#4 Rule #1 Investing

This will be the best resource you will ever come across. ​​ It’s an amazing resource when used for confirming an investment idea, and it’s even better at quickly and easily Valuing that idea. It's my favourite resource of the 5 mentioned, and It will take your investing to the next level. Soon, you’ll find out why. ​​ Excited!? Good, you should be. ​​ This is going to be awesome...

What to expect

Be forewarned: After reading this post, and playing around with the website a bit, you will most likely find this toolbox to be your ‘go-to’ investing website for evaluating a potential investment. Why you ask? because it can help you do a lot, in a very little amount of time.  ​​​​ The Rule #1 Toolbox has great functionality, it will help you:

• Review the fundamentals of a company you're looking to invest in through a summarized list of all the most important metrics.

• Quickly and easily value a company, and see if it’s on sale right now.

• Find companies to potentially invest in by doing something called ‘the 3 circles exercise’.

• Create a Watch List of all the companies you’d like to own, but aren’t quite at the price you want to pay.

This Toolbox will be an extremely powerful resource when you learn how to properly utilize it, and that’s exactly what I’m going to show you. ​​ Try not to worry, it’s easy and very fun. ​​ You’ll likely find yourself searching companies often, and seeing if they are currently on sale, sometimes, just for the heck of it. ​​ So, have fun, and enjoy this post.

Sometimes to move forward, you must first go back...

This is Part 4 of the 5-part series, and if you somehow started here, first of all, Hi, thanks for reading! Second, please read the intro, and the other three posts that came before this one. ​​ They really are amazing resources, and you don’t want to miss them (I even threw in some bonus resources in Part 2 for good measure…)

Here they are:

Intro :The 5 Best Resources

Part 1: It Starts with Magic

Part 2: Focus on the Guru’s

Part 3: Corner of Berkshire and Fairfax

Part 4: Well, that’s this one… so, you’re already here...

Part 5: Also, Coming soon… (Dec. 13, 2016)

Phil Town

This investing resource comes from a great guy named Phil Town. ​​ I had the pleasure of meeting him and his beautiful wife at a conference in Atlanta, hosted by Mr. Town himself. ​​ (He is still putting these events on, and I’d highly recommend going. ​​ They are for anyone who wants a great weekend of learning about investing, and making new friends along the way).

Phil is also hedge fund manager, and author of 2 New York Times best-selling investment books, Rule #1 and Payback Time. Both of which are excellent investing books. ​​ He was originally taught how to invest when he was a Grand Canyon river tour guide, back in the 80's. ​​ An individual on his tour (after barely surviving the rafting adventure) decided to teach Phil how to properly invest the Rule #1 way. Phil turned that knowledge into quick money, turning $1000 into $1.45 Million. ​​ That’s just crazy right!? ​​ Since then, he’s been on multiple different TV and radio shows, as well as touring the country as a motivational speaker. ​​ Today he continues in his mentor's footsteps, still teaching others how to invest, the Rule #1 way.

What is Rule #1 investing

This is an old adage from our good pal Warren Buffet, who said;’ there are only two rules when it comes to investing, Rule Number 1: don’t lose money, and Rule number 2: don’t forget Rule number 1’. ​​ Simple as that. ​​ His belief is that if you keep your focus on the downside risk, instead of upside potential you will become rich in the long term. ​​ We can achieve this by investing in great companies, that are very unlikely to make us lose money over the long term. ​​ Seems kinda obvious, right? ​​ And it is, but too often we get caught up in a ‘story stock’ and we begin to see Dollar signs, and the potential huge upside potential, while (to our detriment) we never even consider the downside. ​​ That’s why Buffett has his two simple rules, and it’s important to always remember them, before we make any investment.

Phil’s Philosophy

He’s all about taking care of the ‘little guy’, and in this case, that’s us. ​​ He believes that everyone should learn how to invest, so that they can one day, achieve financial freedom (hard to argue with that). ​​ He doesn’t think the mutual fund managers are looking out for your best interest, so your best choice is to learn how to invest on your own, and I agree. ​​ 80.8% of mutual funds did worse than the S&P in a 5-year period, so really, what are you paying them for?

Phil believes that in order for an investment to be worth your time it must pass something called the 4 M test:

• Meaning - must be capable of understanding the business.

• Moat - the company must have a Durable Competitive advantage.

• Management - Must have honest, shareholder oriented management.

• Margin of safety - It must be on sale to its intrinsic value.

The Business we’re looking at must also have excellent Fundamentals. ​​ There are six growth rate numbers & debt that you should look at when valuing a company. ​​ These must have 10 years of data and must constantly be growing over time, and all should be above the 10% mark. ​​ They are:

• Book Value per Share + Dividend rate

• Earning per Share growth rate

• Operating Cash per share growth rate

• Sales growth rate

• Return on Equity

• Return on Invested Capital

• Low Debt (less than 3 years of earnings)

These metrics all add up to something Phil calls the ‘Rule #1 score’ and we’ll be considering this in more detail later on.

That’s basically everything you need to know before investing, these numbers should all look smooth and consistent over time, and we’ll go into them in a little more detail later in this post. ​​ If you want to go into much greater depth (which is recommended) then read his two books, Rule #1, and Payback time. ​​ They are both great, and are well worth the read.

