ValueInvesting:AValueInvestor’sJourneyThroughtheUnknown…

ByJ.LukasNeely

http://www.EndlessRiseInvestor.comPublished byEndlessRiseInvestor.com

Copyright © 2015 EndlessRiseInvestorPermission to reproduce ortransmit in any form or byany means – electronic ormechanical, includingphotocopyingandrecording–or by an information storageandretrievalsystem,mustbeobtained by contacting theauthors via e-mail atsupport@EndlessRiseFinancial.com

OrderingInformationFor additional copies contactsupport@EndlessRiseFinancial.comASINB00TX2SG4IFirstEditionFirstprinting:March2015Neither the author nor thepublisher assumes any

responsibility or liabilitywhatsoever on the behalf ofthe purchaser or reader ofthese materials. Anyperceived slight of anyindividual or organization ispurely unintentional. Whileall attempts have been madeto verify the informationprovided in the publication,neither the author nor thepublisher assumes anyresponsibility for any errors,

omissions, or contraryinterpretations of the subjectmatterherein.Thisbookisforinformationalpurposes only. It should notbe construed as financialadvice of any kind. We areall free to make our owndecisions when it comes tofinancial and investingmatters. We are allresponsible for your own

actions.

YourFreeGift

As a way of sayingthanksforyourpurchase,I’moffering a free investingmindmapandblueprintthat’sexclusivetomyreaders.

Makingmoney investing

in the stock market offers arare opportunity for

ANYONE to generate andgrow wealth into the future.But in order to reap thebenefits of investing itrequires the right type ofmindsetandprocesses.That’swhy I created the UltimateInvestorBlueprint.

This Blueprint includes

the 5M™ Mental Model(detailed in this book),advanced video tutorial, a

Mindmap of the process, aswell as checklists, andmuchmore. It encompasseseverything an investorwouldneed on their journey toinvesting success, whetheryou’re a seasonedprofessional or newbieinvestor. You can downloadthis free blueprint by goinghere.

https://uibfreegift.endlessriseinvestor.com/blueprint

SeeAlot…YouSeeLittle,

SeeLittle…YouSeeALot!

ContentsFAQ – DOUBTERS READTHIS

7 Reasons Why YouNeedToReadThisBook

5 Rules To Use ThisBook&GettingTo5Million

Standing On TheShouldersOfGiants

FromWallStreetToTheHumanCondition:The80/20

PrincipleMyStory

THE 5M™ MENTALMODELWHAT IS THE 5M™MENTALMODEL

MARKETMASTERYDO YOU KNOW

YOURCOMPETITION?

KnowYourCompetitionIs It Important…AndKnowable?AComplexAdaptiveSystemInvestingOrSpeculatingWhereToFindOpportunities

MINDSETMASTERYDO YOU HAVETHE PROPER

BEHAVORALTOOLKIT?

GettingIntoAStateOfFlowInvesting As A LeisureActivityApproach Investing Like A“Real”BusinessPersonCommitment &Perserverence To SucceedLong-TermAProsperityMindset

MORALSMASTERYDO YOU HAVE

THE RIGHTPHILOSOPHY?Always Think About RiskBeforeReturnAContrarianStreakStick With A Long-TermApproachToInvesting“Few, Big And Infrequent

Bets”Agnositc Of The MacroEnvironment

MECOM™METHODMASTERYDO YOU HAVE

THE PROPERANALYTICALFRAMEWORK?

TheMECOM™MethodStep#1:MoatsStep#2:EarningsStep#3:CatalystsStep#4:ObligationsStep#5:Management

MARGIN OFSAFETYMASTERYIS THERE A

DIVERGENCE BETWEENPERCEPTION&REALITY?

TheArtOfValuationUsing A Range Of ValuesForIntrinsicValueDiscounted Cash FlowValuation(DCF)LiquidationValuation(LV)PUTTING IT ALLTOGETHERWHAT’SNEXT

AcknowledgmentsResources and FurtherReading

FAQ–DOUBTERSREADTHIS

Is investing right for

you?Chancesaregoodthatitis. Here are some of the themost common doubts andfears that people have beforetaking the leap and joiningtheEndlessRiseInvestors:

Do I have to be a risk-taker? Do I have to taketimeoutofmyday?

Erroneousonallcounts.Ialwayswantedtosaythat.

From developing thepropermindset like thesuperinvestorsofourtimetoeasilyvaluing all types ofbusinesses. How does apersonspend just60minutespermonthon their investing,yet still produce out-sized

investment returns? How toknowwhatkindofbusinessesto invest in and whichbusinessestoavoidtoprotectyourwealth?It'sallhere.

I feel like my time haspassed. Do I need to be inmy twenties and single toget involved in investingnow?

Not at all. This book isfor anyone who is sick of

deferring money makingdecisions to so-called"professionals" and givingtheir hard earned money tomanagers that make moneywhetheryourealizereturnsornot. If you're sick of thestandardmenuofoptionsandprepared to enter a world ofinfinite options andopportunity, this book is foryou

Ijustwantmoretime.DoIhave to spend hours doingthis?

No. It's an option.However,theobjectiveofthe5M™ Mental Model is tocreate freedom of time byarming you with an easy tofollowmentalmodel focusedonthemostimportantfactorsto investment success. Onceyouhaveagraspofthe5M™Mental Model you will be

abletodeterminehighqualityinvestment opportunitieseasilyandefficiently.

I don't have much money.DoIneedtobebornrich?

Absolutelynot.Althoughmyparentsworkedveryhard,Iwasneverbornintoalifeofluxury; I'm no Vanderbilt orRockefeller or Walton, andyouneedn'tbeeither.

Do I need to be an IvyLeague or business schoolgraduate?

Notonebit.Manyoftheworld’s top investors didn'tgo to theYale's of theworld(although there’s nothingwrongwith theYale’sof theworld). There are too manyunrecognized benefits to notcoming out of one. Topacademic institutions aregreat. I believe theydomore

goodthanbad,howevermanyofthesestudentsarefunneledinto these high-stress, high-income, 80 hour week jobs.Formany of them, that's 20-30 years of soul-crushing,unfulfilling work that theybelieveistheonlypath.

How do I know? I'veseen it first hand. And I'veseen the destruction it cancause to a person and thefinancial system as a whole.

This book helps to reversethat.

5M™ Mental Model andMECOM™ Method…itsounds a little cheesy andgimmicky…?

Ha. I thought the samething. In creating aphilosophy and method forinvestingsuccess,Iwantedtocreate something that wouldstick in the minds of the

readers. Something that youwould be able to recall at amoment’s notice whileinvesting. 5M™ andMECOM™ are essentiallymnemonic triggers to do justthat.

They’rewordedthiswaytohelpyounavigatetothefarreachesofyourbrain tohelpyou pinpoint the mostimportant elements forinvesting success. When I

investnow,it’sallIuse.Iamalways thinking in MECOMnow.Ifitcan’tpassthebasicelementsofMECOM,Ithrowitinthetrashandmoveontoanotherpotentialopportunity.It’s all about using timeefficientlyandeffectively.

The cornerstone of greatinvestingisalreadyhere--It'sjust unevenly distributed.Most people just don't knowaboutityet…

7 Reasons To Read ThisBook, Even If You HateInvesting(AsIDid)

A Value Investor’sJourney Through TheUnknown isn't just aninvestingbook,perse,thoughon the outside it may looklike one. Just as PoorCharlie's Almanac isn't justabout investing, this bookisn't quite what it appears (I

wishIwasascoolasCharlieMunger).

Even if you hateinvesting, here are the sevenreasons you should read atleast thefirst fewchaptersofthisbook:

#1You'll Learn How ToBecome World Class InRecordTime.

Whether you want to

learnhowtocreateaportfolioof high quality businesses,how to "think" about thestockmarket,orhowtoeasilyvaluebusinessesinlessthanaminute -- the true "goal" ofthisbookistoprovideexactlythat: a process for investingsuccess. The vehicle I choseis the 5M™ Mental Model.Throughout this book, I'llteach you all of the mostefficient and important

techniquesandcheckliststhatmatter most to yourinvestment success. Eachsection will take a minimalamount of time, but result inyou having The UltimateInvestor Blueprint. My hopeis for book to make you amasterstudentatinvesting.

#2You Will Get In The BestMentalShapeOfYourLife.

Thementalmodelsyou'lllearn, apart from businessanalysis and valuationtechniques, are all compliantwith"valueinvesting."Ifyoufollow this book, you won'thavetothinkaboutbeinglostas you make investmentdecisions, since this mentalmodel is built usingmnemonic triggers to helpyou remember the elementsthat matter most to investing

success.Ifyoueverdecidetofollow another investmentprocess or system, you'll betwice as effective, becauseyou'll understand howeverything is interconnectedfrom the various mentalmodels youwill learn in thisbook.

#3Investing (And Life) WillBecomeBrighter.

Iposeaquestiontoyou:have you really learned howtoinvest?Evenwhilewritingthisbook,InowrealizedthatIhadn't.Back then, investingwas part of my job. It'ssomething I did, either goodorbad,efficientornot.Now,I truly have a system andprocess for success. And theprocesses andmentalmodelsin this book go way beyondinvesting.It'slikegoingfrom

blackandwhiteTV to color.As you'll see, the mentalmodels built into 5M™ willaffecteverythingyoudo.Lifeitself becomes much betterwhen you are equipped withworldlymentalmodels.

#4InvestingIsTheConfidenceAdvantage.

Beingagreat investororcapital allocator, or even

articulating investment ideasbetterfromthementalmodelsin this book, can be a forcemultiplier in your confidencelevels and understanding ofinvesting. Increasedconfidencewiththeabilitytosupportyoursignificantotheror family members issomethingIcan'texplainwithwords. It makes you feellargerthanlife.Youwalkinaroom and people can notice

theconfidence.

#5It Doesn't Take Much ToBecomeImpressive.

In the first 24 hours, I'lltake you from being all overthe place in your investmentprocess to helping youpinpointthethingsthatmattermost to investing success.With more and moreinvestors giving up on the

stock market all together, orherding around the samestocks, it gives you a muchbetter opportunity tooutperform the generalmarket.

#6TheMarketsAren'tRigged--They'reBeatable!

It took me years todiscover just how profitablevalue investing really is.The

reason for this book is tomake sure others don't makethesamemistake.

Make this book a keypart of your investmentstrategy to earn valueinvesting returns over thelong-term. The money youcould make off of even justone great idea will pay forthisbookmanytimesover.

#7

Because It's Fun AndLucrative At The SameTime.

Knowingthatyouhaveasystem that can lead you inthe right direction toinvesting success can be anextremely fulfilling andlucrative endeavor that willstay with you for a lifetime.And intermittently, I willkeep you entertained andamused with some stories of

successes and failures alongthe way. Investing mentalmodels and analysis? Check.Funny and ridiculousinvesting anecdotes? Gotthose too! After all,sometimes we learn morefrom our mistakes than oursuccess. Hopefully you canlearnfrommineandothers.

This is the furthest thingfromatextbook.Seethenextsection on how to use this

book.

HowToUseThisBook:5RulesAndGettingTo5

MillionPeopleIt's crucial that you followthese rules at all cost. I willnotbeheldresponsibleifyoudon't.RULE #1. Think of ThisBook As A Buffet (no...not

Buffett).DONOT read this book

from beginning to end. Justdon'tdoit.

Let's be honest --- Mostpeoplewon'tevenneedmorethan 100 pages to gainincredible insight intosomething theyweremissingabout investing. Check thetable of contents, go to thechapters that are mostintriguing to you, and just

discard the rest...until youneedit.

Mandatory sectionsdepend on where you are asan investor. If you are acomplete newbie, theMarketandMindsetsectionmayhelpyou the most initially. Ifyou've dabbled in the stockmarketorhavea401(k),thenthe MECOM™ Method andMargin of Safety sectionsmay appeal to you most. If

you are a seasonedprofessional, the mentalmodels and philosophysections may tickle yourfancy.Herearesomepopulargoals, along with thecorrespondingsections:Market Mastery(understanding of the stockmarket)

KnowYourCompetitionIs It Important…And

KnowableA Complex Adaptive

SystemInvestingorSpeculatingWhere to Find

OpportunitiesTotal page count: 18

pagesMindset Mastery(psychology)

Getting Into A State ofFlow

Investing As A LeisureActivity

Approach InvestingAsA“Real”BusinessPerson

Commitment &Perserverence To SucceedLong-Term

AProsperityMindsetTotal page count: 28

pagesMorals Mastery(philosophies)

AlwaysThinkAboutRiskBeforeReturn

AContrarianStreakStickWithALong-Term

ApproachToInvesting“Few,BigAndInfrequent

Bets”Agnostic of The Macro

EnvironmentTotalpagecount:22

MECOM™ MethodMastery(businessanalysis)

TheMECOMMethodStep#1:MoatsStep#2:EarningsStep#3:CatalystsStep#4:ObligationsStep#5:Management

Totalpagecount:149Margin of Safety Mastery(valuation)

TheArtofValuationUsingARangeofValues

forIntrinsicValue

Discounted Cash FlowValuation(DCF)

LiquidationValue(LV)Totalpagecount:63

RULE #2. BESKEPTICAL.

Don'tletmeoffthehookthateasily.Seriously, I'mnotkidding. If you believe someof these tips, tricks orconcepts aren't correct, thenletsstartaconversationabout

it.NotonlywillIfinditfun-- it will make me a betterperson and investor bylooking at things from allkinds of different angles andviewpoints.

Never assume somethingis absolute because someoneelsesaidit--Alwaystrustbutverify.

“Truewisdomisknowningwhatyoudon’tknow.”

ConfuciusRULE #3. DON'T LETSKEPTICISM BE THEEXCUSEFORINACTION.

It's important to alwaystry todisproveprocessesandideas, regardlessofhowsaneorrationaltheyappearatthatmoment in time. Skepticismis a worthwhile task in thepursuit of worldlyknowledge.

As Munger says, "it's ayear wasted if you don'tdisproveoneofyourideas..."

Letmeknowifyouhaveadditional elements to add tothe system or prove mewrong. Through yourfeedback and help, thissystem and book willcontinuetoevolveovertime.RULE #4. SKIP THEMATH IF IT'S TOO

DENSE.Youdonotneed tobea

mathematician to read thisbook.

I've included manydetails and calculations forthe geeks and curiousindividuals out there.However,theyaren'trequiredto achieve the results youdesire.

I encourage you tobrowse these sections,

howeverthereisnoreasontobeintimidatedbyit.Theyarearen't mandatory to achieveinvestment success. So ifyou'reoverwhelmedwithanyof the information orcalculations,justskipthem.RULE #5. HAVE FUNWITHIT.

All facts and figuresmakesforaveryboringread.I've included numerous

stories and case studies foryour enjoyment and addedvalue.

The content is meant tobereadandprocessedasyouwish.Althoughit'sablueprintand system for investmentsuccess, you by no meanshave to read it frombeginning to end in onesession. It's encouraged, butnotnecessary.

Enjoy the exploratory

and discovery process. Havefun with it. Remember: thisisn't a school assignment.Takeitatyourownspeed.OUR BIG GOAL -- 5MILLIONPEOPLE

Iwasvisitingmy familyfor the holidays just likeanyoneelse,butthisyearwasdifferent.

It was Christmas of2008,anditseemedtheworld

wascomingtoanend.MajorWallStreet firmsweregoingunder. I was even a littlescared by the wholeenvironment.

All my family memberswere asking me what to do:“ShouldItakemymoneyoutof the stockmarket?” “WhatshouldIdo?”

First off, I never giveinvestment advice. Everyoneistheirownperson.Theyare

more thancapableofmakingtheir own decisions. But thistime people were panicky.There was a dire look inGrandmother’s eyes as shesaw her hard earned savingdwindle during this stockmarketnervousness.

I felt bad. I told myfamily, “its probably thewrong time to sell now.” Imean, the market was downalready around 30%. I said,

“aslongasyou’reinvestedinhigh quality, cash flowgenerating companies thatyoubelievewillbearoundforthelonghaul,thenthereisnoreason to panic and sell atthese levels. In fact, youshould probably be buyingmore.”

ThisisusuallywhenIgetthat side head tilt that is anormal occurrence from myboxer dog, “What do you

mean buy more? It’s goingdown.” Most people can’tcomprehend that a securityactually becomes less riskythe lower it goes (as long asyou’ve identified a highquality investmentopportunity).

SoIleftthatnightfeelingpretty good about myself.Hopefully I had staved offdisasterformyrelatives.Andhopefully I had kept them

from falling prey to Mr.Market’sfunnylittlegameofvolatility, and “lets see howlow it can go before yousell…” Mr. Market can bereallysicksometimes.

Anyway, fast forwardthree months and the markettook another leg to thedownside in early 2009.Before it was all said anddone, the market hadcorrected 50% from high to

low leaving many marketparticipants scratching theirheads, and wondering whatthehellhappened.

Our next family gettogether was around 4th ofJuly. It had been a horriblecouple of years forme as aninvestor,howeverthingswerestarting to turnup.Ofcoursethe topic of the dinner tablerevolved around this crazystock market and everyone’s

retirementaccounts.I wanted to know how

everyone made out, and tomy utter amazement, almosteveryoneofmyrelativeshadsold the majority of theirholding in February andMarch of 2009 because thepainoflosingmoneywastoodifficulttobare--myjawhitthefloor.

Theyknewnothingaboutthe businesses they were

investing in, and as a resultthey panicked and sold at atime when they should havebeen doing the exactopposite.

There was a majordisconnect between howpeople ought to invest andhow they think they shouldinvest.And this is the reasonbehind the 5M™ MentalModels and this book: armindividuals with the right

mental models to investbetter.

Prudential conducted asurveyin2011asking,“whenare you likely to put moremoney in the stockmarket?”Shockingly, 44% said theywould “NEVER” put moneyback in the stock market toinvest.58%saidtheyhadlostfaith in the stock market alltogether.

These emotional

responses of fear anduncertainty kept individualsfrom making rationaldecisions. Many weren’tarmed with the right set ofmental models to make thedecision-making processeasieronthemselves.

Today, things aren’tmuch better. The world isturning a blind eye to “real”investing, with many stillwanting nothing to do with

the stock market. Or if theyareinvesting,individualsrelymore and more on “passive”strategiessuchasindexfundsandassetallocationstrategiesin their 401(k) policies orIRAs to help them invest inthe markets, all the whilemaking them think it’s safe(and collecting managementfees).

Thereisabetterway!In other words, the

mental models you learn inthisbookwilldoalotofgoodbeyondyou andyour family.Our investing behavior andphilosophy can help decidewho the future wealthgeneratorsareinthecountry.

My goal is to reach 5million people. And that’sjustthetippingpoint.Imagine5 million happy investorswith the confidence andunderstanding of how to

invest how he/she wants,without the noise of theoverall market. And withouthaving to deal with moneymanagerstakingmanagementfees from simply tracking anindex.

It’sneveraneasytasktobegin something new,however subtle changes cancreate a snowball effect thatis likely to be felt for alifetime. A mind developed

andarmedwithanarsenalofthe right mental models ispower.

This book is not the endall, be all of value investingbooks ormentalmodels.Butitdoescontainmanyvaluabletruths and philosophies tohelpyouimproveasathinkerand investor. Whether youchoose to use the modelswithin this book or not, isentirely up to you. Either

way,Iwillhelpyoufindyourown way if your thoughtprocessdeviatesfromours.

Enjoythejourney!

STANDINGONTHESHOULDERSOFGIANTS

I am not a master

investor,noramIanexpert.I’myourhumbleguidein

your journey to investingsuccess.Thankstothepeoplebelow,we have been able tocompile concepts, theories,philosophies,andideasintoa

finely detailed mental modelfor our reference, any timeweneed it.Anymistakes (oranything odd) you encounterin this book is no fault ofanyone below. It was all mydoing.

Although there arehundreds who have helpedmeinmyjourney,belowisalist(innoparticularorder)ofthe many who had a lastingeffect on the creation of the

5M™MentalModelyouwilllearn within this book (seemore in theacknowledgements section attheend):

WhitneyTilsonJacobWolinskyBillAckmanTimMelvinGuySpierDavidEinhornScottGreenberg

RobSckalorWarrenBuffettMohnishPabraiCharlieMungerMasonHawkinsDonaldSmithScottBarbeePeterCundillBillMillerHowardMarksTonyRobbinsTimFerrissJoelGreenblatt

NassimTalebJohnMackeyJohnTempletonVitaliyKatsenelsonMitchKovitzJoelHirshJonShapiroGeorgeSorosPatDorseyDavidGardnerToddCombsTedWeschlerJaeJun

TimMcElvaineChrisHohnNoahKaganBrettFogle

FromWallStreetToTheHumanCondition:

The80/20PrincipleInAction

I woke up in a daze--it

felt like I was upside-down.Inthatmoment,anoddsenseof weightlessness came overmybody.Ithoughttomyself,“maybeIwasjustdreaming.”

As I finally 'came to',bloodwas running downmyface. Itwasat thatmoment IrealizedIWASupsidedown.Atthispoint,allIcouldthinkabout was getting out beforethecarenvelopsintoflames.

With blurred vision, Ilooked over at the passengerseat, not having rememberedifanyonehadbeenin thecarwithme.Thank goodness noone was there. I thought to

myself, "at least no one elsewasharmed."

Once the car eventuallycametoastop,andIgatheredmyself, I was able to climbout of the smashed driver’ssidewindow.30secondsaftersomehow stumbling out ofthe car, the car burst intoflames. "Whoa", I thought tomyself,"thatwasclose."

Sorry,Iamgettingaheadofmyselfhere...letmerewind

tothebeginning.In late 2007, I had just

moved back to St. Thomas,located in the US VirginIslands(whereIwasbornandraised). I had spent thepreviousyear inWashington,DC, working for anIntellectual Property LawFirm, and I hadmyheart setonlawschool.Thatis,untilIrealized I was spending themajority of my time

researching businesses andinvestingmysavings.

I was a regular personwho worked, saved somemoneyandtriedtoinvest.Soit was really by coincidencethat I realizedwhat Iwantedtodotherestofmylife.Thatis what brought me back toSt. Thomas, the opportunityto work at an investmentfirm.

Ihadbeenworkingatthe

Investment Firm for about ayear,workingverylonghoursat the office to provemyselfto the owners and mycolleagues. Maybe I wastrying to prove something tomyself too. I wouldconsistently wake up around4:00am to read and research,and would usually leave theoffice at 7:00 PM or laterduring the weekdays. Theweekends were not much

better. I was downrightexhausted.

This brings us to themomentthatchangedmylifeFOREVER.Thateventfulcarride home on a Friday nightwould be a turning point inmylife.LittledidIknowitatthe time, but it would be ablessingindisguise.

Itwasaninterestingtimeinmy life. I had spent yearstryingtofigureoutinvesting.

I thought I had anunderstanding,butthe“GreatRecession” caused almosteveryone to second guesstheir approaches to investing(includingmyown).

Things were starting torecover but people were sohurt from the preceding twoyears ofmarkets turmoil thatmarket participants didn'tbelieve anything anymore.They thought the stock

market was one big virtualcasinonow.

People were knowinglyselling companies for muchless than theywere worth. I,on the other hand, thought itwasagreattimetobeavalueinvestor ifyouhad themoxytofollowatruevalueinvestorphilosophy.

Thankfully I keptpurchasing my best ideas.Things were starting to turn

upforme,butatwhatcost?Iwas so exhausted and tired.The days seemed to blurtogether into one, until itfinallyhappened.

It was Friday night inSeptember, 2009. I’d spentabout 80 hours at the officethat week and it was onlyFriday. I decided I needed abreak so I went out with afew ofmy good friends to alocalpub.Ilefttoheadhome

alittleaftermidnight.ItwasanormalSt.Thomasnightwiththe conditions dark andaround 80 degrees. Thewindows were down and Iwas listening to BB King. Iknow, probably not the bestto listen to jazz music whiledrivinghomeatnight.

WedriveontheleftsideoftheroadintheUSVI.SoIwas travelingon the left sideof the road on the north side

oftheislandheadingtowardsmy house when theunthinkablehappened:

I FELL ASLEEP ATTHEWHEEL.

Thecarhadveeredtotheleftoftheroadoverthewhiteline, and hit a drain pipe.After the sudden crash, thedrain pipe acted as a rampand sent the car air borntwisting sideways. This iswhen I woke up to the car

flipping and rolling overacross the road and thenslidingalongtheguardrailontherightsideoftheroad,andeventually coming to ascreeching halt facing theotherdirection.

It was an odd feeling ofweightlessness initially.Thencame the ferocious body-rattling,thrashingandviolentcareening that only aprofessional race car driver

couldknow.When the car finally

came toa stop, Ididn't sayaword.IknewIhadtogetoutofthecar--FAST.

I was in a hurried state,butaneeriesenseofcalmnesswas over me as well. Iassume the adrenaline waskickinginatthispoint.

The passenger sidewindow frame was smashedin and the driver’s side

window was equally as bad.Theentire leftsideof thecarwas also lodged up againsttheguardrail.Ipulledmyselfthrough the small openingbetweentheguardrailandthecarwindow,cuttingmyarmsand hands as I reached forfreedom. Blood was startingto pour out at this point. Irememberhavingglassinmyhairforweeksfromclimbingthroughthatwindow.

I know what you arethinking -- WHAT DOESTHIS HAVE TO DOWITHINVESTING?!?!?

Don’tworryIwillgettothat shortly. I want you toknowhowthiswholeprocessstarted,sothatyoucanseeallofthetrialsandtribulationsittook to create the mentalmodels you will learn aboutinthisbook.

There will certainly be

times in your life, and ininvesting, when you thinkyouaredownforthecount.Itis essential to learn how todeal with these moments ifyouaretosucceedinlifeandinvesting.

Personally, I haveexperienced a lot of tragedyinmy life--I have had a bestfrienddieinmyarmsfromanasthmaattackwhen Iwas13years old while studying for

our final exams, and lostmyfather suddenly when I was23 years old leaving me astheheadofthehousehold.Alloftheseexperiencesmademestrongerasan individual,butitwassopainfulatthetime.

I tell you this not todepress you or to ask forsympathy.Quite theoppositeinfact.Wecanalllearnfromdifficult situations andcontinue toevolveandgrow.

Eachtragedyhaschangedmylifeforthebetter.

That’s how you have totreat less than fortuitouseventsorsituations.Everysetbackisanopportunity.That’slife--whenyoufalldownorstumble, you have to learnhowtopickyourselfup,learnfrom the situation, and keepgoingforward.

I had no idea at thosemoments of extreme

emotional pain that it wouldguide how I look at peopleand the world. Thosemoments gave me a strongthresholdforpain(physicallyand mentally), but it alsomade me understand theimportantthingsinlife.

Iamalwaysofthebeliefthat these things happenedbecauseIcouldtakeit.Ihavealways sought out toaccomplish difficult things.

As they say, the bad timesmakethegoodtimesbetter.

The key learning pointfromtheseexperiencesinmylifeisthatyoumusthavethatability to FAIL FORWARD.The dark times are nothingmore than an opportunity indisguise.Itisjusttoughtoseeitatthetime.

That accident was apivotalpointinmylife.

When I had time to

reflect on what happened, IthoughtabouthowcloseIhadcome to dying. It made methink a lot aboutmyself, mylife, my future and what Iwantedtoberememberedforin life. I realized I had toincorporatecertainhabitsandboundaries for myself in lifeand I needed to create aprocess and a system thatwouldhelpmetoinvestmoreefficientlyandeffectively.

The reason thatexperience changed my lifeforever is that it made merealize that something had tochange. I loved my job toomuch toquit, it'swhat I lovetodo.

However, it was killingme. I had to create a systemthat would help decrease thelearning curve for investingandbusinessresearch.

Little did I know that

night,aneconomistwouldbethe one to help change mylife forever. It's too bad hehad passed away 100 yearsago,Iwould'velovedtohavemethim.

The man who changedmy life is named VilfredoPareto. He popularized the80/20 principle, or ParetoPrinciple.

Iknow...Iknow.Parteo'sPrinciple, or the 80/20

principle, has been paradedaroundthemediaasawayto"hack"yourway through lifeor your career (or anythingfor that matter). Andnormally I would cast offsuchthingsthathavebecomesopopularinthemainstreammedia. However, thedisconnect occurs frompeople not using this simpleprinciple (thus, we are safefornowascontrarians).

Important note:Although,Paretowasthefirstto popularize the concept,Tim Ferriss (Author of theFourHourWorkWeek,etal)was the one that lead me toPareto, and this way ofthinking. So he has just asmuchanimpactonmylifeasPareto, and for that I amentirely grateful. ThanksTim!

Pareto essentially

established that "80% of theoutput from a given solutionor system is determined by20%oftheinput."

Here are some examplesofthe80/20principle:

80% of theoutcomes comefrom 20% of theefforts.80% oframifications comefrom 20% of the

sources.Morespecifically:80% of a business'sprofits come from20%oftheactions.80% of investmentsuccess comes from20% of theelements.

This list really does go

on forever. In fact it wouldprobably take an entire book

to discuss how Pareto'sprincipleaffectsoutlivesonadailybasis.

And the ratio is ofteneven more disproportionate.It's not uncommon to see99/1, 95/5, and 90/10. Ourfocuswillbeonthe20%thatgetsus80%ofthewaythere.Oncewegettothe80%,thenyou can hone in and focusmoreonthetaskathand.

WhenIfirstcameacross

his work, I was slaving over12-15hourdaysasaportfoliomanager at an investmentfirm managing the ValuePortfolio.Itwasnoone'sfaultbut my own. I wanted tolearned as much as possible,as quickly as possible. I hadto know everything, and allthe businesses I wasinterestedin.

Ittookthatnearfatalcarcrash to realize that there

needed to be a better way.Little did I know at the timethatthenearfatalcrashwouldend up changing my lifeforever.

Leadinguptothecrash,Iwascompletelyovermyheadand generally helpless. Evenworse, I had no idea at thetime.Iwaswakingupat4amto letmyboxerdog (Harley)out for a walk and I wouldstart reading or researching

something--anythingIcouldget my hands on that Ithoughtcouldhelpme.WhenIwasn'tcoachingfootballasavolunteer head coach afterworkduringtheseason,Iwasusually at work until 6 or7pm. There was no end insight.

The day after the crash(withglassstillinmyhair),Iopted to give Pareto's 80/20principle a chance. I thought

to myself, "Why not...I didalmostdiedright?"

IntryingtoascertainhowI was going to continueinvesting and managingmoney without killingmyself, I scrounged upONEquestion that would lead medown my journey to theunknownininvesting:

Which 20% of elementsare resulting in 80% of theresultsforinvestingsuccess?

It's certainly not an easyanswer. Anyone would beskeptical of trying to answerthis question. But thiswasn'tgoingtokeepmefromtrying.

How did I do this, youask…?

Well,itwasn’teasy.I interviewed investors,

studied countless more, andpulled out repeatablestrategies and tactics theyused (or didn’t use) to

succeed."Theartofbeingwiseistheartofknowingwhatto

overlook."WilliamJames

I began to study my

previous successfulinvestments(andthebadonesas well) and I deconstructedand reverse engineered otherinvestorstopinvestmentsand

failures. They have beenused, refined andsystematized into what youread today. You will learnmoreabouttheformulationofthe 5M™MentalModel andMECOM™Methodlater.

However, this is theformula Iused in searchofasimplesystem:

80/20 Formula = Which20% of (sources/elements)are resulting in 80% of the

desired(outcomes/problems)?As you can imagine, the

difficulty lies in establishingwhat20%willleadto80%ofthe results. That's the entirereasonforthisjourney---andthe eventual creation of the5M™MentalModel(wewillgettothissoon).

AlthoughIhaveanaturalaffinity towards valueinvesting, I also have anunderstanding of how

dynamic and challenging itcanbe.Ifindvalueinvestingtobethemostintriguing,fun,frustrating, depressing,lucrative, and exciting careeryoucould everhave (I knowthatwasallovertheplace).

And that's the beauty ofPareto's law. It helps you to"see the forest through thetrees." It helps you to focuson the most importantelements first. Once those

elements are executed orperfected, then you canventureoutsideofit.

REMEMBER: beingbusy for the sake of beingbusyisaformoflaziness.It'slazy because it doesn't takeinto consideration theelements that will actuallyproduceresults.

Focusing on theimportant few, whilediscarding everything else, is

the way to a productive life.Of course, you will need totry many different things toascertain what matters most.This can be frustrating atfirst, but it's a necessaryprocesstoseewhat"sticksonthewall."

Itcould takea fewdays,a few weeks, or even a fewmonths. However, onceyou've conducted thisimportant process, you will

know what works and whatdoesn't. It's just part of theprocess.Sothere'snoneedtogetfrustratedbyit.

Once you implement the80/20principleintoyourlife,youwillnevergoback.GuruInvestorEdge,ValueInvestorConfidential and 5M™ arejust a few of the manyexamples of the 80/20principle in action forinvestors that you will learn

aboutinthisbook.Using the investing

versionof80/20analysis,mygoal in this book is to helpyou gain an advantage inunderstanding whether anybusinesshas thepotential forinvestment. Thus, saving aninvestorhoursofwastedtimeandenergy.

