Let’s start with a question: Are you a spender or an investor?  Pop Quiz.  Ready.  Go.  Question #1 I’ll give you $100 today or a new Mercedes next year?  Which one will you take? A) The cash, B) the car, C) why are you even looking at other options, you’d be crazy not to take the car.    Ok, let’s move to question  #2, I’ll give you $100 today or $100 next year.   Which one will you take? Think about it…  A) The cash today, B) the same cash tomorrow.   C) Of course you wouldn’t wait!  What’s the point? You wouldn’t get anything in return for waiting.  There.  In one minute we’ve narrowed down whether you are an investor or a spender.  You’re a spender if you don’t get a return.  You’re an investor if the future is worth somewhere between $100 and a new car.  The question of whether you will invest is really just a question of how much you believe tomorrow can offer.   How much could the future be worth for a bit of sacrifice today?  Well, I’m here to tell you that your future is brighter than you can even imagine! The great Benjamin Graham, one of the most legendary investment teachers of all time said: “Without a saving faith in the future, no one would ever invest at all.  To be an investor, you must be a believer in a better tomorrow” – Benjamin Graham.  What if I told you that if you invested $1,000 today you could retire with millions of dollars 40 years from now?  What if I told you that if you invested in learning the skills of analyzing businesses today you could be accepted into the best colleges in the world?  What if I told you that if you became a stock picking pro, like we’ll show you how, you’d basically guarantee yourself a future of prosperity and freedom?  Legendary investor Warren Buffett, the Oracle of Omaha, took $10,000 and turned it into a $70 billion dollar net worth, and along the way he left breadcrumbs of exactly how someone could repeat his success.  It’s actually a very simple formula. Become a young investor, and we’ll show you how your future holds astonishing returns, why you’d be crazy not to start investing today.    We’ve put together the cumulative wisdom of decades of the world’s top stock investors and business analysts, and boiled it down to the key principles to teach it to anyone.  True investing is simple, but it’s definitely not easy.  It takes guts, a passion to learn and rock solid discipline.  Better yet it’s some of the most fun you can have.  So decide now to be a young investor, and you will part of the next generation of the best business analysts, stock pickers, and investors the world will ever know.  Now, let’s change the world!

We’ll only invest in a company when the price we pay today is significantly less than the value we will get tomorrow.  But how do we know what the value of the company is? Let’s take Apple.  What is the value of the world’s largest business of consumer electronics?  Well, the value of any business is the present value of all future cash the company will make minus the cash it needs to invest to make this happen.  Let’s assume that today, Apple sells 200mn products per year at an average price of $1,000 each.  So they make $200 billion dollars a year in sales. But to make those 200mn products, they spend $700 to design and make them and $100 to buy the equipment.  So they’re taking home $200 per device, or 40bn dollars.  Would you pay $40 to receive $40 this year?  No, not unless you think Apple is going to keep making money next year.  Ok, let’s assume Apple sells 5% more products every year at the same price of $1,000. (Interactive graph showing revenue, profits and value under profits line is shaded).  Next year they make $44bn, the following year they make $48.4bn and so on.  The value of Apple then becomes everything under the line.  Let’s assume Apple can keep this trend for the next 40 years.  The total amount of profits going forward, at today’s value is about …  $675 billion dollars.  Not bad, eh?   Divide that by the number of shares outstanding, and we have the value of the shares at about $111 dollars per share. Now let’s tweak with the numbers.  Let’s say instead of growing 5% per year, Apple only manages to sell the same amount of devices every year going forward.  The graph (becomes flat) and the total value of Apple is nearly cut in half to $391mn, or $64/share.   (At the current share price that means you’re going to lose half your money). Now, let’s assume that Apple manages to have very strong growth of 15% per year for a few years, but in year four the company has competitive pressure and profits get cut in half.  Then they get cut in half again and profits remain at this level going forward.  The value of Apple plummets to $220bn or $36/share.  Ouch! So the value of what a company is worth really rests on just two questions, 1) how much are profits going to grow and 2) how long are these profits sustainable?  Those are the two things that determine how much value comes back to you in the long run as an owner of the business.  ‘How long will this last?’ is probably the most important question you can ask yourself, in trying to figure out what something is worth.