Why you should use the Rule #1 Toolbox

You should use it because it is the best resource I’ve ever found that can find, value, assess, and confirm an investment idea. ​​ It’s sort of like the one stop shop for all things investing. ​​ You can Sign-up for a free (30 day) account and give it a try. ​​ It’s worth it. ​​ Enough with that, let’s get into how to use this website.

The Rule #1 Website

The website itself is handy as well, especially if you’re brand new to investing. ​​ Phil has beginner videos, and a huge library of blog post to choose from, so if you have the time, dig in. ​​ You can go to the ‘Start Here’ page and watch all his introductory videos.  ​​​​ His resource page is loaded with some of his investment ideas, but it will cost you an email address to get them (not too big of a cost right?). ​​ The focus for us however, is the Toolbox. ​​ So, let’s head there.

Toolbox

If you haven’t already done so, open the link to the toolbox, and sign up for a free account. ​​ Click the ‘Sign Up Now’ button.

This will bring you to the ‘Register Now’ screen. ​​ Fill in the necessary fields. It’s quick and easy, all you need is your name, email address, and a password and you’re all set. It looks like this:

Read the disclaimer, then click the agree, then submit and you’re all set! Quick and simple. ​​ Now that you’re signed in, you should be at this screen:

(Source: Rule #1 Toolbox)

Idea Generation to confirmation to valuation; using the 4M’s Exercise

This could probably be a blog post all on its own it’s so awesome. ​​ It’s the most comprehensive way to generate an idea, and potential confirm it all rolled into one. ​​ It combines your own personal list of companies with that of the fundamentals of the company, then finishes with the valuation, to give you the most complete steps for looking at any given company. ​​ It’s awesome. You’re going to love it.

So, sit back, grab yourself a drink, and follow along. I’m going to show you how to properly go through this exercise, so that later, you’ll be able to do this on your own at a much faster pace. Stick with me here, this is important…

3 Circles Exercise/ Meaning

This process starts with an excellent way to get a new investment idea, because it adds something new to the equation; The 3 Circles Exercise. ​​ This makes the idea generation much more focused on businesses you are more likely to understand. ​​ Phil Modified this idea from a great Author named Jim Collins, and his #1 Bestseller Good to Great.  ​​​​ Jim calls this exercise ‘The Hedgehog Concept’ and it involves three circles:

• what you are deeply passionate about,

• what you can be the best in the world at, and

• what best drives your economic or resource engine.

These three questions are meant to correctly drive the direction of a business from good, to one that is Great. ​​ Phil takes this idea and Modifies it to fit the everyday investor. Phil’s three circles are:

• Passions: What are you passionate about?

• Talents: What are you talented at?

• Money: What do you spend your money on?

Ok, that’s interesting, but why do we care about that?

Well, the whole point of the three circles exercise is to find companies that you will be able understand, and thus, have a greater aptitude for investing in them. Phil calls this the ‘Meaning If we look at our passions, talents, and where we spend our money, odds are that we’ll find a company that we can understand. ​​ This is called your ‘Circle of competence’ meaning you’ll be able to easily grasp how the company operates and makes money, and therefore, will be able to better value it into the future. ​​ Understanding a company is everything when it comes investing in one, and to being able to more accurately predict where the company is headed. ​​ Phil’s website has the ‘Three Circles Exercise’ built into it so you can quickly discover companies within your circle of competence. ​​ It can be fun, and easy, so play around with it (this information is available in greater detail in Phil’s book Rule #1).

Once you're in the toolbox, Click then click the tab. Next Read ‘Step 1: Meaning’, and then add all the relevant passions that apply to you.

Note: if you hover your mouse over a sector, it will give a brief description, and a few ticker symbols you will likely recognize from that sector. ​​ 

(Source: Rule #1 Toolbox)

​​ Click a sector, then click the right arrowto add it to you list. These should be sectors that you’re passionate about. ​​ Maybe you like to go out to restaurants a lot, or you’re really into technology, add those sectors to your list, then click the once you’ve completed your list. ​​ Repeat this for all three circles until you’re satisfied with your list. ​​ Once you’re finished it should look something like mine;

(Source: Rule#1 Toolbox)

Don’t get too caught up in this process, it’s meant to be fun, so don’t be too concerned if you think you don’t have any talents related to those sectors.  ​​​​ Odds are you’re just not thinking about yourself in the right way. ​​ For example:

Passions:

What are you passionate about. In other words, what do you like to do? Or spend your time doing?

Talents:

This is what you’re good at. ​​ Your hobbies, maybe what you do for work, and for fun. ​​ For me, I like to eat good food/cook, snowboard, hike, exercise, invest, and i’m also a bit of a nerd... I think I’m good at those things, so I added:

• Food and Beverage

• Computer Software, Services, & internet

• Care

• Financial Services &

• Leisure and media

Money

This one’s really easy, it’s what you spend your money on. ​​ It’s usually closely linked to your passions and talents. ​​ We all buy food, clothes, gas (oil), and usually healthcare, so those three are usually added to everyone's list.

Hit the button again and you’ll be given a (possibly large) list of possible sectors that fit within your circle of competence.