We have set-up LifeTime Access to GuruInvestorEdgeONLYforour

readers. Follow the hiddenlinkbelow:

https://GuruInvestorEdge.com/LifetimeAccess

I told you I would havesurprises and gifts for you. Iam all about giving andaddingvaluetopeople’slivesbeyondthenorm.

MyStory

Congratulations on yourdecision to invest in ValueInvesting:AValue Investor’sJourney Through TheUnknown.MynameisLukasNeely, and I am theFounderof EndlessRiseInvestor.comand Value InvestorConfidential (a premium

monthly newsletter forEndlessRise Investor readerswhere we conduct in-depthinterviews with topperforming investors on theirbestideas).

It took a car crash thatalmost ruinedmylife tostartseeing things a little moreclearly.Icametoarealizationearly on in my investingcareer as a Hedge FundPortfolioManagerthat:

YOUCANNOTBEASUPERSTARIFYOU

FOCUSONEVERYTHING!

Over the last 10 years I

have developed a simpleMentalModelandMethodtohelpinvestorsbuildportfoliosand find incredibleinvestment ideas. Thecomponents of this Mental

Model, and the Methodswithin,havebeenusedbythegreatest investors of ourgeneration and beyond,helping them reachinvestment returns in thebillions of dollars. Weinvested hours of research,development,andtweakingtomaximize effectiveness andefficiency.

For the first time ever, Idecided to put the entire

mentalmodeltogethersothatyou, the individual investor,can get similar results foryourself and your family.Theseare themost importantcomponents to investmentsuccess!

Ifyouneedtounderstandthe stock market better, wehaveasectionforthat.

If your psychology, ormind,isgettinginthewayofyour investment success, we

haveasectionforthat,too.If you need help with

portfolio management orasset allocation, we’re goingtocoveritinthisbook.

If you need help withdeveloping an investmentphilosophy that fits yourpersonality best, we’ll walkyouthroughit.

Ifyouneed to learnhowtoanalyzeabusinessquicklyandefficiently,we’llgiveyou

the tools (as well as bonusmaterials,valuationtemplatesandchecklistsattheend).

If you need help withbuying and selling decisions,you’llalsofindthatinside.

Ifyouneed to learnhowto value a business quicklyand efficiently, usingdiscounted cash flow orliquidation value, we have asectionforthattoo.

Thisbook isunlikemost

books on the subject ofinvesting. It is written in aneasy-to-read format so youcaneasilycomeback to it asa reference for yourinvestment decisions, timeandtimeagain.

Mostinvestingbooksaretheoretical, or are written bypeople that have never trulymanagedmoney.The systemyouwillfindinthisbookwasborn from years of in-depth

research and analysis. Wedevelopeditintoaviableandunderstandable processwhileusing the mental models inthe real world to managemillionsataHedgeFund.

When you apply thetechniques and tips in thisbook, youwill become twicetheinvestorinhalfthetime

Please Store thisReference Book in a SafePlace.

I promise that you willcomebacktoitoverandoverinthecomingyears tomodelyour investmentprocessafterwhat we have inside. Use it,mark it up, andmake it yourown. Use it as a referenceanytimeyouwant.“Lifeislikeasnowball.Theimportantthingisfindingwetsnowandareallylonghill.”

WarrenBuffett

As you keep using and

adapting the Mental ModelsandMethodswithinthisbooktofityourownpersonality,itwill create a snowball effect.Fromaninitialstateoftrivialsignificance, a person canaccomplish wonders byacquiring worldly mentalmodels.Thesementalmodelswill build upon themselvesuntil it becomes bigger and

bigger. This knowledge willcontinue to build until itbecomesnearlyimpossibletostop.

Notonlydoes this relatetoyourinvesting--butlifeaswell.

FIG:1 The SnowballPrinciple

*Thisimagewillbeplacednexttoimportantideasand

conceptsthroughoutthebook.

If you’re ready to

become a Super Investor,thenlet’sgetstarted…

Enjoy!

The5M™MentalModel

Do you want to knowwhat makes the differencebetween a great investor andamediocreone?

Don’t dodge thequestion.

Try to answer thisquestion as honestly aspossible, because it’s the

basis of this book and ouroverallgoalsasinvestors.

Remember: I’ve donethis for a living. I’vemanaged moneyprofessionally. As a result, Ibelieve I have fairly goodunderstandingofwhatittakestobesuccessfulininvesting.

And I don’t say any ofthis to brag either. Anyonethat knowsme, knows that’snothowIoperate.Ijustsayit

toimpressuponyouthatwhatyou read here today is bornfrom real-world experienceand with real money on theline.

In trying to answer thequestionabove,I’vespentthelast 8 years studying andevaluating hundreds ofinvestors; some great ones,andotherswho,howdoIputthis politely, needed a lot ofhelp.

I’vereadover250bookson investing, the art ofvaluation,behavioral finance,portfolio management, andasset allocation. I attendednumerous seminars andconferences, and boughtnearlyeverynewsletteronthesubject. I consumed everypiece of information I couldget my hands on to find thebestwaytoinvest.

I have interviewed some

of the greats, ranging fromVitaliy Katsenelson, MitchKotivz, Joe Koster, JonShapiro, and many more. Iwas even taught by a coupleof the masters, WhitneyTilson and Glenn Tongue(formerly T2 Partners), at anadvanced value investingcourseat theValueInvestingCongress when I was 24yearsold.

I was looking for a

system or process whichwouldhelpanyonebecomeapowerfulSuperInvestor.

What I found was quiteinteresting…there’s nomagic pill or push-buttonsolution thatwill guaranteeinvestingsuccess.

What I found insteadwere certain mental models,little-known techniques andphilosophies that areusedbysome of the world’s greatest

investors to produce theirincredibleexcessreturns.

In this special book, I’llreveal to you the investingtechniques and processes ofthe greatest investors. I havealsoputittogetherinaneasyto digest mental model foryou to use over and overagaintoyourheart’sdesire.

Myintentistogiveyouabasicstep-by-stepresourcetoinvesting and building on

each component of 5M™,includingareasyouwillneedto develop and master inorder to become a thrivinginvestor.

Here is 5M™ and the 5areas to master in order tobuildandgrowyournestegg(Fig.2):

FIG. 2: The 5M™ MentalModel

Masteringanyoneortwoofthesestepswillserveyouwell,buthavingasolidunderstandingofALLfivestepsandphasesof5M™willputyouwellonyourwaytoinvestmentsuccess,aswellasputtingyouinthetoptierofallinvestors.

A SIMPLE, PROVEN,REPEATABLE SYSTEM IS

THE LIFEBLOOD OFEVERY SUCCESSFULINVESTOR.

Now that you have anoverviewofthe5M™MentalModel,wewillgointodetailon each component of the5M™MentalModel.

PART1:MARKETMASTERY

DoYouKnowYourCompetition?

"Mr.Marketistheretoserve

you,nottoguideyou."BenjaminGraham

If you remember in the

lastsection,weexplainedthe

5M™MentalModelandhowit provides a simple, provenand repeatable system forinvesting success. Since younow have an overview of5M™, we will dive into thedetails on each of the 5M™components.

In this chapter, we willdiscuss the first section of5M™ and learn how toMaster the Market. By theend of this section you will

knowhowto:Analyze yourcompetition and howtobeatthem.Determine whethervariables are bothimportant &knowable.Viewthemarketasacomplex adaptivesystem.Determine whetheryou are investing or

speculating.Find opportunities inthemarket.

THE STOCKMARKET

IS A PRODUCT OFHUMAN ACTION…ANDHUMANACTIONCANBEHIGHLY IRRATIONAL,FEARFUL AND GREEDYATTIMES.

As long as humanscontrol the decision-making

process in the stock market,the stock market willcontinue to act like humans.Humanemotionalaction,andreaction, createsunpredictable cycles ofexcitement, fear, depression,euphoria, calmness, actionand inaction. And it willconstantly repeat itself overtime.

REMEMBER: “themarket is only there to serve

you,notguideyou.”Independent thought is

vital as you determine thevalue and staying power ofthe business that interestsyou.Thiswillhelpyouprofitfrom the underlying businessfundamentals, rather thanmarket folly. Focus on thefundamentalsofthebusiness,not movement in usuallyirrational stock pricebehavior.

Asaninvestor,youareina great position to takeadvantage of Mr. Market'sirrationality and emotionalresponse,when you buy at adiscounttotheintrinsicvalueof the underlying business.We will discuss a business'sintrinsic value later in theMarginofSafetysection.

Contrary to popularbelief--you need to envisionMr.Marketknowingnothing.

If you visualize Mr.Market as nothingmore thana place that quotes stocksbased on irrationality andemotion short term, youwillconsistently look foropportunities that presentthemselvesinyourwatchlist.

It will be the investorsthat take advantage of Mr.Market's short termirrationalitythathavethebestchanceofenjoyinglongterm

investment success.Speculators and short termtraders will inevitably havean uphill battle as theyconstantly fightmarket noiseandtransactioncosts.

KnowYourCompetition

"Ifyouknowothersand

knowyourself,youwillnotbeimperiledinahundredbattles;ifyoudonotknow

othersbutknowyourself,you

winoneandloseone;ifyoudonotknowothersanddonotknowyourself,you

willbeimperiledineverysingle

battle."SunTzu

(ChineseMilitaryGeneral)“This game is too

hard…”“I can’t hope to win or

competewith the likesof the“big boy” hedge funds and

banks…”This is the general

sentimenttowardinvestinginthe stock market, andessentially this sentiment iscorrect.

However…Instead of finding areas

where an individual investorcould be successful, he/shestillinvestsliketherestofthemarket,whichisexactlywhatthe big Wall Street players

wantyoutodo.

“Whenyouplayinsomeoneelse'ssandbox,theyaregoing

tomaketherules.”NoahKagan

In this section, we will

pointoutsomeweaknessesofthe market, so you will bebetter-equippedtomakegreatinvestmentdecisions.

Investing long-term goes

against the very nature ofWall Street. Theymake verylittle money if investors justbuy and hold investments.Theywould cease to exist intheir current capacity if allinvestors did this. Now withthat said, I also don’t thinkthey are going anywhere,anytimesoon.So, it’sbest tounderstand them and theirrationale behind variousdecisions.

Wall Street iseverywhere: CNBC,Bloomberg, newspapers,financial reports, getting amortgage for your house.Thereisverylittleyoucandoto evade them on a dailybasis.

Because their veryexistence relies on activity,Wall Street cannot afford tobe contrarian. Major WallStreet firms cannot pay their

bills with customers whowon't generate a lot ofcommissionsforthefirm.

I will probably get a lotof hate mail for this, BUTinvestors would do well toavoid interactions with WallStreet(asbestyoucan).

ItisimportanttokeepinmindyoucannotblameWallStreet for their actions. Theyare merely fighting forsurvival, doing what they

weretaughttodo.Doesitmakeitright?Of

coursenot.But it’s like blaming the

shark for eating the seal.Animalshavebeenhardwireda certainway over centuries.It is difficult to reverse thatinstinct inanyperson’s finitelifetime.

It’s not the individuals,it’s the system and theincentives that need to

change.(Myguessisthiswillnever happen. Too manypeople are making too muchmoneytoletitgonow.)

The bottom line: what'sgood for investors is notnecessarily good for WallStreet (and vice versa). Theinterests are not alignedproperly for Wall Street toserve as stewards of long-termcapital.

Most ofWallStreet gets

paidontransactions,nothoweffectively that transactionultimatelydoesover the longrun. Underwriting fees,InvestmentBankingfees,andcommissionsareusuallypaidup front, and collected fromeach trade or transaction,regardless of whether thesecurity goes up or down.Now, you can begin to seewhyWallStreetwantsyoutokeep transacting more and

more(it’showtheygetpaid).Outside of commission

fees to brokers, mutual fundmanagers are paid'management fees' to coverday to day expense andsalaries,regardlessofhowtheactualfundisdoing.

Hedge Funds typicallycharge a 2/20 fee of assetsunder management. Thismeansa2%management feeand 20% of profits

(sometimes above a hurdlerate). Through myconversations with somehedge fund managers, andhaving been in the industryfor a number of years, thefund usually pays all of itsbills, salaries, and bonusesfromthe2%managementfee.The 20% performance fee isjusta“cherryontop.”

Essentially, there is noreal incentive for them to

perform.All they need to dois make sure they keep yourmoney, and performrelatively in-line with themajormarketindices.

It seems registeredinvestment advisors arepopping up everywherenowadays and essentially actasa“fund-of-fund”ormutualfund. They may toutthemselves as having lowerfees then their competition,

but they are still chargingmanagement fees of at least.5-1% and then recommendan appropriate assetallocation strategy withadditionalfees.

Do you recognize athemegoingonhere…?

Wall Street is slowingbecoming a commoditybusiness.

Because of the lack ofindependent, contrarian

thought, the big players arechasingeachother’stailsandconcentrating in the sameareas as their competitors.ThisprovidesnorealvaluetoYOU,theinvestor.

Very few firms onWallStreet have the incentive tomakeyoumoneyorgenerateasignificantamountofAlpha(outperformance) for yourportfolio. Listening to themmay feel like the right thing

to do because they are the“experts,” but it’s really justlining their pockets, notyours.

Ifeveryonejustfollowedthe Warren BuffettPartnership fee model, weprobably wouldn’t have nearthe amount of aggressiveactivityorriskybehaviorthatweseeonWallStreetday-inandday-out.

In his early partnerships,

Warren Buffett charged a0/25fee.

Whichmeans therewereno management fees, and hekept25%oftheprofits.

Waitthere’smore…Heonlytook25%ofthe

profitsifhemadeyouatleast6%onanannualizedbasis(or“hurdlerate”).

Soifyouearned5%orifyou lost 20%,Buffett earnednothing.

How’sthatforincentive?Ifhedidn’tmakemoney

for his investors, he had tofoot the bill out of his ownsavings to pay for staffsalaries, his own bills or paybonuses.

How many Wall Streetfirms would be able to dothis…?

That’s an easy answer…NONE!

Obviously there are

many other marketparticipants’ brokers,institutional funds, etc., andtowriteaboutthemanddetailall their strengths andweaknesses would take atleast500pages.

The reason I point thisout is to show how WallStreet and the Stock Marketare incredibly short-termoriented, and put very littleemphasisonthefundamentals

oftheunderlyingbusiness.Thereisverylittlereason

to look beyond the nextquarter or next year becausethey are concerned withcommission based activity orjusttryingtomatchthemajormarket indices formanagement fees (closetindexing).

Because of the stockmarket’s short-termorientation, individual

investors are providedopportunities in certain areasofthemarketplace.

Knowingwhoyouinvestagainstcanprovideinsightasto where opportunities willpresent themselves. WallStreet institutions and HedgeFunds dominate trading andflow of funds in the market.Beingignorantoftheirtacticsandbehaviors is sure to be adetriment to your investment

success. Looking foropportunities that are causedby the short-term nature ofWall Street is ultimately aworthwhileendeavor.

NothavingknowledgeofWall Street's short-termbehaviors and decisionmaking process is akin toenteringtheforestwithoutthemap.

Thetimetohavethemapisbeforeyouentertheforest.

Wewilldiscusswheretofindtheseopportunitiesattheendofthischapter.

IsItImportant&

Knowable?“Itain’twhatyoudon’tknowthatgetsyouintotrouble.It’swhatyouknowforsurethat

justain’tso.”

MarkTwain

One of theworld’s best-known investors, WarrenBuffett, has consistentlyexplained thatmost investorsmakeamajormistakeintheirinvestment strategy. Thismistake is that they put theemphasis on what they canknow, but not enough onwhether it is or is notimportant.

There are plenty ofthings that we know asindividuals,butmanyoftheseissuesreallyaren’timportant.

Imagineyouareinvestedin a great business. Youbelieve in thisbusiness long-term, it isgrowing likecrazyandhasmadeyouagreatdealofmoney.However,therearerumors that they will beannouncing a bad quarterlyearningsnumbertomorrow.

Whatdoyoudo?Most would run for the

hillsonanyrumorofsuchanevent, but ultimately no oneknowswhatthestockwilldoevenifitweretoreportabadnumber.

So,evenifweknewthata company was reporting abad earnings number, is itreally that important if webelieve the business willcontinuetogrowandprosper

wellintothefuture?When you invest in the

stock market, you need tothink about the mostimportant components toinvesting success, rather thansome random rumor or dataset.Justbecausesomethingisknowable, doesn’t make itimportant to your investingsuccess.“Noteverythingthatcanbe

countedcounts,andnoteverythingthatcountscanbe

counted.”AlbertEinstein

Only pay attention to

things thatare ImportantandKnowable.

Acompany that isdoingwell financially, has a greatproductorservice,andhasanexcellent management teamin place is a company that

you should look at investingin.

Ifabusiness:Has sustainablecompetitiveadvantages,Produces a steadystreamofexcessfreecashflow,Has readilyidentifiablecatalysts,Has a reasonable

debt levels andcapitalstructure,Hasacompetentandtrustworthymanagement team,andTrades at areasonableprice,

…then not much elsematters when it comes toinvesting.

Would you agree thatthose factors are most

importanttoinvesting?Isurelywould!Now, be careful. This is

wheremanyinvestorswilltryto complicate matters. Itseemstoosimple,doesn’tit?

Well, it is simple. It’sjustnoteasy.Ashumans,wetendtocomplicatethingsthatseem to be too simple,becausewethinktherehastobemoretoit.Thisisthemainreasonwemusthaveasystem

to help keep us within the“lines”offindinghighqualitybusinessesforthelong-term.

Research and real-worldexperience of managing ahedge fund portfolio haveshown these components tobe the most important. Timeand time again they are thecommon components andtraitsofourbestinvestments,and the greatest investmentsofinvestinglegends.

Coincidence???Ithinknot.TheMECOM™Method

discusses the components ofinvesting success. We willtalk about this more inSection4.

Sure, there are otherfactorsandtypesofanalyses.It is never “cut anddry” andnosinglepieceofanalysisfitseverybusiness.

However, the

components of MECOM™haveproventhemselvestobethe most importantcomponents to investingsuccess.“Basedonmyownpersonalexperience–bothasan

investorinrecentyearsandanexpertwitnessinyearspast–rarelydomorethanthreeorfourvariablesreallycount.Everythingelseis

noise.”MartyWhitman

(ThirdAvenueFunds)

If a business has all thecomponents listed above, doyou really need moreinformation?

At that point, you’vedone your homework, andidentified a low riskinvestment. Now, all youwouldneedtodoisweighthe

decision against your currentpositions to see if this newopportunity offers betterlong-termpotential thanyourcurrentpositions.

Intheworldofinvesting,unimportant excessinformation leads to excessmistakes.

More information anddata doesn’t mean betterdecisionmaking.

Focus on what’s most

importantandknowable!Moving Away From TheMacroStuff

Too many of us stillfocus strongly on the macropicture.We feel it is a saferbet, something that we canbetter control. However, itreally shouldn’t be part ofyour main investmentstrategy, ifyouwant toseeareal positive effect on your

finances.Remember, we want to

focus only on things that arebothimportantandknowable.Isthemacroenvironmentandtheglobal economicmachinereally knowable to any highlevelofprobability?

Make it simple foryourself.

If it’snotboth importantand knowable, you move ontothenextidea.

The macro environmentisveryimportant,butitisnotknowable to any highprobability, therefore I payvery little attention to it.Ourtimeisbetterspentelsewhere.

Of course, the realdifficulty is identifyingwhether or not something isimportant.

Because of this, youcould spend an inordinateamount of time getting to

know things that may notmatter in the future. It is forthis reason that no marketexpertisabletoreallypredictwhatwillhappenonthestockmarketswith any real degreeof consistency. As much aswe can know various things,we cannot know everythingandmuchofitisn’timportantanyway.Long-TermThinking

If you want to invest instocks, you must think long-term.

If you understand this,youalsounderstandthatyourportfoliowillgrowandshrinkover time. That is somethingyou know will happen, andsomethingthatisimportantaswell.

The importance ofholding over the long-termthroughthe“ebbsandflows”

of the market is the key tolong-term thinking andcompounding investmentsuccess.

By focusing on thisimportant concept, youunderstandthatthebusinessesyou invest in will likely beworthmore 5-10 years downthe line, than when youinitially invested (even if thestock drops at some pointthroughout that time frame).

Investors shouldn’t let short-term trading and marketfluctuation get in the way ofyourlong-termthinking.

The reality of thematteris we cannot know whatstockswilldointheshort-to-intermediateterm.

It’s important to know,butitisinherentlyimpossibletoknowwithanyhighdegreeofprobability,soit’sawasteof time to devote too much

timetoit.What you can know is

whetherornotabusinesshassustainable competitiveadvantages, as well as highquality assets and a highprobability of producing freecashflowintotheforeseeablefuture. These are factorsevery investor should focuson, and will carry themajority of the weight indetermining investment

success.If you don’t allow the

market to compoundinvestments over timebecause you want to tradeactively, you are cuttingyourselfoffattheknees.

Remember: The marketis there to serve you, notguideyou!

AComplexAdaptive

System“Inthecomplexadaptivesystemthatisthestockmarket…therewillbe

dominantnarrativesthatmost

everyoneagreeswithandthatseemtoprovidepast

explanationsforwhathashappenedandpredictwhat’slikelytohappen.…wedon’tmakeforecastsandconformportfoliostothoseforecasts.”

BillMiller

Learninghowtoinvestislikely one of the mostmultifaceted lessons anindividualwill learninhisor

herlifetime.Thisisbecausethestock

market is a highly complexsystem of interconnectingshares, companies, investors,and other networks that relyandfeedoffofeachotherforboth successand failure.Thestock market is a complexsystemthatmankindhasbeentrying to fully understandsinceitsinception.

In fact, being able to

accurately predict theconstant ebb and flow ofthese rarely precisetransitionswithinthemassivebackdropthatisthemarket,isthedreamof investorsacrosstheglobe.

Unfortunately, it's adream that very few willaccomplishduetothevolatileand unpredictable nature ofbusinessandmoney.

This shows that the

marketplace functionsbecause of the dynamicnetwork and collectivebehaviors within the system.Eachentitywithinthemacro-structure mutates and adaptsso as to increase thepossibility of survival as awhole.

In its simplest form, acomplexadaptive systemcanbe broken down intoheterogeneousagents.

These agents, orinvestors and speculators,interact with each other, andthe market, similarly to acolonyof ants.This is called“emergence” because thepatternsandregularprocessesbecome recognizable in themuch larger entity of thestock market from theinteraction with smallerentities, like traders, brokers,andshares.

This system can't bereduced to a pile ofinformation throughreduction or deduction, butmust be calculated through acomplex method of allinteractions occurring, andthe understanding of howthey cause change in oneanother.So what does all of thatmean?

Essentially it means thatcause and effect are notstaticallylinked.

Andby that Imean, justbecause something happenedin the past, it doesn’t meanyou should expect it in thefuture.

Just because theeconomyisat thesamedebt-to-GDP level as it was in1929, doesn’t necessarilymean we are going to

encounter another GreatDepression andmarket crashof80%.

Withthatsaid….Observingpastbehaviors

during certain events iscertainly an interesting andfun endeavor. Seeing howbehavior develops and formsinto feedback loops toincrease or decrease theeffects can help yieldunderstanding.

“Historydoesn’trepeatitself,

butitdoesrhyme.”MarkTwain

The complexities of so

many different interlockingpieces, living and invented,adaptingwithinthemselvestobuild andbreakdown suchalarge scale system,make thestock market seem like asentientorganism.

It also makes it one ofthe most unpredictablesystems in the world. Itsintricacies and wildlyunstablebehavior,suchasthedot.comboom(andbust)andthe big market crash during1987,make itunderstandablethat individuals leave thestock market and investing,nevertoreturnagain.

Sowhat dowedo aboutit?

Nothingreally.Youshouldexpectboom

and bust periods. Expect theunexpected. Never lean toofartoonesideofthemarket’sbearishorbullishperception.

Tryingtoguesswhatwillhappeninthestockmarketisafool’serrand.

Aninvestorwillbebetterserved to focus on the mostimportant factors andcomponents to investing

success.

InvestingorSpeculating

"Thestockmarketisfilledwithindividualswhoknow

thepriceofeverything,butthevalueof

nothing."

PhillipFischer

Ultimately,thereareonlytwo types of marketparticipants---Investors andSpeculators.

Understanding thedifferencebetweenthetwoisVITAL to achievingleisurely, long-terminvestmentsuccess.TheInvestor

Investors believe thatstocks represent a fractionalownership stake in a REALbusiness.

This is the samementalityforbonds.InvestorsseebondsastheloanstothatREAL business. Investorslook at the underlyingfundamental value of a stockand assess its intrinsic valuewhen making buy and selldecisions.

Only when an investorhas an edge do they act; themomentwhentheyknowthatthereisthatelusivedifferencebetween perception andreality.

That’s when trueinvestors act (buy or sell).Ultimately, the decision willbe based on intrinsic value,and whether there are betterrisk-adjusted investmentopportunities elsewhere

compared to your currentholdings.

Investors have a greaterprobability of ascertainingthat moment of differencebetween perception andreality, because they areaware of the underlyingfundamentalsofthebusiness.

The ultimate goal of theinvestor is to buy securitiesthatofferareasonablerateofreturn over the long run,

consideringtheriskincurred.Risk is the key to any

investor's decision makingprocess.TheSpeculator(Trader)

This is when you hearfrom normal folks about thisstock or that “hot tip” andhow well they are doing inthe market right now. Theytalk about a stock that madethem 137% in 6 weeks, but

you hear nothing about theirexuberance 6 months later.This is the nature of themarket.

Iwouldventure toguessthat more than 95% ofspeculatorshavenoideawhatthe underlying fundamentalsare of any of the companiesthey buy or sell on a dailybasis.

Speculators are in theguessinggame.

I don't know about you,butwhen I investmymoneyinthevolatilestockmarket,Idon’t want to be in theguessinggame.

Every day onTVand innewspapers you get rampantspeculation on what themarketisgoingtodotodayorwhatitwilldoaftertheGDPnumberisreported.Thislevelof excess information canlead to bad decision making

overthelong-term.Investors don’t care

about these things.Speculators and traders focuson short-term activities,technical indicators and/orquantstrategies.

Remember: there’snothing wrong with being aspeculator. I was actuallytrainedasaderivativestraderwhen I first entered theindustry. I don’t regret it at

all. I learned a great dealabout the interconnections inthemarkets.

Ultimately, my tradingdays helped to develop mymental models about theinterconnectedness of thestockmarket.And it also ledmetounderstandthat tradingwas not part of mypersonality.Ifellinlovewithvalue investing soon after,andtherestwashistory.

With that said,speculators and traders doserveapurposeinthemarketjustas investorsdo.Infact, Ihave many friends that aregreat traders and they makelotsofmoney.Youcanmakemoney as an investor or as atrader.

Personally, I knowmorepeoplethathavemademoneyin investing than trading.Trading is very difficult and

busywork.So investing is better

suitedforsomeonethatwantstomakemoneyleisurely.

The purpose of thissection is to differentiate thetwo correctly so we knowwhereyouarecurrently.

Are you an investor orspeculator?

WheretoFindOpportunity

intheMarket

Investing is a simpleconcept in theory: purchasegreat businesses withenduring competitive

advantages that are tradingbelow their conservativeestimatesofintrinsicvalue.

However…We know through

experience that this is moredifficult than most expect.With a simple mental modelofchecklistsandawatch listofyourfavoritebusinesses,itbecomesmore obviouswhena great investmentopportunitypresentsitself.

TheProblem…

Typically, high quality,high return, high free cashflow businesses reachfascinating levels ofundervaluationveryrarely.

The majority of aninvestor’s time will be spentfinding special situations, oractive value type situations,by finding hidden values orinvesting in under-covered

areas of the investmentlandscape(smallcapspace).

When an opportunitypresents itself to invest inhighqualitybusinesseswithamargin of safety, an investorneedstobepreparedtoinvestand invest heavily in thatopportunity.

You will not get manyopportunities to invest inincredible businesses atincredible prices. Don't be

scaredof themoment.Relishtheopportunity!

Always update andmaintain your watch-list andprepareforsuchsituations.

Andyouwillbereadytopurchase those kinds ofinvestments when theypresentthemselves.Market Inefficiencies: HowOpportunitiesAreCreated

One-Time / Fixable

Events:OilSpillsNaturalDisastersTerroristAttacksBadloans

MacroEvents:RecessionsDepressionsCyclicality

Forced SellingEvents:

DeletionFromIndexDividendEliminationStockTradingUnder$10YearEndTaxSellingBustedMergers

Underfollowed /UnfollowedBusiness:

Small-MidCapBusinessesLowVolumeBoringBusinessesBusiness No LongerReportingFinancials

Special SituationEvents:

Spin-OffsAssetsConversionsMergerArbitrageChapter 7 and 11Bankruptcy(BeCareful!!!)

Where To Find InvestmentOpportunities:High Quality InvestmentIdeas:

www.GuruFocus.comwww.EndlessRiseInvestor.comwww.InsiderMonkey.comwww.GuruInvestorEdge.comwww.MaketFolly.comwww.hvst.com

Special Situation InvestmentIdeas:

www.SpecialSituationsMonitor.comwww.BaseHitInvesting.comwww.CSinvesting.orgwww.ValueAndOpportunity.com

www.ValueLine.com

In this section, wecovered your competition inthemarketplace,thevariablesthat are most important, themarketasacomplexadaptivesystem, the differencebetween investing andspeculating, and how (andwhere) to find opportunitiesinthemarket.

In the next section, we

will learn how to MasterYour Investment Mindset(psychology).

Susceptibleinvestorswillbe tested by the manyofferings and temptations ofthestockmarket.Itiseasytospeculateinsteadofinvestforthelong-term.

We are all emotionalhumanbeings.

Youneed tobeawareofthe vagaries and fluctuations

that the stock market willthrow your way. By beingprepared, you will better beable to reign in the wrongemotional response. PrudentinvestorswillalwayswaitfortherightopportunitythatMr.Market will eventuallyprovide.

Understanding thedifference betweenspeculationandinvestingwillserveyouforalifetime.And

it will grow your futurewealthaccordingly.

Let’s get started on thenextsection!

PART2:MINDSETMASTERY

DoYouHaveTheProperBehavioralToolkitToBe

Successful?

“AlotofpeoplewithhighIQsareterribleinvestors

becausethey’vegotterribletemperaments.Andthatiswhywesaythathavinga

certainkindoftemperamentismoreimportantthanbrains.

Youneedtokeeprawirrationalemotionundercontrol.Youneedpatienceanddisciplineandanabilitytotakelossesandadversitywithoutgoingcrazy.Youneedanabilitytonotbedrivencrazybyextreme

success.”CharlieMunger

If you remember in thelast section, we learned howto Master the Market, andhow to let it serve us, notguideus.

Since you now haveMastery of The Market andknowhowtofindinvestmentideas, wewill now dive intodetail on Mastery of YourMindset.

In this chapter, we willlearn how to Master Your

Investment Behaviors andPsychology.

Bytheendofthissectionyouwillknowhowto:

Get into a state offlow.Invest as a leisureactivity.Approach investinglikea“Real”businessperson.Have thecommitment and

perseverance tosucceedlong-term.Have a prosperitymindset.

In order to achieveincredible long-term returnsyouneedtonotonlyhaveanability to condenseinformational and analyticaldata (which the MECOM™Method will provide later),but you must also have abehavioraladvantageoverthe

averagemarketmember.How do humans make

decisions?It’s quite simple really:

humans will normally seekpleasure or run away frompain. It’s what behavioralpsychologistscallyour“fightor flight” response. Justknowing this informationalone will go a long way inunderstanding how we canbetter equip ourselves to

handle averse psychologicalbiases.

Unfortunately, pain andfear are the most powerfulmotivators when it comes topeople making decisions.This can have a disastrouseffectoninvesting.

The average marketparticipant is emotional andlacking adequate informationto make rational and logicaldecisions. The average

marketparticipantknows"theprice of everything, but thevalue of nothing." I wouldventure to say with highprobability, that 95% ofmarketparticipants are short-term in nature. Essentially,the average marketparticipant views the marketasagiganticvirtualcasino.

This means that when amarket participant sees thevalueofhis/herportfolioturn

negative, they will be moreprone to making irrationaldecisions. They make thesedecisions because they haveno understanding of themarketorthebusinessestheyare invested in. They werealways standing on shakyground; they just hadn'trealizedityet.

This unfortunate humanbehavior of avoiding paingives investors, like us, a

greatopportunity.Take a look at the next

figure(fig.3).More than likely, we

have all had these feelingswheninvesting.

IknowIhave.

FIG:3HumanPsychologyintheStockMarket

Print it out, pin it up onthe refrigerator or in youroffice.

Just make sure youremember how feelings andemotions can affect themarkets, regardless offundamentals.

GettingIntoaStateOf

Flow

Doyouknowhowmanythoughts you have per day?100,500,1,000?