On $100 over one year.  No not really.  You either make a $2 or $10 gain, that’s the difference of a McDonald’s value meal. But if you take this over 40 years this is the difference is surprisingly enormous! Do something like Pabrai did in his presentation: https://www.youtube.com/watch?v=zXRSVvKf0Bc

Let’s play a game.  Ready?  Open a financial newspaper like the Wall Street Journal, turn to the stock quote section, and pick any company at random, and look at the high and low from the past year. Ok, let’s see here.  We have GM.  They make cars and trucks.  Over the past 52 weeks, their stock traded as low as $28/share and as high as $39/share.  They have 1.6bn shares outstanding, so that means that the market value of GM was as low as $45bn and as high as $62bn.  That’s a difference of $17 billion dollars in value.  Now the car business doesn’t really change that much, you sell  plus or minus 5% more vehicles per year, a Chevy Silverado is a Chevy Silverado, they’re not figuring out how to replace gasoline for water, or how to fly to the moon.  It’s basically the same business this year as it was last year.  So how in the world could the value fluctuate by $17 billion dollars?  (And more so, how could this be the same with every single company on the stock quote page)? Was last year an exceptional year of price swings?  Nope Is there something the market knows that we don’t know?  No. So, what’s the explanation?  Well, it can be summed up into four short words “THE MARKET GOES NUTS”. Let me tell you a story.  It’s a story that legendary investor Benjamin Graham told.  It is about a business partner of yours, named Mr. Market.   Imagine you own a business together. Now, Mr. Market is a good guy, but he suffers from wild mood swings.  One day he wakes up, and the sky is blue and he’s feeling good and he is feeling really, really good.  So offers to buy out your stake in the business for way more than it is worth.  Then the next day, he wakes up and it’s raining, he’s feeling desperate, and he is screaming that the world is going to end.  He offers to sell you all of his stake in the company for half of what you paid for it.  You take it!  The next day, Mr. Market offers to pay a price that is neither extraordinarily high nor extraordinary low, so you just do nothing.  Now the value of the business didn’t really change from day to day, what changed was the erratic moods of Mr. Market.  In Short, Mr. Market is one moody dude. So does this mean that we shouldn’t invest in the stock market, because of these wild swings in the short term?  To the contrary!  The fact that we are offered deals from time to time should make us very, very excited.  Our goal is to 1) identify what the company is worth, and then 2) to wait for Mr. Market to have a bad day and buy it at a large discount.  Benjamin Graham called this giving ourselves a “margin of safety”.  Buying dollars for fifty cents. Ok, you’re thinking.  This is all well and good, wait for the market to crazy and buy below the fair value, but one problem, how can we be sure that we can even come close to knowing the value of a company?  How can we be sure that our forecasts (wild guesses) are even in the ballpark?  Aren’t there a ton of smart people and computer programs waiting to scoop up a bargain as soon as it becomes available? Now, I’ll be the first to tell you that I have been dead wrong on the value of companies on many many occasions.  I’ll also admit that for over half of the companies on the market that frankly I have no idea what the true value of the company is.  Why, remember our lesson before, the value of a company boils down to 1) How much these profits grow to and 2) how long these can last.  If you don’t know how long those profits will last, you can’t compute what the company is worth.  Most companies is a wild guess how long those profits can last, because they don’t have any real defenses.  They don’t have an economic moat.  So we can’t really feel comfortable about the value.  The good news is, there are, some exceptional companies.  With a substantial moat around their castle, that we know can’t be competed away easily.  These high-quality businesses we can have much more assurance that they will have a value today, and a value tomorrow.  These are ones that we can feel sure that we are at least in the ballpark of being calculate their long term value.  So when Mr. Market comes to us in one of his bad moods, wanting to sell us shares at a discount, we say “Sure!  Give me all you got!” Recap: 