Scroll down until you find one that jumps out at you, and click on it. I clicked on

. ​​ You’ll be given a list of all the public companies listed in that sector. The companies with the largest market cap are at the top (if you’re following along you will see MCD, YUM and CMG are the top 3). But, I like to look at the ‘Best’ Companies on this list, not just the biggest, and that is found easily through something called a Rule #1 score. Click on the right and this will list the companies in this sector, from best to worst. ​​ Here’s what it looks like:

(Source: Rule #1 Toolbox)

As you can see, the top three companies based on their fundamental score (Rule #1 Score) are Chipotle Mexican Grill, Buffalo Wild Wings, & Texas Roadhouse. ​​ These companies all have amazing scores of 97 or higher.

Note: The Rule #1 score is calculated by taking the 6 fundamental growth rate numbers + debt, and adding the scores together. ​​ For example, if ROIC is higher than 10%, it gets a score of 100, the more 100’s the company gets, the better the Rule #1 score will be.

For comparison McDonald's has a Rule #1 score of 41.

The next step would be to pick a company. ​​ I usually either start with the company with the highest score, or one I’ve been interested in for a while. ​​ In this case the highest scoring restaurant is CMG so I’d click the button which takes us to the next phase of the analysis. Moat.

Moat

This is another concept that Warren Buffett and Charlie Munger believe is fundamentally important for a business to be ‘Great’ and Phil agrees. I’ll let Buffett explain it to you, then I’ll briefly go over the different types of Moats to look for.

Thanks Charlie!

In Phil's book Rule #1, he says there are 5 different types of moats to look for in a company that can give it a durable competitive advantage. ​​ They are:

• Brand - They have high brand recognition, and customers are willing to pay more for basically the same product (Coke, Nike).

• Secret - Intellectual property (3M, Intel).

• Toll -exclusive control of a marketplace (Railroads, Media companies).

• Switching - Deeply ingrained in the customer's business, making it unfeasible to switch (IBM, Microsoft).

• Price - Lowest cost producer (not lowest price) (Walmart, Home depot).

So, now we continue on with our CMG example and ask ourselves; ‘What kind of Moat does Chipotle have? Hmm, good question… well, what kind of moat do you think it has? Look at the list above and see where you think it fits best. ​​ You can also refer to the website, where it gives a brief description of the different types of moats available. ​​ Note: Not all companies will have a Moat, it’s important to keep this in mind… though i believe CMG does have a strong Moat. To continue on, simply go down the list and select the Moats that you think fit, then click the button when you’re done.

(Source: Rule One Investing)

Let’s quickly go over why I selected Price moat. Here’s how this kinda goes in my head... I don’t think they are too cheap price wise, and anyone can choose to eat anywhere, so no Price or Switching moat there… Definitely not a Toll style Moat, as they aren’t the only place you can get a burrito… And I don’t think their recipes are all that secret, so that moat’s a no. ​​ They do seem to have a pretty strong Brand moat, and seem to have lots of customers who, if craving a Burrito, won’t settle for anything but Chipotle. Therefore, in my sometimes humble opinion, they have a Brand Moat. They seem to have captured a large share of the ‘Fast & Healthy’ market, and you can see strong evidence of this in their growth numbers (which we’ll go over soon). I also think they have a strong Brand Moat because even up here in Canada, I’ve heard great things about it, though I’ve never actually had it myself. (have you had it? Is it good?) Note: Lately the brand moat has ​​ been damaged recently with an E-coli scandal.

One more thing to think about at this point is how big the Moat actually is. ​​ Remember the Castle analogy; the Moat protects that castle from outsiders trying to attack, so the bigger the moat the longer the castle is protected (though no moat lasts forever). You should also ask yourself if this is the best business in the industry? and, what makes it better than its competition? ​​ These questions help to solidify that the company has a strong and potentially lasting Moat.

Do you agree with my moat selection? You don’t have to, this is your process, so ultimately, you must make the decision.

Management

Sometimes you need a great leader to lead a great business. ​​ That’s why this next step is so important. ​​ We really need to be able to figure out if the individual leading the company is going to do so in a way that will realize long term value for the business. ​​ Really, we don’t want ‘ok’ leadership, we want ‘Next Level’ leadership. Management is one of the most important factors when it comes to investing in a business, it also happens to be one of the toughest areas to be sure about. ​​ It’s subjective, and sometimes you don’t know how the CEO will act until he’s backed into a corner (I found this out the hard way in the past). ​​ But, we can look at a few common factors that make for a Next Level CEO:

• A great CEO is driven - They live and breath the company, it’s all they talk about. ​​ They jump out of bed in the morning excited about their day, and can’t wait to accomplish their goal. ​​ That goal is usually a big hairy audacious goal (BHAG) as Jim Collins calls it. ​​ It’s something bold, something difficult, and often, something great. ​​ That’s what drives them, it’s what gets them so excited in the morning, and makes them stay late. ​​ It’s the driving force.

• A great CEO is shareholder oriented - his/her interests are aligned with those of the shareholders. ​​ They are in it for the long term, and won't do stupid things short term, just to get a little bonus. ​​ They care about the longevity of the business more than they care about their paycheck.

Ok that’s good to know, but how do we find that stuff out?

Great question! ​​ I believe there are a five key things to look out for, when determining if the company does in fact, have a great CEO at the helm. Note: most of the grunt work is done through research on the CEO, I like to read the quarterly and annual reports that the company must issue, as well as googling the CEO and reading all the articles about that person. ​​ This is an important step, so take your time.

