Chapter 2 – A Crash Course of the Stock Market

What is share of stock?

Stock is share of a public listed company. By buying share, you are buying part of a company and
become part-owner.

How to make money owning stocks?

1. Cash dividends
Eg - Starhub: Decide to pay 100% net profit as dividend
Share: 2.36 SGD
Net profit: 315.5M SGD
Outstanding share: 1715.3M Stock
Earnings per share = 315.5M/1715.3M = 0.184SGD/share
Decide to pay 0.2SGD/share

If we buy 5000 share at 2.36SGD, Investment = 11,800SGD

Earning that year = 5000*0.2 = 1000SGD
Dividend Yield = (1000/11800) *100 = 8.47%

2. Share price appreciation

Not all company pay dividends. They need cash to growth aggresively (reinvest). Called 'growth
stocks'. We make profit through capital appreciation
Eg - Amazon - 120 USD January 2010, 268 USD January 2013
Our Net profit - 268-120=148USD
Dividend Yield = (148/120)*100 = 123.3%

How much to invest in?

Malaysia - Min 1 Lot equivalent of 100 shares.

How much is a company's share really worth? (In detail Chapter 6)

Important for us to decide either we are buying at a cheap or expensive price.

To know a company worth (In short), Calculate PE (Price to earning) ratio

EG – Yummy Inc. earns 1M USD/year net profit.

How much would you pay? 1M/3M/5M/10M?

1. PE ratio = Price of the company / Annual net profit

2. PE ratio = Price of the share / earnings per share
What is the PE Ratio of Most Public Listed Company?

EG – Coca-Cola
Stock Price : 77.71$
PE Ratio : 20.64x
Earning Per Share = (77.71/20.64) = 3.77$
PE Ratio of 20 meaning wait 20 years to get return? People so stupid?
Actually people expect the net profit to increase every year.

PE Ratios, Earning Growth Rate (EGR), PEG Ratio

If PE ratios = Earnings growth rate same, then company is fairly price.

If the annual growth rate = 20%, the PE ratio should be 20 for the company to be fairly price
PEG ratio – (PE Ratio/Earnings growth rate)
PEG ratio < 1, Stock is cheap
PEG ratio > 1, Stock is expensive

Using PEG Ratio to Compare Companies.

Company Apple Inc. IBM

Stock Price $442.80 $197.51
PE Ratio 10.04x 13.95x
Earnings per share (EPS) $44 $14.40
Earnings Growth rate 18.98% 9.86%
PEG ratio 0.53 1.41

To conclude Apple is cheap, IBM is expensive.

For Apple to be at correct price. PE should be 18.98x
Stock price to be 44*18.98 = $835.12
For IBM, PE Should be 9.86x
Stock price to be 14.40*9.86 = 141.984

But… How to know earnings growth rate?

What Makes Share Prices Fluctuate Daily? (Demand and Supply)

Buyer = bull (believes price up)

Seller = Bear (believes price down)
Price up if (good news): -
potential buyer > potential seller,
price down: -
potential buyer < potential seller,
Economy slow down
Company made unexpected loss

Buy (bid) for a price, Sell (ask) for a price

The difference is ‘spread’
All in all, price is driven by emotion
Understanding Stock Exchanges and Indexes
Stock market is supermarket to buy and sell stock. Learn to invest in a few.

Stock Indexes Measure the Performance of a Stock Market

How well is a stock market performance?
Use indexes – Bursa Malaysia Kuala Lumpur Composite Index (30 largest stock in bursa malaysia)

How have stock indexes Performed over time? (S&P 500)

If you can hold your stock for a long time, you can make more money as compared to bank interest.
S&P 500 will continue to go up over time due to 3 reasons. Population growth, inflation, change in
index stocks.

A look at Other Indexes

Other index rises over time as well.

Being a Global Investor

It makes sense to invest in own local market because we are more familiar with companies there.
However, the writer has generated more from US Market. Some unique advantages include:-
(Later)

Beating the index is the game.

To make money in share market is to beat the index. This book teaches to make money not through
long term.

Not all stocks are Builts the same

How is a stock classified? It is important to note that in different points in market cycle, different
category will have advantage.