1. Stocks fluctuate wildly on a yearly basis.  The true value of the business does not change much.
2. The reason behind this is that there is a man names Mr. Market that is just plain NUTS!

3. If someone offers you a dollar for fifty cents, take it!

Now, we’re getting to the fun part, picking stocks.  But where do we start?  One common investment Maxim is to “invest in what you know”.  There’s truth to this to be sure, we need to know what we own, but frankly, we also know a lot of bad companies.  The truth is, if we bought everything we know, we’d end up with a rubbish portfolio.  For example, let’s go back 15 years.  In the year 2000, what were the companies that the average person knew?  We shopped at Sears every weekend, we surfed the internet on Netscape, we took pictures with Kodak film, we bought GM cars and we flew on Delta Airlines.   Alright, sweet!  Load up a portfolio of the things we know! The problem is that all five of those well-known companies would go bankrupt in the next decade and we would lose all our money.  Just because something is well known, doesn’t mean that it’s a good business. Warren Buffett taught that we do indeed want to own simple, easy to understand businesses, but that we also need these businesses to have a competitive moat around them.  The problem with all of the businesses we mentioned before is that none of them really had a protective moat around them.  Sears was out priced by Wal-Mart, Netscape lost out to Microsoft explorer, Kodak was uprooted by a change in the technology, GM’s cars went out of favor, and Delta went bankrupt along with just about every other airline.  If you want a business that is good at torching piles of cash, airlines are always a good place to start! So how do we start finding truly good businesses? Start by asking yourself a few questions: What products am I happy to pay a price premium for because the service they offer can’t be replicated by another? What services am I happy to pay for because the cost to switch services would be too high? What platform do I use because it is on the only one where I can meet up with a certain type of people, because of the network or marketplace can’t even be compared to a peer (eBay) What products have been around for generations, you can picture your parents and grandparents enjoying them, and easily picture you grandkids enjoying them as well? Legendary investor, Peter Lynch who averaged a 29% return per year over 23 years at Fidelity, tells the story of his wife coming home from the grocery store and mentioning a new product, pantyhose in an egg shaped case, called “L’eggs”.  She raved about what good products they were.  He also noted that she was picking up more leggings than ever, because she was visiting the grocery store twice a week compared to the department store which she only visited maybe every other month.  With this knowledge in hand, he began to aggressively buy shares in Hanes, the maker of the L’eggs panty hose.  The stock became a 30 bagger for his fund, meaning it didn’t just double or triple, it went up 30x!   He found the idea, not from the wall street journal, but from paying close attention to how people were using the products around him. Looking for investment ideas?  Go to the grocery store, what products will I pay for the branded good vs. the generic grocery store brand? I also like to screen for certain financial criteria that could be indicators that the business possesses a strong moat.  Here are a couple of factors you can look for – A business that has very stable earnings, with little fluctuation year to year. – A company that has positive cash generation every year, even when the economy is weak.  (Cash generation is the cash profits minus the investments costs to grow the business). – A company that has made a return on invested capital above 12% every year for over a decade. – A company that pays a dividend that grows consistently every year.