Here’s Five attributes that make up a ‘Next Level’ CEO:

First -A good CEO will use team talk instead of egocentric language. ​​ What this means is that you want the CEO to use the term ‘WE’ a lot, or talk about how well everyone else did, and how it was a team effort. ​​ You want a CEO who doesn’t take personal credit for the company's achievements and instead, praises the work of the employees.

Second - A good CEO will blame his/her success and the company's success on luck.

Luck seems to be the magic word when it comes to having a great CEO, so keep on the lookout for it in the 10 Q’s and 10 K’s (quarterly reports, and annual reports).

Third - ​​ A good CEO will be an owner of the company, and should be a buyer of the company's shares, when they are at a good value. ​​ This helps to align his/her interest with that of the shareholders. ​​ They will not sell shares in advance of release of some bad news. ​​ Though you may see them sell shares to support a charity.

Fourth - A good CEO doesn’t require a ridiculous salary, but would be happy to make money alongside the shareholders, through the growth in the underlying value of the company, thus lifting the share price. ​​ They should be doing the work because they love it, not for the money.

Fifth - A good CEO will openly and honestly admit when something is not going as planned, or they failed to meet their goals. ​​ They will admit to the problems up front, and discuss how they plan to fix them.

“The CEO is going to be the final deciding factor for whether we really want to own his company. ​​ The CEO determines the focus of the company, the happiness of the people working there, and ultimately, the return-on-investment we’re going to get when we buy the whole thing. ​​ CEO’s who stick to their knitting and who focus on what they do well, are the right CEO’s for us.”

• Phil Town ​​ 

Examples of good CEO’s

If you want to know how a ‘next level’ CEO should talk, read Warren Buffett's annual letters to shareholders. ​​ His is candid to a fault, and very entertaining as well. ​​ He openly admits when he’s made an error in judgement, and doesn’t make an excuse for his mistakes.

Another great CEO you should check out is John Mackey of Whole foods. ​​ Like Warren Buffett, he is open and honest with his shareholders and is a good example of what an excellent CEO should look like.

I’ll finish this section with another quote from Phil…

‘The guy or gal who runs things is critical. ​​ You don’t get a great company without a great CEO. ​​ Don’t fall for CEO jargon and hype phrases. ​​ The numbers don’t lie, and if a CEO isn’t explaining what happened candidly in the letter to the owners, how can you trust him/her. ​​ If you can’t trust him/her, you can’t buy the business’

• Phil Town

So, the question is, does Chipotle have a ‘Next Level’ management team?

This is where you’d put in the time to research the management, and find out if you think they are compensated ‘fairly’ for the work they do. ​​ Also look back at the 10 Q’s and 10 K’s management section, and see how the individual talks to the shareholders. ​​ Is it all about him/her or about the team and their Big goal?

Another great idea is to see what the employees think about their jobs. You can find answers to these questions through a website called Glassdoor. (you’ll see a CEO approval rating of 87%, which is pretty darn good).

(Source: Rule #1 Toolbox)

Go through the checklist and find the answers to the questions it asks. ​​ Take your time, this is important.

For this example, let’s assume they are honest and trustworthy, passionate the company and its goals, and owner oriented. So, we click all three boxes and then we hit the ​​ button.

Margin of Safety

This is where the true value of the business is uncovered.  ​​​​ This is the step we take if the company has passed all of our other tests thus far, assuring us that this is a ‘Great Business’ to invest in. ​​ But, we can’t pay an infinite price just because it’s a great business, in fact, we don’t ever want to pay full price for any company we want to own. ​​ 

Remember, we always want to buy $1 worth of value for $0.50 or less. ​​ This means we want to buy it when it’s on sale, so that we’re protected in case we make a mistake in our assessment... We’re giving ourselves a cushion (which feels good on the Hiney...). ​​ The other half of the equation is, that if we are right, and this is a great business, buying the company when it’s on sale will dramatically increase our investment returns (which I’ll prove later). Sound good? Let’s check it out.

Phil’s MOS Calculator, It’s all about the Future...

The next, and possibly most important step to consider, is what growth rate we are going to use to value the company into the future. ​​ Phil’s calculator uses the current EPS, and combines that with the selected growth rate to look at what the company should be worth ten years from now. ​​ To find the Sticker price today, the calculator uses something called an MARR, or Minimum Acceptable Rate of Return. In other words, what percent return you would accept as a minimum for buying this company. ​​ Phil recommends using nothing less than 15% due to inflation, taxes, and transaction costs, so that you’re still making out OK in the end. ​​ This can also be considered the Discount rate, for any value investors out there…

Now that we have sticker price, we want to discount that by 50%, giving us our Margin of Safety (MOS) price. We discount the sticker so heavily to protect ourselves from well, ourselves. ​​ We are likely to make a mistake at least sometime in the future, so we want to have as big a buffer as possible, so that we greatly limit our downside risk. ​​ Remember, Rule #1 is Don’t Lose Money, and you can see that if we stick to our margin of safety price, in ten years, we are very unlikely to lose any money on this investment. ​​ Cool right?!

With a little practice, this process begins to become much quicker, and really, a lot of fun.