Try65,000thoughtseach

day!!!Whether we want to

believeitornot,ourbraincanbearunawaytrainifweletitgetthebestofus.Itcancauseus to elicit certain responsesif not trainedproperly.Someof these responses can bedetrimental to progress andinvestmentsuccess.

The processes in thisbook will help counteractperverse human psychology

biases, which can be atremendous detriment toinvestmentsuccess.

There was a study doneby Australian PsychologistAlan Richardson whichshowsthepowerofthemind.

Students were chosen atrandom and put into threedifferentgroups.Noneof thestudents had any experienceprior to the experiment. Theexperiment went on for

twenty days. The first grouppracticed free throws everyday. The second group didnothing. The third groupvisualizedmakingfreethrowsfortwentyminuteseverydaywithnophysicalpractice.

After the twenty days,the second group didn'timproveatall.Thefirstgroupthat practiced everydayimproved by 24%. The thirdgroup that only visualized

makingfreethrowsimprovedby 23%. This was almost asmuch as the group thatpracticedeveryday!

Being a former athletethat’s spent countless hourspracticing many differentsports,Ifoundtheseresultstobequiteinteresting.

Richardson felt that,prior to any engagement, anindividual should both feelandseeforbestsuccess.

This is essentially theMECOM™Methodinaction.

(We will discuss THEMECOM™ METHOD inchapter 5. No need to skipahead)

As you research andanalyze businesses, you arevisualizing how a greatinvestment should lookthrough MECOM. By usingthis method, you’re alreadyvisualizingwhich factors and

elements are most importantto investment success, andyou will be able to pinpointthem more accurately duringyourresearchphase.

Toreallyallowthemindtofocusoncertainthings,theprocess must allow anindividualtovisualizeandactonimportantfactsordata.

REMEMBER: Theaverage human onlyconcentrates for a few

seconds.Because of human

genetics we are eitherspendingmost of the day onthe left or right side of thebrain.Thehemispheresofthebrainarepopularlyreferredtoas the logical side (left braindominant) and the creativeside (right brain dominant).MECOM™forcesyoutouseBOTH.

Essentially it allows you

to access the whole brain byusing visualization andanalyticalmechanisms.

Which side of the braindoyouprimarilyoperatein?

MECOM™ allows themind to be focused on whatmattersmost.

You will not be leadastray by cell phone usage,reading emails or thinkingabout life's daily problems.This focused process allows

the mind to 'zero in' on atarget to produce greaterresultsinashorteramountoftime.

I cannot express to youenough how you must havebasiccontroloveryourmind.The best and easiest way todo this is with a process.However, this is commonsense that most people willignore.Thegreatestinvestingtoolisyourbrain,youcannot

let it keep you fromadvancinginlife.

It’s imperative that youallow the mind to enterMECOM™. If you want theresults intheshortestamountof time (minutes instead ofhours or hours instead ofdays), fully immersingyourself in MECOM™ ismandatory.Having a processandbeingcompletelyfocusedon it canhavebreathtakingly

fantasticresultsattheend.StevenKolter,bestselling

author of The Rise ofSupermanandfounderof theFlow Genome Project,defines flow as “optimalstates of consciousness,where we feel our best andweperformourbest.”

Haveyoueverlostadayor an evening researching orreading or finalizing aproject, and not really

rememberingithappen?Ifyouhave, thenyou’ve

likely entered a state of flowwithoutevenrealizingit.

I would venture to saythat Flow is the secret saucebehind all great investors.However,thisisasubjectthatisveryrarelydiscussedintheinvestingworld.

Let’s put it this way: atsome point you’ve probablyheard top athletes talk about

how they are “in the zone.”For example, in 1997,MichaelJordanhadthegameof his life with the flu ingame 5 of the NBA Finals.He was on the verge ofpassing out during the gamebutagreaterforcedrovehimtokeepgoing.

Warren Buffett talksabout it all the time too. Hesaysit’sallhethinksabout--he’s just "wired for

investing." He also has aframework to discern goodinvestments from bad. Andover the years, he’sdeveloped mental models tokeep him focused on factorsthatmattermost in investing.These mental models keephim focused on the task athand and they keep him outof trouble.They keep him inthe “zone” (or “in a state offlow”).

Thesementalmodelsareessentially his MECOM™process.

Being in a state of flowcan cut down the learningcurve substantially, howeveryou first need to know whatyou’re doing. If you look atthe typical chart of thelearningcurveprocess, itcanbe a whirlwind of emotionandfrustration.

FIG: 4 Learning Curve ofAverageInvestors

While it can be easy togive up and move onto thenext “shiny” object, the topinvestors will keep learning,and run through levels. Theywillreachareasandlevelsofunderstandingthattheydidn’tevenknowexisted.

We like to call it, TheEndless Rise InvestorApproach to investing. It’s

how we came up with thename for our entire missionof empowering investors. Aswell as helping individualsinvest better with access tobetterideasandopportunities.

All too often investorsbecome overwhelmed withthemountains of informationbeing thrown at them on adaily basis. By focusing onthe select few elements thatmatter most to investing

success, an investor gains anedge over the rest of themarket. This, in turn, willallowyoutoreachlevelsyouneverbeforeimagined.

FIG: 5 Learning Curve ofEndlessRiseInvestors

Onceyouunderstand the5M™MentalModel,andcanefficientlyanalyzecompaniesusing The MECOM™MethodandMarginofSafetysections, youwill allowyourmind to enter this state offlow as you start investingand researching businesses.Thentheskyisthelimit.

This is the very idea

behind The MECOM™Method.

It allows the mind toenter a hyper-state ofanalytical flow by showingthe investor which factors toconcentrate on the most.Visualizing how greatinvestment ideas should lookand the process of investing,accesses both sides of thebrain.

Thus,MECOM™allows

forwhole-braininvesting.It allows for

visualization, as well asaction.

Through whole-braininvesting, MECOM™ offersa far superior method tosuccessfulinvesting.

With this focusedattention on the mostimportant components toinvesting success, you willallowyourselftoenterastate

offlow.

InvestingAsALeisure

Activity

“…Ifyoucanbuyafewgreatcompanies,thenyoucansit

onyourass.That’sagoodthing.”

CharlieMunger

There’snoescape.The thought of investing

isconstantlyon themindsofmost individuals as theysearchforwaystoboosttheirwealth.

The issue that mostinvestors face is that theydon’t know how to properlyapproachit.

When it comes to

investinginthestockmarket,most individuals watch themovement of the numbersand the data with a feverishregularity. Many see theirefforts in thestockmarketasa business that must bemonitoredregularly,“tick-by-tick.” They constantly watchforperceived“tell-tale”signsof when they should buy orsell, in hopes of gainingoutsized returns through

activity.The problem is activity

doesn’tmeansuccess.Infact,it’squitetheopposite.

There's no question thatthe trickiest part of investingischoosingtherightapproachand the right system. Eventhe most seasoned ofinvestorswill, at some point,find that their investmentchoices will not perform asanticipated. This can cause

them to become more activein hopes of looking busy orprovidingvalue.

Investing is not a staticexercise. Achievinginvestment success isn’t justabout making one rightchoice.Notonlydoyouneedto make the right choice inyour investments, you alsoneed to exercise suchqualities as patience andcomposure.

Sosuccessfulinvestingisnot only choosing the rightinvestment, but also waitingfor the right investment andholdingontoit.

Instead of being on aconstantsearchforstocksthatmay or may not produceresults, an investor should,instead,patientlywaitforthatone stock that promises todeliverprofitable resultsoveritslifetime.Theseinvestment

opportunities must meet avery specific set ofparameters in order to makethegrade,andtherefore,maybefewandfarbetween.

We discuss this more insection 4 of this book: theMECOM™Method.

Asaleisureinvestor,youwant to understand how apotentialbusinessactuallyfitsin relation to the rest of theworldoranindustry.Looking

for this unique perspectivecould give you some insightthatothersmaynotbeabletoglean from just studying acompany's specificfundamentals.

Whenyou're analyzingaparticular stock you want tomake sure that it has sometype of moat (sustainablecompetitive advantage) thatwill make it harder, if notimpossible,forcompetitorsto

swoop in and take over apercentage of the marketshare. You're looking for adeep moat that continues toget deeper as the businesscontinuestogrow.

This will allow yourinvestment tocompound inaleisurelymanner.

Greatstockopportunitiesdonotcomealongeveryday,so you have to keep on thelookout for them and add

themtoyourwatch-listwhenthey do come along.Sometimes itmay take yearsfor that right pitch to comealong, so patience is keywhen it comes tomaking therightdecision.

ThisphenomenonalwaysremindsmeofaquotebythegreatalgebraistJacobiPascal,"All man's miseries stemfrom his inability to sit in aroomaloneanddonothing."

In short, don’t be busyfor the sake of being busy.Doingnothingisaconsciencechoicetoo.

You need to resist theneedtotradeortransacteveryquarter just to make sureyou're looking busy. Instead,it is better to simply lead arelaxedand leisurely lifestylewhile maintaining yourwatch-list until that perfectopportunitycomesalong.

You have the bestanalysts in the world atyourfingertips.

Usethem!Historicallyspeaking,the

pioneersofanyventureoftentake the arrows. The samegoes for investing andresearching great ideas. Youactuallyincreaseyourlevelofriskbytryingsomethingnew.

There is great newsthough.

Hedge funds andinstitutional funds are legallyobligedtoreporttheirend-of-the-quarterholdingswitha45day delay. This filing iscalleda13Ffiling.

We are able to see fundposition on a more real-timebasis through 13G and 13Dfilings. 13G filings must befilediftheyaccumulatemorethan 5%of the business, and13D filings must be filed if

they accumulate more than10%ofthebusiness.

The goal with thesefilings is to find “long-term”and “focused” valueinvestors. Understand theirphilosophy and make surethey are long-term investors,andnot likely to trade inandout of the market everyquarter.

Once you find investorsthat fit your philosophy, you

want to focus on the top 10positions in that manager’sportfolio.

We focus on the top 10positionsfor2reasons:

1) The top10positionswill drive themajority ofthe gains in theirportfolio.2) Managersfocustheirbest ideas in their top 10positions.

There is no reason tofocusonamanager’s20thor50th best idea. If a managerhas a great idea, he/she willgive a higher weight to thatidea in their portfolio. Theyessentially tell you whichstockstopayattentionto.

Thereyouhaveit!You have the best

investment managers andanalysts working for you

underoneroofandyoudon’thavetopaythemadime.

Howgreatisthat?How’s that for a nice

littleshortcutinfindinggreatinvestmentideas?

This strategy alone willpay for itself in time andmoney. It will save youmonths, if not years, ofresearch finding high-qualitybusinesses. IwishIhadusedthis strategy earlier. I could

have spent more time at thebeach.

There is one caveat, butit doesn’t really concern ustoo much because we aren’tblindly rushing into anyinvestment that these fundmanagersmake.

We only see theirholdings on a quarterly basiswith a 45 day delay, so it’spossible for investmentmanagers to buy and sell

stockbeforeyouevenhaveachance to act. The positioncouldevenbeahedgeagainstanotherposition.

Therecouldbeanumberof reasons why a fundmanager is holding a stock.That is why you need toknow which managers tofollow. As important as it isto find the right investmentmanagers to follow, it isequally, if not more,

important to know whichmanagerstostayawayfrom.

Many skeptics will statethat by the time you haveaccesstotheinformationitistoo late to piggyback off theinvestmentmanagers.

Thiswouldbe true ifwefocused on hedge funds oractivefunds that trade inandout of securities on a regularbasis. It would also be truethat we could be hurt by

blindly following them intotheir stock ideas,butwealsodo our own homework. Wenever blindly follow anyoneinto anything. That’s not aninvestor.

Asaresult,westayawayfrom those active fundmanagers. Over the years, Ihave compiled a list of thelonger-term managers.Obviously this is not set instone, and managers are

subject to buy and sell anysecurityatanytime.

However, I havefollowedandresearchedthesemanagers for over 10 years,and this is a list of mangersthat are focused, long-terminvestors. Sometimes theytake years to build a fullposition. This is the kind oflong-term philosophy wewanttopayattentiontoo.

Warren Buffett

(BerkshireHathaway)Charlie Munger(BerkshireHathaway)Ted Weschler(BerkshireHathaway)Todd Combs(BerkshireHathaway)Monish Pabrai(PabraiFunds)

Mason Hawkins(Southeastern)Bruce Berkowitz(FairholmeFunds)Bill Ackman(PershingSquare)David Einhorn(GreenlightCapital)Jeff Ubben(ValueAct)Chris Hohn(Children’sInvestmentFund)

Leon Cooperman(Omega)Seth Klarman(BaupostGroup)Eddie Lampert (ESLInvestments)Dan Loeb (ThirdPoint)Carl Icahn (IcahnEnterprises)Guy Spier(AquamarineFund)MichaelPrice(MFP)

Wilbur Ross (WLRoss&Co)Whitney Tilson(KaseCapital)Donald Smith(DonaldSmith&Co)

How’s that for an All-

Staranalystteam?This is not an all-

inclusive list of great stockpickers;however, this shouldbe a great starting point for

any investor to find greatinvestmentideas.

Feel free to add orsubtract to this list over timeasyoubuildyourwatch-list.

REMEMBER: the goalof this strategy is find highqualityinvestmentideas.Youshould never blindly followanyone into an investmentwithout doing your ownhomework.

That being said, it’s still

agreatplacetostart.WheredoIfindthem?

www.GuruFocus.comwww.InsiderMonkey.comwww.MarketFolly.comwww.EndlessRiseInvestor.com

AlwaysHaveaChecklist

Over the years, we havelearned many valuablelessons on how to find thebest possible investment

options.However, we did not

come to that knowledgewithout making a fewmistakesalongtheway.Evenafter you've done all theresearch and analyzed everypossible angle you can thinkof, things can still turn sour.Lessons are to be learned ateveryturn,andthosethatleadtolosseswillremainwithyouformanyyears.

Thetrickistotakethoselessons and avoid repeatingthem. You can do this bymaintaining a checklist thatwill eliminate the risk offorgettingtocheckforcertaincircumstances thatcould leadyoudownthewrongpath.

Our simple MECOM™Method checklist consists ofabout 27 different items(broad based). Click here toaccess a checklist of the

MECOM™Method.When you study your

list, you will be able tocompare it toother factors inyour portfolio and determinewhat risk factors you wouldbe exposed to. Realistically,anybusinessyouchoosewillhave some element of risk,but it will be up to you todecide what percentage ofrisk you're willing to take

based on your checklist andotheravailableopportunities.

Investing in the stockmarket is not for the faint ofheart. It can be quitefrightening to put your hard-earnedmoneyatrisk.

However, you'll soonrealize that taking some verybasic steps can yield someverypositiveresults.Thereisnoneedtoputallyourmoneyintoyourinvestmentideasall

at once. It's not complicated,but by applying simplelogical measures, yourchances for success can beamplified.

When you trust yournatural instincts and avoidletting your emotions get inthe way of analyzing yourinvestment choices, you'llknow the great investmentsfrom the mediocre ones. Attheendof thisbookyouwill

have top knowledge to buildonandcompound,whichwillserveyouwellovertheyears.PlayingWithintheLines

Stayingawayfrominsideinformation is another reasonfor investing as a leisureactivity.

Whenyouareentrenchedin the financial world, therewill be times when the linesof legality or conflicts-of-

interestbecomeblurred.By being independent

andbeingoutoftheinfluenceof Wall Street, you can setyourself apart from thecrowd.ThisisanotherreasonI have chosen to investoutsideofWallStreet.

Not only does it limitdistractions but I never haveto worry about the line oflegality by mingling andhaving personal

conversations with topexecutives.

Of coursewithout insideinformation, you will havelessinformation.Betweenthetwooptions,IpreferinvestingwithlessinformationbecauseI know I won't allowmyselfto be anywhere near thatethicalsideline.Ibelievethatan investor should alwaystake the extra step in stayingwithinthefieldofthelaw.

Seth Klarman, managerof$24billionBaupostGroup,says “If you play near thesidelines,youmightstrayoutof bounds or someonemightthinkthatyoudid,”hewrote.“We strive to play in thecenterofthefield.”

He calls it the "FootballFieldTest."

Whatever your decision,youwould be well served toalwaysstrayfromrunningout

ofbounds.Playinthemiddleof the field; if you run aproperly executed play it isthe quickest and shortestdistancetotheend-zone.AlwaysHaveAWatch-list

Your watch-list is acritical component of aleisureinvestor.

By accumulating highquality businesses in yourwatch-list, and constantly

maintaining them over time,you will be prepared whenthe market presents anopportunity to invest in abusinessonyourwatch-list.

Personally, I havedeveloped two proprietarywatch-lists over the last 10years of researchingbusinesses: a high qualitybusiness watch-list and aspecialsituationwatch-list.

IfAllElseFails…Use low-cost Index

Funds.Yes,Isaidit.If you don’t have the

adequate time or energy togiveafewhoursperweekorper month to investing, thenthis is probably your bestoption.

I would rather you beinvestedinthegeneralmarketbecause I believe you will

earnasatisfactoryreturnovertime.

Theworldingeneralwillcontinuetogrowandproducemore and more goods andservices. I believe the U.S.will continue to be a leaderbecause of its structure andruleoflaw,butthat’sforyoutodecide.

Either way, investing inlow-costindexfundsisbetterthanearningnothingatall. It

is likely that this investmentvehicle should yield areasonablereturnovertimeifyou add a certain amountfrom your pay check everymonth. Even if you findinvesting difficult, there’s noreasontobeleftbehind.

BOTTOM LINE: Withregular investments of asteady percentage of yourincome into index fundseverymonth,wealthisbound

to follow20, 30, or 40yearsintothefuture.

Allyouneedtodoisputaway 5% of your incomeeverymonth into one or twolow-cost index funds.Essentially, that’s all you'dhavetodo.

Since many activemanagers consistently under-performtheindexes,theoddsof you, as an individualinvestor,makingasignificant

returnonyourinvestmentarehigh.Statisticsshowthatonlyone in 200 managers havesuccessfullyoutperformedtheindexbymorethan3%everyyear.

Vanguard is the goldstandard of low-cost indexfunds.

Having an equal mix ofthe S&P and Russell fundswould make a good mix.Starting early on in your 20s

and investing 5%, 10%, or15%ofyourmonthlyincomeinto these funds wouldeliminate the need to go intobonds and other forms ofinvesting.The returns shouldmake it well worth yourwhile.

Although I would beconsidered a “stock picker,”the numbers speak forthemselves.Alow-costindexfund strategy is surely away

for the average investor toparticipate in stock marketgains with extremely littleinvestmentoftimeoreffort.

Just make sure to giveyourself room to add toyourpositions over time. Neverbuytoomuchduringtimesofeuphoria, and never selleverything when all aroundyouseemstobefallingapart.

Because somuch capitalis tied up in the hands of

Hedge Funds and MutualFunds,highquality largecapstocks are usually incrediblyovervalued.Usually thegoodstuffistooexpensive.

Unfortunately, this isnotconducive to leisureinvesting,soaninvestormustbeverypatientoverthelong-termtowaitforopportunities,and events thatwe discussedearlier.

Ifyou fashionyourself a

long-term investor, and wantto learnmoreabout the ideaswe send value investors andinstitutional firms, pleasecheck out the special limitedtimeaccessbelow.

Thepointof thisbookishelp you become a betterinvestor through themethodsand philosophies of greatinvestors. This specialLIFETIME access is here tohelp you get started on the

path to finding greatinvestment ideas andopportunitiesrightnow.

Asagiftfrommetoyou,tohelpyouinvestleisurely:Iwant to give you LIFETIMEaccesstoGuruInvestorEdge.Get your Lifetime Accessnowatthishiddenlink:https://GuruInvestorEdge.com/LifetimeAccessHowincredibleisthat?

InvestLeisurely.

ApproachInvestingLikeA“Real”BusinessPerson

“Investmentismost

intelligentwhenitismostbusinesslike.”

BenjaminGraham

There is a common

misconception thatentrepreneurs and businesspeoplearerisktakers.

Notsofast!Contrary to popular

belief, entrepreneurs are notmajor risk takers. In fact, itmay come as a surprise tomany, that most successfulentrepreneurs are incrediblyrisk-averse.

When it comes tobuilding a business, they doeverythingwithintheirpowerto reduce the level of risktheyexpose themselves to.Acloser view of some of themajor entrepreneurs of ourtime will reveal that taking“high-risks” was NEVER apart of their strategy whentheybegantheirbusinesses.

For example, Ray KrocoftheMcDonald'senterprise,

and Herb Schultz ofStarbucks, both had minimalinvestmentriskbuttheywereable to yield exceptionallyhigh-returnsjustthesame.

EvenBillGates investedonly$50,000togetMicrosoftoff the ground. Thatwas thetotal amount of capital putinto thecompany,certainlyalow risk / high rewardventure. As we know, itturnedoutquitewellforBill.

Ofcourse,hisinvestmentcould have gone either way.He could have gonecompletely bankrupt or hecouldhavebecomeextremelywealthy;however,hislevelofrisk was extremely small incomparisonwithhispotentialrateofreturn.

Gates knew theprobabilities,andheknewtherisk-reward profile (KellyFormulaatitsfinest).Evenif

he failed initially, I wouldventure to guess that hewould have made the samedecision every day of theweek.

BOTTOM LINE: Gatesdidnotinvestaportionofhiswealth that he wasuncomfortable investing.Investing is inherently risky;anythingcouldhappenatanymoment.

What separates the great

investors from the mediocreones, is the ability tocorrectly perform basic mathand probability. And thenusingthosebasicprobabilitiesin different scenarios andsituations (stress test). Gateswasmorethanwillingtotakeon the uncertainty that camewith investing in a newventure because of the lowrisk-high reward-highprobability profile of

Microsoft.If you take care of the

downside, the upside willtakecareofitself.

A business person isconstantly evaluating therisks and probabilities ofthose risks. They want toknow all the possible waysthey could lose money andhowtominimizethoserisks.

Understanding theunique downsides to any

businessventure is similar interms of how you analyzeyourriskinvestinginstocks.

You want to focus asbestyoucanonhowyoucannegateorshieldyourselffromrisk.

It’s essential to yourfuturesuccess.

Commitmentand

PerseveranceToSucceedLong-Term

“Unlessyoucanwatchyourstockholdingdeclineby50%withoutbecomingpanic-

stricken,youshouldnotbeinthestockmarket.”WarrenBuffett

If you don't know

somethingyouneedtoknow,thengooutandlearnit!

Ifyoudon’tknowhowtodo something that you wanttodo,thengooutanddoit!

There is no obstacle toobig.

I listen toobjectionsand

concerns from manycustomers, and manycolleagues, thatprevent themfrom achieving investingsuccess:

"But I don't knowhowtoinvest.""But I don't have abrokerageaccount.""But I don't havetime to be a goodinvestor.""But I don't know

how to calculate acompany's free cashflow.""But I don't knowhowtofigureoutifacompanyhasamoatornot.""ButIdon'thaveanyinvestingbackground.""ButIdon'thaveanyinvestmentmaterials."

"But I don't knowwheretoevenstart.""But I don't haveenoughmoney."

When I hear thesequestions sometimes, I amshocked.

I think to myself,"What’sgoingonhere?"

First, I offer all of thisinformationwithinourbooks,as well as our trainingmaterials and methods at

EndlessRiseInvestor.com.Second, and more

importantly, no one knowsanythingrightaway.

You have to go out andlearnit.Youhavetostrugglea little and keep movingforward.5M™isagreatfirststep in learning a simple,proven,repeatablesystemforachievingsuccess.

Inlife,justlikeinvesting,theremaybe dayswhenyou

wanttoquitorgive-up.Theremay be days when I letpeopledownorpeopleletmedown.

Trust me there were afew days when I wanted toreenact scenes from themovie Office Space. Youknow...calmly disconnectingall the cords from mycomputer and politelydropping it out of a three-storywindow.

You may feel alone attimes; value investing inparticularcandothistoyou.

In these moments it isessential thatyouthinkaboutwhy you are investing in thefirstplace?

Imagine it’s one of tworeasons:

1)Toaccumulatewealthand produce passiveincome for yourretirement.

2)Toaccumulatewealthand produce passiveincome for yourselfand/or your family. Toput yourself and yourfamilyinabetterpositionthantheyareinrightnow.This should be all the

motivation you need to keeppushingforward.

Alwayskeepinmindthatinvesting could change your

life and your family's lifesomeday. If you keeppersevering, and if you keeplearning, you will berewardedintheend.

Here is a simpleblueprint for wealthgeneration:

1)Strivetobethebestatwhatyoudo;2)Savebyspendinglessthanyouearn;3) Invest in High

QualityBusinessesforthelong-term;4)REPEAT

IT REALLY IS THAT

SIMPLE.You’ll be shocked how

quickly your wealth willgrow when you follow thissimplestep-by-stepblueprint.

AProsperityMindset.

Whetherwelikeitornot,

our brain iswired to preventwealth.

That's right -- thousandsof years of evolution has

hard-wired our brains to act(orreact)tocertainsituationsin certain ways.Unfortunately,manyof thesereactions are counterintuitiveto our goal of achievingwealthandprosperitythroughinvesting.

However, there’s goodnews…

There is something wecandoaboutit!

Byarmingandeducating

ourselves about our geneticpredispositions, we cancombatthenegativefeedbackloops and psychologicalbiasesthattrytoholdusbackinlife.

Surely, thiswillnotbea“one-size-fits-all” approachor a quick fix. It will takeyearstomasteryourmindset,and counter your negativepsychologicaltendencies.

However, merely being

aware of our negative biasescanhelpkeepusfrommakingunduemistakesinourpursuitofprosperity.

Just having awarenessand knowledge about thesebiases can make a hugedifference in your financialworld. It’s so importantbecause it can be thedifference between successandfailure.

Prosperity is not a state

of financialwell-being; it’s astateofmind.Butinordertobesuccessfulandrunthroughthe barriers of life andinvesting, you need to armyourselfwith this prosperousmindset.

It’sanattitudeabouthowyouapproachlife.

Guy Spier (AquamarineFund)talksabout thisagreatdeal in how he approacheslife. Despite his incredible

proclivity for enormoushumility, he’s an amazinglybrilliant person. He’s morethan generous with his time,andgenuinelycaresforothersaround him. It’s very rare inthe world (especially thefinancialworld).

He discusses a book, “ASimpleActofGratitude,“thathad a tremendous impact onhis life. After reading it, hewas so excited by the notion

that he started handing outgifts to random people, likethedoor-man.Hewouldalsowrite 3 thank you notes fivedays a week to people thathadtouchedhislife.Heevencredits his thank you note toMohnish Pabrai for helpingdeveloptheirrelationship.

I remember first readingabout Guy in the Manual ofIdeas July 2012 issue,whichis when I first heard him

discuss the book, and how ithad changed his life. In thetranscript he said anyonereading this should contacthim,andhewouldsendthemacopyofthebook.

Icould’veeasilyorderedthebook,butIwantedtoseewhat hewould do. So I senthim a message. Lo andbehold a package arrived atmydoortwoweekslaterwitha thank you note and the

book.Iwasamazed.Hehadno

idea who I was, but he wasmore than willing to helpanother human being out. Itspeaks wonders for hischaracter, and the kind ofperson he is. How incrediblewasthat?

BOTTOM LINE: Beingnicetopeople,doingtherightthing, andprovidingvalue topeoples’liveswillALWAYS

paythebiggestdividends.AsGuysays,“somuchofwhat’sgood in my life is from thecompounding of humangoodwill.”

This prosperity mindsetwill focus you on positivityand pushing forward, nomatter the obstacle. Mostpeoplethinkofinvestingasamind-numbingprocedurethattakesplacebehindthescenesofnormaldailylife.Although

it can be tedious at times,investing is one of the mostworthwhile skills to learn asan individual because of itsdynamics.

It’s essential to you andyour family's future wealth.It’s important to put aside alittle time each day or eachweek to look at yourinvestments. And reallyunderstand the underlyingfundamentals.

Most individualscompare long-term investingtowatchinggrassgrow.

But have you ever seenhowfastgrassgrows?

The first step inachieving investment successisBELIEVING.

Contrary to popularopinion,believingyoucandosomethingisactuallythefirststeptoachievingit.Thisfirststep is often overlooked by

the majority of individualinvestors.

Weendupwithsomuchstressinourlivesbecausewedon't pay attention to ourmindset.

There is great newsthough; creating a prosperitymindset can be achievedquicklyandeasilywithalittleworkandperseverance.

Having a ProsperityMindset means not focusing

on things that YOU don’thaveorthingsthatYOUcan'tafford to purchase. TheProsperity Mindset does notallow us to be envious ofother people because there isso much prosperity in theworldforYOUtocapture.

Ifyoufocusonthethingsyou don’t or can’t have, youhave a scarcity mentality.And there is nothing moredetrimental to your overall

well-being than a scarcitymindset.

AsCharlieMunger says,"There is nothing morecounterproductive than envy.Someone in the world willalwaysbebetterthanyou.Ofallthesins,envyiseasilytheworst,becauseyoucan'tevenhave any fun with it. It's atotalnetloss."

I love that quote. Itmakesmelaugheverytime.

Doesanyofthisdescribeyour general attitude towardslife?

Ifso,don'tworry.I had the same kind of

mindset. It’s actually quitecommon. This is not thementality we want when weare trying to acquire wealthand invest in businesses,whichiswhywearegoingtochange your mindset rightnow.

You ONLY need 2

THINGS:1) A willingness toapproach your life in adifferentway.2) Thecourage to takeaction with your newapproachtolife.

This is not an all or

nothing transformation. Thisis something that will take

placeovertime.Soyouneedto approach it day by day tomakesureyouare taking therightsteps.

Thereisnoreasontofeeloverwhelmed because I haveevenmoreGREAT news foryou...I will be here to helpalongyourjourney!

Perhaps you look atsituationsdifferently.Youseesomething and thinksomethingbadrightaway,or

maybe you worry about thebills stacking up or nothavingenoughforretirement.

Whenever you feel theburden of life or investing, Iwantyou towritedownonapieceofpaperthese6words:What'stheworstthatcouldhappen?

Betruthfulnow.Iwantyoutoreallywrite

all the bad things that are

happening in your life, afteryouwrite down, "What’s theworstthatcouldhappen?"

I am willing to bet thatthings aren't as bad orimpossible as you firstimagined.

NowIwantyoutothinkabout andwrite down all theprosperity and abundance intheworld.Iwantyoutothinkabout how you can positionyourselfinthatprosperityand

abundance:● Be grateful for thethingsyouhaverightnow!● Be optimistic of thewealthyouwillaccumulateovertime!● Be optimistic of yourfuturesuccess!● Bemore thanwhatyouarerightnow!

I believe in YOU! It’s

important that you develop

this Prosperity Mindset soyou can believe in yourselftoo.

In developing aprosperity mindset, it’simportant to align yourperception of wealth withyour attraction to it. Thismeans you cannot havenegative opinions towardswealthorwealthyindividualsand hope to be wealthyyourself.

Itstacksthedeckagainstyou.

First,itreallyisn'tniceorlogical to have negativeopinions towards anyone (ofcoursewealldoattimes).

Second, people tend togetwhat they deserve over alongperiodoftime.

Admire people that havecome from nothing to bemillionaires or billionaires.Takenoteoftheirstoriesand

methods in how theyachieved such great success.Clonethem!

Trust me…Successleavesclues.

Meet them, read aboutthem, try to interview them,andlearnasmuchasyoucanfrom them.Themoreyoudothis,themoreyouwillrealizewhat it takestobesuccessfulas an investor, as well as anindividual.

While changing yourmindset from scarcity toprosperity, you need to turnyour attention away frompeople, thoughtsorsituationsthat do not promote yournewfoundprosperitymindset.

Think about it: what’sthe ratio of nice storiescomparedtohorrorstoriesonthenews?

Whydohumansfocussomuchonnegativenews?

Thenewsmediaevenhasa saying, “if it bleeds, itleads.”

Theyknowthathorrororfearmongerstorieshitatourverycore.Itgetsourattentionevery time, so it can be verydifficulttoturnoff.

You do not want toobsess about problems andchallenges. And this doesn’tmean turn a blind-eye either;always be aware of the

problems and issues, andacknowledgethem.

You always want to beaware of the problems, butwallowing in these problemsand challenges is notproductive to our family orour society. If you allowyourself to enter a scarcitymindset, you subconsciouslyallow yourself to be focusedon things thatmake you feelpowerless.

You must train yourmind to acknowledgeproblemsandchallenges,andthen turn your focus back toprosperity and how to fixthem to keep movingforward.

Onceagain,thisdoesnotmean you lose all sense ofreality.

You still need to payyourbills,yourstudentloans,your mortgage and you still

need to be conservative inyour valuation of businesses.The prosperity mindset doesnot mean you abandon allresponsibilities; it justmeansyou need to stop obsessingover your negative problemsand challenges so you canworktofindingsolutions.

Anytime you feelyourself losing control youneed to start asking yourselftherightquestions:

What can I learn fromthis?

How can I improve thesituation in a positivemanner?

What'stheworstthatcanhappen?

HowdoIcomeupwithasolutiontotheproblem?