For those of us who love investing in the stock market, the process of buying stocks for the long term is very much like a game. Some of the world’s most famous investors have actually compared investing in the stock market to sports such as baseball and basketball. Most people do not currently invest in single stocks. For many of them, if it is a game, they believe that it is rigged against them. In this program we will learn that investing in stocks is indeed very similar to a game, and also that the game is fun and not really rigged against small players who love the game and do their homework. With all games, it is important to know and understand the rules before you start playing in order to have the most fun and success at the given game. This program will take you through what we believe to be the most important rules of the stock market game. In order not to keep repeating the word stock, let’s learn right off the bat that another word for them is equities. Later on we will explain exactly what equity really means. But first to the “game” stuff. For those of you who play or otherwise love baseball, you know that it is “three strikes and you’re out.” The person at bat gets only three chances per turn to swing at good pitches (except, of course, for the case of foul balls; every rule, it seems, always has one or more exceptions!). If the pitcher throws three good or fair pitches, the batter cannot just let all of them pass by before being called out. Batters are not allowed to simply let three good pitches go by, waiting always for a better one (or one that will give them a better chance to hit a homerun). Paraphrasing legendary investor Warren Buffett, in the game of the stock market, batters can wait until just the right pitch. You, as an equity investor, are allowed to wait for the pitch that seems perfect for just you. Another famous investor, Steve Schwarzman (the head of Blackstone) in a recent story in Barron’s (a great weekly publication for people who love to invest) compared his great investing team to one playing basketball, but without the 24-second rule. Investors can wait as long as they want before pulling the trigger on their best and easiest shot. One of the things that tends to turn potential investors off to actually buying stocks is the abundance of scary news headlines. [HERE IT MIGHT BE A GOOD IDEA TO COMPILE SEVERAL SCARY HEADLINES FROM RECENT NEWSPAPER, MAGAZINE, ONLINE, ETC. ARTICLES] Venturing into the world of equity investing seems scary indeed! What if I lose all my money? what if the big Wall Street types cheat me out of my hard-earned savings?; what if, as many say, this game is really not winnable for the small investor? Again, please believe us…nothing could be further from the truth! The game is winnable and fun. What’s even more exciting, this game involves real money, and if you work hard at it, can help you end up with enough money to more easily live the life you want for yourself, your family and all those you care about. So let’s move on to the first important rules of the game. The most important rules of the stock market game Rule # 1: Investing in the stock market is for the long term. You need to learn to be patient. In order to have the most fun and be the most successful you can be as an equity investor, you have to play for the long run. We know this is probably the most difficult rule to stick to, but no money that you are likely to need in the next five years should be put in the stock market. See over long periods of time, stocks have proven to be the best and most reliable way to get rich, but this is true only over the long haul. Over short periods of time, stocks can be very volatile; that means they can go up (but also down) a lot over just a few days. Other than scary news headlines, this is probably what drives most potential investors away. They see that the stock of a company they like suddenly falls 10% or more in a single day, and that seems very scary indeed! Rule # 2: Be prepared; do your homework. Some people who don’t like the idea of equity investing compare it to gambling. Again, nothing could be further from the truth. Luck plays little or no role in how well you do in the stock market in the long run. Stocks are not as speculative as many people think. Gambling is little more than speculation – courting “Lady Luck” as they say. Equity investing can be seen as a game, but also as very serious work. You can make it very much fun, but it is, at the end of the day, work. We have been “lucky” enough in that our work has been at the same time a game we love to play. Some (but really very few) professional sports players can say the same thing! We want to teach you the rules of the game to make this kind of work as much fun as your favorite game. In a later section we will talk more specifically about the homework required to make the stock market game as fun as it can truly be. Rule # 3: The only “free lunch” in the world of finance is diversification. The financial world (the world of investments) is a complicated one, though as we will learn here, not quite as complicated as it seems or the media make it out to be. They say that “there ain’t such a thing as a free lunch.” In the world of finance, though, there is and that is the one that comes from diversification. Diversification comes from the word diverse, which also means varied. It simply means having a good variety of investments. When it comes to stocks, a diversified “portfolio” (or basket or group) of stocks means one that has enough variety. That means that the owner of a diversified stock portfolio owns companies of different sizes and from different industries (and preferably even countries), thus not “putting all of one’s eggs in one basket.” Diversification allows some parts of the stock portfolio to go up, just as others are going down, giving some more stability to the value of the entire portfolio (reducing the volatility of the entire portfolio).