Step 4a: Margin of Safety, Chipotle

As you can see, there is a lot of information on this page, for now let’s focus on the top half, which are the Rule #1 score and all the growth rate numbers. ​​ These numbers are what we need for our MOS calculation. The analysts are expecting a 21.27% growth rate for the next few years and we need to see if that’s a legitimate number based on their past growth rates (Note: analysts are almost always wrong, we just don’t know which direction they’ll be wrong, or by how much). ​​ 

So, must now figure out if we agree with the analysts, or disagree. ​​ We do this by looking at the past growth and asking ‘Is this sustainable’? ​​ Remember, we’re looking out Ten years, so we want to be conservative. ​​ Here’s what the page looks like in case you’re not following along (for some crazy reason). You may notice that I chose a personal growth rate of 15%, and I’ll explain why below.

(Source: Rule #1 Toolbox)

As you can see in the top right corner, Chipotle has an amazing Rule #1 score. ​​ In fact, it has a perfect score. ​​ This immediately tells me three things:

• This is a great company, with a really great track record.

• Because of this great track record, it likely still has a solid Moat.

• Because it’s so great, it’s going to be difficult to buy this company on sale.

You can see all the growth number are well within the green (above 10%), but they have been decreasing slowly over time. ​​ You can see that the 1 year numbers are waaaay down from before. ​​ This could be due to the E-coli scandal I mentioned earlier, but Return on equity (|ROE) and Return on Invested Capital (ROIC) are still amazing. ​​ Management seems to really be able to put the excess capital to work. ​​ What this tells me is that they won’t be paying a dividend anytime soon, at least until growth slows down, which we should be fine with, if they can keep compounding their cash at these high levels. we’d much rather see 22.4% growth, rather than a 4% dividend… right? ​​ The number that you’ll want to give the most weight to when trying to figure out a reasonable growth rate is BVPS + Dividend Growth Rate, it shows the company's ability to produce equity, which is an excellent predictor of the health of a company going forward.

They also have zero debt, which is another big plus for management in my books. I learned the hard way that Debt kills, so the lower the better in my books. A growth company like Chipotle shouldn’t be taking on debt. ​​ They should be using the cash from operations to continue to grow the business if it makes sense to do so. ​​ At these growth numbers, you can see that management has been very prudent in the investments they’re making into the company's future. ​​ This also means that they are likely growing organically, which is likely more sustainable into the near future.

Before we move on, let’s compare this to another restaurant company, just so you can see what not-so-great growth numbers look like… Here’s a screenshot of McDonalds…

(Source: Rule #1 Toolbox)

As you can see, there’s a lot more red for McDonalds, and a lot of negative growth numbers. ​​ Management still seems to getting a good return on equity and capital, so it’s not all bad.

The next thing we need to check is ‘how smooth has the growth been for CMG? ​​ We can do this by looking at a growth chart on this site. The theory goes like this; the smoother the growth lines, the more predictable the company. ​​ The more predictable the company, the easier it is for us to value out into the future. Make sense?

If you click the button at the top left, you’ll be brought to this screen:

(Source: Rule #1 Toolbox)

See how the lines move at a steady clip upwards? This is exactly how you want growth numbers to look. ​​ You want to seem them moving parallel to each other as uniformly as possible. ​​ This demonstrates sustainable and consistent growth.

(If you scroll down on this page you’ll be confronted with multiple charts, all demonstrating the past growth history of company's growth numbers).

Let’s again look at McDonald's for comparison...

(Source: Rule #1 Toolbox)

I must admit, this doesn’t look as bad as I expected it to... ​​ But, you can see that Book value Per Share really fell off the map since 2014, and that growth overall has been flat since 2006.

Let’s look at one more, just so you can see what a truly bad chart looks like.

And for that, I have the pleasure of showing you the chart for Sears (SHLD), which has been slowly failing for many years now. Let’s take a look.

(Source: Rule 1 Toolbox)

Yikes, that is ugly. ​​ See how the lines cross over each other than cross back? We don’t want to see that, that means some of the numbers are dropping while some stay the same or increase slightly. We want all those growth numbers to be moving together otherwise, how can we predict the future of this company? Answer: you can’t. ​​ Just look at this chart then scroll back up to the Chipotle chart… Huge difference. ​​ Now you know what to look for.

Growth rate

Alright, that was fun, but let’s get back to the analysis of CMG and move on to the actual calculation. ​​ As mentioned earlier, the whole purpose of looking at the growth numbers, and comparing it to the chart, is to find a suitable growth number to use in our Margin of Safety analysis. ​​ If you’re following along with the analysis, you would have seen that the analysts are predicting a 21.27% growth rate. ​​ To find our number, we look at the growth rates over the last ten years. ​​ Based on that, you could say that the analysts are probably accurate in their predictions, but remember, they aren’t looking out ten years like we are.

I think the analysts are a little too optimistic. ​​ I think I’d go more with a 15% growth rate. ​​ Remember, we want a growth rate that is both probable and sustainable. ​​ It’s always a good idea to be conservative with your choice, the more conservative you are, the more likely you’ll have an accurate Margin of Safety and thus, make fewer mistakes.

Note: compare your growth rate to that of the analysts, and always choose the one that is lower. ​​ Here’s where you insert your number if it’s lower than that of the analysts.

Click the button once you’ve selected your growth rate, and we’ll continue to our valuation.