Classifying Stocks into Sectors

Taking example of S&P 500, it divides into 9 sectors
a) Consumer discretionary (Optional) sector (Nike, Adidas, Mercedes, BMW)
b) Technology Sector (Apple, Microsoft, Huawei)
c) Finance Sector (Maybank, CIMB, Public Bank)
d) Industrial Sector
e) Materials Sector
f) Energy Sector
g) Consumer Staples Sector
h) Health Care Sector
i) Utilities Sector
Item a, b, d, e is known as cyclical sectors. Correlate to economy health. Good economy = Stock
perform well.

Item c, f, g, h, I is known as defensive sectors. Essential that people used. When economy good =
Stock not so perform. When economy bad = perform better than economy. Less volatile. Less
growth potential.

Chapter 8 in detail.
Always remember that at one particular time, there will always be sector with better potential.
Avoid when a particular sector is down.

To Think: What category are there in Malaysia share market?

Classifying Stocks by Market Cap

How large are they? Determine by Market Capitalization. Determine by their worth in stock market.
Market cap = Share price x Outstanding shares
IN US: Mega Cap, Large Cap, Mid Cap, Small Cap and Micro Cap

Mega + Large – Safer but less exciting

Established industry market leader
Strong brand & competitive advantage
Predictable stable revenue and profits
Financially strong and able to weather recessions/ market downtimes
Hard to grow (double/triple in size)
In some case, they drop a lot during recessions, cause them undervalue. Usually are the first to
recover from recession. OPPORTUNITY!!!

Mid + Small + Micro – More exciting but riskier

Less established local player
Weaker competitive advantage
May have potential become Mega or large caps.
Financially less strong, can easily bankrupt when recession.
Detail in Chapter 5 & 6 on the analysis.

Writer preferences, 80% large cap + 20% small cap

To Think: Are the price cap category same in Malaysia?

How do I know When a Stock has the Potential to Rise?

1) Logical approach (Fundamental Analysis) – Value Engineering
Company become more valuable by increase sales revenue, net profit, cashflow. This is by judging
their competitive advantage, current sales & profits, financial projection, management decisions,
assets and liabilities. This determine the company’s true value. However, in short term, price move
based on market sentiments (emotions)

2) Emotional approach (Technical Analysis)

Study chart pattern.

Which Approach to use? Fundamental or Technical Analysis?

If Fundamental analysis, must hold more than 5 years.
Long story short, both analysis.
Chapter 3 – Technical Analysis: Reading the Emotions of the market

Can you Really Predict the Emotions of the Markets

Difficult to predict emotions of players in stock markets. However, possible to identify periods of
increasing optimism, increasing pessimism or period of uncertainty (Price consolidation) from stock
charts.

How to Read Stock Charts

Opening Price, Closing Price, Day High Price, Day Low Price.
Bullish day? Bearish day?
Simplest chart is ‘Line Chart’ (Not useful to know market sentiment)

‘Japanese Candlestick Chart’

To Note: If I want to be a Weekly trader, which timeframe chart should I look at?
Green – bullish day
Red – Bearish day

Identifying Stock Price Trends

Price Uptrend
– Identify Higher high points and higher low points. Price go up and down, but every time comes
down will up higher.
Drawing a Trending support line
Draw a line connecting higher low points. The line is trending support line. As long as line stay above
support line, trend remain uptrend.
Strategy: Buy when price dip and ‘bounce off’

Is this good example?

Price Downtrend
Lower high point, lower low point.
Every time prices go up, they move down even lower.
Pessimistic investor. Wait for major news for trend to change.
For writer, never buy a stock in downtrend. You never know when it really broke from downtrend.
However, worth keeping a watch.

Drawing a Trending resistance line

Draw a line at lower high point. If stock line remains under this line. Trend had yet to reverse.

Identifying changes in Trends (This is the important part!)

In downtrend, wait for reverse before we buy. Careful with short-term rallies called ‘bear traps’
(temporal bullish)
Similar to uptrend.
How to identify reversal signals? Next… simplest two (2) strategies.

(Method 1) Using Moving Average Crossover to determine trend change.

Simple Moving Average (SMA) - compute average closing price of a specific number of periods.
It does not predict price direction. It defines current trend direction.
Eg. Writer generate 50 DMA (shorter) and 150 DMA (longer).

During downtrend, Green (150DMA) always above blue (50DMA). Both moving average sloping
downward. (Time to sell)
During uptrend, Blue (50DMA) cross above (150DMA). Both moving average sloping upward. (Time
to buy)
This is useful for Medium and Long term.
Note, how many Day moving average should I use? (10? 20? 50? 150?)
Find out what is Bollinger bands? (Default setting)
What can we find out from Volume?
Try experiment with different moving average and see the result.
Info from internet, 5-8-13 DMA for daily traders.