Many people dream of opening their own business. While there are many good reasons to become a so-called entrepreneur (somebody who starts their own company), many of the benefits from having your own company (plus the “free lunch” from stock portfolio diversification) can come from the far easier task of investing in stocks. See, what many people who fear the stock market do not seem to understand is that when you buy a stock, you are really becoming a company owner. Alright, I know that buying just $100 of a company’s stock does not make you an owner of a big piece of a company in the stock market. But yes, even $100 (or less) of stock means that you are one of the owners of the company that “issued” that stock. Yes, a small owner or shareholder, but an owner nonetheless. Companies issue stock in the stock market when they have an IPO (short for initial public offering) of their shares. That is because a company’s stock allows its owners (also called shareholders) to share in the ownership of that company. Companies whose shares are traded in the stock market can have many millions of owners or shareholders. Thus, $100 of a company’s shares makes you an owner of a small part of that company. You can see from this that investing in the stock market is “serious business,” at the same time as it can be a fun game. Never forget that when you buy shares in a company, you become one of its owners! While we have been talking a lot about “stock market investing,” there is an important concept that just thinking about “the stock market” as if it were this one big thing misses. At the end of the day, there is really no such thing as a stock market. There are many markets or stock exchanges around the world (and increasingly, shares of stock are just traded electronically, without regard to any physical location). But the point is that there is really no stock market, but a market of stocks, and that we want to think more and more in terms of individual companies. For the sake of simplicity, though, we will continue from time to time to talk about “the stock market.” When you buy stocks, you buy pieces of companies, so it really does not matter in the long term what “the stock market” is doing. You only need to care about the company or companies in which you invested. Stocks are simply an “ownership title” to individual companies. Just like somebody who buys a car (or a house) gets a title indicating ownership of that specific property, a shareholder (any part owner) in a company gets shares of stock for the amount they invested in the company. Nowadays, investors do not get actual paper certificates indicating the amount of stock they own in a company (unless they specifically request them, which takes time, and is not really necessary or practical). But that is also the case with your money in a bank account. That money is moved back and forth electronically, and you only get the actual paper money as and when you need it. In order to more easily “trade” (buy and sell) shares of stock, it is easier to just keep it in the more common electronic form at your brokerage company. Actually, many companies do allow you to buy stock directly from them and keep it with them, without the need to pay brokerage commissions. For long-term investors who own shares in only a few companies, this is perhaps one of the best ways to be a company owner. All companies have owners. A small company started by a single entrepreneur may have only him or her as the single owner. The large corporations that have “public” stock (shares that are traded by the general public) have many owners, and for them it is much easier to have shares of stock that can be readily bought and sold by the general public in the so-called equity or stock market. In fact, US government regulations require that a company, once it reaches a certain number of owners, must go public in the process known as an IPO to allow its now large number of owners to be able to buy and sell their shares of stock in the company more easily. This is what investors call stock market liquidity. The more actively a company’s shares of stock trade in the public market, the more liquidity they are said to have. Liquidity is generally a very good thing. A big investment, such as a house, for example, can have very little liquidity. A house is not a “liquid” investment in that it cannot be easily and quickly bought and sold. Companies, on the contrary, in the form of stock, can be traded very easily and quickly, and are thus said to have much higher liquidity than individual homes. Stocks are much more liquid investments than houses. But investors often fall in the trap of “misusing” or abusing the liquidity of their stocks. That the equity market offers daily liquidity does not mean one should use it, just because it is there. Liquidity is an additional, attractive feature that stocks offer over other alternative investments. But this daily liquidity is not something that one should use to violate our rule #1 (investing for the long term). The daily liquidity is an advantage that allows investors to sell stock in a hurry if they need it to for unforeseen circumstances, but never forget that if you buy a stock, you should be prepared to own it for five years or more if you really want to make the most of the stock market game. Just think about it this way. Let’s pretend that your sibling or a close friend is starting a small company. He or she is doing really well, but needs more money (capital) to expand. He or she asks you to become a part owner in the business by investing in it some of your savings. You agree. Would you try to sell your ownership in the company just a few days later? Most likely not! It should be the same thing when you decide to buy a public company’s stock. The only real difference is that your sibling’s or friend’s company is a private company with just two shareholders, whereas there are many more owners in a public company with shares in the “stock market.”

