a home, paying college tuition, sponsoring a wedding, underwriting a hobby, starting a business, or enjoying a comfortable retirement.
Quality Value Investing assists readers in discovering how to keep stock-picking super simple by focusing on the tangible current wealth and present value paradigm instead of speculative future share prices or business growth targets.
The Mission of Quality Value Investing serves everyday investors keen on the investing model of buying and holding the common shares of excellent businesses when trading at reasonable prices. The investors desire inspiration to self-manage their portfolios. In addition, they seek an easy-to-read, value-added, and timeless book in their quest for lower costs and lesser risks in investing across market cycles.
Chapter 1: Adopt a Checklist Approach to Investing
Subject Matter: Introduce a checklist approach to stock picking by employing a rigorous yet straightforward methodology for researching and analyzing a company’s business model for current wealth and its share price for present value.
Summary:
An investment checklist for researching and analyzing stocks, exchange-traded funds, or any financial product is beneficial to ensure we conduct the due diligence necessary for sound decision-making toward long-term portfolio success.
Just as airline pilots use mandatory checklists to depart from and arrive at airports safely and successfully, mindful quality-driven value investors construct alpha-achieving portfolios with checklists that increase their chances of maintaining a safe and profitable basket of the stocks of quality businesses.
Stock selection objective — Buy and hold the common shares of US exchange-traded, predominantly dividend-paying, well-managed, financially sound businesses that produce easy-to-understand products or services, have durable competitive advantages from economic moats, enjoy steady free cash flow, and are trading at a discount to the perceived intrinsic value at the time of purchase. Then, of utmost importance and perhaps the biggest challenge, practice patience in waiting for the investment thesis to play out as projected over a long-term horizon.
Limit due diligence to a company’s current wealth and its share price’s present value instead of unreliable predictive analysis or business modeling overkill. The checklist items aim to answer the crucial question, “Is this a stock whose current wealth and present implies a quality, enduring enterprise?”
A successful journey favors the prepared. Our ultimate objective as quality-driven value investors is safely reaching our investing destination.
Chapter 2: Begin With the Enterprise’s Value Proposition
Subject Matter: Define the value proposition or durable competitive advantages of a targeted company’s products or services. For example, invest in slices of outstanding companies producing in-demand and profitable products or services that are assisting consumers worldwide in solving personal and business problems, wants, or needs.
Summary:
Invest in slices of outstanding companies producing in-demand and profitable products or services that are assisting consumers worldwide in solving personal and business problems, wants, or needs.
Read the filings submitted by senior management to the US Securities and Exchange Commission or SEC, such as the 10-K annual reports, 10-Q quarterly reports, and 8-K current events or equivalence in other countries.
Streamline the value proposition of an enterprise with an economic moat assignment of wide, narrow, or none. A company enjoying market dominance within a limited pool of competitors, or an oligopoly, is an ideal wide-moat strategy.
While conducting due diligence on a business, ask, “What value do the products or services offer existing and potential business or retail customers? If in the general market for either, would we purchase the goods or services of the company?”
Define the business’s competitive advantages in an elevator pitch containing one or two sentences or phrases. Describe why we believe the targeted company is an enduring quality enterprise.
Chapter 3: Screen For High-Quality Business Models
Subject Matter: Evaluate a business’s senior management returns on growth, profitability, equity, and capital and how each is essential to quality-driven investing.
Summary:
At a minimum, assess a business’s returns on management by analyzing and measuring revenue and earnings growth, profit margins, and returns on equity and invested capital.
Seek cash-generating companies providing wide, or at least comfortable, safety margins. Favor businesses with efficient and transparent management that leverage compounding returns for stakeholders.
Remember the internal customer, as satisfied employees deliver quality products and excellent services, translating to loyal customers and sustainable profits.
Senior executives and board members come and go. Therefore, it is imperative to own slices of companies that demonstrate durable competitive advantages supported by quality operations with outstanding returns on management despite the inevitable turnover.
Concentrating investment research on the business’s fundamentals increases the potential to pick the alpha-achieving stocks of enduring enterprises.
Chapter 4: Calculate Shareholder Yields
Subject Matter: Unveil proprietary due diligence that averages the total shareholder yields to measure how a targeted stock compares to the prevailing yield on the intermediate Treasury benchmark note. What is the equity bond rate of the common shares?
Summary:
When researching a stock for inclusion in a portfolio, consider the return to shareholders as a leading barometer of the worthiness of owning a slice of the business.
Implement the checklist methodology to confirm that a targeted stock’s shareholder yields exceed the bond rate or the weighted earnings, free cash flow, and dividend yields.
Formula to determine a shareholder yield rating — Sum of earnings yield % + free cash flow yield % + dividend yield %, divided by three = average shareholder yield. Compare to the prevailing yield on the Treasury benchmark.
The yield-on-the-cost basis is an ideal recourse to forward high-yield dividend investing. Measure a stock holding’s yield-on-cost instead of chasing current dividend payouts.
