This post contains the key lessons I learnt from the book: The 52-week low formula by Luke Wiley.
1. A company that has really good recent performance has not made you any money. It has made money for those who already own the stock. You would be putting in new money. A company that has had really bad recent performance has not lost you any money. It has lost money for those who already own it. So which one you should buy? Which one do most investors buy?
2. If you were truly trying to buy low, then wouldn’t the headlines, analyst recommendations and investor enthusiasm be pretty underwhelming? If you were truly trying to sell high, then wouldn’t the headlines, analyst recommendations and investor enthusiasm be pretty overwhelming?
3. Company performance, good or bad, creates an overall impression – an halo – that shapes how we perceive its strategy, leaders, employees, culture and other elements.
4. Undervalued stocks have usually underperformed. But not all underperforming stocks are undervalued.
5. The five common mistakes investors make are:
- Trusting their emotions rather than engaging their mind. When there is euphoria, people buy. When there is depressed stock prices, people sell. They should do the opposite if they want to be successful.
- Lack of discipline. You need to have a process to buy, hold and sell. You will have to decide in advance what you will do if there is euphoria or catastrophe.
- Taking someone else’s investment counsel at face value.
- Information overload: Trying to analyse too much information.
- Buying familiar stocks rather than thinking about value.
6. The five filters of the 52 week formula:
- Filter 1: Durable competitive advantage: It is not about buying any company at a 52 week low. It is about buying a company with a durable competitive advantage at the 52 week low.
- Filter 2: Free cash flow yield ( Margin Of Safety): The free cash flow yield multiple over the 10 year year treasury bond is known as the margin of safety. The higher the free cash flow yield over the 10 year treasury bond, the higher the margin of safety.
Free cash flow= Operating cash flow -capital costs of maintaining current capacity
Enterprise value = Market cap+Debt-Cash
Free cash flow yield= Free cash flow/ Enterprise value
- Filter 3: Return on Invested Capital: The return on invested capital should be greater than the cost of capital.
- Filter 4: Long-term debt to free cash flow ratio: Long term debt to free cash flow should be less than 3 years.
- Filter 5: 52 week low: The company should be trading close to its 52 week lows. Companies who have a trailing 12 month return of more than -25% are good candidates to invest in, if they fulfil other criteria.
7. Diversify by investing in 25 stocks.