Doing your homework when it comes to investing in stocks means learning as much as you can about the companies in which you invest before you become a shareholder. Just like you probably would not invest in your sibling’s or friend’s company if it wasn’t because you obviously know them, you should not invest your hard-earned savings in a company’s stock before you know the company pretty well. Before investing in the company of your sibling or friend you would probably also want to know what their business is really all about. It should be no different in the case of publicly-traded stocks. The great thing about publicly-traded companies is that there is a lot of free information about them out there! You really do not need to spend a penny to do quite a bit of research on the public companies you are considering as investments. There will be other sections devoted to the nitty-gritty of equity research, but suffice it to say for now that the more you know about the companies in whose stocks you invest, the more comfortable you are likely to feel really owning them for the long term, and according to our rule # 1, that’s what it’s all about! See the better you know your companies, the less likely you are to be scared by the periodic headlines that the media will throw at you. It is these scary headlines that cause investors who do not know enough about their companies to often dump their stock at the worst possible times. The more you know about your companies, the better able you will be to separate the headlines that just grab attention from the real threats that could endanger your investment. Just like nobody is perfect, and the times are not always good, companies, yes even the greatest companies of all time, go through rough patches. While it is true that if something radically changes in a company you once knew well, you should be willing and able to sell it, it is also true that most of the scary headlines one from time to time reads on some of the world’s best companies are little more than short-term noise. Again, the better you know your investments, the less susceptible you will be to selling at the wrong time due to the wrong headline. In our experience, great companies do not just turn into bad ones overnight or over a single calendar quarter, and steep stock price declines caused by a single bit of bad news more often than not provide buying opportunities (rather than the reason to sell, as many investors mistakenly do). Public companies are required in the US (and a growing number of countries) to report quarterly results. That means that investors get a chance four times a year to evaluate their companies’ “report card.” This can mostly be seen as a good thing; four times per year do not seem like too many (and definitely not like too few). However, a growing number of long-term investors worries that the quarterly reporting cycle may be leading to too much short-term focus on the part of company managements. While four times a year seems to us like an adequate number for company “report cards,” we very much agree that corporate managements should not let this frequency get in the way of their true long-term strategies. Instead of worrying too much about the short-term volatility in stock prices that quarterly results may produce, long-term investors should use this volatility (the price swings up and down) to their advantage. As we have said, a scary news headline (or even a bad quarterly report) affecting a long-term great company may provide just the buying opportunity the long-term investor has been waiting for to buy the company’s stock. The legendary investor Warren Buffett often talks about how weird it is that many people want to buy companies when they are expensive. Also known as “the Oracle of Omaha,” Mr. Buffett says that, when it comes to just about anything else, people always like to get a bargain. They want to buy the goods or services they need when they are being sold at a discount. So why not stocks? People, as Mr. Buffett claims, feel better buying stocks when their prices are going up, instead of taking advantage of the occasional stock SALE! to build positions in the companies they like for the long term. Thus, we (like the Oracle of Omaha) recommend that investors use the volatility of the stock market to buy stocks they like for the long-term when the prices are down due to some scary news headline. Again, the more homework one has done, the better one will be able to distinguish a single bad quarterly report from something that has really changed for the long-term at a great company. When the investor’s knowledge (acquired through homework) indicates that the bad quarterly report is only a “one-off,” the more reason to aggressively buy the stock for the long term (rather than doing what most investors tend to do – sell the stock on the weakness). Homework – A few initial words on the Nitty-Gritty As we explained earlier, when you buy a stock, you are actually buying a piece of a company; you’re becoming a company owner! You would not make such a big decision before carefully considering your investment. It is funny that people often spend more time researching a movie or carefully studying the specs of a piece of electronic equipment they are planning to purchase than when buying a piece of their own company! Buying a stake in a company (no matter how small the piece may be) should be a pretty serious, carefully-studied decision. Learn as much as you can about the company in which you are going to invest. Perhaps the original idea came from being a loyal user of the company’s products or services. That’s usually a great start. But it should not end there. The value of a company, any company, is nothing more than the discounted value of the company’s future cash flows. Now that’s probably a mouthful, so let’s see what each piece of this definition means. The stock market is considered