In a further test of shareholder value, calculate owners’ earnings to reveal the bottom-line rate of return for stockholders — The sum of five-year annualized trailing EPS growth % + dividend rate growth % = owners’ earnings.
Chapter 5: Valuate Quality Company Stock Prices
Subject Matter: Focus on four preferred and three alternative valuation multiples. QVI’s select valuation multiples include price-to-sales, price-to-trailing earnings, price-to-operating cash flow, and enterprise value-to-operating earnings.
Summary:
Quality at value matters in every area of our financial lives, including the stock market.
An attractive stock price becomes a nonnegotiable prerequisite to initiating the productive partial ownership of a quality company. The preservation of invested capital becomes supreme following the stock purchase.
Limit speculative valuation multiples, such as price-to-book, price-to-forecasted-earnings, and price-to-earnings-growth, to tiebreakers instead of tiemakers.
The best time to buy slices of high-quality enterprises is when other investors flee the stock based on near-sighted negative news or events.
We increase our propensity to achieve portfolio alpha by picking the value-priced stocks of enduring enterprises.
Chapter 6: Uncover Enterprise and Share Price Downside Risks
Subject Matter: Assess enterprise and share price risks to determine the potential downsides. In doing so, we aim to assign grades to the company and its common stock based on several measures of investment risk.
Summary:
Understanding and managing risk is more important than predicting market movements and stock prices. The goal is to buy shares of the stock when the overall downside is below the perceived market tolerance for acceptable risk.
Focus on four vital areas that estimate the company and its underlying stock’s measurable threats in the context of its potential behavior in a down market cycle — debt coverage, price volatility, short interest, and total return performance.
Lessen risk by equal-weighting a stock portfolio. When inclined to underweight a stock, ask, “Why do we own it in the first place?”
Returns are unpredictable, while risks are controllable. Measuring, understanding, and accepting the downside risks of a company and its common shares from an unforgiving market offer the best opportunities for investing with a tolerable, asymmetric risk/reward profile.
Manage the downside while allowing the upside to take care of itself.
Chapter 7: Curate an Actionable Investment Thesis
Subject Matter: Curate equity analysis using a proprietary strategy concentrating on the company’s current wealth and the stock’s present value.
Summary:
Research and compose an investment thesis, driving an actionable company and stock rating counteracted by potential catalysts that confirm or contradict our hypothesis.
An investment thesis summarizes why the company and stock have rated a buy (bullish or accumulate), hold (neutral or watch), or sell (bearish or avoid) founded on the stock picker’s most recent research and analysis.
Compose the curated investment thesis using an actionable review that weighs the company and stock ratings in each current wealth and present value category.
Entertain potential catalysts that would confirm or contradict the thesis. Catalysts involve anticipated or surprise events that could accelerate or decelerate our view. Essentially, specific inflection points are what the bulls and bears say, which can be verifications or repudiations of our thesis.
Weigh and assign an overall rating of a buy, hold, or sell to the company and its stock as one unified investment. Answer the question, “Would a quality-driven value investor buy, add, hold, reduce, sell, or avoid this equity?”
Chapter 8: Become a Quality-Driven Value Investor
Subject Matter: Why buying and holding the shares of enduring enterprises at reasonable prices remains an ideal approach to alpha-achieving common stock investing.
Summary:
Most professions or disciplines require the mastery of no more than 6 to 8 fundamentals for sustainable success. Stock market investing is no exception.
Value investing is neither dead nor dying and survives as a superior strategy. We are comfortable acknowledging that quality and value endure across market cycles, whether bull, bear, or range-bound.
The inherent risk to the quality value investing model is that near-sighted growth and income investors permeate the stock market.
Take comfort in knowing that quality and value prevail in the financial markets, just as in farmers’ markets.
Remain loyal to the stock markets’ original, well-intended good deeds by taking an affordable partial interest in a publicly traded company and thus aligning with Wall Street’s more credible role of providing needed capital to fund worthy businesses.
Chapter 9: Set Strategic Financial Goals
Subject Matter: Share a simple yet powerful goal-setting template to support the quest to achieve savings and investment objectives relevant to our lifelong journeys.
Summary:
Goal setting should be a part of every saver or investor’s toolbox — an actionable template or categorized approach to writing a practical plan for setting achievable goals.
Any goal-setting strategy should be fun, creative, and attainable. Pursuing stretch goals, or hard-to-reach dreams, is essential for ensuring we are not taking ourselves off the hook. However, targeting achievable outcomes is paramount.
Practical goal setting requires three general rules of thumb based on planning, simplicity, and structure — have a plan and work the plan, keep the plan super simple, and write the goals with George T. Doran’s SMART approach or specific, measurable, attainable, realistic, and time-bound.
Adopt the essential concept of Be→Have→Do. If I be someone worthy of wealth, I will have a sense of financial security. Then, I will do what is necessary to earn, save, and invest.
