Sunday, September 24, 2006

Single Best Investment - some of the rules

I recently reviewed the book, The Single Best Investment, which provided a framework for investing in stocks likely to outperform the market over lengthy periods of time.

I am going to provide a synposis of some of the rules that the author suggests to find suitable candidates using this dividend-and-value-oriented approach:


  1. Company has to be financially strong, minimum B+ Value Line rating, or BBB+ S&P credit rank;
  2. Dividend yield at 150% of the S&P500, but hopefully at 200%+;
  3. Yield has to be expected, and shown to have grown over 5-10 years, at at least 5% annually (twice the expected inflation rate);
  4. Dividend payout ratio less than 50% (except for utilities and REITs);
  5. Company should have at least moderate earnings growth of 5-10% annually (both historically and going forward);
  6. Price/Sales ratio below 1.5, and hopefully less than 1.0;
  7. Price/Earnings ratios lower than the market, AND must less than the reciprocal of the long-term bond rate;
  8. Book value ratios should be lower than the market, and;
  9. Growth of cash on the balance sheet is a big positive.

There are, of course, other rules and suggestions, but I'd suggest to you that these encompass the heart of the book and suggested technique.

Since almost all of these rules as stand-alone situations have been shown by various academic studies to produce some level of market outperformance, combining them is obviously going to provide a platform for outstanding results with enhanced safety of capital.





JW

The Confused Capitalist

4 comments:

James said...

In regards to numbers 2 and 7, I have been trying to find the average yield and average p/e of the tsx composite with no luck. Do you have a recommendation where I could look these numbers up.

thanks

James

Jay Walker said...

Hi James,

I know that the Globe and Mail publishes the pe ratio every weekend in the Globe Markets page in the business section. (Current TSX composite pe = 16.4 and TSX/SP60 pe = 15.5).

As far as the yield goes, I'm not sure where this information can be obtained.

However, I'd suggest that pulling up the ishares ETF for the TSX composite [as capped] (symbol: XIC) would provide a pretty good proxy for this number. The TSX site [www.tsx.com] currently reports that dividend yield at 2.32%.

Hope this helps you.

Anonymous said...

I am confused on calculating reciprocal of the bond rate described in the book. If in the book the market's P/E is 24 and long term bonds yield is 6% where the number 18 came from. I do not see the relation, or I am missing something. Can you help? Thanks

Jay Walker said...

Hi Anon,

In your example, the reciporal of the bond rate would be 1/0.06 = 16.667. So under your example, you'd be searching for something with a PE lower than the 24 of the market,and the 16.67 of the bond reciporcal.

Jay