Consolidation: The Sideway Trend

Move sideways between upper and lower range. Market undecided. But eventually will go either
uptrend or downtrend.
For writer, prefer to not invest when in consolidation pattern. It will bounce between support line
and resistance line. However, short term traders sometimes buy when it bounces from resistance
line.

(Method 2) Support line.

Stock price fall to certain level and push back upwards. The price level is support line. It is not certain
will fall to this level before bounce.
If normally moving average does not confirm uptrend, upward momentum won’t last long.
The more time a support line is hit, the stronger it becomes.
If it breaks below support line, and candles remain below support line for few daily candles. Stock
price might drop even lower. Become new downtrend

Resistance line
Stock price rise to certain level and cannot move above it. The price level is resistance line. Don’t buy
when price is near to resistance line. Observe for new uptrend.

The safest point to buy a breakout.

First it breaks out of resistance line then it falls (Point 1). It should touch the resistance line which is
now the support line and bounce back (Point 2). Point 2 is safer entry point.

Many more indicators

Method 1 – DMA
Method 2 – Support/resistance lines

Note to self, find out

- Trend indicator: MACD, DMI
- Volatility indicator: RSI, Stochastics, Bollinger Bands (overbought/oversold)
Which is for short term investing?

Probabilities, not Certainties

Probabilities of success 55%-70%.
Although trend is confirmed, news might affect as well.

Reliability and Risk Management?

Even though right 50% of the time, still can make money if profits outweigh losses when indicators
failed.
Risk management – Cut losses when indicator fails.
Placing Stop Loss Orders
When you determine the stock break from resistance price, set stop loss order at candle below new
support line.
Chapter 5: How to Pick Stocks of Award Winning Company
Pick individual stock that beats the index.

Winning Stocks Beat the Index

Even during recession, there are stocks that shine.

Philosophy of Successful Stock Investing

Step 1: Identify Great Businesses
Understand the business model (What is this?)
Great business: Increase profit & sales consistently over long term, strong competitive advantage,
financially strong to withstand recession

Bad business: Losing money, inconsistent profit, too much debt (easily go bankrupt during recession)

Step 2: Invest When Stock is undervalued and on Uptrend

Buy when there’s discount
Buy when price below intrinsic value (true value)
Why and why great stock sell at cheap price:
Eg: Lower than expected profit (NIKE), affected by a strike, new product failure, bad news (British
Petroleum), competitors bad result, fears of recession (American Express).
This irrational fear drive price to below intrinsic value, great discount.

Note: Look through business news, study if their company had fall below their intrinsic value, is their
company great business? However, make sure it’s uptrend before buying.

Step 3: Sell for Profits when Stock Price Reverses to Downtrend

Writer’s tip, instead of waiting for a confirm downtrend, sell a stock when it falls 5%-8% below
recent high.

8 Criteria for Winning Stocks

Learn to read income statement, balance sheet, statements of cash flow

Note: Read secrets of self-made millionaire for accounting concept, read out for Carlsberg,
Heineken, Guinness, Tiger, Anchor

1st History of Consistently Increasing Sales, Earnings, Cash Flow

See track record for the last 5 years, especially recession. If consistent, future earnings also more
predictable.
In a graph, show earnings and dividend.
Also verify sales revenue. Earnings can be manipulated; sales cannot be changed.
Make sure operation Cash flow has been increasing. In some case, profit & sales increase, but
cashflow decrease. Inefficient at collecting money owe to them.
Where to find?
Sales, Earnings, cash flow under Annual Report.
‘income statement/ profit & loss statement’ – sales and earnings
‘statement of cash flows’ – operating cash flow (net cash from operations)

Note: try www.google.com/finance & https://my.morningstar.com

2nd Sustainable Competitive Advantage

Wide economic moat. Eg, Branding, economics of scale, Market leader, special formula, technology,
patent.
Check for:
Gross profit margin = (Gross profit / sales revenue) * 100%
Net profit margin = (net profit after tax / sales revenue) * 100%
Margins should be higher than closest competitor

Note: what are Malaysia Brand with Economic Moat? Technology sector is more volatile (Eg. Nokia)

3rd Future Growth Drivers

Company should be selling to markets with population growth, rising employment rates & wages.
More applicable to global company?
Growth factors:
- New products line development.
- Application of patents
- Expansion in capacity
- Opening new markets & building more outlets.