Money is a highly personalized domain. However, it is wise to leave emotions out of our money management and set goals with purpose.
Chapter 10: Discover Our Circles of Competence
Subject Matter: Discover how to invest within a circle of competence by buying what is known and understood.
Summary:
Staying within our circle(s) of competence is a sage method to help protect our invested capital.
Rational, disciplined, and patient investors discover their circles of competence in the sectors and industries that house the common shares of their targeted companies.
Always ask, what sectors or industries are within our sphere of confidence? On the contrary, which should we avoid or leave to professional money managers with histories of generating alpha in their areas of expertise?
Although the price is what we pay for ownership slices of these collectively excellent companies, value, over time, is what we get.
Despite compromising some of the lesser risks of passive investing, quality-driven investors who enjoy researching and owning slices of excellent businesses purchased at value prices still delight in active investing but at lower costs and lesser risks than the speculative trading of faceless stocks.
Chapter 11: Embrace Dividend Value Investing
Subject Matter: Reveal an alternative yield methodology for outperforming Treasury rates without the limitations of the dividend growth strategy—such as overweighting dividend history—or the inherent risks of forward high-yield dividend investing.
Summary:
Dividend value investing focuses more on the company’s quality and the stock’s value than its dividend growth history. Any dividends are a bonus payment in the short term while waiting for capital gains to compound over the long term.
Owning the common shares of world-class enterprises purchased at reasonable prices builds winning portfolios over time from the compounding total return of capital gains and dividends, our two best financial friends.
As an alternative method, measure a stock holding’s yield-on-cost basis instead of chasing forward dividend payouts.
Avoid initiating a position in stocks with dividend payout ratios exceeding 60 percent.
Follow the value investor playbook of buying equities on our terms instead of allowing the crowd to determine the entry price, for better or worse. First, have our online broker deposit dividend payments to an insured or government-protected cash account. Then, tap into this accumulation of dry powder to purchase new or add to existing investments at bargain prices according to sound valuation analysis.
Chapter 12: Master the Art of Behavioral Investing
Subject Matter: How to profitably apply cognitive behaviors such as rational thought, discipline, and patience to a quality-driven stock-picking strategy and, thus, counter the blatant lack thereof in the financial markets.
Summary:
Emotion-free rational thought and a pinch of common sense often equate to success when investing in stocks for long-term compounding.
Disciplined investors perform bottom-up analyses focused on finding quality companies regardless of the specific industry or any macro conditions of the general economy, which are forever guaranteed to be fickle.
Patient, quality-driven value investors remain stoic, wondering when or how opportunities will emerge —knowing they often do, eventually.
Many investors must increase awareness of the mental pitfalls that sabotage stock-picking and portfolio construction, whether professional or retail-managed. Mastering the art of behavioral investing bridges the ever-widening gap between psychology and money.
Investors who master the art of behavioral investing look forward and beyond, knowing that a legacy portfolio comprising the slices of exceptional, enduring enterprises continues to compound in the appreciative hands of loved ones or designated charities.
Chapter 13: Achieve Stock Market Alpha
Subject Matter: Choose proven—albeit broadly unpopular—investment practices that create alpha instead of challenging it.
Summary:
Most investors, whether professional or retail, underperform the market. As a result, they are perpetually craving new but speculative investing methodologies and stock-picking ideas for a straightforward reason — their chosen approaches to portfolio management are not producing alpha.
The primary strategy of quality-driven value investors is protecting invested capital from permanent loss. They equal-weight their portfolios to eliminate bias and unreliable predictive analysis.
By sidestepping the crowd, alpha-achieving investors weigh stocks for the long term instead of voting for them in the short term and paying an unnecessary premium.
When using an investment advisor or subscribing to an investment service, ask what produces the better run rate for the portfolio manager or author — the advisory and subscription fees or the returns on the investment picks.
Become a reformed and informed investor from lessons learned. Invest in great companies over a long-term horizon and benefit from total return compounding protected by wide safety margins.
Book Appendix is copyright 2024 by David J. Waldron. All rights reserved worldwide.
About the Author
David J. Waldron is the contributing editor of Quality Value Investing and author of the international-selling book Build Wealth with Common Stocks: Market-Beating Strategies for the Individual Investor. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. His work has been featured on Substack Finance, Seeking Alpha, MSN Money, TalkMarkets, ValueWalk, Yahoo Finance, QAV—Australia’s #1 Value Investing Podcast, Money Life with Chuck Jaffe, LifeBlood with George Grombacher, The Acquirer’s Multiple, Capital Employed, Amazon, Barnes & Noble, Apple Books, the BookLife Prize, and Publisher’s Weekly. David previously enjoyed a 25-year career as a postsecondary education executive. He received a Bachelor of Science in business studies as a Garden State Scholar at Stockton University and completed The Practice of Management Program at Brown University.
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