It’s so important to beproactive in defeating thisscarcity mindset. Weshouldn’t spend hours

worryingaboutthingsthatareunproductive; it’s a waste oftime.

These things include:wallowing in self-pity, beingenvious of other people,worrying about money andfinance,andnottakingactionbecauseoffearoffailure.

Don'tfocusonwhereyouare,focusonwhereyouwantto go and how you’ll getthere!

The Prosperity Mindsetdoes not allow for negativethoughts or situations to takeoveryourlife.Weknowtheyexist. We are aware of thedangers and risks in theworld.

The difference is---wewelcome these situations asopportunity!

Stay prosperous myfriend.

In this chapter, you

learned how to enter into astateofflow,howtoinvestasa leisure activity, how toapproachinvestingasa‘real’businessperson,howtoshowcommitment andperseverance in yourinvesting and how to use aprosperitymindset.

In the next chapter wewill learn how to MasterYour Investment Morals(philosophy).

PART3:MORALSMASTERY

DoYouHaveTheProperPhilosophy?

“Toeducateamaninmindandnotinmoralsisto

educateamenacetosociety.”TheodoreRoosevelt

It was mid-2009, just

after the near collapse of thestock market. Businesseswere beginning to reboundbuttheentiremarketwasstilljittery.Thatincludedme.

I was just put in chargeof managing a portfolio forthe first time. I had neverseen a portfolio go down by50% before. Even though Iknew each of the businessesin the portfolio were of highquality, I still had this devil

onmyshoulder tellingme to“sell something during thissuckersrally.Themarketwilljustcrashagain.”

I had identified thebusiness as having numerouscompetitiveadvantagesintheform of an ecosystem,extremebrandloyalty,supplychain advantages, andgrowing in free cash flow atover 30% per year. Thereturns on invested capital

wereveryimpressive,andthebusiness had free cash flowyield at over 10% for abusinessgrowingrapidly.

The company had arunway to growth through apipeline of new products, aswell as likely increases in itssubscriber base throughiTunes and office spaceintegrationwithdesktopsandtablets.Theyhadnodebtandlots of cash on the balance

sheet. Management at thetimewasthemostinnovativeand creative team on theplanetwitharecordforbeingstewards of shareholdercapital.

I started purchasing allthewayupuntil2008.ThenIbecame shell-shocked as themarket begun to crash.InsteadofpurchasingmoreinabusinessIknewtobeoneofthebestintheworld,Isaton

myhands.Not only did I dothat,butIalsosoldtheentirepositionatabig lossas soonas the stock started to rallyoffthelowsin2009.

Of course we know thestory here: Apple continuedits trajectory upwards as itincreased more than 5 timesoff its lows in 2009. Seefigure6belowofmybuy/selldecisions, and the missedopportunity. It’s still the

worst loss (and lostopportunity) of my career,and it happened because Ididn’t have the right mentalmodels in place to keep megrounded and focusedon thetaskathand.

All my analysis on thisbusiness went out thewindow.

FIG: 6 Apple (AAPL)

Missed Opportunity. 2007-2015

I allowed myself tobecome overwhelmed bythe stock price instead ofthe factors that reallydrive the business:valuation, free cash flow,growth, underlyingbusiness fundamentals. Ihadnoplan,andIdidnothaveasoundprocess.It’sthe main reason I failed

earlyonininvesting.In the last section, weexplained the mastery ofyourmindsetininvesting,andhowitprovidesabasefor your investingpsychology andbehaviors.Since you now haveMasteryoftheMarketandof yourMindset, nextwewill dive into detail onMasteryofYourMorals.

In this section, we willlearnhowtoMasterYourInvestmentPhilosophy.Bytheendof thissectionyouwillbeableto:

Think about riskbeforereturn,Approach investingwith a contrarianstreak,Stick with a long-term approach to

investing,Usethe“few,bigandinfrequent bets”methodfor investing,andUnderstand that theunderlyingbusinesseswill dictateinvestment, not themacropicture.

Morals are defined as “aperson's standardofbehavior

or beliefs concerningwhat isandwhat’snotacceptableforthemtodo.”These are not the kind ofmorals that your mother orfathertaughtyougrowingup.When we talk about yourmorals in this book, we arereferring to YOURINVESTMENTMORALS.Essentially this is yourinvestment philosophy andhow you view investing.

Yourphilosophywillkeeponpoint during the good times,as well as the bad. So try tothinkof themasyourmoralsbecause they ARE thatimportant to your investingsuccess.Your morals are somethingyou would never abandonbecause they make you whoyou are. Thus, yourinvestmentphilosophyshouldbecome engrained into your

thought process because itwill become a part of yourinvestment toolbox andsystem.Just like your mindset, youuse your investment moralssubconsciouslywhileyouaremaking decisions.You neverknow when you may needeach one, but it’s imperativethat you learn them andingrain them in your mindnow because you could need

thematanymoment.As long as the world exists,therewillalwaysbeaneedtounderstand investing.Historyis packed full of fascinatingand worldly knowledge thatis just waiting to be pluckedby someone who wants tolearn.TODAYthatsomeoneisyou.Take a look at the figurebelow (fig 7). It shows mythought process on buying

and selling decisions now(part of my morals). Thisfigure is by no means set instone. I am a very visualperson, so having thishanging in my office is adaily reminder tostick tomysystem.

FIG:7Buy/SellDiscipline

AlwaysThinkAboutRisk

beforeReturn“Focusonthedownside,andtheupsidewilltakecareof

itself.”MarkSellers

Every great investor has

onethingincommon:They think about risk

before ever contemplatingreturn.

Contrary to popularopinion,thegreatestinvestorsare extremely risk-averse. Agreat investor will alwaysfocus on risk first --- rewardsecond. The majority ofinvestment strategies and

systemsdonot focus enoughonriskandtheprobabilityofpermanentcapitalloss.Ionlyknow of one such strategy,andthat’svalueinvesting.There areonly a fewoptionsyou can use to help youdecrease your risk: hedge orsell when appropriate, knowyour investment intimately,holdcash,investinthe“risk-free” rate, diversify to acertain extent, and of course

invest with a margin ofsafety.GOLDEN RULE: DON’TLOSEMONEY

1st Rule of Investing:Don'tlosemoney.

2nd Rule of Investing:Don'tforgetthe1stRule.

As many know, thisstatement was made famousby Warren Buffett, and I

agree with himwholeheartedly.ThisiswhyIbelievethatinvestinginariskaversemanneristhebestwayto protect your capital andincreaseyourwealthoverthelong-term.

Any permanent losses toyour investments can wreakhavoc on the beauty ofcompounding. Evencompounding at very lowratescanbringaboutmassive

success, so an investor’sfocus should be onunderstanding the potentialfor permanent loss in anyinvestment.

Of course this doesn’tmeanyouneverincurrisk.First,we need to define risk.The definition of risk is aninteresting topic altogether,but I define risk as theprobability of permanentcapital loss over several

years. Fluctuations in stockprices do not constitute risk.The underlying businessfundamentals, and its futureprospectswilldeterminewhatconstitutesrisk.“Riskcomesfromnotknow

whatyou’redoing.”WarrenBuffett

Thereisnohard-fastrule

on how to eliminate risk

completely. This is why thebest way to mitigate risk isthrough an appreciable (andexpanding)MarginofSafety.We discuss this in greaterdetailinsection5.

We’re all human. Thereis a speculative urgeencapsulatedinallofus.

The first step is toacknowledge it, and thenmove on to makingunemotional and rational

decisions. The idea of quickand easy money cansometimes be too difficult topass up, but we must resistthe urge. Speculativesituations give marketparticipants the greatestprobabilityofrisk.

It may sound counter-intuitive; however, avoidingrisk at all costs is the bestway to produce wealth overthelongterm.Thisiswhywe

focus on the businessfundamentalsandamarginofsafety.

Therewillbemanytimesthroughout your investingjourney when you will betemptedbyspeculative ideas.Don’t give in to thetemptation.Themarketwantsyou tomake these impulsiveandspeculativedecisions.

Always search for freecash flow and protection in

the form of assets. Todecrease your risk in anyinvestment,alwaysinsistonamarginofsafety.

It’s funny tome that themajority of investors thinktheyneed to incursignificantrisk to attain significantreturns. If you are able tomitigate your losses, andcompound your moneysteadily over time, yourreturnsWILLbesignificant.

This brings us to anotherimportanttopic.Volatility≠Risk

Volatility is opportunitytoavalueinvestor!Notrisk.

In fact, we welcomevolatility.However painful itmay be in the short run, weknow that it allows us toestablish positions in highquality businesses or specialsituation opportunities that

offer the highest probabilityofsuccess.

Our view is that themarket and its individualcomponents are notefficiently priced ALL thetime.NowrealizeIsaid,“Notall the time.” We are notbelievers in efficient markethypothesis(EMH),butwedobelieve the market does afairly good job of valuingsecuritiesmostofthetime.

Our main issue withEMH is that it ignores tailrisks and uncertain orunforeseen events. Historyhas proven repeatedly thatyou need to be prepared fortheunknown.Asaresult,youneed to expect theunexpected. And actuallyprepare to be wrong. This iswhy you want to positionyour portfolio in such aconservative manner. Value

investors know they willeventuallybewrong.These times of uncertaintyare welcomed. When themarket over reacts to theupside or downside, it cancreate opportunities for long-term value investors to takeadvantage of in a risk aversemanner.

AContrarianStreak…

“Valueinvestingisatitscorethemarriageofacontrarianstreakandacalculator.”

SethKlarman

Focus on the futureproductivity of the business

you are investing in, what’shappening right now at thisverymomentintime.

Try to take a step backandseethebiggerpicture.

Obviously you can’tpredict the future, butcarelessly extrapolatingcurrent trends into the futureis a recipe for disaster. Bothon the upside and thedownside.Themarketismostdangerous when market

participants lean too far inonedirection.Thiscansetupimportant inflection points inoverallinvestorpsychology.

Having a contrarianstreak comes with a majorcaveat: don’t be contrarianjust for the sake of beingcontrarian.

Investors know that amajor factor to investingsuccess is the ability to gowhere otherswill not. That’s

whereaninvestorwillbeableto achieve excess returnsversus the overall market, ifexecuted properly. However,the concept of contrarianismcan be taken to extremes attimes.

REMEMBER: Themarket is right 90% of thetime.

Also, we don’t want tobe too negative all the time.The U.S. and global

economies are likely toproduce more goods andservicesoverthenext50-100years.

Andofcourse,therewillbecorrectionsalongtheway,butIdon’twant toget in theway of that freight train bybeing too negative orcontrarianallthetime.

With that said, greatinvestors have streaks ofbeing a contrarian. This

meansyoumustbewillingtotake theother sidewhenyoufeel sentiment andfundamentals have swung toanextreme.

As the market rises andentersaeuphoricphasebasedon soft fundamentalprinciples, you must bewilling to sell or trimpositions if the marketbecomes toofrothy.Thinkofthetechbubbleof2000orthe

housingbubbleof2007.Ultimately, you want to

be “buy and hold forever”type investors, but there willbe times when the marketbecomes highly irrational. Ifyou are right about thebusinessesyouinvestin,evenbear markets will notdislodge the growth of thebusiness.

Duringthesesituations,itcanstillbeaprudentactionto

alter your portfolio byincreasing cash positions orhedging your currentpositions. There have beentimes when I have gone to50% stocks and 50% cashwhen I think the market isoverly optimistic about thefuture.

Conversely, when themarket enters a depressedphase based on panic andfear, you must be willing to

buy with both hands. Thesearethetimesthatprovidethegreatest chance ofoutperformance.

It can be a very difficultendeavortoactcountertotheoverall market or sentiment.After all, it’s against ourgenetic makeup to runcountertotheherd.

Undervalued securitiesare almost never popular atthe time of investment. They

are certain to be out-of-favorandheavilyscrutinizedbythemedia and analysts as theyrush to lower price andgrowth estimates that theywere too optimistic about inthefirstplace.

Youwanttoalwayshavethe mindset of buying whatothers are selling and sellingwhatothersarebuying.

When you pay attentiontotheactivitiesofthecrowd,

it’s important to focuson thesentiment of the generalmarket, as well as thefundamentals. It’s in thesetwo areas where an investorcan see the pendulum ofrational thought swing toextremes. These are theinflectionpointswediscussedearlier.

When the market isselling a security forirrational reasons, the selling

can sometimes get to anextreme level beyond logic.This creates the undervaluedopportunities that we searchforonaregularbasis.

You will always bewrong--initially,thatis.

Themostdifficultpartofbeingcontrarianis theFACTthatyouwill bewrongwhenyou first purchase yourinvestment.Notonlywillyoube wrong, but you won’t

know when things will turnaround.

This can have adevastating impact on yourpatience as a value investor,butwewillprepareourselvesforthatsituationrightnow.

As an investor you willNEVER be completelycertainiforwhenyouwillbeprovencorrect.That’swhy itis SO important to have aproven repeatable process to

investing.Itwillkeepyouonthe tracks when things getrocky.BOTTOMLINE:Contrariansare almost always wronginitially as they suffer 'paper'losses. It’s important to notlet this dissuade you fromstaying on course andfollowingyoursystem.

StickWithALong-TermApproachToInvesting…

“Ifyouarenotwillingtoownastockfor10years,donot

eventhinkaboutowningitfor10

minutes.”WarrenBuffett

ThestockmarketisNOT

acasino.I have nothing against

price speculation, but youmust know the differencebetween investing for thefuture production capabilityof the business versusinvestingonthehopethatthepricewillchangeoverashort

periodoftime.It’s for this reason thata

distinctionmustbemade:areyou an investor or aspeculator?

Focus on the long-term,not on the day-to-daymovements of stock prices.Stockpricesareonlytheretotrickyouintoimpulsebuyingandselling.

Knowing a businessintimately and its future

earnings potential will meanthe difference betweeninvesting and speculating.Valueinvestorshavealongertime horizon thanmost.Youcould even call it “timearbitrage” ifyou’d like ---asthegapbetweencurrentpriceand intrinsic valuewill closeovertime.

Mutual fund timeframesare measured in quarters,while hedge funds are

measured in months (someare in days). This provides agreat amount of opportunityfortheindividualinvestor.

When value investorsmakeapurchase,theyalwayshope the price goes lower sotheycanpurchasemore.

This is where valueinvestors deviate most fromthe mainstream investmentworld.

When I tellpeople that I

hope the stock goes lower,they look at me like I amcrazy.

But let me put it thisway:

Imagine you were abouttopurchasethehouseofyourdreams at a discount to itsreal value, and the ownerdrops the price by 20%,wouldyoustillpurchaseit?Of course you wouldpurchase it. You may be a

little skeptical of the pricedrop, but if your duediligence finds nothingwrong, you just bought thehouse of your dreams for20% less than you plannedon.

Usethe“Few,Bigand

InfrequentBets”MethodforInvesting…

"Youonlyneedafewgoodideastomakeasignificantdifferenceinalifetime."

BruceBerkowitz

Over-diversification willleadtoanaveragereturnovertime.

Asa result, Iwill gladlytake short-term volatility forabove-averagereturn.

Afocusedportfoliohelpskeep you concentrated inyour best ideas and it keepsyousharp.Thereisnoreasonto have more than 10

investments in your portfolioat one time, and certainly nomore than 20. Anytime yourportfolio gets closer to 20positions you will start tomirrortheindices.

In essence, they becomeunconscious closet indexers.And becoming a closetindexer is the death kneel ofanygreatinvestor.

Aninvestorisessentiallysaying,“Idon’tknowwhatto

do” or “I don’t know wheretoput thebulkofmy capitalbecause I can’t distinguishmy best ideas from themediocreones.”

Closet indexing isessentially “giving up” ininvestingterms.

Great investors don’tstrive formediocrity. This isthe entire reason why wefocusonourbest ideaswhilediversifyingappropriately.

PortfolioManagement

Being a successfulinvestor involves more thanbeingagreatstockpickerandhaving a great temperament.Thereviewofone'sholdings,as well as proper andopportunistic trading, is vitalto successful portfoliomanagement. An investor’sjob as portfolio managerincludes: watching cash

levels, diversifying properly,controlling the amount ofpositions in portfolio, andmaking buying-selling-hedgingdecisions.

Havingasoundportfoliomanagementunderstandinginconjunction with a valueinvestment system providesthe maximum potential forany investment portfolio.HavingonewithouttheotherisakintopurchasingaFerrari

withouttheengine.However, with the two

workingtogetherinlock-step,thepotentialisincredible.

As investors, we arealways on the lookout forbusinesses that will last thetest of time. However,capitalism can be brutal tocompanies that do notmaintain or expound upontheir competitive advantages.Although,certaininvestments

mayonlybeinyourportfoliofor a finite period of time,portfolio management lastsforever. Therefore, it is veryimportant to have a properportfoliomanagementsystemin place to help navigate theinvestmentwaters.

These are three maincomponents of a greatportfolio:● Cashlevels● Concentrated

● UndervaluedsecuritiesCash levels are very

significant. Cash allows youto take advantage ofopportunities as they presentthemselves. As mentionedearlier, I’ve been at cashlevels of more than 50%during extreme bull markets.This is not uncommon forme. Typically I have about10-20% of the portfolio in

cash. During extreme bearmarkets sell-off it will be 0-5% as we put the cash toworkbyinvestinginourbestideas.

Iknowcashisnotlookedupon greatly in theinvestment community.However, cash gives youliquidity and helps todecrease opportunity costswhen/if markets eventuallycorrect. Cash becomes very

valuableduringthesetimes.Investing in undervalued

securities at a significantdiscount to intrinsic value isthe primary job in portfoliomanagement. It’s by far themost important responsibilityofaninvestor.The business fundamentals,aswellasthepricepaid,willdetermine the future returnsofaninvestorovertime.

WhentoBuy?Never feel forced to buy

thepositionallatonce.Try to leave room to

average down the initialpurchase price of yourinvestment.

Italwaysdependson thesituation, but a good rule ofthumbis toascertain thesizeof the position you want toaccumulate.

Let’s say you want to

accumulate a 5% position inyour portfolio with thisinvestment. I would usuallypurchase a small amountinitially (usually 2% of theportfolio).

If the stock pricecontinuedtodropandnothinghas changed fundamentally,youwillbemorecomfortablein purchasing more (maybeanother 3% of the portfolio).This brings the total

investment of your portfolioto a little under 5% with agreater margin of safetybecause you purchased at alower price from intrinsicvalue.

If it was a greatinvestment at a higher price,it’sanevenbetterinvestmentat the lower price (all elsebeingequal).Youmust learnto take advantage of thesetypes of opportunities,

howeverpainfulitmayfeelatthetime.

The ability to averagedown in the price paid foryour investment is a criticalfactor in trading and futurereturnsthat’snotwidelyheldby most money managers.Usually on Wall Street youhear that you should neveraddtoalosingposition.Theywill say things like,“averaging down is for

amateurs.”I think this makes them

soundlikeamateurs.This statement has no

bearing on the underlyingfundamentalsofthebusiness.It projects linear thinking, asit is focused only on whatthey see in front of them --thestockprice.

First, rarely will thepurchase of a security turnintoprofitsinstantly(evenfor

traders). It takes time for aninvestment ideatobeseenorunderstood by the market. Ifyour analysis is correct, thecompany will trade towardsits conservative estimate ofintrinsicvalue.

Second, an investmentactually becomes less riskythe lower the price paid (allelse being equal). This is aconceptthatescapeseventhemostseasonedinvestors.

If the underlyingfundamentals of the businesshaven’t changed, and youmakeaninvestmentatalargediscount fromintrinsicvalue,wouldn’t it be a betterinvestmentatalowerprice?

Mostmarket participantsfail to see this logic becausetheyareswayedbytheshort-term loss of the originalposition,andthinkthemarketis telling them they are

wrong.Fear and panic must be

thrownoutthewindowwhenyouarepurchasingstockinabusiness. If an investordecides to make aninvestment, he/she shouldresist the urge to purchase afull position to help combatthe psychological biases toloss.

I want to reiterate thispointbecauseIthinkit’svery

important.Imagine you decide to

invest. And let’s say youwould like this business tocomprise 10% of yourportfolio. You believe it’s agreat business with enduringcompetitive advantages, andit’s trading at a reasonableprice.

It would not be bestpracticetopurchasetheentire10% all at once on your

initialinvestment.Instead,trypurchasinga smallerpositionofsay5%.

If thestocktradeslower,an investor will not bepowerlessinpurchasingmoreof the stockat a lowerprice.Establishing partial positionschangesaninvestor’smindsetinstantly. By initiallypurchasing the partialposition,aninvestor’smindismore focused on opportunity

of when and where topurchasemore.

This is in direct contrastto the investor thatpurchasesa full position instantly, onlyto see the stockmove lower.This can lead to regret andfear. And this leads to aninvestor panicking fromlosses.

Investors that establishpartial positions know theycan purchase more at lower

prices, which lowers theiraveragecostper share.Thus,an investor is able to lowertheir risk and change theirpsychological biases. This isa very powerful tactic inpurchasing securities. Andone that is rarely talkedabout.

Of course, this scenariodoesn’t exist in a vacuum.Thereareothersituationsthatdemand an investor’s

attention.Thinking about the two

perspectives of purchasing asecurity that goes lower, orpurchasing a security thatgoes higher, can give yougreatinsightintowhetheryouthinkthecompanyisofgreatquality with enduringcompetitiveadvantages.

As a value investor, ifyou are willing to purchasemoreofacompanyasitgoes

lower in price, or if you arewillingtopurchasemoreofacompany as it goes higher,can distinguish a decisionfrom being an investment orspeculation.

If a business is truly agreat investment you shouldhave no problem purchasingasthestockpricegoeslower,just as you should have noproblempurchasingastockifitgoeshigher,aslongasitis

trading at a significantdiscountfromintrinsicvalue.If you have an issuepurchasing the stock of abusiness as it continues todrift lower, or higher, thenyouprobablyhaveno reasontomaketheinvestmentinthefirst place. You would bebetterservedtothrowitawayand move on to the nextpotential investmentopportunity.

WhenToSell?

This is a question thatcomesupquitefrequently.

Value investors areusually very good at findingundervalued investments, butthey have difficulty inknowing when to sell. Thisdecision is made difficult bythefact that there isnoexactnumberfortheintrinsicvalueof a business.As an investor

youhavearangeofpotentialvalues, but there is never aprecise number. This makesthesellingprocessevenmoredifficult.

I believe there are twotypes of investments: long-term High Quality MoatInvestments and long-termActive Value investments(specialsituations).

Highquality investmentsareinvestmentsIplantohold

forever, but this doesn'talways happen. Better ideascome along or thefundamentalscanchange.

With active valueinvestmentsIalwayssellhalfof the position if it reaches100% gain or is within therange of intrinsic valuecalculations. At this point Ihave essentially written mycost to zero and I am free tosell the other half of the

positionasIseefit.Other than that, I have

one universal rule when itcomes to investing: at theright price, virtually anysecurity can be sold. If aninvestment is overvalued anda better opportunity presentsitself, I will sell theovervaluedsecurity.

It’sthatsimple.Noteasy,butsimple.

Stop-loss orders are

another way traders (andsometimes investors) try tocontrol risk of stock pricemovement.

I learned the hard waythat stop-losses do notdecrease risk. Instead ofpurchasingmoreofasecurityyou deem to be a greatinvestment,yousellthestockbecause you are afraid oftemporary stock pricemovements. The market

doesn'tknowthevalueofthatinvestmentintheshort-term.

When you use stop-losses, you become a captortothemarket.Youessentiallyput the market in control ofyour decision-makingprocess. And we know weneverwantthat.

As you can see, everyselldecisionisbasedonpriceversus underlying value ofthe business. The timing and

executionofthesaledependson opportunities that arepresentatthattime.

If a stock increased, andwasstillundervaluedwithnootheropportunitiespresent, itwould make sense to holdyour investment. If a stockwere fairly or overvalued,while other opportunitieswereabundanteverywhere,itwouldmakesensetosellandpurchasenewopportunities.

TimingtheMarket

Tryingtotimethemarketis another issue investors runinto.

Timing the market is afutileendeavor.Thebestonecan do is try to buy whenothers are fearful, and sellwhen others are greedy.That’s the extent of mymarkettiming.

Think about it this way:

You do the proper researchon a business you want toinvestin.Thestockistradingat$7.00.Themarket is quitefearful over the prospects inthe short-term becausegrowth didn't come in asexpected.

Yourresearchshowsyouthatthecompanyhasastrongrecurring revenue stream thatwill be around for a longtime.Youthinkthiscompany

has few competitors and hasthepotential tobearoundfor30years.Ittradesat10xfreecashflowandissignificantlybelow its readily attainableliquidationvalueof$20.00.

Do you take a pass oninvesting in the companybecause you think thecompany might go down to$3.00? Or do you invest inthecompanyrightnow?

Imagine this scenario:

sayyoupurchasethestockat$7.00and the stock rallies to$12.00in6months.

What do you do now?Do you sell the wholeposition?Doyousellsomeoftheposition?Ordoyouholdfor the long term or at leasttillitreachesfairvalue?

Let’s say you decide tosell the whole decision orpartial position in hopes ofpurchasing it lower. This

opens up a quandary that iscommonamongalmosteveryinvestor: trying to improveperformance through tradingan INVESTMENT.The urgecansometimesbetoogreattoovercome.

So at this point you sellthe security. How do youdecide when to get back in?Doyougetbackinat$10.00,$8.00 or $6.00? What if itralliesto$15.00...doyoubuy

again knowing that it is stillundervalued(justnotwiththesamemarginofsafety)?

Remember, you believethis business to be a viablelong-term investment. Whyare you trading it in the firstplace?

Atthispointwehavejustoverlycomplicatedthematterby trying to time themarket,instead of letting itcompound.

I have developed asimplephilosophy:

● IfIbelievethistobeagreat business that I amconfidentwillbearoundforaVERY long time, I hope tonever sell. I also know thisisn’t always practical, so Iwill hold until the businessfundamentals deteriorate or abetter investment opportunitywith much better businessmetrics and competitive

advantages comes across mydesk.

● If it’s more of anactive value (turnaround orliquidation) investment, thenI will follow the rules fromabove for great businesses.Themain difference is IwillALWAYS sell 50% of mypositionif it rises100%.Therest of the position is sold atmy discretion. Thisessentially gives me a free

positiontodoasIplease.Wediscuss the more in theCatalyst section of theMECOM Method in section4.

There are times when itcan be prudent to hedge orsell positions that areovervalued. However,investors are better served toinvestingreatbusinessesthatcan compound your moneyandinvestmentovertime.

The only time to sell a greatinvestment is when youbelieve a better investmentexists.Although investors donot focus on short-termtrading, good tradingdecisions can mean thedifference between successand failure.Whether I like itornot,investorshavetotradesometimes as new or betteropportunitiesarefound.

AgnosticoftheMacro

Environment…

"Inthe54years(CharlieMungerandI)haveworkedtogether,wehavenever

forgoneanattractivepurchase

becauseofthemacroorpoliticalenvironment,

ortheviewsofotherpeople.Infact,thesesubjectsnever

comeupwhenwemakedecisions."

WarrenBuffett

Personally,Ihavewastedcountless hours trying tomake sense of the macropicture. And I’ve also madevery costly mistakes in the

process.Ultimately, the

underlying business will tellyouallyouneedtoknow.Allaninvestorneedstodoispayattention to the businessestheyfollow.

Listening to macro ormarketpredictions is awasteoftimeandenergy.

Focus on what is mostimportant to making aninvestment decision in a

business:

Sustainablecompetitiveadvantages,Produces excessand stable cashflow,Possesses readilyascertainablecatalysts,A “fortress like”balancesheet,

Capable andtrustworthymanagers,andTrades at areasonablediscountto its intrinsicvalue.

If a business exhibits all

or most of thesecharacteristics, what else doyouneedtoknow?

I know there’s a lot of

noise out there right now inthe investing world.However, if a businessexhibits all thesecharacteristics, it’s probablybest to mute the TV (unlessoneofyourfavoriteinvestorscomeson),turnofftheradio,and stop reading SeekingAlpha. It’s probably time tobuy regardless of the macropicture.

Where Are The GreatMacroInvestors?

There aren’t manyconsistently great macroinvestors that I can nameoffthetopofmyhead.

Canyou?Icanthinkofonlythree:

RayDialo,GeorgeSoros,andJohnBurbank.

Eventhen,thesethreearehighly contrarian, and havevalue investormindsets, so I

take these pickswith a grainofsalt.

On the contrary, I havenamed,andcouldcontinuetoname countless other valueinvestors that haveoutperformedthemarketoverthelong-term.

Just something to thinkabout.

Ihave touchedupon thisalready, but as we havelearned, the stock market, as

well as the general economyisacomplexadaptivesystem.

Correctly applyingpredictions on what theeconomy will do IS anextremely difficult endeavor.An investor’s time is betterspent researching individualbusiness and looking for adivergence betweenperception and reality (priceandvalue).

Macro (top-down)

investors tend to be trendfollowers,notcontrarians.

Thus, there is littlemargin of safety. Top-downinvestors tend to investwhentimesaregoodandsellwhentimes are bad. Of course theproblem with this is that themarket has already priced inthese potential great ornegativetimes.

Thismeansaninvestorisplaying the greater fool

theory of speculation. Therearetoomanyvariables,whichmeans an investor wouldneedtobequickandaccurateinordertomakemoney.

As you may haveguessed,thereisanotherissuewhen it comes to gaugingwhether certain expectationsare already priced into thecurrentstockprice.

Imagine you predict themarketwill continue togrow

at 5% and you purchasesecurities; however themarket is expecting 10%growth? You could still losemoney because the marketwas expecting the higherratesofgrowth.

In this scenario, it’slikely themarket already bidup prices in response to the10%growth.Ifgrowthcomesin anywhere under 10%, themarket could take a turn for

the worse, even if it wasbetter than your 5% growthestimate. Identifying themarket's expectations shouldbe understood beforemakinganyinvestment.

Value (bottom-up)investors focus on importantANDknowablethings.

They focus exclusivelyon the underlyingfundamentals of eachbusiness that they choose to

research. They judge eachbusinessonthemeritoftheseunderlying fundamentals.This allows for a simplerstrategy than that of a topdown strategy. Bottom-upinvestors do not predict, andshould never compromisetheir conservative approach.They normally look attangible things, and makeprobabilities based onconservative financial

metrics.Of course this hinges on

actually having the ability toconservatively value asecurity.Wediscussthislaterin The MECOM™ Methodand Margin of Safetysections.

When you are able toconservatively valueunderlying securities, thenyou must have the patienceand discipline to wait until

you have a big enoughmargin of safety from itsintrinsicvalue.

Thus,theactualdirectionof the economy is of littleconcern to the bottom-upvalueinvestor.

In fact, in analyzing theindividual securities, youactuallygaininsightastothenature of the overall market.You can see within theunderlying businesses that

you follow whether themarkets are euphoric ordepressed (or somewhere inbetween).

By using a bottom upstrategy, investors can pointto specific reasons forinvestment. It becomesmucheasier to make decisionswhenyouonlyfocusonafewcritical variables that matterthe most to businesses andinvesting. There are just too

many variables in the macroworldtohaveagreatamountofsuccessoverthelong-term.

It can be very difficultfor anyone to change theirmind after making aninvestment. By focusing onthese factors and reasons forinvestment, you can comeback to this at a later date.Thiscanhelpyouobjectivelyre-evaluate the investmentdecision, and if need be,

make the decision to sell ifyou are wrong. This can bedifficult todowhentherearetoomanyvariablesinthetop-down universe. You mayevenbebiased to latchon toother positive numberswhileignoring your original reasonforinvestment.

By only focusing on afew important and knowablevariables, you will makebetter decisions for the long

termasaninvestor.There are too many

intelligent people trying topredict the unpredictable orunknowable. Investorswouldbe better served not tomakeinvestingthisdifficult.

I, for one, will play onanother field using a simplebottom-upinvestingstrategy.

In this section, welearned: how to concentrateonriskbeforereturn;howwe

musthaveacontrarianstreakin order to outperform themarket; the importance ofhaving a long-term approachtoinvesting;thatfew,bigandinfrequent bets can best leadto outperformance; and howwe must remain agnostic ofthe macro picture to besuccessful.

In the next chapter wewill learnhowtoMasterTheMECOM™ METHOD

(businessanalysis).Let’s get started on the nextsection!

PART4:MECOM™METHODMASTERYDoYouHaveTheProperAnalyticalFramework?

As youwill recall in the

lastsection,weexplainedthemastery of your morals ininvesting,andhowitprovidesa base for your investingphilosophy.

Since you now havemasteryofTheMarket,YourMindsetandYourMoralswewill now dive into detail onyour Mastery of TheMECOM™Method.

In this chapter, we willlearn how to analyze anybusiness using theMECOM™Method.

Bytheendofthissectionyouwillbeableto:

Determine whether abusiness hassustainablecompetitiveadvantages.Analyze the “real”earnings of abusiness.Pinpoint catalyststhatwillallowforthestockappreciation.Quickly analyzewhether a business

establishes properleverage and debtcontrol.Determine whethermanagement iscompetent andtrustworthy.

