In one sentence: Phil shows how he screens a company in about 45 seconds: check the historical numbers, look at the growth trend, take the analysts' growth rate with a pinch of salt, run a rough margin-of-safety calculation, and then use Cal-Maine to show why you still have to understand the business.
Key ideas
- Assumes steps 1–3 are done. The shortcut covers only Munger's fourth filter, price. Phil admits that you can't truly value a business you don't understand, so this is a triage to decide whether a deep dive is worth the hours. [05:00–08:00]
- Why it exists. A friend's manager put $1M into 100 companies at about 1% each. Phil went through all 100 in about an hour to judge whether they were good companies and bought at fair prices. [07:00–09:00]
- Step 1, the back-window view. The Rule #1 score, with moat, management and predictability all green, tells you how the business has performed. It tells you nothing about the future, but history rhymes. [09:00–11:30]
- Step 2, growth-rate chart. The four moat growth rates (earnings, sales, cash flow, equity or book value) should move in parallel, like railroad tracks. One line out of step is a red flag to investigate, not a reason to reject. [11:30–13:30]
- Step 3, trend and maturity. Look at the 3- and 5-year growth rates rather than a single year. Apple's had slid from 30–40% to single digits while return on equity was about 35% and debt was low, which is the profile of a maturing cash cow. So you shouldn't pencil in a high growth rate. [13:30–16:30]
- Step 4, the margin-of-safety pass. Use trailing-twelve-month EPS (Google "TTM EPS"), then the analysts' five-year growth estimate, and use a PE of roughly double the growth rate. For Apple: about 10% growth, a PE of 20, and a value of roughly $106 against a $119 price, so it's fairly priced. With the analysts' 10.89% it comes to about $127. [16:00–21:00]
- Step 5, payback or cap-rate cross-check. Apple's free cash flow was about $10 a share, so a 10% cap rate suggests about $100. Phil also notes that none of this is faster for anyone else just because the numbers are rough, since it's the same margin-of-safety analysis done quickly. [19:00–22:30]
- Don't look at the share price first. Phil estimates what the business is worth before he sees the chart, because he doesn't trust the market to be pricing it correctly. [23:30–25:00]
- Analysts lean optimistic. Their banks want investment-banking business from the companies they cover, so a very bearish analyst is bad for business. Treat their growth rate as a ceiling and compare it with the last three years. [25:00–28:00]
- Cal-Maine as a warning. All-green score, but earnings leaped from about $2 to $6.51 a share, and the growth rates were erratic. Using the analysts' 22% growth and a PE of 45 would suggest it was worth far more than the $43 price. Using the 16% growth and the PE of 33 implied by its history, he gets about $101. Using a Nasdaq 9% growth and an 18 PE, he gets about $30, with a payback value of about $27. [28:00–38:00]
- The business explains the numbers. The 2015 avian flu killed about 15% of US hens and cut egg supply, while feed (corn) costs fell about half, so profits spiked. Egg farming is cyclical because new hens arrive quickly, and egg prices then fell below cost of production. Even a quick screen needs some knowledge of the business. [38:00–41:00]
How it maps to RuleOne
- This is the manual version of what the screen does: score the history first, then compare the price with a rough value. The stock page's growth and valuation sections are the place to repeat the steps on any ticker.
- Use the trend and the cash-cow signals (falling growth, high ROE) when choosing a growth rate on a stock page. Cut the analyst figure to match the 3- and 5-year history.
- A spike in earnings is a cue to check the business story and the cycle, not to extrapolate.
Buffett, Munger and Graham links
- Munger's fourth filter ("a price that makes sense") and the margin of safety: Graham, The Intelligent Investor, chapter 20.
- Cyclical earnings: Graham's advice in The Intelligent Investor to average earnings over several years instead of using the latest peak, which is the same instinct as looking at ten years of EPS.
- Buffett's 1996 and 2000 Berkshire letters on the limits of analysts' forecasts are worth reading alongside Phil's point about analyst incentives.
Words to know
- TTM EPS: trailing-twelve-month earnings per share, the starting point for a quick value.
- Parallel growth rates: earnings, sales, cash flow and equity growing at similar rates, a sign of a steady business.
- Cash cow: a mature business with slowing growth, high return on equity and plenty of free cash flow.
- Cyclical: earnings that rise and fall with supply, demand or input prices, so a recent peak overstates normal earnings.
Try this
Pick a company you like on All stocks and run the five-step screen in under five minutes. Check the history, look at whether the four growth lines are parallel, find the 3- and 5-year growth rates, and then use a conservative growth rate to estimate a value. Then open /stock/TICKER/ and compare your number with the site's. Write down one sentence on why the price is above or below your value.
Check yourself
- Why does Phil avoid looking at the share price first?
Answer
He wants a view of the business's value that isn't influenced by what other people have been paying. He doesn't trust the market to be pricing it correctly. - Why should you cut the analysts' growth rate?
Answer
Analysts are rarely too pessimistic, because negative views can upset the companies that their banks want as clients. Compare the estimate with the last three to five years and use the lower figure. - What did the Cal-Maine example show?
Answer
A green score and surging earnings can come from a one-off event (avian flu plus cheap feed) in a cyclical business. If you extrapolate the spike, you overvalue it. You need to understand the business.
Short quotes
"I don't want to be influenced by what other people have been doing with price." (Phil, ~24:30, auto-transcribed)