to work like a “discounting mechanism” that brings future cash flows back to present value. See a $1 you receive today is worth more (in terms of what you can buy with it) than “the same” $1 one year from now, let alone 30 years from now. Due primarily to inflation, the value of any currency (dollar, euro, pound, etc.) declines over time in terms of what you can buy with it (its value declines in purchasing power). Thus, when calculating the real value of money received in the future, financial experts always discount the value of cash received in the future back to its present value. The stock market generally does that work quite well; money that a publicly traded company is going to receive from its business in the future is discounted back to its present value, helping determine the stock’s price in the present. As a company owner or shareholder, you co-own a company’s future cash flows (the cash the company will generate from its earnings in the future). Owners of stock share their claim to the company’s future cash flows with its creditors (investors to whom the company owes money). The creditors (banks and possible bond holders) have more priority when it comes to their claim to the company’s cash flows. Thus, interest on debt is paid before any dividends can be declared by a company. Also, in the unfortunate case of a bankruptcy, shareholders of the company do not receive a penny back of their investment before the company’s creditors are paid back. Thus, the discounted value of a company’s future cash flows is “split” as follows. The total value of the projected future cash flows of a company discounted back to the present time is often referred to as the company’s “enterprise or firm value.” Part of the enterprise value “belongs” to the company’s creditors. Thus, you must first subtract the company’s net debt from its enterprise value to come up with what is known as the company’s equity value. The company’s or firm’s equity value is then divided by the its total number of shares outstanding to come up with what a share of stock should be worth today. See the “problem” (or perhaps better said, the opportunity) is that nobody knows for sure what a firm’s future cash flows will really be. That’s where the homework comes in. The stock market in a way “aggregates” all the opinions and knowledge of market participants to come up with what the “consensus” thinks a company is worth at any given point in time. In a way, the price at which a firm’s stock trades in the market is the general view of what the company is likely to earn in the future (and thus the cash flows it will generate). In later sections we will go into more detail as to the difference between cash flows and earnings, but at this point it is enough for you to understand that they are obviously related and help determine the price of a stock. To the extent that, by doing your homework, you as an investor have a strong sense of how the company is likely to do in the future, you can take advantage of the “misunderstandings” that take place in the stock market every single day. Scary news headlines may motivate other (perhaps less knowledgeable or prepared) investors to panic out of their stock. When those panicky investors sell their stock after scary headlines, they force the price of the stock down, making for great buying opportunities for knowledgeable investors that have done their homework. Now I know you must be thinking, “How can I possibly be more knowledgeable than the professionals who make their living in the stock market?” Believe me. You can beat them more often than not. See, professional investors are often subject to limitations and “career risk” that should not burden you, and that “force” them to make wrong decisions from time to time. Professional investors may not want to show to their bosses or clients that they own a stock that reported disappointing quarterly results. Again, if you, based on your homework, strongly believe that the poor results were only a blip, you can use the weakness caused by professional investor selling to buy the stock of a long-term great company at a bargain price! If you feel you got a great price on a stock you had wanted to buy for the long term, you are more likely to hold on to it through thick and thin. In our experience, this is almost always the right thing to do with the stocks of great companies. Here it is worthwhile making a distinction between great companies and great stocks. In the long run, since stocks are no more than pieces of companies, great companies are really great stocks. We do want to foster long-term thinking here, so for the most part, you should believe great companies also have great stocks. However, one should always be prepared for the eventuality of having to sell a stock due to unforeseen circumstances or emergency situations. For those rare cases, it is important that you buy the stock of a great company also at a great price, and this is not always the case. “Sentiment” toward stocks (how the consensus of market participants “feels” about them) moves over time, and more often than not “overshoots” in one direction or the other. Market participants from time to time get overly excited about a company and its short-term prospects, and we call this “sentiment getting too positive.” Conversely, from time to time, sentiment overshoots on the downside, and the consensus of markets participants gets too negative on a stock due to scary news bunching up over a short period of time. This type of situation is what from time to time creates particularly good buying opportunities in great companies with stocks that will do great over the long term (but that are by many considered to be “bad” stocks). If you do your homework as a potential investor in such a company, you will be able to benefit the most by confidently buying it at a particularly good point in time (for you, as the buyer).