IntroductionToTheMECOMMethod™

"Nowisepilot,nomatterhow

greathistalentandexperience,

failstousehischecklist.”

CharlieMunger

MECOM™ is theframework that helps tosystemize informational andanalyticaldata.This iswherewe will do the bulk of ourwork.

Essentially this is thechecklist for analyzing ANYbusiness(publicorprivate).

Thequesttodevelopthisframework began when I

started working at aninvestment firm in 2007,which justsohappened tobeduringtheendofagreatbullmarket before the eventualmarket crash from the GreatRecession.

DuringthistimeIstudiedeverything I could get myhands on, reviewed everyinvestment I made,researched what other greatinvestors had done and I

deconstructed the variousvariables and componentsintowhatyouseetoday.

It didn’t take long torealize that I kept comingback to the same variablesthat seemed to be commonamong the best investmentsof the top performinginvestors,aswellasmyown.

I will never forget theday I found thesecommonalities. It felt like I

found the holy grail ofinvesting by inverting anddeconstructing the greatinvestors and their best andmostprofitableideas.

I had isolated the mostimportant components andvariables that were, inretrospect,obviouslythemostimportant to investmentsuccess. And I couldn’t waittotestitout,andshareitwiththeworld!

Whatyouseehere todaywith 5M™ and theMECOM™ Method is theculmination of thatcomprehensive research andreal-world experiencemanaging millions of dollarswith plenty of trials,tribulations and triumphsalongtheway.

MECOM™ serves as aGrande Checklist forunderstanding potential

investmentcandidates.Itisbynomeans“THE”

grande checklist or all-inclusivethoroughanalysisofthe business. However, if abusiness does not pass thebasic MECOM™ test I willnot compromise. It getstossedinthetrashbin.

No checklist is perfectfor every situation. Thefurther you go through lifeinvesting, the more you

realize there is no holy grail.However, hard work andstaying within a rational andlogical system will serve aninvestor very well over thelong-term. This checklistserves to keep us out of badordangerousinvestments.

Ideally, wewant to ownbusinesses that pass all thecomponents of MECOM™.Asyouwillsee,therearenotmanybusinesses thatpassall

dimensions of MECOM™,but it’s important to knowthatwhenyouaremakingtoomany compromises on abusiness,it’sprobablytimetowalkawayfromit.

I hate to break this toyou...INVESTING IS NOTEASY.

I know this isn’t thesentence you anticipatedseeinginabookexplainingarisefromfailuretosuccessin

investing, as well as asystematic method foranalyzing businesses in 5simplesteps.

Yet, that’s just thequandarywefindourselvesin--- Investing is simple, butnoteasy.

This is not a “fastmoney” type of strategy orprocess; this process ismerelyawaytohelpanalyzebusinesses more effectively

and efficiently. A byproductof this will be compoundedreturns of your wealth overtime.

Thischecklistisdesignedtohelptheindividualinvestorinvestbetter.

ThisistheentirereasonIdothis.

I strive to show you aprocess that you can ingrainin your mind to makeinvesting as simple as

possiblewithoutwasting anymore time than is absolutelynecessary.

This process will saveYOU hours of analysis andresearch. The process willfine tune your research andhelpyoufocuson thefactorsthatmattermost.

Personally,Ilovereadingandanalyzingcompanies,butnothing is more frustratingthanspendingsignificanttime

readingaboutandresearchinga company, only to find outthat you have to throw it inthetrashbin.

MECOM™ helps toweed out the bad apples andnotwastetime.

FIG: 8 The 5 Steps of TheMECOM™Method

Looks simple, right?That’s because it is. It’ssupposedtobesimple.

I have assembled asimple process through acountless number of hoursresearching and analyzingbusinesses and investors.Time and time again I keptcoming back to these samevariables before making a

decision ofwhether to investinabusinessornot.

As I said earlier,MECOM™ is a simpleprocess,BUTinvestingisnoteasy. The purpose of thisprocess is not to makeinvesting easy. The purposeofthisprocessistomakeitaseasy as possible. It will takesomework initially, just likeanything else in life, but ifyoustickwithit,youwillsee

therewardsofyourlaborwellbeyond your wildestimagination.

Clickheretoaccessa

checklistoftheMECOM™Method

Let’sgetintothecomponents

ofMECOM™.

Step1ofMECOM™:

Moat(s)

“Thekeytoinvestingisnotassessinghowmuchanindustryisgoingtoaffectsociety,orhowmuchitwill

grow,butratherdeterminingthecompetitiveadvantageofanygivencompanyand,aboveall,thedurabilityofthatadvantage.Theproductsorservicesthathavewide,sustainablemoatsaround

themaretheonesthatdeliverrewardsto

investors.”WarrenBuffett

If you have been

investing for some time,there’snodoubtyou’veheardofthetermmoat,asitrelatestoinvesting.

Forthenewinvestor,youmightbewonderingwhatthehell a moat has to do withinvesting?!?!

Don’t worry, I haven’tforgottenaboutyou.

A moat was a popularmetaphor created by WarrenBuffetttodescribeabusiness

that has a competitiveadvantage. Essentially thecastle is thebusiness and themoat is the competitiveadvantage.

The moat by itself wasnotenoughthough.Thecastleand its people had toconstantly make sure themoat was filled withcrocodiles and piranhas, andalwaysfilledtothetop.

At any moment a

marauder could come in andtry to attack the castle. Themoat made sure it was welldefended.

There is a reason this isthe first step. Without themoat…well, the businesswould never survive asustained attack by thecreaturethatiscapitalism.

Capitalismisabrutalandvery competitive place. Wewant to make sure we have

some sort of competitiveadvantage in place beforewastingtime.

The first question wemust ask ourselves is, doesthe business have asustainable competitiveadvantage?

Now if you are like mewhenI firststarted investing,you’re probably askingyourself…

“Great, now how do we

determine if abusinesshas acompetitive advantage ornot?”

Don’tgettoofrustrated--- it’s not as difficult as youthink.

Of course it will takesome research, but I willshow you a few quick anddirty ways to invert theprocessandhelpspeeduptheanalysis to see if it’s worthyofourtime(ornot).

There are two ways todiscover businesses withmoats:

1) Yougothroughyourvast array of mentalmodels which tell youthat a sustainablecompetitive advantage isa possibility even thoughthe profits have nottrickled down to the

bottomlineyet…(this is difficult for eventhe most seasoned ofinvestors)OR

2) You use a simpletechniquecalledinversionto find which businessesareabletoproduceprofitsabove and beyond theircompetitors right now.

Then find out why theyare able to do this, andwhat the probability ofthemcontinuingtodothisintothefuture?When I look for

businesses that have moatcharacteristics, I will use thelatter approach, the inversionmethod.

Tryingtounderstandanybusiness,isagreatexercisein

trying to solve problems bylookingat thembothforwardandbackward.

CharlieMunger explainsitbeautifully inhis speechatthe University Of California,SantaBarbara,onOctober3,2004.

Mungerlovedtogivehisfamilypuzzles.Thiswasoneofthem:

“There’s an activity inAmerica, with one-on-one

contests, and a nationalchampionship. The samepersonwonthechampionshipon two occasions about 65yearsapart.”

“Now,”Isaid,“nametheactivity?”

“Can you name theactivity?Howdoyoucometothatanswer?”

Munger said only onepersoninhisfamilyansweredit correctly because of the

way he thought about theproblem.

He goes on to say, “Ihaveaphysicistsonwhohasbeentrainedmoreinthetypeof thinking I like. And heultimately got the rightanswer,andhere’sthewayhereasoned:

It can’t be anythingrequiring a lot of hand-eyecoordination. Nobody 85yearsofageisgoingtowina

national billiard tournament,much less a national tennistournament.Itjustcan’tbe.

Then he figured itcouldn’t be chess,which thisphysicist plays very well,because it’s too hard. Thecomplexityofthesystem,thestamina required are toogreat.

But that led intocheckers.Andhethought,Ahha! There’s a game where

vast experience might guideyou to be the best eventhough you’re 85 years ofage.”

Going backwards andforwards in one’s thinkingcan help to improve yourability to solve problems. InthecaseofMoats,itwillhelpus to delineate whethersustainable competitiveadvantagesexist.

Finding sustainable

competitive advantages isbest thought of as theexplorationprocess.

This iswhere you reallygettounderstandthebusinessand its competitors. I lovethispartthemost,however,IamalsoawarethatthisisalsothetoughestpartoftheentireMECOM™Method.

Don’t despair! I willshow you how you can seepotential sustainable

competitive advantages in abusiness by looking at it’smoat metrics. I will explainthe moat metrics in just alittlebit.

And before we go anyfurther, I also want tocongratulate you for makingitthisfar!

Youshouldbeincrediblyproudofyourself!

Youjustmadeitintothetop2%ofinvestorsoutthere!

A lot of investors(professional and individual)don’t even bother with thispartoftheanalysisortheydoit incorrectly because theythinkittakestoomuchtime.

However,thisisthemostcritical part of any long-terminvestment. Lots of investorsthink it’s enough to focusononly valuation ormanagement. And whilethese factors are important,

you aren’t investing in abubble.

Capitalism is a dynamicenvironment andwemust beable to determine whether abusiness has a competitiveadvantage, so it cancompound our investmentover the long-term. High-return businesses willconstantly be assaulted bycompetitors.It’sthenatureofcapitalism.

As I stated before, thereisnoneedtoworry.

I will show you somequick tips using the moatmetrics to discern whether abusiness has a potentialcompetitive advantage(s) ornot. We can then comparethem to other competitors toqualify whether a truecompetitive advantage existsornot.

Let’s startby identifying

thedifferenttypesofmoats.Essentially there are five

main types of competitiveadvantages:1.Intangibleassets2.Tangibleassets3.Costadvantage4. Customer switchingcosts

5. Networkeconomics.

Pat Dorsey (Dorsey

AssetManagement)hasdoneatremendousamountofworkoncompetitiveadvantagessohedeservesthehattiponthisone.1)IntangibleAssets

The thing that can becomplicated about intangibleassets is that they'reintangible.

It can be difficult toclassify exactly what this

competitiveadvantagemeans.There isagreatdealofworkthat must go into whether abusiness possesses intangiblecompetitiveadvantage(s).

Generally, an intangibleasset pertains to the thingsthatmakeacompanyunique.Things that are untouchableby other companies such asbrands, licenses, trade-marks,patents,andother intellectualproperty. Itmay also include

geographical advantages andcompany culture, which canaffect the durability of acompetitiveadvantage.

Agreatexampleofbrandloyalty and intangible assetsat work can be seen throughbrands like Harley-DavidsonandApple.

More than one hundredyears ago Harley-Davidsonset up shop, and althoughthere are many other brands

and styles of motorcyclesaround the world, this onestandsabovetherest.Infact,thesebikesaresopopularthatmany men and women havethe brand name tattooed ontheirskin.

Would you classify thatas a rabid and loyal fan? Iwould!

Apple,ontheotherhand,ishailedasoneoftheleadersinportablemedia,music and

communication.Asaresultoftheirfans’brandloyalty,theirproductsrestatthetopoftheprice charts, while theircompetitors (who offersimilar products at a fractionof theprice)don’t get nearlyasmuchbusiness.Thisbrandpower is one competitiveadvantage that Apple holdsabovetherest.

Because this competitiveadvantage is intangible in

nature it is also subject tochangeveryquickly.

2)TangibleAssets

Lots of investorswouldn’t include tangibleassets as a competitiveadvantage. However, I willdisagreewiththisone.

Abusinessthatownsrealestate or land that isstrategically located at vitalcorners around the world

offerscompetitiveadvantagesthatotherscouldnevertouch.

Imagineowning thatonehotel right on the beach inMiami or owning a buildinginthemiddleofTimeSquare.These are big-timecompetitive advantages ifmanagedcorrectly.

Forexample,thinkaboutairports.

What is more strategicand vital to an area than an

airport?Ferrovial SA (FRRVY)

isbased inMadrid andownstwo of the best infrastructureassetsintheworld:London’sHeathrow Airport and ETR-407tollroadinToronto.Thelong-term agreements andpricing power provides themwithagreatmarginof safety(as long as managementdoesn’tsquanderit).

What about sporting

venues?Madison Square Garden

(MSG)isprobablyoneofthetop five (if not top) sportingvenues in the world. Thisstrategic location and iconicstatus should provide themwith a steady recurringrevenue stream and adequatepricingpowerinthe“citythatneversleeps.”

How about billboardadvertisingandrealestate?

Lamar Advertising(LAMR)ownsrealestateviabillboardsinsmalltomid-tiermarkets. The real estate isstrategically located, and thecompanyhasastrongmarketshare. In addition, many ofthe areas they ownadvertisingrealestate,donotallownewbillboards.

As you can see, tangibleassets canhold a spot on themantle of sustainable

competitiveadvantages.

3)Customer SwitchingCosts

Customerswitchingcostsisapowerfuladvantageinthebusinessworld, as they openup the ability for companiesto raise prices and changepolicies without losingcustomers.

Theseswitchingcostsareusually a one-time cost that

makes switching from onecompany or service toanother too expensive orinconvenient to bother.Having high switching costscan keep consumers fromtaking their business to acompetitor, even if thecompetitor has better pricesorproducts.

One place where thistypeofcompetitiveadvantageis seen frequently is among

mobile phone companies,who lock their customers infor a period of one to threeyearsthroughadiscountedorfreemobiledevice.

This contract forcescustomers to stay within theguidelines and policies oftheir contract or be forced topay a penalty in order to bereleased early. These costscan vary depending on howlong is left on the contract,

and while some companiescharge fairly reasonable rates(although they're higher thanaverage), others make itnearlyimpossibletomaketheswitch.

Sometimes these costsaren't financial at all, butrather thecostsaremeasuredin learning curves, becauseswitching from one productto another means learning toidentify an entirely new user

interface and operatingsystem.

SwitchingfromaMactoa PC is a good example ofthislearningcurve.

Adobe would fall intothiscategorytoo.

4)NetworkEffects

The way that a networkeffect occurs in the world ofmoat economics andcompetitive advantages is

veryinteresting.Asabusinessorproduct

increases in value andpopularity for new andcontinuing users, suddenincreases in growth across anetwork of consumers, canactuallyraisethecompanytothe top of their industry inrelativelyshortorder.

Thisisrecognizedasoneof the most importantcompetitive advantages

because it can make such avast difference in a shortperiodoftime.

Agreatexampleofthisiscreditcards.

I am willing to bet thateveryonehas a credit card intheir wallet right now. AVISA, MasterCard orAmerican Express? So whydo you have them in yourwallet?

Yes, obviously to make

purchasesoncreditordebit.But why do you carry

thosespecificbrands?It’s because merchants

accept them, and as long asyou carry them, merchantswill accept them. It’s aviciousnetworkeffectcycle.

Ebay is another exampleas more and more peoplecome to one location to selltheirgoods.

Social media networks

are another example of howquickly businesses can growwhen you have tremendousnetworkeffects.

5)CostAdvantages

Thisisprobablythemostimportant sustainablecompetitive advantage ---especially when it iscombinedwithothertypesofmoats.

All consumers are

lookingforadealonproductsthat they buy, which meansthat companies that can gettheirproductstocustomersata lower price than thecompetition have acompetitive advantage oversimilarbusinesses.

Being able to undercut arival companyon the cost ofgoods or services is a bonus.Additionally, companieswhocan produce at a lower cost

can also charge at the samepricepointascompetitorsbutmake more for their efforts.Cost advantages can be adifficult competitive edge togain in the early stages ofbusiness because they oftenrequire very large orders toachieve the right balance forloweredpricesongoods.

Asacompanybuildsandexpands into a larger entitywiththebuyingpower,itwill

be capable of purchasinglarger orders to lower costsandgainmoreprofits.

A prime example in thiscategoryisWal-Mart.

This retailgiantoperatesall over the globe, providingconsumers with essentialproducts from all ranges oflifeatcompetitiveprices.

Having thousands ofstores globally makes Wal-Martaverystrongcompetitor

in itsmarket, and because ofits size it not only sells itsproductsforlessbutisabletokeepcosts low forcustomersandstillmakealargeprofit.

Delivering lower pricesthan a competitor has beenexplained as cost advantage,but there are other costadvantages that consumersthink about as well, such asconvenience, speed, andexceptionalservice.

Providing better all-around products than othercompanies can produce anenduring competitiveadvantageforabusiness.Itisdifficult to pinpoint andcalculate, but it is surelypossible.

Having superior valuebased on craftsmanship,service, functionality anddesign can also give abusiness an advantage over

its competition and make aclaim in the market for acompany'sbrandandability.

Starbucks and WholeFoods are great examples ofthis.

That’s Great --- But HowDoWeFind‘Em…?

So, now we know whatto look for as sustainablecompetitiveadvantages.

Now it’s time to look at

the“MoatMetrics.”I use certainmetrics and

numbers to find moat typebusinesses. I started to callthem “Moat Metrics” and itjuststuck,soIcontinuetosayittothisday.

These metrics arenumbersorratiosthatshowahigh quality, high returnbusiness.

Establishing whether ornot a business actually has a

competitive advantage canleave much to theimagination.Inthisparticularinstance,Ibelieveit’sbesttouse a process of inversion tohelpuslocatebusinesseswiththe potential for sustainablecompetitiveadvantages.

We do this mainlythrough screening forbusinesses producing excessamounts of free cash flow(FCF) and excess return on

investedcapital(ROIC).Allthecashintheworld

doesn’tmeananythingforthefuture if you aren’t able toconsistently reinvest the cashandproduceoutsizedreturns.

Essentially,CashFlowIsGreat, but ReinvestmentOpportunities Are TheDriving Force BehindOutsized CompoundedReturns Over The Long-Term.

ROIChelpsusdeterminewhether there is potential forreinvestment.IfIhadtopickonemetrictofocusontohelppinpoint businesses withsustainable competitiveadvantages, it would beROIC.

Thus, we will focusintentlyonthismetric.

ROIC businesses arecommonly referred to ascompounders because they

areabletoreinvesttheircashflow. The more cash that isproducedbythebusiness,themore room for reinvestingwhich provides for growthand compounding. You canseetheappealof investinginthesetypesofbusinesses.

Thetrickisthreefold:1) Finding thesebusinesses2) Objectivelydetermining whether they

will produce these returnsin the future with a highprobability3) BuyingatamarginofsafetyIf you can locate these

consistent ROIC businesses,it will lead to the power ofcompoundingovertime.

Jae Jun atOldSchoolValue.com has aneasy to navigate stock

screening suite for free. Feelfreetocheckitouthere:

http://www.oldschoolvalue.com/stock-

screener.php

Will They Continue ToProduceTheseReturns?

Once we find thesebusinesses, howdoweknowif they will continue toproducethesereturns?

Unfortunately, past

performance doesn’tnecessarilypayitselfforward.You don’t profit from thegrowthofyesterday.

Sohowdowedeterminewhether a business will beable to produce consistentlevels of ROIC into thefuture?

There isnoeasyanswer.Thefirstthingyouwanttodoistimetravel.

Wait…What!?!?

Yes,timetravel.You need to take a step

back, try to see the forestthrough the trees, andobjectively analyze whetherthe business will likely bedoingthesamethingin5-10-15yearsthatit’sdoingnow.

Take Apple (AAPL) forinstance:It’sagreatcompanyandproduces a tonof excessfree cash flow with highROIC. It has established a

great ecosystem and networkeffectswith iTunes,and theircustomers are incrediblyloyal.

But…Are we able to predict,

with a high level ofprobability, how the nextgeneration of iPhones, iPads,and MacBook's will beperceivedbyconsumers?Andwill they buy the new appleproducts? Will competitors

poach the talent from Apple(Tesla’salreadytakingAppleemployees)? Will newcompetitors create betterdevices which will drivecustomers away from theAppleecosystem?

This constant change intechnology and innovationputs many technologybusinesses at a majordisadvantage (not un-investable, but at a

disadvantage nonetheless)because of its ever evolvingandchangingland-scape.

This is not a knock onApple. I think it’s anincredible companywith lotsofcashandrelativelynodebt,and it has establishedagreatnetwork of loyal fans. I justcan’t really see where theproduct line will be in 10years with the increasedcompetition and low barriers

toentry(aswellascontinuedleadershipofthecompany).

Wewant businesses thathave stable industrycharacteristics and highbarriers to entry, such asrailroads,beverageproducers,andbanks.

Conversely,Icanpredictwith a higher degree ofprobability thatU.S.Bancorp(USB) will sell low-riskmortgagesandproducereturn

on equity (ROE) in the midteens.

Icanalsopredictwithaneven higher degree ofprobability than Apple, thatUnion Pacific Railroad(UNP)willlikelymovemoregoodsandservicesintheU.S.while earning at least 20%ROEin10years.

Indeterminingwhetherabusiness will be able tocontinueproducingROIC,an

investor would need toobjectively understandwhether the business willlikely be doing the samething, with relatively thesame impact/results, that it istoday. This involves havinganunderstandingoftheactualbusiness,itsmanagement,theindustry and theircompetitors.

Ifyoubelieveabusinesswill be able to consistently

produce FCF and ROIC intothe future, then determine aconservative estimate ofintrinsic value using FCF,comparetheintrinsicvaluetocurrent market prices, anddecide whether your marginofsafetyissufficient.

Are you invested inbusinesses with sustainablecompetitiveadvantages?Sustainable Competitive

Advantages Don’t EndWithTheBusiness

I believe it’s just asimportant for individuals tohave competitive advantagesinlife,aswell.

Itcouldbeyoursmileoryour good looks or yourpatience or your ability totake action or maybe evenyoursuperiorintellect.

It could be any numberofthings…

The point is to find acompetitive advantage thatgives you a leg up on yourcompetition. Once thatcompetitive advantage isknown,focusongrowingthatadvantage(aswellas findingnew ones). Never stoplearning and providing valuetoothers.

For example, I believevalue investors, in general,have a myriad of different

competitive advantageswhich sets them apart fromtherestoftheinvestingarena,suchas:

Avoiding the noiseoftheoverallmarketandmacroforecastsInvesting for thelong-term with verylowturnoverValuing businesses,notstocks

Using a Price/ValueStrategy for stockselectionGoing beyondGAAP (GenerallyAcceptedAccountingPrinciples) inascertaining the“real” value of thebusinessExecuting a veryfocused portfolio of

no more than 20holdings

It is important to

remember,notallcompetitiveadvantagesarecreatedequal.

A company’smanagement team shouldlook at its own competitiveadvantages critically todetermine which ones aremost beneficial to thebusiness.Thentheyshoulddo

anything in their power toprotectit.

If you ever ask anexecutive what theircompetitive advantage is andtheydon’thaveananswer…

Runtheotherway.Bigbusinesses,andsmall

businesses alike, will requiredifferentgameplansasfaraspotential competitiveadvantages, like costadvantages and network

effects.For instance, a retail

company will focus on itscompetitive advantagedifferently from medicalcompanies or theentertainmentindustry.

Inorderforabusinesstocorrectly execute its plan forsustaining its competitiveadvantages, a business mustremember that this may goagainstwhatanalystsonWall

Streetthinktheyshoulddo.It is important for a

business and itsmanagementto be focused specifically onthe typeof industry that theywork within and how theirbusiness relates to itsconsumers and theenvironment in which it'sbeenestablished.

Listening to financial“experts” and succumbing toWall Street’s every whim, is

asurerecipefordisasteroverthelong-run.

Whether you choose tofocus on the five types ofcompetitive advantages, oryou're already implementinga fewof them inyour lifeoryour investments, it'simportant to monitor theirsuccess rates. You shouldalsokeepaneyeon the levelof your particular moat, andwhether it is helping the

businessgrow(ornot).It can be easy to spend

too much money on a greatidea or something you thinkthe customer will love.However, losing track of abusiness’s real competitiveadvantageandprotecting thatcompetitive advantage canmean all the differencebetweensuccessandfailure.

Doesyourbusinesshave

acompetitiveadvantageoveritscompetition?

Whataresomeofyour

competitiveadvantagesthatyouwouldliketoshare?

Step2ofMECOM™:

Earnings--Canyoucountthecash?

“Thecriticalinvestmentfactorisdeterminingthe

intrinsicvalueofa

businessandpayingafairorbargainprice.”WarrenBuffett

When analyzing a

business’s earnings youalwayswanttoaskyourselfifyoucancountthecash.

Does the company produceexcessFCF?

It seems every majorcollapseofstocksremindsus

whatweneedtofocusonthemost.

Theonedeterminantofagreat business or worthwhileinvestment is the cash thatyouwillbeabletotakeoutofiteventually.

The illusion of earningsby solely focusing on“earnings-per-share”(EPS) isan often used barometer indeterminingthevaluationandqualityofabusiness.

Time and time again thenew crop of analysts, WallStreet investors andexecutives fixate on thesereadily-attainable numbersdespite the horror stories ofthe past when people focussolely on these generic andeasily-manipulatednumbers.

Andit’ssuchatravesty.But it does serve an

important lesson: Never get“seduced” into great

investment storiesbecauseofrapidly growing stock prices,revenuesorEPS.

It’sfarbettertofocusonanother measure of earningsto determine quality andcorporate performance, suchasfreecashfloworROIC.

It ismuchmoredifficultto manipulate the cash flowstatement. Income statementsare notorious breedinggrounds for subjective

reporting and accountingshenanigans to help thecompany hit Wall Street’soften aggressive projectionsand targets. As a result, wedon’twanttofocustoomuchon the income statement asfarasearningsareconcerned.

Remember:Cashisking!It needs to flow though toFCForowner earnings for ittomeananything.

Themore free cash flow

a business will be able togenerate over time whilereducing debt, the higher theintrinsic value will be overtime.

By focusing solely onfree cash flow (and ownerearnings), we can focus onthe actual dollar amount thatcan be returned toshareholders through fourmainactivities:

1)Reinvestment2)Debtreduction3)Dividends4)Buybacks

These continued

activities WILL raise thepriceand intrinsicvalueoverthelong-term.FreeCashFlowIsn’tJustaBarometer for a QualityBusiness.

Discounting these freecash flows back to its netpresent value can help youcalculateanintrinsicvalueofthebusinessaswell(basedonconservative estimates, ofcourse).

Don’tbescaredbythis…We will go over this

simple valuation calculationin the margin of safetysectioncomingupnext.

In researching and

finding the correct earningsof the business, we want tofocus onFreeCashFlow (orowner earnings), first andforemost.

If the business doesproduce excess FCF you canmove on to the nextcomponentofthechecklist.

If the company doesn’tproduce FCF (or ownerearnings) or has no hopes toever produce it, then it’s a

pass.This is when I always

need to remindmyselfof theKISS principle --- Keep ItSimpleStupid.

No need to makeinvesting any more difficultandcomplicatedthanitneedstobe.

Keepitsimple!WhereToFind:Cash Flow Statement

(gurufocus.com,morningstar.com)FreeCashFlow(FCF)=CashFromOperations–CapexOwnerEarnings=NI+D&A+/-OtherNon-Cash–AnnualMaintenance Capex +/-changesinworkingcapitalStable FCF And RevenueGrowthOverLast 10YearPeriod?

Not only must the

business be able to producefree cash flow, but youwanttomakesureyouhaveahighprobability the business isable to produce these resultsovertime.

Oddly enough, the onlyway to do this is by lookingbackward.

Stable and growing FCFandrevenueoverthelast5-10year period can help usconservatively estimate with

ahigherdegreeofprobabilitythe intrinsic value of thecompany.

While there is noguarantee of what the futureholds, the past stability orgrowthofthebusinessshowsthe quality and potentialstayingpowerofthebusiness.Attheveryleast,thestabilityof thebusinessprovidesus asound base from which tocalculate conservative

mathematicalcalculations.We look for four main

types of businesses forrecurring revenues/cash flowbusinessmodels:

1) Service businesses(high quality w/ highswitchingcosts)2)Franchisors3) Subscription basedbusinesses4)Razor/razor-bladetype

businessesOfcoursethebusinessof

today doesn’t profit fromyesterday’s stability orgrowth.

So, it’s important toalsohave an eye to the future aswell.

Is there a competingtechnology, service orproduct that is better qualityand/orlowercost?

These are the types of

questions you want to askyourself when you areinvestingforthelong-term.

The graph below ofCoca-Cola (KO) shows aperfect example of a stablebusinessthathasbeenabletogrow revenue, freecash flowand equity for an extendedperiodoftime.

FIG:9Coke(KO)Revenue/Free Cash Flow / TotalEquity

As a result, the sharepriceincreasedaswell.

FIG: 10 Coke (KO) SharePrice

Essentially, the stabilityof earnings gives us anelementofpredictability.

This element ofpredictabilitygivesusabetteropportunity to calculate thecorrect intrinsic value of thebusiness.

This is the reason werequire the stability ofearningsandrevenue.

WhereToFind:Income Statement(gurufocus.com,morningstar.com)Cash Flow Statement(gurufocus.com,morningstar.com)Gross / Net Margins AreBest (near best) In TheIndustry?

This may be Warren

Buffett’sgreatestsecret.Focusing on themargins

of the business (gross andnet) can tell you a great dealabout the quality of thebusinessandtheindustryasawhole.

In fact, gross and netmargins are part of theprevious “moat metrics”section in searching forbusinesses with sustainablecompetitiveadvantages.

The profit margin iswhat’s left over to thebusiness after the costs ofrunning the business. Simplystated, it’s theprofitsdividedby sales thatwill give you aprofitmargin percentage (thehigherthebetter).

So why is profit marginsoimportant?

The profit marginessentiallypaintsaportraitofthe competitive landscape in

that industry, aswell as howthe business is competing inthatindustry.

Low-Margin Industry:grocery stores and discountretailers are notorious forincrediblylowprofitmargins.The industry as a whole hasvery few barriers to entry,andit’sverydifficulttobuildsustainable competitiveadvantages.

High-Margin Industry:

railroads and beveragedistributors have been highprofit, high return businessesfordecades.Theindustryhasstrong barriers to entry withhighcapital expenditures anddistribution factors givingthem sustainable competitiveadvantages.

Our obvious choicebetween a high marginbusiness or a low marginbusinessiseasy.

We will focus ourattention and energy to highmargin, high returnbusinesses.WheretoFind:Income Statement(gurufocus.com,morningstar.com)Is The BusinessConservative In ItsAccountingOfEarnings?

Inascertainingwhetherabusiness is conservative oraggressive in its accountingof earnings, we must firstunderstand whether GAAP(generally acceptedaccounting principles) arerepresentative of the “true”earningsofthebusiness.

There is no easyway togo about this step, but Iwillprovidealittletrickattheendofthischapter.

We need to determine ifmanagement uses aggressiveor conservative accountingstandards. Trust me when Isay there are a number ofways management canmanipulateearnings:

Over or Under-StatedExpenses

Short-term earnings canbe temporarily boosted ifmanagement decides tomove current expenses to

laterperiods.InflateSales

By booking a sale beforeit is actually earned,revenuecanbeartificiallyinflated. An examplewould be managementcoercingdistributorsorre-sellers to take moreproductthantheyneed.

ChangeAccountingMethods

A business that changes

its accountingmethods orfirmisaredflagthatmustbe looked into verycarefully. You will findthis information in thefootnotes, but make surethe change is for alegitimatereason.

UseofReservesReserves are used for anumber of reasons:potential litigation,warranties, liability,

product returns or baddebts. This can be a verysubjective line item, sojust be aware bycomparing the actualaccounts to the doubtfulaccounts. Watch out foranylargechanges.

RestructuringCharges (one-timeexpenses)

Management could addextra expenses to a

restructuring charge,thereby decreasedexpenses in the future tomake it look like thebusiness is earning morethan it really is. This is afavorite tactic of newCEO’s. Sometimes it’sjustified, but many timesit’snot.

DiscretionaryCostsManipulation

These include R&D,

marketing and advertisingexpenses,aswellasbasicmaintenance costs. Bydramatically cutting backin any of these areas, itcan manipulate theearnings to look higherthantheyreallyare.

*Manyofthesesubtlemanipulationhintscanbefoundinthefootnotes,whichmakesthemveryimportantto

payattentiontoonaregularbasis.

We won’t go into detail

on all thedifferentways thatmanagement can manipulateearnings (especially with theincome statement). That’s atopic for a whole book. Infact,Iwillprobablywriteonesomeday.

The point is,management has a great deal

of “wiggle” room when itcomes to reporting theactualearningsof thebusiness.Themanipulation can be quiteextensive.

If you are interested inknowingmoreaboutearningsmanipulationandhowtospotit correctly, there are twobooksIhighlyrecommend:

Quality of Earningsby Thornton L.O’glove

FinancialShenanigans byHoward Schilit andJeremyPerler

Just recognize that thepicture management paints,isn’t necessarily reflective ofreality.

Here are a couple oftricks I discussed earlier tohelp you quickly spotpotential manipulators.Obviously, this is not a

panacea for finding earningsmanipulators, however it is agreat place to start and savesometime.Trick #1: Net Income andOperating Cash FlowsTrackingTogether

As you may havenoticed, I am not a very bigfan of the income statement.The cash flow statementallows for much less

flexibility (and potentialmanipulation) than theincome statement. Which iswhy we use the cash flowstatement to “check-in” ontheincomestatementtomakesureeverythingisreasonable.