Where to find?
a) Company annual reports
‘CEO’s message’ – see company’s growth plan and sales forecast
b) Analyst reports. Google it…
c) Projected long-term growth rates forecast
www.reuters.com/finance/stock. At least 10% per annum

4th Conservative debt

Debt should be able to pay off within 3-4 years
Long-term debt < 3x current net income after tax
Under Long term debt, non-current liability in income statement.
This is not applicable to banking and commodities company. They use debt as leverage to run
company.

5th Return-of-Equity (ROE) consistently above average (eg. ROE > 15%)
ROE = profit generated from money shareholders invested in.
ROE = (Net income after tax/total shareholders’ equity) x 100%
High ROE meaning sustainable competitive, meaning what you invest will grow which lead to share
price also grow
Company 12% considered good investment
ROE can be find under annual report>financial performance summary/financial ratio
6th Management is Holding or Buying the company stock
Meaning company director having confident in their own stock

Note: where to find Malaysia insider trading information?

OBEY THIS 6 CRITERIA TO FIND A GOOD STOCK

Chapter 6 How to Pick Stocks of Winning Companies II

Criteria 7th and 8th will determine time to buy.

Criteria 7th Share Price < Intrinsic value

For a machine that print RM100 for your today. How much would pay? Most is RM100.
If a machine that print RM100 a year from now? Depends on opportunity cost/discounted rate.
If put money in bank can get back 5%, opportunity cost/discounted rate will be 5%.
x * (1+0.05) = RM100
This is discounting future value to present value.

Definition: Intrinsic Value of a stock is equal to present value of all its future cash flow from
operations

Find by adding up projected cash flow from operations over the next ‘x’ year and discount to present
value.

(Cash&equivalents – total debt owed) / outstanding shares = WTF? What is this value for?

Net cash per share? Fot what?

Example 1
Calculate Intrinsic Value of One share of Yum! Brands as of 2012.

Step 1: Cashflow next 10 years.

Cash from operations (last 12 months) and project with long –term growth rate.
YUM cash from operations is 2,171 million for last 12 months.
It’s long term growth rate is 13.26%. We can calculate the cash flow projected.
Eg.: 2,458.8M (2013), 2,785M (2014)

Step 2: calculate the right discount Factor (DF)

The riskier (more volatile), the higher discount factor.
Check the stock’s beta value to know volatility.
>1 volatile, <1 less volatile.
www.reuters.com/finance/stocks

Apply discount rate based on table as such

Beta Discount rate
<0.8 5%
1 6%
1.1 6.8%
1.2 7%
1.3 7.9%
1.4 8%
1.5 8.9%
>1.6 9%
YUM’s beta is 0.9, discount rate is 5%
Discount factor = (1/1.05^n).

Step 3: Discount future cash flow to Present value/discounted value (DV) and sum up
Discount value = Cash flow (projected) x discount factor
Intrinsic value for the next n year = ‘sum of discounted cash flow’

Step 4: Find value of each share

Intrinsic value per share = Intrinsic value for next n year / total outstanding share
= $74.03 (YUM)
To be more accurate: (Cash and equivalents – Total debt)/Total outstanding share
= -$4.65
Intrinsic value = $69.38
At writing time, value is $66.10. YUM is undervalue.

Note: find Intrinsic value calculator online.

8th Stock price uptrend
Refer Chapter 2 & 3

How to pick winning stocks?

1) Use tips from other book, ranking system.
2) Read news for good news and bad news. If good news, see if new uptrend, if bad, see temporary
or permanent?
3) Look at company which product we use
4) Get idea from analyst reports (see what they recommend to buy)
5) Mentor and investment buddies

Monitoring portfolio
8-10 stocks are fine, hold too many hard monitor.
Large defensive company – 1 months once monitor
Smaller riskier cyclical company – 1 week once
Don’t get excited or sad over a few points change, observe the trend.

Note: make it habit to monitor at end of the day

Monitor Quarterly Financial Reports

Try Google Finance, www.klse.com.my

Knowing when to sell

Must know when to sell even before know when to buy

Selling rules
1st Fundamental reason – Company no longer profitable
Mismanagement, two or more directors sell their share, profit margin decline > 4 quarters while
competitor consistent, account receivable increase faster than sales revenue

2nd Technical reason – Moving average

3rd Cut losses with stop loss orders

Writer put 6-8% stop loss below purchase price. If more than that, safe to assume trend had failed.