Valuation

This is the fun part. ​​ We get to find out what chipotle is Worth. ​​ Again, Price is what you pay, Value is what you get. As smart, long-term oriented investors, we never pay full price. Ever. ​​ Here’s the page we’re on now if you’re following along.

(Source: Rule #1 Toolbox)

Once you’ve used this calculator a few times, you’ll find yourself valuing all sorts of different companies. ​​ It’s really fun, and if you put in the real work required to Understand the company, it can really pay off. It may look overwhelming at first, but it’s simple once you do this a couple times, and we’ll go over it quickly here.

If you focus on the left hand-side of the calculator, you’ll see the numbers needed to find the company’s current intrinsic value, aka it’s Sticker Price. ​​ If you float your cursor over the (?) beside each number, it gives a brief description of each value needed.

At the top you see Earning Per Share (smoothed, to get rid of extremely high or low years), You can check this number against the most recent year's EPS and adjust accordingly. ​​ Next, you can see my chosen 15.00 for the Future Growth Rate, and under that we have the estimated EPS in 10 years of 61.09.

The next number that you must consider is the Future P/E (Price to Earnings ratio). ​​ In other words, what’s a fair P/E ratio the company could be trading at 10 years from now? ​​ The default future PE is simply double your expected growth rate, which in this case would give us 30 (it’s the default P/E because companies tend to sell at roughly 2x their current growth rate). ​​ To check to see if this number is feasible, look to the right of the calculator, where it says . ​​ You can see on CMG that the range is from 30.40-66.70. ​​ This tells me that our 30 P/E is probably a little too conservative since it’s never been at that level before. Note: you want to make sure the future P/E falls within the range of past ratios, and is reasonable to expect in a bull market on the stock you’re analyzing. ​​ For this example, I’ll bump up our future P/E ratio to 40, which I think is still conservative.

Future value of CMG

The next box displays the estimated Future Value of Chipotle, and in this case, it came out as $2443.6. ​​ At this point, I always like to check and see if this number is within the realm of possibility for CMG. ​​ To do this, I check to see what the market cap for CMG would be if it were to reach a value of $2443.6, and if it’s a reasonable number. ​​ You’ll be able to say as well as I can, what’s reasonable or not, but we can compare it to similar companies that have large market saturation. ​​ To do this, simply multiply the number of shares the stock has by the estimated future value and you’ll get its future market cap. ​​ Let’s check it out:

Current market cap = $11.07 Billion

Number of shares =28,949,162

Future value = $2443.6

Number of shares x Future Value = Future market cap

28,949,162 x $2443.6 = $70,740,172,263 or $70.74 Billion.

Check this against the current market cap of other saturated restaurants in the market:

YUM Market cap = $23.67 Billion

MCD Market cap = $100.7 Billion

Based on these numbers, if all goes accordingly, I think it’s feasible that CMG could have a market cap of $70.74 Billion in 10 years. ​​ So, our number gets a PASS in my books. ​​ Again, this is subjective, and ultimately, it’s your choice.

The next box is MARR %, again this is the Minimum Acceptable Rate of Return. ​​ Phil has this set to 15%, but you can adjust it up or down depending on the return you’re happy with. I’d only think of making this number bigger, not smaller. ​​ We want large returns. No settling for us.

The final box is the MOS %, which stand for Margin of Safety. ​​ This is set to 50% automatically. ​​ As Rule #1 investors, with the likes of Warren Buffet, we want to pay $0.50 for $1.00, that’s why we set it to 50%. ​​ We’re also not all geniuses, and thus we make mistakes. ​​ So, we set ourselves up to Not Lose Money by demanding a large margin of safety built into the price we pay.

Note: if you have any questions about this calculator or anything else, email me, and I’ll get back to you right away:

contact@nextlevelinvesting.com

Now that we have all those numbers filled in and figured out, we hit the button and the calculator works its magic. ​​ Be sure to read the then click OK and see what the calculator spits out.

Valuation Results

Here’s what my analysis of CMG came out with:

(Source: Rule #1 Toolbox)

So there you have it. According to our calculation, the MOS price for CMG is $302, with a sticker price of $604. ​​ I feel comfortable with that analysis, what do you think?

As you can tell there are a few other metrics we haven’t covered, in the calculator, they are:

Margin of Safety Yield: This is the Return on investment you would receive from earnings of the company at the margin of safety price, if you owned the entire company (Calculated as EPS/MOS)

Payback Time: Which is the amount of time it would take the company to pay back your entire investment with its earning, if you owned the entire company (9 years at the current MOS price).

Payback Time Price: The price at which it would take the company 8 years to pay back your entire investment if you owned the entire company. This metric is used to demonstrate an alternative entry price for stock ($238.27 in this case).

Red Zone Price: This is the price when you start to think about selling the shares you own. ​​ It’s calculated as 120% above the sticker price.

Green Zone Price: This is the area where you want to be a buyer. ​​ Its any price below the MOS price. ​​ Both of which are represented in the graph at the top of the page:

(Source: Rule #1 Toolbox)

As you can see CMG still isn’t quite in the Green Zone yet (though it does look like it’s currently trending towards the MOS price…). ​​ You may also notice that each time it entered the Green Zone it was a great time to buy, and when it was in the Red Zone, it would have been an excellent time to sell. ​​ It’s important to frequently re-calculate the stocks you own as they change and grow, this chart will move with those changes, adjusting accordingly.