If operating cash flowdeviates too much from netincome,youcanbewillingtobet that management isutilizing aggressiveaccounting standards ---

Especially if it has deviatedfor an extended period oftime.See an example of how weanalyzethisusingthechartofCoca-Cola(KO)below.

FIG: 11 Coke (KO) NetIncome to Operating CashFlow(OCF)

Asyoucan see from thechart above, we analyzedCoca-Cola Net Income vs.OperatingCashFlowsforthelast10years.Thereisacloseenough approximation of thetwo and it’s steady, so thereare no apparent red flags,althoughoperatingcashflowshave historically trackedhigher.

Ifnetincomelevelswereconsistently higher (>25%)than operating cash flows, itwould raise a huge red flagforvirtuallyanybusiness.

At this point you wouldneedtodigintothecompanydeeper,butIwouldbewillingtobet therewassomesortofearnings manipulation goingonunderthesurface.

Trick#2:Readthe income-

taxfootnoteinthe10-K.Another trick in learning

whether thebusinessengagesin aggressive or conservativeaccounting methods is tocheck the difference betweenthe tax paid to the IRS(current taxes) and GAAPtaxes(incometaxprovisions).

In the 10-K (AnnualReport), there will be anincome tax footnote that youmustanalyze.Onceyouhave

located the income taxfootnote, you want tocompare the differencesbetween Current Taxes andIncome Tax Provision for atleastthepast5years.

The point of thecomparison is to evaluatehowunderstatedoroverstatedthe earnings are for thatperiod of time. There shouldbe red flags going offeverywhere ifyourealize the

business has been profitableandnotpayingtaxes.

On the other side of theequation, if current taxesandprovisioned taxes are in-line,this essentially means that“real” earnings are similar toGAAPearnings.This tellsusthat we wouldn’t need tomake any major adjustmentsto our earnings calculation.Morethanlikelythebusinessis conservative in its

accountingmethods.BOTTOM LINE: There

areamyriadofdifferentwaysfor management to window-dress earnings results. If abusiness’s accounting is toodifficult to understand, thenmanagement usually has itthiswayforareason.

Stay clear of businessesthat aren’t completelytransparent with regard totheiraccountingpolicies.

These two tricks shouldhelp you quickly andefficiently decide whether abusiness is high quality ortrying to take you to thecleaners.WhereToFind:Income Statement(gurufocus.com,morningstar.com)Cash Flow Statement(gurufocus.com,

morningstar.comFootnotes of 10-K of thebusiness (Investor RelationsWebpage,SEC)

Step3ofMECOM™:

Catalysts“Valueinvestorsarealwaysonthelookoutforcatalysts.Whilebuyingassetsatadiscountfromunderlyingvalueisthedefining

characteristicofvalueinvesting,thepartialortotalrealizationofunderlying

valuethroughacatalystisanimportantmeansofgeneratingprofits.”SethKlarman

Catalysts help us

pinpoint potential eventswhichwillcausethebusinessto grow and/or the stock torise.

Cheap prices cansometimes be enough of acatalyst for share priceappreciation, however wewant a greater assurance forshare price appreciation andmarginofsafety.

The presence of readilyestablished catalysts helps toincreaseourmarginofsafetyby potentially increasing thespeedofreturn.

We define catalysts in 5

main categories in order ofimportance:

1. Future growth in the

underlyingbusiness2. Future growth in the

industry3. Managementcatalysts4. Businesscatalysts5. Supply/Demand

catalystsShareholders benefit in

two ways after a stock is

purchased at a discount fromabusiness'sunderlyingvalue:

1. The stock begins

rising to convergewith its underlyingintrinsicvalue.

2. An event(s) occurswhich causes thevalue to be realizedinstantly or over timeby other marketparticipants.

Althoughaninvestorwilllikelydoextremelywelloverthe long-term by purchasingbusinesses at deep discountsto their intrinsic values, wewant further confirmation.We never want to becompletely held captive bythevagariesofhumannatureand the irrationalbehaviorofthemarkets.

Wewanttoinvestinhighquality businesses at deep

discounts to intrinsic value,which have likely events inthehorizontobringaboutfullvalueofthatinvestment.

Investors call theseevents“catalysts.”

Catalystsreduceriskandhelpinvestorsby:

Reducing theirdependenceonmarketforces for investmentreturns

Fast-tracking the timebetween price andvalue

All of this helps to

increasean investor’smarginofsafetyovertime.IsThereFutureGrowth InTheUnderlyingBusiness?

We all know businessescreate a lot of value for aninvestor, if they are able to

growprofitablyovertime.The main reason we

wantthisgrowthissowecanparticipate in the benefits ofcompounding in a tax-deferredmanner.

Holding onto areasonably priced businessthatcontinuestogrowyear-inand year-out allows you toreap the reward of a risingstock price without everhavingtosell.Thisiswhywe

focus so intently onsustainable competitiveadvantages. The ability of acompany to continue toproduce excess profitabilityover the next 10-20 years,and beyond, increases thebusiness’s intrinsicvalue thatmuchmore.

Many of the bestinvestors of our time figuredout this strategy early on intheir careers. Still, others try

tomakeitmoredifficultthanitneedstobe.Itdoesn’t takemore than 3 or 4 greatinvestments to make anincredible difference to yourinvestment returns. In fact, Iam willing to make a wagerthat the bulk of yourinvestment gains in yourentirelifewillcomefromlessthan5businesses.

Just think,allyouwouldneed todo issitbackand let

the compounding effects ofyour top 5 ideas take you tolevels you never beforeimagined. You simply findhighquality,moatbusinessesand buy them at reasonableprices.That’sit.

Theonlyproblemis….aninvestor doesn’t knowwhichinvestments will get themthere.Youcanhaveageneralidea, but you never reallyknowuntilithappens.Thisis

whywestillwanttopurchasethe growth in thesebusinesses with a margin ofsafety.

Investing strictly forgrowthcancarrymany risks.Now, don’t get me wrong,youcertainlywantthegrowthin the business -- you justdon’t want to pay toohandsomelyfor it.Whenyoupurchase these “high quality,moat” businesses, you will

normally be paying a higherpricethanyouareusedtoforthatgrowth.

Youmustneverbeafraidof paying a reasonable pricefor a high quality business.Time is the friend of highqualitybusinesses.

“Paying-up” isacceptable,but it comeswithacaveat:Youmustbeabletodetermine if a business islikelytocontinuegrowing.

There are four mainquestions we use to help usbetter understand the futuregrowth of the business. Youcanview thembelow tohelpyou in being able todeterminewhetherabusinessis likely to continue (orembark on) its growthtrajectory:

Whatare thegrowthprospects for the

future of thebusiness?Is the businessgrowing at anundisciplined orunsustainablerate?Will the historicprofitabilitycontinuetogrow?What ismanagement’sincentivetokeepthebusinessgrowing?

1)What are the growthprospects for the future ofthebusiness?

You can actually findthis information in theManagement,Discussion andAnalysis (MD&A) section inthe 10-K (annual report).Management will discussopportunities for growth, soyou want to pay particularattention to this section. It is

importantforyoutostayveryobjective in your analysis ofthis section. Management isusually incredibly optimistic,so you always want tomakesure that the growthopportunities and projectionsseemreasonable.

Here are a few tips onwheretofocusyourattention:Have R&D labors beeneffective?Oraretheylikely

tobeeffective?InnovationandR&Dcan

help a business to stay on agrowth trajectory byconstantly producing betterproductsandservicesthanthecompetition. But this doesn’tjust happen out of thin air.Testing, research anddevelopment are essentialparts of a great business thatwants to continue to getbetter.Keepingaconstanteye

on R&D expenses as apercentage of sales can giveyou a good idea of theculture.

For example, Google(GOOG) spends over $2.5billion per quarter on R&Dexpenses which means theyconsistently spend over 10%of their revenues onR&D toimprove their products, userexperience, and develop newproducts. This kind of R&D

spendasaportionofrevenuemakes it very difficult forotherplayerstocompete.

Itenablesthebusinesstocontinually improve the userexperience in search, aswellas develop new products orentirely new businesssegments (think their self-drivingcars).

Abusinessthatisabletocontinually increase thequality and value of its

products and/or services willproduce competitiveadvantages for that businessover time. In fact, Googlecontrolsmorethan65%ofitsmain business segment,making them the largestglobalsearchengineplayerinthe world by a staggeringmargin.

Of course, this doesn'tmean that the business isn’timmunetounsuccessfulR&D

campaigns. A good way toevaluate successful R&Dexpenses is to compare thepercentageofsalesfromnewproductsorinnovations.

For example, Apple(AAPL) is all the rage rightnow (and who could blamethem). Their R&D hascontributed greatly to newgeneration iPhone and iPadsales. The iPhone 6 debutedinOctoberof2014,andblew

the“doorsoffthehinges.”They posted earnings of

$8.5 billion on revenue of$42.1 billion, thanks to theiPhone 6 sales. This was an11% and 6.3% increase,respectively, from the samequarterthepreviousyear.

Apple has spent anaverage of 4% of its salesdollars on R&D programssince2005.ThisyearlyR&Dexpense has helped Apple to

drive revenue growth pershareof35.7%peryearoverthis period. That’s veryimpressive.

As you can see, R&Dcanhaveasignificant impacton the future growth of thebusiness, when executedproperly.

It is important to notethat therecanbeanoticeablelag in ROI from R&D, aswell. So, that must be taken

intoaccount.Are transformativeproducts / services neededforthebusinesstogrow?

The constant design andproduction of new productsor services can be extremelydemanding and difficult toexecuteovertime.

The problem lies in nottruly having a historical baseto help fathom whether the

new product or service willbe successful. Even with aperfectly executed testingstrategy and early sales data,it's essentially a guessinggame (and not a highlyprobableoneatthat).

Remember: most newproduct launches fail. Forevery new successful iPhoneoriPadlaunch,thereare10ormorethatfailedmiserably.

Innovative companies

like Facebook, Tesla, Appleand Google are difficult toforecast because theirproducts and services aretransformative. In someinstances they are evencreating new industries fromtheir innovative andentrepreneurship mindedculture.

Personally, I think it’sgreat.Ithinkit’sgreatforourfuture and great for society.

And I admire thosebusinesses and their leaders.We certainly try to invest inthemattherightprices.

However, as an investor,it makes it very difficult toforecast anything that's neverhappened before. Sometimesit takes a bit of imaginationand creativity with a hint ofrationalpragmatism.

Sohowdoyoufigureoutwhether there is potential

growthwith these businesseswhen there is a very lowprobability of predicting thefuture?ConsumerReports(paid)

Consumer Reports is anexcellent publication to helpyou find unbiased ratings,comparison and user reviewsonproducts(newandold).Talk to/Interview current or

targetcustomersYour friends can be a

hugehelphere.Callupsomeofyourbetterfriendsthatusethisproductandask for theiropinion of the product. Evenif they don’t have theproduct,askfor theiropinionofit.Productmessageboardsareagreatresourceaswell.

Don’t be afraid toventure out to any of yoursocial media sites and ask

yourfriends.Itisamazingthekindofanswersyouwillget.You’llstartthinkingofthingsyou never contemplatedbefore. Social medianetworks earn their “chops”for this access to valuablefeedbackalone.Interview/talk to employeesorexecutivesofthebusiness

Talking to the actualemployees and executives of

the business can help youtremendously if ascertainingthe believability and cultureofthebusiness.

It’s kind of funny, butsalespeople are probably thebest employees to interviewbecause they are in thetrenches. If they are havingdifficultysellingaproductorservice,that’sawarningsign.Interview/talk to employees

or executives of thecompetition

I always try to askcompany executiveswho/what scares them mostin their competitors. If theysay nothing, there’ssomething wrong. If theyanswer truthfully, you willhaveagreatunderstandingofthe truly innovativecompanies in the industry, aswell as the best

products/services.Youcanfindinformation

on employees and executivesof these businesses on socialmedia (specificallyLinkedIn)or the company website. Ithas been my experience thatthey are more responsive onsocialmedia.

If you find answers thatareconsistentandreasonable,you know that the businesshas a higher probability of

executing on new productlaunches. This increases thelikelihood of increased salesin the future, as well as itbeing a potentially goodinvestmentopportunity.

A byproduct of thisresearch is it gives you agreater understanding of, notonly the business and itscompetitors, but also, the“true”cultureofthebusiness.

It’saWin-Win!

Are there warning signalsshowing slow growthahead?

There can be manywarning signs to a business'sgrowthslowingdown.Hereisa list of potential warningsigns that you should beawareofbeforeinvestment:The company makes achangeinbusinessmodel

Itdoesn’ttakeageniustorealize, if a business ischanging its business model,there’s likely to be sometroubles ahead. That’s not agood thing. Even if thebusiness must change itsbusiness model because theindustryistoocompetitiveornolongerprofitable,itwillbedifficult for a business toproperly execute a change inbusiness model without a

certainlevelofexpertise.There are numerous

examplesoffailedchangesinbusiness models, but thisdoesn’tmeanitcan’tbedone.

Forexample,PayPalwasoriginally envisioned to be acryptography company.That’s code for web securitycompany.YouseewhatIdidthere. I keep tellingmywifehow funny I am, but shedoesn’tbelieveme.

After several years ofdifficult times,PayPal finallyfounditsbusinessmodelwithonline payments. It wasn’teasy, and the executive teamcontemplated giving up, buttheir flexibility andcompetitive spirit prevailed(again something to be saidabout entrepreneurial cultureofabusiness).

PayPal was able toexecute this change in

business model and reachheights never imagined.Althoughthisexampleshowsit can be done, you shouldviewchangesinacompany’sbusiness model with a keeneye.

IfyouviewPayPalastheexception,ratherthantheruleit will help you pinpoint apotential slowdown ingrowth.

Thecompanystartstargetingnewcustomerbases

Ifabusiness’scoregroupof customers is starting toslow, management will startto seek growth elsewhere.This is a sure indication ofslowing growth ahead, andonewewanttobeawareofinthe language of the AnnualReports.The company begins to

increase its dividend payoutratio

This is a sneaky andsubtle signal of limited orslowing growth. When abusinessisunabletousecashflow for re-investment in thebusiness or find reasonableacquisitions,theywillstarttoreturn more of the cash toshareholders in the form ofdividends (first time orincreaseindividendpayout).

The dividend payoutratio is defined as thepercentageofearningspaidtothe shareholders in dividendpayments.

Let’s say a businessconsistently has a payoutpercentage of 20% everyyear. If this number starts toincrease (all else beingequal), you can rest assuredthat this is a subtle hint thatmanagement is having

difficulty finding opportunityforgrowth.

It’s also interesting topay attention to businessesthat initiatedividends for thefirst time after a tremendousperiodofgrowth.

For example, Apple(AAPL) initiated its firstdividendpayoutinAugustof2012 after years ofimpressive growth. This wasa worrisome sign for

investors thatpaid toohighaprice for that continuedgrowth. Subsequently, Appledidstarttoslowandthestockprice eventually came backdown to earth after a 40%drop from its highs ---effectively washing out theweakholdersofthestock.

FIG 12: Apple IssuingDividendsForTheFistTime

Of course once the dustsettled, this was still a veryhigh quality, GROWINGbusiness. It just wasn’tgrowing at the rapid rate itonce was in the past. This,coupled with changes infuture leadership at Apple,createdasenseofuncertaintyin the stock even as thebusinesscontinuedtogrow.

This is yet anotherexample of opportunitypresenting itself in the stockmarket.

By not buying popularstocksbiduptounreasonablepricesbecauseofgrowthandmomentum, an investor isbetter able to take advantageof opportunities when theypresent themselves. Theinvestor that was able toqualify Apple as a high

qualitybusiness,whilesittingback patiently anddisciplined, was able topurchase Apple at incrediblyrisk averse levels after thepanicwasover.

The best businesses willbe able to balancereinvestment opportunitieswithastabledividendpayoutratio. If they are truly greatbusinesses, they should beabletodoboth.

Did the business make amanagementchange?

Management changesduring growth phases are aninteresting topic. I couldprobablywrite awhole bookonthistopicalone.

Essentially, you want tomake sure the team that wasresponsible for thegrowthofthebusinessisstillinplaceatthe helm of the business. If

they are removed for somereason, you must make surethenewmanagement team isaprotégéofpreviousteamorhas been successful atpreviouscompanies.

Very rarely do greatexecutives appear out of thinair without ever beingsuccessful before. A historyof success is the bestpredictoroffuturesuccess.

When ascertaining

whetherabusinessislikelytocontinue on its growthtrajectory, it is incrediblyimportant to never overlookmanagement's role in thegrowth.

Amanagementteamthathasbeenpartofthehistoricalgrowth, should give you ahigher confidence ofcontinued growth versus anew management team thathasneverprovenitself.

It has been myexperience that managementteamsdon'tgetenoughcreditfor growth of the business.Most businesses come toregret letting go of theseteams and usually find outafter significant turnover inmanagement.

"Itrytobuystock

inbusinessesthataresowonderfulthatanidiotcan

runthem.Becausesoonerorlater,onewill.”WarrenBuffett

I’m all for finding great

businesses that anyone canrun, but I also keep closerecord of great managementteams. Just as greatinvestment opportunitiesdon't come along very often,neither do great CEOs ormanagement teams. When

you find a greatmanager trytoneverlethim/hergo.Atthevery least keep track of themanagerandhis/herprotégés.

Andofcourse,whenyoufind those great businesseswith great managementteams, you have hit theinvestingjackpot.

Steve Jobs is probablythe most famous example ofthis scenario. Steve createdApple from thegarage inhis

house. And after incrediblegrowth, he was ousted fromhis own company when theboard of directors sought adifferent path for thebusiness.

After being ousted fromhisowncompany,hewentontolaunchNeXTComputerin1985 which was bought byApplein1996.Onceagainhewas rejoined with his oldcompany which was but a

pittance of its former self.Jobs went on a mission toturn Apple around and theend result is technology thatispartofoureverydayfabric.He was responsible foriTunes, the iPod, the iPhone,the iPad, iTunes store, touchscreens and many of theawesome apps we use everyday.

Steve Jobs was a veryspecial and dedicated owner

operator, however there havebeen many others, such asLarry Page at Google,MichaelDellatDell,HowardShultz at Starbucks, ReidHoffman of LinkedIn andCharles Schwab of CharlesSchwab.

Greatmanagersmatterincommodity-type businesses.This is an important concepttobeawareofwheninvestingin a business with new and

unprovenmanagementteams.Does the business possessinteresting future growthprospects?

The main question wewanttoanswerhereis:

Can the business modelberepeatedorreplicated(themoreglobalthebetter)?

Iftheanswerisyes,thenthenextquestionwemustbeable to answer is how long

canitbesustained?This is the most

important question, and onethat should not be takenlightly. After all, a businessthat has the ability to growforever is better than abusiness that will becomeobsolete through technologyorothermeans.

Forexample,let’slookatthe 2014 MD&A section ofthe10-KforDirecTV,which

provides digital televisionentertainment in the UnitedStatesandLatinAmerica.

In the 2013 MD&Asection of the 10-K,Management discloses thatthesubscriberbasehasgrownfrom28.1Millionsubscribersasof theendof2010to37.8Millionsubscribersattheendof 2013 (10% CAGR). Thisgives us a great picture of arapidlygrowingbusiness that

could present a possibleinvestment opportunity now,or in the future. Either waywemayhaveagreatbusinesswith a recurring revenuestream on our hands, and attheveryleastweshouldputiton our watch-list if it meetsthe rest of our criteria for agreatbusiness.We want to always have anunderstanding on the sourceoftheearningsgrowthtoo.In

order to do this we want tocompare earnings to relevantmetrics of the business. InDirecTV’scase itwillbe thesubscribers.

FIG:13 DirecTV Subscriber

GrowthwithEPS

In this case, we arecomparing subscribers toearnings-per-share (EPS).You can see from the figureabove that as subscribersincrease, so does EPS (fig.13).Ifinstead,EPSincreasedwhile subscribers decreased,then it would indicate thebusinesswas getting creativeunderneath the surface by

cutting costs or some sort ofvariation. Of course, thesetypes of tactics are lesssustainable foundations ofearningsgrowth.

This table would implythat subscribers are themainsourceofearningsgrowth.

Through our quickanalysis,weseethatDirecTVis growing at a very healthyratethroughit'scorebusiness.

Butalas...

The business of todaydoes not grow fromyesterday’s growth. So wemust have a reasonableexpectation that the businesswill be able to continue onthiscurrentgrowthtrajectory.

Obviously this questionposes a great deal ofproblems and is prone tosubjective interpretationsregardingthefuture.

Time to pull out the

crystalball....DirecTVhasbeenableto

execute a repeatablebusinessmodel within the US, and isnowgrowingrapidlyinLatinAmerica as well. This givesus confidence in theircontinued execution in theU.S. and Latin Americanmarkets, as well as potentialexpansion overseasinternationally.

This gives us evenmore

confidencethatthereisalongrunway for growth in thefuture.Next,wewanttocomparethebusiness to its competitors,while always being on thelook-out for disruptivetechnologies to the businessmodel.

In DirecTV's case, weknow that the satellite TVmarket is a very capitalintensivebusinesswithonlya

hand-full of competitors toDirecTV (Comcast, AT&T,Dish). It isveryexpensive tomaintain and update thesatellites and equipment, andwe believe they are best ofbreed in this growingcategory.

Becausewe believe theyare the“bestofbreed” in thecategory, with bettermanagement and a moreentrepreneurial minded

culture, we also believe it islikely they will be at theforefront of technologyupdates or disruptivetechnologies. At the veryleast, they will be able toacquire these disruptivetechnologieswiththeiramplecashonhand,aswellastheirability to generate continuedexcess free cash flow withtheircurrentbusinessmodel.

So, as you can see, we

haveshownabusinesswitharepeatable business modelandonethathasareasonableexpectation of continued andsustainablegrowth.WheretoFind:10-KMD&A (search growthopportunities)Are the growth trendsSecularorCyclical?

Cyclical growth is

growth that is highlycorrelated to the overalleconomy. As we know, theoveralleconomyissubject tovarious cycles over time. So,we want to make sure wearen’t investing in cyclicalbusinesses during potentialpeakperiods.

FIG: 14 Cyclical GrowthPhase

Secular growth is thekind of growth we arelooking for in our long-terminvestments. These aregrowth trends driven bysocial or demographicchanges. Through thesechanges in consumerpreferences, demand forcertain products and servicescanhavesustainedgrowthfor

alongperiodoftime.

FIG: 15 Secular GrowthPhase

Examples of seculartrends would be theexpansionof the internet andan aging population (effectsspendingpatterns).

And secular growthdoesn't mean there won’t becyclical cycles within it. Forexample,Amazonisaretaileratheartbuttheirpresenceanddominanceonlineinasecular

market sets them apart fromotherretailersandkeepsthemon a very consistent path asthey take away market sharefromotherretailers.Justlookat this revenue trajectory,even through the greatrecession(fig16).

With that said, it’simportant to differentiatesecular growth trends fromrisingcommodityprices.Justbecause a commodity price

has increased along with abusiness's earnings, doesn'tmean it is becauseof seculargrowth. You want to alwaysmake sure that commodityproducersareabletoincreaseproduction of the commoditysold while keeping theaverage cost of productionnearthelowsoftheindustry.Inacommoditybusiness, thelowestcostproducerwillwininthelong-termeverytime.

FIG: 16 Amazon Revenue

GrowthTrajectory

It’s crucial that we areable to distinguish betweenshort-term cyclical growthandlong-termseculargrowth.Greatbusinesseswithinlong-term secular growthindustries are likely todemand a much higherpremium than that of acyclical business (and rightlyso).

Secular growthbusinesses won't ebb andflowwiththeeconomy.Theirstockpricemayebbandflowwiththegeneralmarketortheeconomy; however, theunderlying business shouldnotbetoocorrelatedwiththeeconomy. A business withseculargrowthwillalsohavelongerlastingbusinesscyclescompared to a cyclicalbusiness.

Identifying seculargrowth industries andbusinessesisnoteasy.

Ihavetried(andstudied)anumberofdifferentwaystopinpointseculargrowthandIalways come back to onesimplequestion:

Is thisan industrywheremychildrenorgrandchildrenwillwork?

This question (howeverbasic and simple) forces you

to see the bigger picture. Itwill help you visualize thefuture landscape of thebusiness and how it may (ormaynot) be likely to changeovertime.Current Secular GrowthTrends

Continued shift ofconsumer spendingto online/mobilecompared to

traditional brick-and-mortar retail(Amazon)Continued movetoward alternativeenergy solutions(solar, wind, etc.)(SolarCity)Continued adoptionof LNG (liquefiednatural gas) as thefuel for UStransportation

(natural gasproducers likeExxon, Devon andChesapeakeEnergy)Continued demandinfastfoodforbetterquality food sourcesat reasonable prices(Chipotle)Continuedshiftfromcash/checks toelectronic payment(MasterCard, Visa,

VeriFone)Continuedgrowthofdeepwater oildevelopment(Transocean,Diamond Offshore,Oceaneering)Continuedshiftfromoffline hotel andairline bookings toonline (Priceline,Expedia)Continuedshiftfrom

traditional yellowpage directoryservice to an onlineand real-time model(Yelp)

Potential Future SecularGrowthTrends

Legalized onlinegamblingintheU.S.could have apositive impact foronline gambling

sites, while thebrick-and-mortarcasinoscould takeahit(BoydGaming)Oil and natural gasexportationcouldbea game changer inthe U.S. (CheniereEnergy)

This little exercise is all

well and good, but,personally, I like to see the

numbers. Assumptions arenot enough forme.Not onlydoIwanttoseethenumbers,I want there to be areasonablelikelihoodofthosenumberscontinuing.In trying to find seculargrowth trends, you need topinpoint theactualreasonforthe growth, whether its babyboomers retiring, newhousehold formation ormodernization in third world

countries.Onceyouhave thereason behind the seculargrowth trend and why it islikely to continue, we canstart to put some numbersbehindit.

I have listed below anumber of publications thathelp in gathering insights topotentialseculartrends:

AdvertisingAgeESRI Business

InformationServicesEuromonitorMintelHarrisandMaritzTrendwatching.comMarket ResearchWorld'swebsiteWho'sBuyingSeries(greatresource)

Do market shareprojections show potentialfuturegrowth?

Many analysts use thebusiness's market share todetermine whether thebusiness has interestinggrowthpotential.Theydothisby getting a total estimate ofthemarket in the future, andthen assigning the business'spercentage of that market.This will give them theirfuture growth potential thattheycangrowintoovertime.

Always be cautious of

takingmanagement'swordofmarket share. You want toknow how they havecalculated market share, andthen ascertain whether it's aconservative number, andwhy it's likely to grow overtime.

Ifmanagementisusingacalculation other than totalrevenues or total earnings, Iwould look further into thebusinessanditsmanagement.

WheretoFind:10-K (search for Industry orMarketSize)Is the business growingorganically or throughmergers and acquisitions(M&A)?

An investor should beable to classify whether abusiness is growingorganicallyorthroughM&A.

It is important to distinguishthe two because a businessthat is growing organicallywill usually be considered ahigher quality business. Thiswill have an effect on thepremium and/or intrinsicvalueofthebusiness.

Here are some examplesof businesses meeting thesecharacteristics:

Fast food Mexican grillcompany Chipotle (CMG)

has made virtually noacquisitions, and they havecontinued to grow sinceinception. Growingorganicallythroughyourowncash flow is a powerfulcharacteristic that manybusinessescan’tdo.

By focusing on thecontinued growth of thebusiness, Chipotle doesn’thave to worry about over-paying on acquisitions or

integrating a new business.Management can focusintentlyonwhatitdoesbest-producedeliciousburritos (tothechagrinofmywife).

Pepsi (PEP), a food andbeveragecompany,madebigacquisitionsin2010and2011and would be considered aselective or opportunisticacquirer. Usually anopportunistic acquirer is notbuyingacompanytoscaleits

business.They use times of

weakness and opportunity togrow their existing productlines. These businessestypically purchase businesseswithintheirownindustryandhavetheexpertisetoproperlyexecute the integrationof thenewcompany.

Thistypeofstrategyandpolicy toward acquisitionshouldsoundfamiliar toyou.

It’snowonderwe love thesetypesofbusinesses.

It’s value investingat itsverycore.

Precision Castparts(PCP), a manufacturer ofcomplex metal componentsand products, is a serialacquirer and has spentbetween4%and347%of itscashflowfromoperationsonacquisitions each year. Withthe average spent on

acquisitions from cash flowfrom operations over the lastfewyearsbeingover100%.

When you’re playingwith your cash flow levelsthat close to the vest, abusiness is leavingvery littlemarginforerror.There’sverylittlemargin of safety in thiskindofinvestment.

When serial acquirersbecome aggressive in searchofgrowthatanycostitcanbe

incredibly damaging to thebusiness.Unless thebusinessisabletooperateandexecutethe acquisition at nearperfection, there arenumerousriskssuchasusingtoomuch debt or paying toohighapriceforthebusiness.

Take WorldCom forinstance. In the 1990s,WorldCom was able tosustain growth rates greaterthan 20% for an extended

period by buying up smallertelecom businesses. In theyears to come, it wouldrequire them to startacquiringlargerbusinessesinorder for themtosustain thatkind of continued growth inrevenueandearnings.In October 1999,WorldComtriedtodojustthatwithabidtomergewithSprintCorpfor$115 billion. The deal wasblocked in June of 2000 by

theJusticeDepartmentduetoconcerns it would create amonopoly.

Subsequently,WordCom’sstockplummetedas the future prospects forgrowthdisappeared(Fig.17).The business was furtheremboldenedinotherscandalsfromtheCEOBernieEbbers.

WorldCom filed forChapter 11 bankruptcyprotection on July 21, 2002.

Shareholders werecompletely wiped out andbond holders received 35.7cents on the dollar in bondsand stock in the newcompany.

FIG: 17 WorldCom Chart,1992-2001

By no means are theseexamples absolute.There areplenty of examples ofsuccessful serial acquirers,such as Tesoro, Valero,Constellation Brands,Flowserve, ChesapeakeEnergy, Kraft, Target,Comcast,PrecisionCastparts,VisaandWaltDisney.

Most of these are high

quality businesses, but theywould also be classified asserial acquirers because theyspendasignificantportionoftheir cash flow fromoperations on acquisitionseachyear.

You need to always beaware, and considerdiligently, the sustainabilityof growth strategies that aremerelydeal-driven(M&A).

Another strategy to help

differentiate quickly whethera business is overlyacquisitive, is by comparingthe total goodwill plusintangibles to total assetsfromthemostrecentquarter.A firm that is moreacquisitivewillhaveahigherratio (unless they areconsistently buying belowbook value which is highlyunlikely as most businessesoverpay).

Ratios below 5% aretypically organic or selectiveacquirers.Anythingover15%would be considered moreaggressive.Butofcourse,it’sall relative to the specificsituation, the quality ofacquired business, and thepricepaidforthatbusiness.

This ratio gives a quickand dirty assessment ofwhatthe business has done in thepast.Upon further inspection

you may deem theacquisitionssynergistictothebusiness and its futuregrowth.

This M&A ratio is aquick little trick to see howactive a business was in thepastwithacquisitions.

REMEMBER: Justbecause a business isclassified as a serial acquirerdoesn’t mean it’s a badinvestment opportunity. Each

business should be analyzedonacasebycasebasis.

However, as a generalrule, wewant to be cautiousof growth from serialacquirers.Serialacquirersarenotorious for taking on agreat deal of debt andoverpaying for acquisitions.Add to the fact, the twobusinesses must nowintegrate into one businessand one culture --- this can

make acquisitions a riskyendeavorifnotexecutedwell.

FIG:18 Cycle Classificationof Different GrowthStrategies

Ideally, we want to findbusinesses that are growingorganically while makingstrategic and timelyacquisitionsselectively.

WheretoFind:Cash Flow Statement(subsection Acquisitions orpurchaseofbusiness)

2)Isthebusinessgrowingatan undisciplined andunsustainablerate?

This is a subject thatdoesn'tgarnermuchattention.

Think about it for asecond...

Whowantstoquestionortell management that thebusinessisgrowingtoofast?

Not only would you becast as an outsider, but youprobably wouldn't be invited

to very many Christmasparties.

Now, I amnot saying tocondemnmanagement'severydecision regarding growth orcontinued growth. However,you need to be cognizant ofwhether or not managementisusingadisciplinedstrategyforgrowth.

Rapidly growingbusinesses that take onexcessivedebtforthesakeof

growth are prone tosubstantial financial risk(especially in cyclicalbusinessesnearcyclicaltops).Theyjustdon’tknowitatthetime.

High growth doesn'tequal profitability. A greatbusiness should be able toprovideboth.

A management teamshould be able to producevalue to shareholders in the

form of reinvestmentopportunities or buybacks inrapidly growing businesses.As an investor, you need theassurance from managementthat they are able to controland balance the growth withprofitability.