4th Protect profit by selling 5% below the high

5th Sell when price cross below 200 DMA

Chapter 8: Building a Winning Portfolio
Defensive Stocks vs. Cyclical Stocks
Defensive stocks
Selling necessities (toothpaste, groceries, medication, water and electricity)
Slow growing industry ‘boring’
Has low beta value.
Invest during uncertainty, market going downtrend.

Note: what are Malaysia defensive sector? Is now downtrend or uptrend?

Cyclical stocks
Products & services that are luxury (Cars, high ends retail, computers, house, travel agency)
Has high beta value

Seven (7) Stocks categories

1st Dividend Cash Cows. Aim for dividend yield > 5%, is in defensive sector, large capitalization
(market cap >10 billion).

2nd Large Cap Predictable. Highly predictable future sales revenue, profit and cash flow. Never go
obsolete. (Macdonald, cocacola, Nike, Visa). Warren Buffet would buy. The share price will surely
rise.

3rd Large Cap Growth. Large company growing rapidly normally technology background (Apple,
Google, Microsoft, Ebay.)

4th Deep Cyclicals. Capital intensive, highly cyclical. (Airline, real estate, construction, banks,
manufacturers.) Unable to respond quick to demand change. Huge uptrend, huge downtrend. Never
hold for long term.

5th Turnarounds. Invest in good company that got hit by bad news. The bad news should be
temporary. Quite risky, if they recover, double/triple. If never recover, make a loss.
Rule 1: Company with large cap & sustainable competitive advantage.
Rule 2: Bad news temporary in nature. Never invest in company with accounting scandal.
Rule 3: Invest when uptrend

6th Small Fast Growers (market cap < 10 billion).

Riskier, bankrupt during recession.
Ensure they dominate a niche, little debt, healthy cash flow.
Huge potential of future growth.

7th Exchange traded funds (Lazy method)

Building a winning portfolio for yourself.

1) Invest in 8-10 stocks. Too much will lost track.
2) Never invest 2 stocks of same sector. Sectors move together.
3) Not more than 3 Turnarounds & not more than 4 deep cyclicals & Small fast growers. Half of stock
should be in defensive nature.
4) Always keep 10% in cash. When situation not good. Better Keep it.
5) Portfolio aligned with lifestyle and risk appetite.
Note: Try Portfolio C: Large Cap Predictable and large cap growth.
6) Adapt portfolio to market cycle. Boom bust cycle 6-9 months.

Chapter 9: Method, Money & Mind: Three keys to success

Method
(Chapter 3,5,6) Stick to rules.
What to buy? Chapter 5&6
When to buy? Chapter 6
50 DMA above 150 DMA, both sloping upward
Daily candle above 200DMA, both upward

When to sell? Chapter 6

Money – Risk & Money Management

Golden Rules
1) Fixed percentage for any single trade
2) Risk Maximum 1.5%-3% of capital on single trade

Example, I got RM10,000. Risk 3% capital on single trade.

3% of Rm10,000 = RM300. How much share I can buy?
I buy Carlsberg at RM 24.52. I put my stop lost at 8% which is RM22.56.
Risk per share = RM 1.96
How much share I can afford? Rm300/RM1.96 = 152.94 or 153 shares
Position in Carlsberg = 3751.56

Position Sizing Formula = (% Risk per trade * Capital)/$Risk per trade

How many investments can I have at a time?

If in the example above, assuming position size 3000 – 3800, can invest 3 concurrently. In doing so,
the risk would be 9%. By using a leverage margin account, can take on larger & more positions. Keep
total risk <10%

Returns to aim for?

Profit target distance should be at least double the stop loss distance. Risk to return ratio minimum
1:2. Based on intrinsic value and price resistance.
Eg. Risk per share = 1.96, potential profit = 6, Risk to return = 1:3

R-Multiple, since Risk will also be same. 3R

Determine the expectancy of your strategy

Expectancy – statistically achieve by following rules over time
Expectancy per investment = (% Win x Average win) – (% Loss x Average loss)
EG. = (55% win x 2R) – (45% lose x 1R) = 0.65R
1 R = 3%
Every 10 trades = 6.5R, 19.5%
Every 100 trades = 65R, 195%

EG.
Capital - RM10,000
R = 3%
Aim to achieve 30% annual return. RM3,000 profit.
Expectancy per trade = 0.65R = 1.95%
30%/1.95% = 15.4 equivalent 16 trades. Per month = 1.333 trades.

Mindset – Managing Emotion