​​ 

Decisions, decisions...

Now that we've completed our valuation on CMG, we have a decision to make. Do we think CMG is at a good enough price to own it at these levels, now that we know the value? ​​ On the valuation page, you simply select your choice from the selection below;

(Source: Rule #1 Toolbox)

For me, I think this is a great company, but it’s still not quite at the Margin of Safety price we calculated. ​​ I really want that safety net, just in case my valuation is too optimistic or the economy goes down the drain. So instead, I’m going to continue to monitor the price until it reaches my MOS by clicking and then hitting the button. ​​ 

Post Valuation

You’re now brought to Step 5: Post Evaluation. ​​ The page is self explanatory, so we won’t cover it in details. ​​ It’s basically a review of everything we just went over, on one page, you can also go back and change your valuation at any point, or adjust as needed as time goes on. ​​ You can also add your own notes or thoughts about the company. ​​ This can be an interesting feature to look back on after you’ve made an investment. ​​ Whether the investment worked out great or was a big fail, it is always good to know why you liked it at the time, this way you can hopefully not make the same mistake twice.

Oh, and if you like the company and want to add it to your own Watch List, click the . Now, every time you login, you’ll see CMG on your Stock Watch list. ​​ You can get to this page by clicking the tab at the top left of the page.

Here’s what your page should look like now that we’ve completed our analysis.

(Source: Rule #1 Toolbox)

As you can see, it gives you a quick snapshot of CMG, its current price, your MOS price, and the sticker price as well as any daily moves that Occurred. Cool, right?!

The Best part about buying with a Margin of Safety

I figured I should mention this before we move on, because, well, it’s awesome… Remember how we set our Minimum Acceptable Rate of Return (MARR) at 15%? ​​ well, that return is actually what we would get if we paid Sticker Price for the stock. ​​ In other words, that return does not include our 50% Margin of Safety price. ​​ So, if we do get to buy the stock at MOS, and everything goes as planned, we’ll get an even better return than 15%! Should we find out what our return would be at MOS? I think yes.

Potential Return on CMG

Well, if you’re like me, and don’t particularly enjoy doing math, use an online calculator to find what your potential return could be. I have one on my site you can find here:

Investment calculator.

To do this, use your MOS price as your starting balance ($302 in our CMG example). ​​ Then use the calculated Future Value as the ending balance ($2,443.60). ​​ Next put in 120 months to represent the period of 10 years. And hit . Here’s what our potential return would be, if we could buy CMG at $302 and the stock hits $2443.60 in 10 years.

(Source: Next Level Investing).

As you can see, if all goes according to plan, we will have a compound annual return of 23.25% for 10 years. ​​ That would be pretty dang sweet. ​​ That turns $10,000 into $80,885.24, Nice. ​​ If we compare that to paying sticker price, and receiving 15% a year, that $10,000 would turn into $40,455.58. ​​ Still not too shabby, but paying MOS is going to benefit us in the long term. ​​ If we can continue to compound that $10,000 at 23.25% we’ll be millionaires in less than 23 years ($1,224,896.36 to be exact). ​​ (note: If you want to play with different rates of return, the calculator is Here).

That’s it!

So, that’s that when it comes to doing our full analysis on a company we’re interested in. ​​ I think after doing this analysis, you can see why it quite literally pays to know what the value of the company is before you buy it, and it especially pays to buy it with a large Margin of Safety.

Before we sign out, let’s quickly go over the next use of this website.

Idea Confirmation

This is where this resource tends to really shine. ​​ You get to combine every resource I’ve mentioned with this toolbox to complete your own valuation, and if it passes the test, Buy it, Dismiss it, or put it on the watch list, and simply wait. ​​ You can quickly and easily check the 30 stocks that you screened in Part 1, or do a quick valuation on the stocks one of your favourite Guru’s owns from Part 2 or someone else's idea from the forum I recommended in ​​ Part 3.

This is really the fun part, and you can really check out any stock you’re interested in. ​​ All you need to know is the ticker symbol and you’re off to the races.

How to play

This is the easy part. ​​ In the top right corner of the page where it says enter the ticker symbol you want to analyze, then hit the Go button. ​​ For fun, let’s look at Apple this time. ​​ Type the ticker AAPL into the space and hit the Go button. ​​ This takes us to the Stock at a Glance page.

(Source: Rule #1 Toolbox)

As you can see, the page is aptly named… You have all the basic information about the company’s stock, and what happened that day during trading hours. ​​ This is also where you can do everything else you need to do to analyze a stock you’re interested in. ​​ As you can see on the left, the Toolbox is organized into four categories:

• Town analysis

• Company

• Financials &

• Industry

Town Analysis

This is the section I’ll focus on when I’m first reviewing a company. ​​ Let’s start with the tab. ​​ Let’s click on that, and quickly go over this page. ​​ Right away you’ll recognize the Rule #1 numbers from our analysis of CMG. (Note: If this is a company you know absolutely nothing about, you’ll want to look at the company profile page. ​​ This page will give you a brief description of what the company does, who the CEO is, the sector, and how to contact them Etc.).