All too often, investors(andWallStreet)believethathigh growth businessesequate to great investmentsregardless of profitability or

valuation. The truth is mostof these high growthbusinesses carry a significantamount of risk. They justdon'trealizeityet.

Growth is great, but thisdoesn’t mean it shouldn’t bemonitored. Mis-managedgrowthwilldestroythevalueofyourinvestment.

Here are some ways todeterminewhetherabusinessis growing in a disciplined

fashion:Is there a proper structurein place for the business togrow?

Besides learning how tofail (and fail fast), I learnedmany things while creatingmy own business. However,there is one thing that standsoutfromtherest:

Your business will onlygoas far as the systems, and

structures you have in placetohelpscalethebusiness.

Most investors don'tfocus enough on this aspectof investing, and leave it tomanagement to figure out.However, it's a veryimportant component in thebusiness'sabilitytogrow.

It’s an unfortunatereality, but many investorswillglanceat thebookvalueand the cash flows of the

business and say tothemselves,“thislooksprettygood.IthinkIwillinvest.”

And they make thesedecisions without a properunderstandingofthesystems,sustainability and scalabilityofthebusinessinthefuture.

Asaninvestor,youwantto know that a business hasthe proper infrastructure tosupportthegrowth(fig18).

FIG: 19 BusinessInfrastruture To SupportGrowth

For example, Wal-Martistheworld’sbiggestretailer.Howis it that theywereableto grow so rapidlywith veryfew hiccups? For one, theyhadtherightsystemsinplaceto accommodate that growthandscaleaccordingly.

When it comes to Wal-Mart, they are unmatched inregards to their supply-chain

management. It is thebest intheworld. But it is only onepart of the structure thatallows them to growwithoutanyspeedbumps.

The supply-chainmanagement combined withtheir efficient approach tostore design, in-depthanalysis of demographicprofilesandincredibleskillinstore location and real estatesavvyproducesastreamlined

and remarkable structure.This typeof systemactsasasustainable competitiveadvantage as long asmanagementisabletoprotectit.

Isn’t that an impressivecorporate structure andsystem?Is the business disciplinedinchoosinglocations?

Normally, I am not a

person that makes absolutestatements.However,Ifirmlybelieve that the bestbusinesses are opportunisticevenduringgrowthphases.

Instead of growing justfor growth sake, the bestbusinesses never feel“forced” to make decisionsthatarenotinthebestinterestof thebusiness long-term.Somanymanagementteamsfeelforced by Wall Street to set

specific goals, regardless oftheenvironment.

These “forced” goalscouldinclude:

Opening a setamountofstoresoverthe short-to-intermediatetermHitting certainrevenue and netincomegrowthratesExpanding into

internationalmarketsThink about this for a

minute:Management gets

pressure fromWall Street tostart increasingthegrowthofthe business by opening newstores. The business isapprehensive,butWallStreetstartswritingresearchreportson their concern of thebusiness'sgrowthprospects.

These reports causeinvestors to worry anduncertainty starts to creepintotheinvestor'smind.Asaresult the stock price beginsto fall as investors begin tosellthestock.

The management catersto the expectations around it,and the faltering share price.The business beginsexpandingandventuring intogeographic areas that

currently sport elevated rentand real estate prices (not tomention uncertainty of newrule-of-law).

When this decision ismade tobeginexpansion, thereal estate or strategy teamwill venture out to findlocations that aren'tnecessarily ideal, butavailable.Their jobis tofindlocations to move intoquicklysotheycanbeginthe

expansion.Thereisverylittlethought about anything elseexcept doing their job andfinding locations as quicklyaspossibleforexpansion.

This short-term strategycan create all kinds of issuesand expenses down the roadif the locations aren't a greatfit. Store closures from less-than-ideal locations will endup costing the business agreat deal of money in the

long-term.It’s much easier to just

sayNOsometimes.Now consider the

opportunisticbusiness:This business waits for

the right situation regardlessof the environment orpressure from third parties.They wait for opportunitiessuch as that perfect locationon the corner of a busyintersection for a restaurant,

or that beach-front propertyinanareawithdepressedrealestatepricesforahotel.

Greatmanagementteamsknow how to run theirbusiness properly, and carevery little for Wall Streetexpectations and advice. Themanagement of the businessknows that if they run thebusinessefficiently,thestockwill do very well over thelong-term, regardlessofWall

Streetcoverage.With that said, ALL

management teams are notcreated equal. Unfortunately,there are bad managementteams in control of publiccompanies.

It’s the reason weconduct thispreliminary(andsimple) research.Wewant toensure you are investing andpartnering with greatbusinesses and great

managementteams.WholeFoods(WFM)isa

great example of anincredibly opportunisticmanagement team. CEO andFounder, John Mackey, hasinstilled a very strictdisciplineofcapitalallocationand quality within WholeFoods. It’s ingrained withinthecultureofthebusiness.

They have very strictcriteria for finding only the

bestlocationsfortheirstores.In fact, Whole Foods hasneverclosedastorethatithasopened since the businessstarted over 30 years ago.And they took10YEARS tofind the right location fortheir first store in SanFrancisco.Onaseparatenote:John Mackey’s book,Conscious Capitalism is agreat book and I highlyrecommendit.

Costco (COST) isanother example. Costco isconstantly criticized byoutsiders andWall Street fornot expanding internationallyfast enough (specificallyChina). They develop theirmanagement teams fromwithin the company. Theydon’t hire outsidemanagement, and they neverwant togrowtoofastoutsidetheirmanagementteams.

For this reason, Costcoonly opens 25-30 newwarehouses each year. Theycouldprobablyopen100eachyear,buttheysticktothislowlevelbecausetheywanttodoitrightthefirsttime.

"WallStreetisinthebusinessofmakingmoneybetween

nowandnextTuesday.We'reinthebusinessofbuildinganorganization,aninstitution

thatwehopewillbehere50yearsfromnow.Strategic

planningisanimportantpartofrunninganybusinessandmoresoforbusinessesthat

operateinmultiplestatesandcountries."

JamesSinegal(CostcoCEO)

InregardstoChina, they

will be there eventually.Sinegal has mentioned

previously that they arewaiting for the rightopportunities and trying togetcomfortablewith the ruleof law. They will enter theChinese market when theybelieveit’stherighttime.

Not many businesseswouldbewillingtoshowthatkind of discipline (especiallywith Wall Street breathingdowntheirback).

Thesearegreatexamples

of businesses which are ableto choose the right locationsat the right time for thecontinued growth of thebusiness.

Is the business foregoingshort-term earnings forfuturegrowth?

It’s common forexpenses to grow at a ratefaster than revenue while abusiness is growing. This

isn’t necessarily a bad thing.However, it’s important forthe management team toproperlybalancethedynamicrelationship betweenexpensesandgrowth.

For example, whenMarriottHotel (MAR) entersa new geographic region, ithas to make very largepayments up-front topurchase the land, build thehotel and secure employees

andmanagement.Asyoucanimagine,manyof these costshappenbefore theMarriott isable to book rooms andproducerevenue.

Because of this, in thefirst few years it’s verycommon to see the interestexpense and depreciationcreep higher. Not only willthe interest expense anddepreciation represent ahigher percentage of the

revenue, the hotel willoperate at a loss for a periodoftime.

However, as the hotelbegins to increase bookingsand acquire new customers,thehotelwillbegin toseeanincreaseinprofitmarginsandcash flows (as long as it isexecuted properly). As youcan see, this can sometimeshide the true earnings powerof a business that is growing

andexpanding.For example, Marriott

investedagoodportionofitsfree cash flow in new hotelopenings andmaintenance ofproperties. Theseexpenditureshidthetruefreecash flows that Marriott’smainbusinesswasproducing.

Because of this, itseemed the business wastrading at a much highermultipletocashflowsthanit

really was.When the capitalexpenditures (Capex) werecut back in 2009 from $490million to $186 million, oneyear later it showed anincrease in free cash flowfrom $151 million to $682million as they cut back ondevelopingproperties.

Amazon (AMZN) isanother prime example (nopunintended).

Amazon is relentlessly

increasing its maintenanceand growthCapex to capturemarket share as quickly aspossible. When the businessdoes mature, and growthstartstoleveloff,youwillseean incredible amount of freecash flow through to thecompany.Inthiscase,Idon’tmind Amazon (and Bezos)trying to acquire as muchmarket share as possible asquickly as possible in this

rapidly growing industry.They have a window to notonly acquire market share,but push others out of themarket with their low cost,incrediblyefficientmodel.

Theonlyquestionat thispointis,willAmazonbeableto pull back the expenses asgrowth starts to level out?Andwill they use the excesscashflowproperly?

Ultimately, timewill tell

on this one. However, I amnotgoingtobetheonetobetagainstAmazonandBezos.

So, when looking at agrowing business, you needtake into consideration theeffectof increasedshort-termexpenses inorder toarriveatthetrueearningspowerofthebusiness.Is the business growingorganically through itsown

cashflows?Abusinessthatisableto

grow organically through itsown cash flows puts itself ina very strong financialposition. This is especiallyimportant in a world that isverydependentondebt.

These days, increaseddebt levels seem to be thenorm, rather than theexception. This increase inleverage can lead to volatile

market cycles, which we’veexperienced quite regularlysincetheturnofthecentury.

Growing organicallyallows a business flexibilityto take advantage ofopportunities when theypresent themselves. Organicgrowth is a more stable andsustainable form of growth,so we always want to be onthelookoutforthesetypesofbusinesses.

The businesses that areable to grow organically arebetter positioned thanbusinesses that use debt tofinance their growth for anumberofreasons:

1) In most cases, cashflow generated organicallyis a cheaper and cleanerform of capital versusissuingequityordebt.2) Managementwon’tbe

forced to make baddecisions from upcomingdebtpayments.3) The business isn’texposedtothevolatilityofcapital markets (bestreason).I’llgiveyouaquicktrick

to help you guesstimate theamount of time a businesswill be able to grow usingorganic cash flow. You can

do this by simply calculatingthe amount of time acompany’s cash isunavailable from workingcapital.

Hereisthecalculation:

Number of days thatinventory is outstanding(DIO)+Number of days that salesareoutstanding(DSO)–Number of days that

payables are outstanding(DPO)

Orputanotherway…(DIO+DSO)-DPONowdon’tbescared.It’s

easier than you think. Youcan find this informationeasily at GuruFocus.com orMorningstar.com.

Somemayrecognizethis

formulaalready.It’sasimplecalculation of the cash-conversion cycle (CCC).CCCsimplytellsaninvestor:once a customer pays for aproduct, the amount of timethat money is tied up withinthe business before themoneycanbeused.

Usually, businessesacquire inventory on creditand sell products on credit.This results in accounts

payable and receivable. Ittakes time for the cash toactually hit the balance sheetuntil the company pays theaccounts payable and collecttheaccountsreceivable.CCC= the time in which thebusiness actually haspossessionofthecash.

Thehigherthenumberofdays in the CCC, the slowerthe business can use theorganiccash flow forgrowth

because it’sunavailable frominventory or various capitalexpenditures.

CCC is very importantfor businesses in capitalintensive or retail industriesbecause of the inventory thatthese businesses must haveonhand.Forexample,RalphLauren (RL) typically has aCCCof90-120days.

Conversely,CCCdoesn’tmatter a great deal to the

software, consulting orinsurance industries becausethere’s no real need forinventory. Theirproducts/services can bedelivered instantaneously.Software companies arenotoriousforhavingCCCsof10 days or less. This allowsthese lowCCCbusinesses toaccumulate and fund asignificant portion of theirgrowth with internal cash

flow.At Amazon, Jeff Bezos

has been able execute theCCC at negative 30-40 daysfor some time now. Thisgives them an incredibleopportunitytorapidlyputthatinternal cash flow back intothe company forreinvestment.

Isn’t that justremarkable?

3)Will the historicprofitability continue togrow?

Revenuegrowthisgreat;however, in order for aninvestor towin at the end ofthe day, the business mustproduceprofits.

For example, Jeff Bezos(CEO of Amazon) has beenable to convinceWall Streetthat Amazon’s (AMZN)current strategy of foregoing

GAAPprofitsnow,togobbleup market share, is what'sbest for the company long-term. This has allowedAmazon to trade at anextremely high multiple toearnings as investors arelooking way into the futureforAmazon's future earningscapability.Personally,Iagreewith his strategy for thisparticular company. Eachstrategyiscompanyspecific.

Let’s look at someindustries, and how thegrowth in revenue hasequated to “real” earningsoverthepast10years:

The Internet Industrygrew rapidly in the 90s andcontinues to grow rapidlytoday. Many of thesebusinesses are able to createprofitability and returns fortheir stakeholders. However,this wasn’t always the case.

Theearlydaysoftheinternetindustry looked very similarto the figure of the solarindustrybelow(fig21).

Many businesses werewiped out during the techcrash between 1999-2001because they weren’tproducing “real” earnings. Itwasverydifficult topickoutwhowould “come out alive”in the eventual crash of theindustry as a whole during

thosetimes.Of course the current

figure below looks muchbetterforinvestorsaslongasthey aren’t buying over-leveraged businesses at highmultiples to earnings (fig.20).

FIG: 20 Internet Industry

Growth,2004-2013*Top5USInternetCompaniesInRevenue:AMZN,GOOG,EBAY,PCLN,YHOO*Blue=Revenue,Orange=Profits

The Solar Industry isgrowing rapidly. The figurebelow shows a growingindustry (fig. 21). However,it’san industry that isunableto grow profitably. Aninvestor would be wise topick investments carefully inthis industry, while puttingemphasisonhighquality,freecash flow businesses with

manageabledebt.

FIG: 21 Solar IndustyGrowth,2003-2013*Top3USSolarCompaniesInRevenue:FSLR,SPWR,SUNE*Blue=Revenue,Orange=Profits

TheAirline Industry isgoing through a veryinteresting transition. It’s anolder industry compared tothe Internet and Solarindustries.Anduntilrecently,the Airline Industry, as agroup, had produced no“real”earnings.

FIG: 22 Airline Industry

Growth,2003-2013*Top4USAirlineCompaniesInRevenue:AAL,UAL,DAL,LUV*Blue=Revenue,Orange=Profits

As you can see in thefigureabove,thereappearstobe a shift occurring, and thefirst investors to recognizetheshiftinairlinesproducingFCF,weretheonesthatwereable to establish positionsbeforeanyoneelse(fig.22).

The airline industry,which was once extremelyfragmented and competitive,

is now controlled by a selectfew companies, after therecent consolidation in thesector. This allows each ofthesebusinessesa littlemorepricing power andprofitability (as long as theydon’tscrewitup).

LeggMason’sBillMillerwasamong thefewwhofirstobservedthisshift.Therewasan immense differencebetween investor perception

and economic reality. As aresult, he was able to takeadvantage of the depressedstocks prices in airlines, andprofited handsomely whileotherswerestillindisbelief.

General Observation:Maybe it’s better to wait forpull back opportunities ingrowth businesses wherethereisadivergencebetweengrowth and profitability. It’sbetterthantryingtochasethe

big growth stories atexpensive multiples toearnings. It seems to be athemethatplaysoutoverandover again in the stockmarket.

Investors constantly getlured into buying high andsellinglow.

Historically, the railroadindustry, the airline industryand the internet industry allhad periods of investor

euphoria, even while theindustryasawholeproducedno ‘real’ earnings andstraddledthemselvesindebt.

Of course, the devil’sadvocatewouldsay,“theyarerapidlygrowingbusinesses…theywere putting themoneyinto the growth of thebusiness.”

Andtothat,Isay,“Whycan’t a business do both:produce growth in revenue,

while showing they can beprofitable,aswell?”

This is what greatbusinesses do. They are ableto balance the growthtrajectory with profitability.This is profitable for allstakeholders.

Will theairlineandsolarindustries ultimately figure itoutliketheprofitablerailroadorinternetindustries?

Timewilltell.

4)What is management’sincentive to keep thebusinessgrowing?

Always check to makesuregrowth isdirectedat thecore business. All too oftenmanagement's incentivestructure is tied to revenuegrowthofthebusiness.

Ifmanagementcan't findgrowth opportunities withinits own business segment, it

will look elsewhere to otherindustries where they lackspecific knowledge orexpertise. This could have apotential negative effectdown the line, so it issomething we want to be onthe lookout for during ourresearchprocess.

For example ITT Corp(ITT), a diversified globalmanufacturer of highlyengineered industrial

products and high-techsolutions, ventured intomultiple sectors andindustries throughout the 60sand 70swhich culminated inthe business purchasingwiderangingbusinessesfromhoteland gaming businesses toinsuranceandmanufacturing.

Asyoucanimagine, thismay help to support revenuelevels for a period of time.However, over the long-term

these different businesssegments become distractingtotheoverallbusiness.

ITT finally spun-off thelast of its non-core assets in2011 with the spin-off ofXylem (a provider of waterandwastewatersolutions)andExelis (a diversified globalaerospace, defense andinformation solutionscompany).

Each of these businesses

will do much better on astand-alone and focusedfoundation, rather than ahodgepodge of differentbusinesses.

REMEMBER:Whenyoubuy high multiples ofearnings in the form of P/Eratios or Cash Flow ratios,you are paying for thosecontinuedexpectations.

Premium earningsmultiples will normally be

attached to growingbusinesses. It makes sensebecause investors are willingto paymore for high qualitygrowthbusinesses.

The problem comes intoplaywhenyoupay“toohigha price” for those earnings,essentiallygivingyourselfnomarginofsafety.

For example, let’s sayyou pay up and purchase abusiness at a P/E ratio of 25

thatearns$1pershare.Ifthecompanydoublesitsearningsto $2 per share, youessentially only paid 12.5timesearningsfornextyear.

Thestockpricewilldropas growth slows or investorsare unwilling to pay a highmultiple for the business.This is exactlywhywewantto avoid paying too high amultiple for any business(evenmoatbusinesses).

For example, the stockprice ofApple (AAPL) is aninteresting case study ininvestor and humanpsychology. It also showshow reality doesn’t mean agreat deal to the averageinvestorifgrowthisslowing,regardlessof thevaluationorstayingpowerofthebusiness.Take a look at the figurebelow(fig.23).

FIG: 23 Apple Chart 2012-2015

FIG: 24 Apple Revenue andNet Income Growth, 2010-2014

Investorswerewilling topay up to 20 times earningsduring an increasing growthphase for Apple. But theywere unwilling to buy thestock (or sold the stock) asgrowth slowed pushing theP/EofApple toa lowof9.5(very low for a high qualitybusiness).

FIG: 25 Apple P/E Ratio,2011-2015

Butitgetsbetterwhenyougothrough the MECOM™Method. In actuality it wasmuch better than just buyinga great business at 9.5 timesearnings. At the lows forApple in 2013, you had theopportunitytopurchasea…

M - High qualitybusiness with

established,ecosystem, networkeffects and anincredibly loyalcustomerbase,E-Tradingataround6 times earningswhenyousubtractthecash on the balancesheet,C - New productlines and products inthe pipeline, activists

involved (Ichan,Einhorn),O–FortressBalanceSheet with low debtandampleamountofcash on the balancesheet,M - And a capableand shareholderfriendly management(hand-picked bySteve Jobs,opportunistic

buybacks, diviprogramimplementation)

Youseewhatwejustdid

there…?Yes, that was the

MECOM™Methodinaction.This “quick and dirty”analysis helps you get to themost important elements ofinvestingsuccess.That’showpowerful it canbe toquickly

determinewhetherbusinesseshave the potential to besuccessfulinvestments.

When you can breakdown the business like thiswiththeMECOM™Method,it starts to lookmuch easier.At the very least, it allowsyou to look at an investmentobjectively when everyoneelseloseshopeorbelievesthebusinessisdead.

Asimpleprocesslikethe

MECOM™Method helps usseetheimportantqualitiesforinvestment, and it allows aninvestor to make objectivedecisions to actopportunistically when thetimecallsforit.

TheMECOM™Methodhelped to breakdown anopportunity inahighquality,recurring revenue businesswithanearningsyieldofover15%, and very little risk on

thebalancesheet.Thisisaperfectexample

of how investor irrationalitycan provide opportunity forus. The MECOM™ Methodhelps us determine whetherit’s a legit investmentopportunity, quickly andefficiently. When the stockprice was rising to newheights everyday (during thegrowthphase),investorsweremore than willing to pay

upwardsof20timesearnings.However, investors were nowhere to be found when thestock price was dropping,eventhoughthebusinesswasstill growing (albeit at aslower rate). Investorscould’ve taken advantage ofthe market panic, andpurchased the business atlower risk levels with asignificantmarginofsafety.

Of course you have the

other side of the spectrumtoo. The business couldcontinue togrow its earningsatanincrediblerate.Amazonis the first company thatcomestomindasanexamplefor this type of business.Although this is rare for anextendedperiodoftime,thereareafewoutthere.

Although there isn’t amargin of safety in this kindof investment, the growth of

the business allows aninvestor to get away with itforthetimebeing.Solongasthe business continues tooutpace growth and businessexpectations.

Ninetypercentofwhatpasses

forbrilliance,orincompetence,ininvestingis

theebbandflowofinvestmentstyles.Since

opportunitiesbystyleregress,

pastperformancetendstobenegativelycorrelatedwithfuturerelative

performance.JeremyGrantham

REMEMBER: All

businesses will eventuallyslow in growth. If you wereabletocatchtheearlygrowthstage of the business, greatjob. However, be cautiousduring times of stockmarket

(or individual stock)euphoria,andbecarefulwhenpurchasing high growthbusinesses after years ofoutsizedgrowthandstocksatall-timehighs.

Thesekindsofstocksarepriced for perfection, andthey are more prone todramatic changes in businessoperationsandstockpricesatanytime (more than likely tothedownside).

In2002,ProfessorCyrusRamezani conducted a studyof over 2,000 publiccompanies by analyzing therelationship between growthand shareholder stock prices.His conclusions were veryinteresting.Of thecompanieswith the fastest revenuegrowth (a 10-year period of167% avg annual salesgrowth),theyproducedworseshare price returns versus

their slower growingcompetitors (avg growth of26%).

Essentially, the hot andpopular businesses could notmaintain their momentum asshareholders were unwillingto purchase at such elevatedlevels or growth rates startedto slow. Their stocksunderperformedasaresult.

Be careful about payingforbusinesses that arepriced

forperfection.

IsThereFutureGrowthIn

TheIndustry?

“Whenasurfergetsupandcatchesthewaveandjust

staysthere,hecangoalong,long

time…”CharlieMunger

CharlieMunger refers to

this mental model as“surfing.”

There are greatadvantages to being the“early bird” or “top dog” ofany industry-wide growthphase. These “surfing”industries or ideas should beno-brainer type of moments.

However, it takes anunderstandingofhowbigtheproduct or industry couldbecomebeforeyouareabletovisualize these types ofscenarios.

“But why is industryanalysissoimportant?”

“Ithoughtwewerevalueinvestors. We don’t careabout anything but theunderlyingbusiness…”

It’s true. The underlying

fundamentals of the businesswill take precedence in ouranalysis (and ultimately thedecision to invest). But thisshouldn’t keep a valueinvestor from brieflyanalyzing where the industrycycle may be presently.Industrycyclesanddynamicscan have an effect on theunderlyingbusiness.

So, it only makes senseto make sure it’s part of the

process. Whether it’s asignificant portion of youranalysis or not is completelyup toyou.Belowwewillgooversomekeypointstofocuson to help you pinpoint theareasthataremostimportant.

Eachindustryhasitsownset of standards within theMECOM™ Method. Theseare mental models that youwill pick up as you investacrossdifferentindustries.

5M™ and theMECOM™ Method will getyou80-90%ofthewaythere.But it’s not a panacea. Therest depends on yourdeterminationandanalysisofthe finer points to yourinvestment.

For instance, book valuedoesn’tmatteragreatdeal toa technology company thatdoesn’t need large physicalassetstogenerateexcesscash

flow. If you are comparingapples to oranges, theanalysisismoot.

You want to alwaysmakesureyouarecomparingapplestoapples.

Another reason we wantto pay attention to theindustry is because we wantto make sure there is a highprobability that the industryas a whole will continue togrowatareasonablerateover

the foreseeable future. Thisprovides an addedmargin ofsafety to your investment, aslongasmanagementisabletoexecute on a strategy to takeadvantage of the industry-widegrowthmovement.

An investor shouldalways be looking for those“surfing” situations byinvesting in thebestbusinesswithin that industry. If aninvestor is able to pinpoint

just a couple of thoseopportunities in his/herlifetime, they can expect toprofitgreatly.

This is an incrediblypowerfulmodel.WheretoFind:http://www.reportlinker.com/(FREE)OurFavorite!!!http://www.investopedia.com/features/industryhandbook/(FREE)http://www.valueline.com/Stocks/Industries.aspx

(FREE)http://www.hoovers.com/industry-analysis.html(PAID)http://www.firstresearch.com/(PAID)

AreThereManagement

Catalysts?

“Cheappricescansetthestageforshareprice

appreciation.However,cheapprices,bythemselves,arenot

reasonorjustificationenoughforustoinvest.”LukasNeely

Most of the time, the

major timely catalysts areinitiated at the discretion ofmanagement or board ofdirectors.Theyinclude:

Liquidations(orderly,fire-sale)Spin-offs or

DivestituresRecapitalizationsMajor Asset Sales(includes merger-arb)BuybacksDividend InitiationorIncreasesActivistInvolvement

Liquidation is the only

catalyst thatbringsabout fullvaluerealization.

There has been a bigpush lately regarding activistinvestors purchasingcontrolling stakes inbusinesses. This gives themvotingcontrolorinfluenceofthe company's stock, whichallows them to elect asignificant portion of theboard of directors.Essentially, these activiststake the potential catalystsactivation into their own

hands.Investors such as Carl

Ichan, Bill Ackman, DanLoeb, Jeffery Ubben andWilbur Ross, purchase largestakes in companies andconvince shareholders thattheir plan for value creationshouldbeimplemented.

The involvement ofactivists is not a catalyst byitself --- it’s theplanand theactions of the activists that

bringtheissuesandproblemstothesurfaceinaverypublicmanner. This can cause fearandactioninmanagement.

And if certain issues arenot fixed over a period oftime, the activistsmay beginto take steps themselves bynominating board seats andpressuring for newmanagement. This can act asacatalystiftherightmanagerisputatthehelm.

Either way, you canbegin to see an appreciablemovement in stock priceswhen activist investorsprovideasimpleandrealisticplanforvaluerealization.

AreThereBusiness-Driven

Catalysts?Catalysts can also come

in the form of a businessturnaroundtoo.

A business turnaround

can create positive feedbackloops which will includepositivity towards the stockand the company, as well aspotential inclusion into amajor index if the businessmeets certain businessmetrics.

For example, BostonScientific (BSX), a medicaldevice company,was left fordead between 2011-2013.Slimmer hospital budgets

combined with increasedcompetition in the medicaldevicesindustryhelpedtoflatlinerevenuegrowthforBSX.

As you can see in thefigure below (fig. 26), usingvery conservative discountedcash flow assumptions, BSXwas trading well below itsintrinsicvalue.

FIG: 26 Boston Scientific(BSX)Chart,2008-2015

Sowhatchanged?For one, the perception

ofthebusinesschangedtothemarket.

However, the actualcause of that changewas theturnaround in thefundamentalsofthebusiness.

Investors ignored theproducts in BostonScientific’s pipeline for

neurotechnology. BecauseBoston Scientific constantlycame in under revenue andprofit expectations, themarket completelyoverlooked the pick-up ingrowthforthecardiacrhythmmanagement productsdivision within BostonScientific.

Simple surveys tocustomers, research andindustry reports on these

products would have alertedan investor to the potentialsuccessandgrowththatthesesectorswereexperiencing.

Todrilldownonthehardnumbers, here are somemetrics to focus on to helppinpoint the potentialturnaround of a “down-and-out”business:

Change fromnegative to positive

FCFIncreaseinFCFIncrease in profitmarginsIncreaseinrevenueImprovingefficiencyratios (CCC, DSO,DPO,DSI,)

Focus on these key

metrics, and you may justspot a turnaround beforeanyoneelse.

In Boston Scientific’scase, FCF bottomed out at$53millionin2010duringitstrouble period, only toincrease again to $704million in2011,and increaseagain to $1,034 million in2012.Allofthesesignswerepresent in the turnaround ofthe business, even as thestock fell below $5.00 pershare as you can see in thefigure above.The stock hit a

highof$13.76in2014.This was a tremendous

time to take advantage of anopportunity that the marketwas unwilling or unable toaccept. In addition, BostonScientific was trading at asignificant discount to itsconservative estimate ofintrinsic value, which givesaninvestoramarginofsafetyin case things got worse forthebusiness.

Sometimesit just takesawhile for the market toactually believe theturnaround and jump onboard. Ultimately, that’s thereasoninvestorsshouldenjoythe search for turnaroundbusinesses.

Individual investors arefaster moving than the bigbehemoth funds. Mostinstitutional funds needacceptance from a team of

fund managers or boardmembers, which can takedaysorweeks.

If an investor spots aturnaround with low risk,he/she is able to takeadvantageof theopportunity,and establish a positionquickly without the need forcommitteeacceptance.

Investors search for theturnaround of a businessbecause it can have larger,

more pronounced returnswhich can be weighed inmultiples of the money youinvest.

However, there is acatch-22…

Turnarounds areincredibly difficult to pin-pointorpredictwithanyhighdegree of certainty (even fortheseasonedpro).

In addition to the focuspoints above, an investor

should look for two maincharacteristics in potentialturnarounds tohelpminimizerisk. This will give you amargin of safety in yourinvestment:

A business tradingbelow liquidationvalue,and/orFavorable earningspower3-5yearsout

It’s important to note:Thereisadifferencebetweena business trading belowliquidationvalueon theopenmarket,andabusinessthatisinvolved in Chapter 7liquidation proceedings.Chapter 7 liquidationinvestments normally bringsabout complete valuerealization in a relativelyorderlymanner.

However, businesses

trading below liquidationvalue outside of Chapter 7liquidation proceedings, cantake longer to realize fullvalue without turnaroundcatalysts inplace.Businessestrading below liquidationvalue in the stockmarketaresubject to the whims of themarket.

Combining both aturnaround situation with acompany trading below its

liquidation value provides apowerful catalystcombination for the patientinvestor.

You will gainconfirmation of the potentialturnaroundwhenthebusinessbegins earning FCF on aregular basis, as well asseeing efficiency metricsimproving.Bythetimethisisrealized by the market, thestock may be moved

significantly towards itsintrinsic value. The greataspect of turnarounds is thatthere is usually a longerrunway for stock priceappreciation.

As you may havenoticed, bankrupt businessesare a subset of turnarounds.The characteristics forinvestmentarethesame.Iamlookingforbusinessestradingbelow liquidation value and

favorable earnings over thenext3-5years.

We are always on thelookout for great businesseswith sustainable competitiveadvantages at a good price.However, there are instanceswhen the odds are in yourfavortoinvestandpotentiallyearn multiples of yourinvestment if the turnaroundtakeshold.

Turnarounds that have

thepotential forat least3-5xyour initial investment couldbe worth furtherinvestigation.WheretoFind:www.TheTurnaroundLetter.com

AreThereSupply/Demand

Catalysts?

And this is the sectionwherethetruevalueinvestorswillwrite tome in scorn…Ican’thelpit,andhere’swhy.

I imagine it’s my earlyinfluence of being trained asan equity, derivative andmerger-arb trader beforefalling in love with valueinvesting. Supply/Demandcatalysts are not fundamentalorbusinessbased,sotheyareoftencastasidebytraditionalvalueinvestorsas“Voo-Doo”orawasteoftime.

In my experience thiscouldn’t be further from the

truth.Ifirmlybelievethatthere

are cycles and imbalancesthat are readily apparent instocks(justas in life) thataninvestor can use as anothertool to help increase his/hermarginofsafety.

Supply/DemandCatalysts fall into two maincategories:

1)ShortSqueeze

2)VolatilitySqueezeA Short Squeeze is a

situation or event where aheavily shorted stock orcommodity moves sharplyhigher because short sellersclose out their positions bybuying back their shortpositions. This can provideupwardpressureonthestock.

For example, let’s say acompanythatweclassifyasa

high quality business goesthrough a difficult period.The recession hit them hard,andmarketparticipantsbeginto sell the stock short inhopes of reaping returns asthestockfalls.

The stock falls from$25to$10pershare.Shortsellersareecstatic,but thecompanyseems to be improvingoperationally. The revenuesarestabilizingandcashflows

are starting to pick up.Margins are starting toadvance,andefficiencyratiosare nearing the best in theindustry.

The stock begins toslowly increase in price. Thestock soon rises 25% over acourse of a month, and theshort sellers start to becomenervous.

The short sellers start toliquidateandcovertheirshort

positions by purchasing thestock they shorted.This kindofactivitycan“feed”onitselffurther to the upside if thereareenoughshortsellersinthestock.

Sohowdowefindtheseheavily short stocks withpotentialforshortsqueezes?