(Source: Rule #1 Toolbox)

You can see that AAPL has strong numbers over the last 10 years, with the growth rates slowly falling for the last 3 years. ​​ Again, steady or increasing growth is ideal. ​​ Remember that the best predictor of future growth is often the company’s ability to grow its equity. Thus, you want to give more weight to the BVPS + Dividend Growth Rate when you’re trying to figure out what growth rate to use in your calculation. Now, if you scroll down, you’ll see where the growth rates are pulled from; 11 years of company financials, aka the Details in Numbers sections. ​​ 

(Source: Rule #1 Toolbox)

Again if you want to discuss any of these metrics, email me! (contact@nextlevelinvesting.com).

Keep scrolling down the toolbox and you’ll see all the key ratios that people like to look at before making an investment.

(Source: Rule #1 Toolbox)

Pretty neat, right? ​​ All the most important company information is found on One page. ​​ This is one of the reasons why I love this site. ​​ The toolbox makes research much quicker and easier to get a quick snapshot of any company I’m interested in.

Growth rate chart

At this point, if I still like the company I’m looking at, I’ll move down the list to the . ​​ I’m now trying to quickly assess what sort of growth rate will be appropriate for AAPL so that I can get a quick snapshot of its current value, and if it’s on sale right now, or worth adding to my Watch List.

Remember, we want nice parallel lines that are increasing into the future. ​​ Based on this chart and apple's growth numbers, it looks like Apple may be slowing down.

What I do after running the MOS test

At this point I usually run a quick calculation on the company I'm looking at. I use my best judgement as to what a sustainable 10-year growth rate could be for this company. I also do the ‘Is this number actually feasible’ test I mentioned earlier. After doing the calculation I have a choice to make:

• If this company appears to be within my MOS right now, I need to continue with my research. Here's a basic list of what I'll do next:

• Check it against industry peers to see if it the best or second best business in the industry. (Also, do a quick value on other top companies for comparison).

• Read 5 years’ worth of 10 K’s and at least one during a market downturn.

• Read 2 years’ worth of 10 Q's

• Check health of cash flow and balance sheet.

• Use resource #5 to keep up with company and see what other investors think.

• **If after all this work is done and the company still looks great and I still like the growth rate I used, I’ll now go to a chart, and do some technical analysis to see how the stock is trending, if it’s overbought or oversold, and how the put options are priced. If I like what I see, I’ll buy my first chunk of shares here. ​​ Then I would likely also sell a Put option for the next bunch of shares I want to buy, that way, I get paid to buy a company I love, at a great price. (We’ll get to the technical analysis and selling put options soon, I swear.)

• If the company looks great but isn't within my MOS price, I'll add it to my watch list. Later, I’ll continue with the steps mentioned above.

Conclusion

Phew! Well that was fun. ​​ I know if you’re like me, you’ll really get a lot out of this resource. It’s fun, right?! ​​ You can probably see how this will benefit you into the future, That’s at least my hope. ​​ I’m sure you’ve thought of this, but I’d recommend checking the stocks you already own against this toolbox, and see if your original premise for owning the company still holds true.

What we covered:

Idea Generation… Awesome

• We learned how to do the 3 circles exercise, (passion, talent, and money) and started with just one of the industries on my list (restaurants).

• We then picked one of the best companies in that industry to do the analysis on (CMG).

• We then learned about how a company protects itself by having a large and deep Moat. ​​ We learned that there are 5 different Moats to consider (Brand, Secret, Toll, Switching, Price) and went over the basic of each.

• We decided that CMG had a Moat, and picked one we thought fit best (Brand)

• We went over what makes a great Manager, and all the characteristics that need to get a ‘Pass’ from us, so that we can move onto the next step.

• Next, we learned how to find a reasonable growth rate for the company, looking at the growth of the financials then checking it against the chart. Once we choose a number we compared it to what the analysts were thinking. ​​ We chose the lower of the two to be more conservative. ​​ We also learned that BVPS + Dividend growth should be weighted more heavily in this analysis.

• Plugged in all our numbers into the calculator, adjusted the Future P/E so to something rational, then checked to make sure the future value was feasible.

• Next, we found our sticker and MOS price, and found that CMG was still trading above MOS, so we decided to add it to our watch list, and continue to do more research while we wait for it to hit our price.

Idea Confirmation? Yes please.

• We quickly went over how to check stocks you have found through one of the other resources, and how awesome and quick the analysis can be.

• I went over the steps I take when I have a stock I want to analyze, and what I do once it passes all the steps.

Takeaway

The whole point of learning this, is to find great companies, and to buy them when they are on sale. ​​ I truly believe, that if we can do this, we will be very rich when we want to retire, and achieve financial independence. ​​ That’s my main goal, and I want the freedom that independence can bring. ​​ If that’s your goal too, you’re in the right place. ​​ If you want to join me on this financial journey, join my email list, I’ll keep you updated with everything I’m learning, and give you some extra lessons on options and technical analysis that you won’t get anywhere else. ​​ They are just me, emailing you. No spam ever. ​​ I’m just a (mostly) regular guy, looking to help and build an awesome community of like-minded investors. So, what are you waiting for? Join us!

Click here to Sign up to the Newsletter now.

Wow, thanks for reading!

I know that took some time to do,

and I honestly appreciate it. My

hope is that it helps you reach your

own financial goals.

We’ll talk again soon,

~Ryan Chudyk~

(I Need Five More Words)