There are two measuresan investor can use to helpidentify potential shortsqueezes:

1)Short-InterestShort Interest is thepercentage of total sharessold short versus the totalshares outstanding of thebusiness. The higher thenumber the better as acatalystforinvestment.2)Short-InterestRatio Short-Interest Ratiois the total number ofshares that are sold shortdivided by the average

daily trading volume. Itrepresents the number ofdaysitwouldtakeforshortto finish buying back allthe shorted shares. Thehigher the number thebetter as a catalyst forinvestment.

*Youwillwanttocrossreferenceyourwatchlistwithbusinessesthatareheavilyshortedtoseeiftheremaybe

potential.

REMEMBER: High short-interest by itself is not areason for investment. It’sjustanothercatalystortoolaninvestor can use to helpincrease themargin of safetyinahighqualityinvestment.WheretoFind:www.ShortSqueeze.com

AVolatilitySqueezeisasituation or event that occursafter a period of lowvolatility. Many traders haveheard of Bollinger Bands.Most charting softwareincludes Bollinger Bandsbecause they are used bymanytraders.

John Bollinger createdthe Bollinger Bands and hesayshisbandsare“drivenbyvolatility, and the Squeeze is

a pure reflection of thatvolatility.” Bollinger bandsare comprised of a 20 daymoving average (DMA) andtwo bands (2 standarddeviation above and belowthe 20DMA). See figure 27below.

Stocks(justlikehumans)don’t move in a linearfashion. It takes time foremotional pain and sufferingtoplayoutasstocksdecrease

in value. There are cycles tohuman emotion and action.Bollinger bands can helpinvestors to see theunderlying marketpsychology a little moreclearly.

FIG: 27 Bollinger BandExample,Apple2012-2015

Asyoucan see from the

figure above, when Apple’sBollinger bands squeezetighter together, there was afairly significant move soonafter.

The line above the chartwith the redcirclespinpointsareasoflowvolatility.Which

usually sets the stage forincreased volatility, orvolatilitysqueezes.

Theonlyproblem….You don’t know the

direction of the potentialmove.That’swhywealwayslook for high qualitybusinesses to invest in atdepressed prices. It helps toincrease the probability thattheupcomingmovewillbetothe upside if we purchase at

large discounts to intrinsicvalue.

Like high short-intereststocks,we only use potentialvolatility squeezes as anadditive catalyst. However,my experience has shownthese events to be significantfactors nonetheless. Thischart above is just one ofmanyexamples.

*Hat tip to DanFitzPatrick for teaching me

about Bollinger Bands. Hewas trained by JohnBollinger himself. And heteaches what he knowseverydaytohelpothersfindapath to investment success.He truly is one of the goodguys in the industry. ThanksDan!

A Supply/DemandCatalystisyetanothertooltohelp skew the risk/rewardprofileinourfavor.

WheretoFind:www.BollingerOnBollingerBands.comwww.StockMarketMentor.com

Step4ofMECOM™:

Obligations

Doesthecompanyestablishproperleverageanddebtcontrol?

This man took a great

deal of condemnation frominvestors and the generalpublic for his purchase ofAmerican InternationalGroup (AIG) after its bailoutand at the depth of thefinancial crisis. He wasridiculed by other investorsand questioned by thefinancial media. I guess wesawwhohadthelastlaugh.

He began establishing alarge position in AIG in

March of 2010 after it wasrecapitalized by the U.S.government.He continued toaddtohispositionin2011asthe stock plummeted from$60toalowof$20pershare.

That man is none otherthan Bruce Berkowitz ofFairholmeFunds.

FIG: 28 AIG Chart, 2010-2015

Currently, AIG is anextremely large position inhisportfolio,upwardsof40%ofhisportfolio.

So, what gave him theconfidence to purchase abusiness like that -- with theconstant public lambasting,government oversight, andstockpricesplummeting?

Certainly there were

other factors for hisinvestment inAIG; however,the new fortress-like balancesheet, and bevy of highquality assets on AIG’sbalancesheetgaveBerkowitzthe confidence to accumulateeven more shares at lowerprices. Thismargin of safetyallowed Berkowitz todecrease the average pricepaid of his investment inAIG. Thus, increasing his

ROI.With the bad assets and

liabilities off AIGs balancesheet, Berkowitz saw asystemically importantbusiness with high qualityassets, underlying businesstrends improving, and abusiness trading well belowitsliquidationlevel.

If you are correct aboutyour investment thesis, andthe stock trades to a lower

level,whyintheworldwouldyou not take advantage oflowerpricesandbuymore?Ifyou know nothing about thebusiness, and its stayingpower,itcanbeverydifficulttodo.

Businesses with strongbalance sheets can giveinvestors the confidence tobuy more of their favoriteideaswhenitseemstheworldiscomingtoanend.

Lower Price Paid =HigherROI

In this section, we willdeterminewhetherabusinesshas a "fortress-like" balancesheetornot.

Alltoooften,thebalancesheetcanmeanthedifferencebetween a bump in the roador bankruptcy. It could evenmean the difference between"paper" losses or permanentlossofcapital.

An investor who knowsthe difference between astrong and weak balancesheetwillbeastepabovetheaverage investor or marketparticipant.

Most investors pay verylittle attention to debt levels,so long as the businesscontinues to grow at a greatrate. This is a mistake thatcan cause permanent loss ofcapitalifyouaren'taware.

Strong balance sheetbusinesseshave theability totake advantage ofopportunities acrossnumerous economic cycles.The same cannot be said forhighlyleveragedbusinesses.

In determiningreasonable debt levels of thebusiness, you need todetermine whether the cashflows are predictable enoughto make debt payments. It’s

important to note that wewant tomake sure there is amargin of safety in the debt-to-cashflowlevelstoo.Ifthecashflowsdeclinewewanttogiveourselvesalittlecushionincasewewerewrong.

The best investors try tokillthecompany!

Yes, you read thatcorrectly...We Want To KillTheCompany.

Whether an investor

wants to admit it or not(consciously orsubconsciously),he/shewantstofindareasontosay“NO.”As an investor, youabsolutelyshould.

“Wespendalotoftime

thinkingaboutwhatcouldgowrongwithacompany…Wetryeverywhichwaytokillourbestideas.Ifwecan’tkill

it,

maybewe’reontosomething.”

BruceBerkowitzGreat investors go

through this activity becauseif theycan'tkill thebusiness,then they know theymay beonto something (this is moreprevalent during times ofnegative perception to abusinessorindustry).

And one of the easiest

waystokillabusinessiswithexcessiveobligationsordebt.Nothingkillsabusinessfasterthandebt.

This is the reason wewant to focus on a few keysareas to determinewhether abusiness has adequateleverageanddebtcontrol.

Here are some tips andtricks to help you determinewhether a business has a"fortress-like"balancesheet:

Moderate-To-Low LevelsOfDebt?

Businesses with limitedamounts of debt have manyadvantages over theircompetitors.

Debt that can be paidbackin2-3yearswithcurrentcash flows and a businesswithverylittlelong-termdebtwould qualify as limitedamountsofdebt.

Here are the 2 mainadvantages of strong balancesheetbusinesses:

1)Allows the business to beopportunistic

Duringperiodsofmarketcorrections (recessions),leveraged businesses have adifficult time takingadvantage of theopportunitiesaroundthem.Incontrast, businesses with

strongbalancesheetsareableto increase competitiveground, and advantages overtheir higher leveragedcompetition.

Businesses that are ableto finance their ownoperations, or have amplecashonthebalancesheet,arebetter able to makeopportunistic acquisitions,buy back stock and/orincrease marketing and ad

budgetstohelpthemgrow.Example of Increasing

Marketing&Sales:During the 2000

recession, Target (TGT)increased its marketing andsales budget by 20%compared to pre-recessionlevels. It didn’t stop therethough.Anincreaseincapitalexpenditures by 50% helpedtogrow thenumberof storesitoperatedfrom947to1,107,

and almost tripled theSuperTargetstoresfrom30to88.

As a result, Target wasabletogrowrevenueby40%duringtherecession.ManyofTarget’s competitors wereunable to take advantage ofsuch opportunities becausethe balance sheet gave it noflexibility. In addition, profitmargin increasedfrom9%to10%, which helped to grow

profitsby50%.How’s that for being

opportunistic during arecessionaryperiod?

Example of growth andmaintenceCAPEX:

Another example duringthe 2000 recession was T.J.Companies(TJX),operatorofT.J. Maxx and Marshallstores. This discount retailerdidn’t “tuck-tail” and runduringthedownturn.Infact,

they expanded. And thestrengthoftheirbalancesheetallowed them to add 300stores at the start of therecession (2000), to a storebaseof1,350storesattheendof the recession in 2002.Capex basically doubled andthe square footage increasealmost25%.

This helped TJX togrowthearningsatafarbetterpace than its competition

duringandaftertherecession.Thesetypesofactionsgo

beyond just helping abusiness maintain marketshare, it helps a business togrowand“gobble-up”marketshare when (or if) thebusiness eventually comesoutofadespondentperiod.2)Less risk of insolvency(bankruptcy)

Thedurabilityfactor!

This is a very importantadvantage considering ithelps you to sleep muchbetter at night. Less risk ofinsolvency means it will bevery difficult to kill thebusiness.

Case Study of BusinessUsing Debt Conservatively:Costco(COST)

Costco is one of theleading retailers in the U.S.,andexpandingglobally.It’sa

great example of a businessthatusesdebtconservatively.VirtuallyallofCostco’slong-termdebtisinvestmentgrade,fixedrateatverylowinterestrates.Asaresult,increasesininterest rates should haveminimal effect on thebusiness.

Costco also staggers thedue date of the debtrepayments, so they arespread out over time. This

helpstominimizerefinancingrisk.

This is an interestingcase study because Costcodoesn’t normally use long-term debt to expand itsbusiness. However, Costcojust recently embarked onlong-termstrategytogrowitswarehouse base. Thisessentially tripled the long-term debt on its balancesheet. So this makes for a

great example to help usunderstand whether thisbusiness still has a strongbalance sheet. This analysiswillgiveustheassuranceweneed that this business willlastthroughvariouscycles.

Now, normally thiswouldbeaconcern.

However, givenmanagement’s history offrugalityandtacticalacumen,this isn’t necessarily a bad

thing. Especially when youbegin to look at the kind ofdebt thatCostcoused tohelpfinance the build-out of itswarehouses.

We will use Costco’sdebt ratios to help usdetermine whether thebusiness has a “fortress”balance sheet and has theabilitytopayitsobligations.

There are two types ofratios to help investors

determine the strength of abusiness’s balance sheet:Coverage Ratios and StaticRatios. Let’s go over eachindividually.

CoverageRatioshelpaninvestor measure the abilitytomeet financial obligations.Normally, the higher thecoverage ratio, the better thebusinesswillbeable tomeetitsobligationstolenders.Thisanalysis helps greatly in

ascertaining the business’scurrent financial position.Each ratio is ranked in orderfrommost important to leastimportant.

The two most common,and useful coverage ratiosinclude the InterestCoverageRatioandEBITDACoverageRatio:

Interestcoverageratiois

used to determine the

business’s ability to payinterest on outstanding debt.It is calculated by dividingearnings before interest andtaxes (EBIT) by the interestexpense.

An interest coverage

ratio below 1 (or around 1)tells an investor that the

business may be in troubleand is having issuesgeneratingsufficientearningstosatisfyinterestexpenses.

In Costco’s case, theinterest coverage ratio is30.62.Asyoucansee,Costcois well within the safe zoneand should have no problembeingabletosatisfyanydebtobligations.

EBITDACoverage Ratiois mainly used by leveraged

buyout firms (LBOs).Essentially, this ratio is thesameas the interestcoverageratio except it helps aninvestor see the potential forthe business to borrow moreorseethepotentialforbuyoutoffers(higherthebetter).

Similar to the interestcoverageratio,aratioaround1 sets off a major red flag.This ratio doesn’t includedepreciation, so any ratiocloser to 1 will be moreproblematic than just theinterest coverage ratio.Depreciation is a real costofdoing business, and shouldtrack the maintenance ofcurrent business operations.Leaving depreciation out of

your calculation for debtobligations is moreaggressive.

“PeoplewhouseEBITDA

areeithertryingtoconyouorthey'reconningthemselves.Telecoms,forexample,spendeverydimethat'scomingin.Interestandtaxesarereal

costs."WarrenBuffett

As a general rule,investors should stay awayfrom businesses that useEBITDAasametric todressup financial statements. Aheavy dose of skepticism iswarranted towardsbusinessesor analysts that useEBITDAin their financial reportingandanalysis.

We state EBITDA hereonly to help an investor inhis/heranalysisofabusiness

being able to meet debtobligations. However, itshould never be used in theanalysis or valuation of thebusiness. As Buffett says,depreciation, amortization,interest and taxes are realcosts!

Costco has an EBITDACoverage Ratio of 40. Wellwithinthesafezone.

Important To Note:These two ratiosgiveyouan

ideaof thecoverageratiosofa business at a presentmoment in time for theinterest of the debt. It doesnotincluderepaymentofthatdebt.

Therefore, it’s importantto perform this analysis forfuture obligations andamortization of the debt aswell. This will give aninvestor a better idea of thefinancialsituation.

For example, look at thefigure below of the futurecoverage ratios taking intoconsideration future interestexpenses and debtamortization with currentcashflows(fig.29).

FIG: 29 Future CoverageRatios, Costco, 2016 andbeyond

As you can see, thecoverage ratios show abusiness well within itsabilitytorepaytheinterestondebt obligations. However,they didn’t take intoconsideration the repaymentofthatdebtinthefuture.

Evenwithallofthatsaid,Costco stillhasan incrediblystrongbalancewithitsability

to meet current and futuredebt payments. It is able toaccomplishthisbecauseofitsstableandconsistentearningsgeneration.

This gives the businessplenty of flexibility to paybacktheobligations,andstillgrow the business. And wehaven’t even discussed thefivebilliondollarsofcashonthebalancesheet.

ThisisjustanothertrickI

use togive furthermarginofsafety in a business beingable to satisfy debtobligations.

REMEMBER: Aninvestor gives themselves abetter ability to determine abusinessbeingable tosatisfyobligations with real cashflow.UsingCash Flow fromOperations (CFO), instead ofEBIT and EBITDA, canprovide a more reliable and

steadymeasure thanearningsthat can be easilymanipulated.

An investor would bewise to give themselves amargin of safety in thesecalculations, as well. Eachindustry, and each businessfor that matter, will producecash flows over differentcycles.

As a general rule, themore cyclical the business,

the higher coverage ratio aninvestorshoulddemand.Cashflows in cyclical businessesare more volatile in nature.The higher coverage ratiogives an investor a largermargin of safety, just to becautious.

For example, incommodity-type businesses,an investor may want todemand more than 10 timescoverage. And in industries

likeutilitiesorhealthcare, aninvestormaywanttodemandonly5timescoverage.Itwillbe specific to the businessandindustry.

Static Ratios help aninvestor measure the abilityof a business to pay back itsobligations. There are fourmain types of static ratios:Current Ratio, Quick Ratio,Debt-to-Equity Ratio andDebt-to-TotalAssetsRatio.

The Current Ratio is aliquidity ratio that measuresthe company’s ability torepay short-term obligations(currentliabilities).

The higher the current

ratio, the better capable thebusiness is to pay its short-

term obligations. A ratiounder 1 means the businesswillhaveatoughtimepayingoff its short-termobligations.Any business with a currentratio under 1 is in a difficultfinancial situation and isn’tmanaging the business verywell.

Costco has a currentratio of 1.20. Although thecurrent ratio isn’t as high aswe would like, it shows that

thebusinessshouldbeabletopayitscurrentliabilitieswithrelativeease.

The Quick Ratio is verysimilar to the current ratio.However, you may havenoticed that inventory couldbe difficult to turn into cashquickly at 100% of its valueduring stressed periods.That’s where the quick ratiocomesintoplay.

The quick ratio is a

liquidity ratio that measuresthemost liquidcurrentassetsto all current liabilities. Thisratio is also called the “acid-test ratio” because it shouldonlybeusedduringthedirestof situations when trying todiscern whether a businesshas the ability tomeet short-term obligations. It’scalculated by adding cash,marketable investments andaccounts receivable and

dividing the sum by currentliabilities. As you can see,inventoriesaren’tincluded.

Costco has a ‘less-than

ideal” quick ratio of 0.55.However,Costcodoesagreatjobcreatinglargeamountsofcash flow on a yearly basis,andtheyhaveconstantlybeen

around this 0.55 quick ratiofor the last 10 years whilegrowing the businesssignificantly.Add that to thefactthattheyhaveamplecashon their balance sheet tocover any short falls. So thisisn’tsomethingwewillworryabouttoomuchinsuchahighqualitybusiness.

The quick ratio is themore conservative view of abusiness’s ability to meet

short-term obligations. Butit’salsothemostextreme.Soit’s not always needed,especially for higher qualitybusinesses.

TheDebt / Equity Ratioisameasureofthebusiness’sfinancial leverage. Itrepresents the proportion ofequity and debt the businessusestofinanceitsassets.

In general, the lower the

debt/equity ratio, the lessleveraged the business. Highdebt/equity ratios can resultin additional interest expenseand volatile earningscompared to similarbusinesses.

Costco has a debt/equityratio of 0.41. And the

debt/equity ratio has rangedfrom 0.08 to 0.41 over thelast10years.ThisshowshowincrediblydebtaverseCostcoreallyis.

The Debt / Total AssetsRatio measures the totalamount of debt compared toassets. Similar to thedebt/equity ratio, the higherratio, the higher amount ofleverage.

Costcohasadebt / totalassets ratio of 0.64. Thisshows the investor that thisbusiness is using leverageconservatively.

Of course, the caveat tousingtheseratiosistheyonlygive you a summary of thebusinessatthatpointintime.

Inmost cases, the assets andliabilities aren’t exactly thereal figures stated on thebalance sheet. Sometimes ittakes added investigation toascertain the real assets andliabilities. We discuss thisfurther in the comingsections.

Still,theseratiosdoserveasagreatplacetostart.WheretoFind:

Companyfilings--10KSearch under Long-TermDebtorDebtDoes The Business HaveWorrisome Off-BalanceSheetLiabilities?

As we briefly discussedin the previous section, thetotalliabilitiesonthebalancesheetaren’talwaysthe“real”totalliabilities.

Letmeexplain.

Inorderforaninvestortocalculate the actual totalliabilities of the business, aninvestor would need tocalculate off-balance sheetliabilities too. Off-balancesheet liabilities arecontractual obligations thatare not included on thebalancesheetofthebusiness.

Off-balance sheetliabilitiesinclude:

Unfunded PensionLiabilitiesLeaseObligationsWarrantiesPurchaseContractsPartnershipsOther contractualobligations not listlistedon thebalancesheet

Don’t worry. These are

easier to find and calculate

thanyouthink.Companies such as

Enron and WorldCom havealmost become synonymouswith egregiousmisrepresentation of off-balancesheetliabilities.

Operating leases arepopular off-balance sheetliabilitiesthathavebeenusedover theyears. It’s importantto note that accounting rulesaretighteningtosubduethese

off-balancesheetliabilities.Essentially, an operating

lease allows a business torecordonlytherentalexpenseof the building or equipmentlease (rental). This issignificantly lower thanbooking the entire lease onbalancesheet.Therebygivingthebusinessacleanerlookingbalancesheet.

Partnerships are anotheroff-balancesheetliabilitythat

must bewatched closely likeahawk.Whenabusinesshasa controlling interest inanother business or engagesin a partnership, it doesn’thave to show thepartnership’s liabilities on itsownbalancesheet.

Asyoucanimagine, thisaccounting technique allowsfor some shady types ofactivity.

Sometimes, hidden

values can be found withinthese partnerships as well.For example, Ali Baba(BABA) proved to be asignificant boost to YahoostockbeforeandafteritsIPO.The hidden value in its AliBabastakehelpedtoincreasethe margin of safety ofYahoo’s (YHOO) stocksignificantly.

In 2012, during thestagnation of Carol Bartz’s

timeasCEO,ourcalculationsindicated that the Ali BabastakerepresentedvirtuallytheentiremarketvalueofYahoowhen it was trading at$15/share(netcash).Manyofthe pros on Wall Street haddifficulty seeing the value inthis hidden asset. This wasmainly due to theirpreconceived negative biasestowardsYahoo.Idiscussthismoreindepthlater.

FIG: 30 Yahoo (YHOO),2011-2015

Great opportunities likethis don’t come along veryoften,butitdoeshappenfromtime to time. That’s why itpays to be prepared, andaware of these situations.This particular instanceprovided opportunity for theprepared and diligentinvestor.However,youwillsometimes

run into businesses that usethe partnerships to offloadsubstantial liabilities. Thusresulting in a better lookingbalance sheet. For example,Enronisaperfectexampleofthisfolly.Enroncontinuedtopile up unwanted liabilitiesinto partnerships while noone was the wiser. Thisultimatelyledtotheirdemiseandfilingofbankruptcy.

FIG:31Enron,1992-2001

As a general rule, becautious of businesses andmanagement teams that haveexcessive off-balance sheetliabilities.

Off-balance sheetliabilities are a discretionaryaction by the managementteam.So,amanagementteamthat wants to “dress-up” itsbalance sheet could do so

easily if they wanted too. Itshould make an investorwonder what else they’retryingtohide.

Greatmanagementteamsare open and transparent.There’s no need for them toplay accounting games andgimmicks with theirinvestors.

Whenanalyzingbusinessratios, an investor shouldinclude a conservative

estimate of any off-balancesheet liabilities into the totalliabilitiesportionoftheratio.The more off-balance sheetliabilities,themoredifficultitcanbetoproperlyanalyzethebusiness.WheretoFind:10KFootnotesSearch Commitment andContingenciesSearch Partnerships, Rental

orLeaseExpenses

Are Capital Expenditures(Capex)Reasonable?

Capital expenditures(Capex) are funds used by abusiness to upgrade oracquire physical assets suchas equipment, buildings orproperty.

Capexisbrokenintotwoforms:

1. Maintenance Capexare expenditures tohelpextendor sustainthe useful life ofexisting assets(maintain).

2. Growth Capex areexpenditures for thepurchase of newassets in an effort togrow the business(growth).

It’seasytoblurthesetwovery distinct definitions ofCapex.Thefocusofthisbookwill revolve aroundmaintenance Capex.We willgo into detail more on thistopicshortly.

As an investor, we caremightily about how earningsflowthroughtouswhenallissaid and done. DeterminingtheCapexofthebusinesswillhelpan investorcalculate the

free-cash flow (FCF) whichultimately flows through tothe investor at theendof theday.

A business with highCapex requirements meansthatcashflowmust regularlybe reinvested to maintainexisting assets andoperations. This ultimatelyleads to lower cash flowsversus a low Capex business(allelsebeingequal).

Forexample,oilandgasproducers (O&G) often losemoney due to the cyclicalnature of the business.Generally, it can be quitedifficulttoinvestinthisspacebecause if an O&G businessstarts to generate out-sizedcash flow, it must spend thecash flow upgrading drillsand allocating funds to findnewreserves.

Barring many of the

major integrated O&Gbusinesses, investors rarelyget to see the cash flowthrough to them because thecash flows are constantlyreprocessed back into thebusiness. This can have adirectimpactonthevaluationof the business on a non-GAAPbasis.

On the opposite side ofthe spectrum, low Capexbusinessescarryconsiderably

lowerriskcomparedtoahighCapexbusiness(allelsebeingequal). A business with lowCapex requirements canreinvest that cash flow tocreate more value forshareholders in the form ofgrowth initiatives, dividendsandsharebuybacks.

FIG: 32 Capex IndustriesLow/High

Asyoucansee,therearesignificantly more highCapex industries andbusinesses compared to LowCapex.TheratioofCapextosalesofmost thehighCapexindustries accounts for 20%or more of the industry’srevenue (some more thanothers).

It’s important to note,

inflation may impair theability of a business withlarge Capex to buy new orreplace existing assets.Conversely, a business withlow Capex can do very wellin an inflationaryenvironment.

Sohowdoesan InvestorCalculate MaintenanceCapex?

Capex can be found inthe business’s cash flow

statement,andthereisusuallyadditional breakdown in theMD&A section. However,most businesses don’tdifferentiate betweenmaintenance and growthCapex in their financialreports. As a result, aninvestor will usually have todo a bit of investigation tofind the maintenance Capexofthebusiness.

The reason for this

necessary exercise is toascertainthebareminimumittakes for a business tomaintain current operationsandcashflow.Thiswillgiveus a normalized Capexnumber to help value thebusiness conservativelyduring growth phases orwhen things go into crisismode and businesses pullbackCapex.

In thecalculationof free

cash flow (FCF),wewant touse use maintenance Capex.But, as we stated before,businesses rarelydisclose themaintenance and growthCapex seperately. This canmake the ascertaining ofmaintenanceCapexadifficulttask.

Thereisnohard-and-fastformula or process forcalculating maintenanceCapex.Aninvestorwoulddo

well to use one or acombination of the followingtwomethods:

1)Maintenance Capex =Depreciation?

This is the mostsimplistic method ofcalculating maintenanceCapex. Depreciation shouldtrack closely to maintenanceCapex.

Thus, if you subtractdepreciation from the totalCapex number, you couldtheoreticallyarriveataroughestimateofgrowthCapex.

If a business is in a lowor consistent growth pattern,itiseasiertousedepreciationfor the calculation ofmaintenance Capex.Otherwise an investor willneed to adjust thedepreciation up or down

dependingonmaintenanceofthebusiness’sassets.

An investor needs toascertainhow long theassetswill last till they need to bereplaced.Focuson the assetsthat need to be maintained(machinery, office buildings)and ex out assets that don’t(likeland).Asageneralrule,maintenance Capex willincreaseasassetsgetolder.

Here is a trick to

calculate the rough estimateof the average age of theassets:

AverageAgeofAssets=(PP&E - AccumulatedDepreciation)/PP&E

An investorwill need toadjust to straight-linedepreciationifthebusinessisusing an accelerateddepreciationschedule.

Forexample, theratioofnet assets to gross assets at

Exxon (XOM) was 56%,which means that the assetsaregettingveryclosetotheirhalf-life.

This would alertinvestors to thepossibilityofExxon seeing highermaintenance Capex toimprove drills and othermachinery in thenear future.In this instance, you wouldmake downward adjustmentsto future cash flows in

anticipation of an increase infuturemaintenanceCapex.

Typically, the closer theratio of net assets to grossassets is to zero, the highertheprobabilitythatabusinesswill face higher maintenanceCapex to acquire new assetsto replace theold in thenearfuture.

Of course you aretrusting that managementcorrectly states the schedule

of depreciation. And weknow how easy it is tomanipulatethisnumber.

There are a number ofdifferent schedulesmanagement can use to statedepreciation (straight-line,accelerated, etc). They couldeven hold back depreciationforanumberofquartersinanattempt to boost GAAPearnings. Or managementcould just be too confident

about the sustainability oftheirassets.

BOTTOM LINE:Depreciation can be verymisleading at times, and canbeeasilymanipulated.

That’s why the nextmethodisabetterapproachinthe calculation ofmaintenanceCapex.2)TheGreenwaldApproach(EPV)

Columbia University

Professor Bruce Greenwaldexplained in his book,ValueInvesting: From Graham ToBuffettAndBeyond, a simplemethod for calculating themaintenance Capex forbusinesses:

Calculate the AvgGross Property,Plant, and

Equipment(PP&E)/sales ratioover7yearsCalculate currentyear’s increase insalesMultiply PPE/Salesratio by increase insales to arrive togrowthCapexMaintenance capitalexpenditure is theCapex figure from

the cash flowstatement lessgrowth Capexcalculated above,which is the truedepreciation for thecompany

Overall, this is the best

method and it makes perfectsense for reliable businesses.However, itwon’tworkverywell for high Capex

businesses. If the Capexnumber is less than the salesgrowth number, thecalculation seems to haveissues.

These two methodsaren’t perfect, but theGreenwald approach,rationally and practically,seems to calculatemaintenance Capex moreaccurately for mostbusinesses.

REMEMBER: Don’tbeat yourself up over themath.

If you feel stuck, or arehaving difficulty calculatingthe maintenance Capex, justtry to use a conservativeestimate of depreciation asthe rough appraisal formaintenanceCapex.Youmayneed to normalize CFO aswell toarriveata reasonableFCFfigure.

MaintenanceCapex=

DepreciationSo…

FreeCashFlow=NetCashfromOperations–D&A

Growth vs. MaintenanceCapex

Sothisbringsusbacktowhy it’s so important toseparate Growth andMaintenanceCapex.

We have determinedalready that maintenanceCapexisacost,whilegrowthCapex is more of aninvestment.GrowthCapex isnormally related directly tothe increasedFCFabusinessis producing. Thus, aninvestormustmake sure thatcapitalisbeingreinvestedatareasonable rate of return torationalize the growth Capexfigures.

Many businesses do notseparate out the maintenanceand growth Capex. This canmake it difficult to calculatewith any degree of certainty.However, there are usuallyclues that we can use toascertain conservativeestimates.

For example, Costco(COST) stated in their latestannual report (10K) that theyopened30newwarehousesin

2014 with a total Capex of$1,993M, and wereanticipating an additional 35newwarehousesin2015withCapex expected to come itbetween$2,500M-$2,700M.

These big increases inCapex are a perfect exampleof growth Capex. However,we were not privy to theexact growth Capex figure(just total Capex). It is clearthat we need to separate the

maintenance Capex from thegrowthCapextoarriveatthetrue profitability of thebusiness.

Imagine that Costco cutall growth projects. Andstopped building newwarehouses tomorrow -- coldturkey.

Whatwouldtheresultbetothefinancials?

The likely result wouldbe massive and quick

reduction in Capex. Thiswould have an almostimmediate increase in FCF.Essentially, the business cutgrowth initiatives for short-termgenerationofFCF.

This was obviously anextreme example, howeverthis is a decision that everybusinesswillfaceatonepointor another. This could be aresult of an broad marketeconomic slowdown or the

businessmaturing.An investor would be wellprepared to know how tocalculate the growth Capexfigures in relation to totalCapex.

In regard to Costco, Ibelieve that either thedepreciation or Greenwaldmethodprovidesareasonablefigure for the maintenanceCapex.Allweneedtodoatthispoint

is find the adjusted FCFnumber with only themaintenanceCapex.Butfirst,let’slookatthecalculationofFCF without separating thegrowth Capex. See figurebelow(fig.33).

FIG:33CostcoRegularFreeCashFlowCalculation

Now see the adjusted FCFnumbers (without growthCapex), and how it impactsthe valuation characteristicsofthebusiness(fig.34).

FIG: 34 Costco AdjustedFreeCashFlowCalculation

As you can see by thiscalculation, it shows the trueearnings power of a businesswhenitjustoperatesitsmainbusiness without any growthinitiatives.

The business hasaveraged just over $2.5billionperyearinFCFinthepast three years. That givesthem a price to market cap

multipleof24.31,andapricetoenterprisevaluemultipleof23.40. It’s a little expensiveformytaste,howeverI thinkit shows how wide thediscrepancy can be invaluations if you don’tseparate growth andmaintenanceCapex.

An investor’sunderstandingofmaintenanceand growthCapex is crucial.Not only is Capex a very

important figure in theoperation and growth of thebusiness, it’s an essentialcomponent of an investor’sconservative calculation ofintrinsic value usingdiscountedcashflows(DCF).

We will discuss thismore in themargin of safetysection,sostaytuned.WheretoFind:10Kand10Qs

CashFlowStatementMD&AsectionSearch for “property, plantandequipment”Search for “cash flow frominvestingactivities”Will The Business Be AbleToWithstandaShort-TermDisaster?

Cash is the lifeblood ofany business. There are 2main avenues in which cash

can provide flexibility andliquidity:

1. Cash on the balance

sheet2. Steady streamof cash

flow from operations(CFO)

We all know that cash

flow is great. It’s a requisitefor any investor in thesustainabilityof thebusiness.

However, if a disaster strucktomorrow, how well wouldthe business react to thesituation?

If a hurricane hit in theGulf of Mexico, would thatinsurancecompanybeabletowithstand the expectedinsuranceclaims?

If a terrorist attackoccurred and shut down abusiness for 60 days, wouldthey be able to make it out

unscathed?If theU.S.slipped intoa

multi-year recession (ordepression), would thebusiness have adequateliquidity on its balance sheettoweatherthestorm?

Understanding theliquidity of the balance sheethelps an investor determinethe amount of time it wouldtake for the business to payits short-term liabilities

(currentliabilities).Theratioswediscussedearlieraregreatfor the bigger picture of thebalance sheet. However,“really” understanding thecurrent assets on the balancesheetcanmeanthedifferencebetween survival andinsolvencyinmanycases.

Wewill touch upon thismore in the liquidationvaluation section in theMargin of Safety chapter,

however this will be a greatintroduction to the specificsof thebalancesheetandhowwe determine how quicklycurrent assets can beliquidated on the balancesheet. The balance sheet isalreadyorganized inorderofliquidity with the currentassets on top and the long-termassetsbelow.

Current assets includecash,accountsreceivableand

inventories. Long-term assetsinclude property, plant andequipment.Cash

Contrary to popularbelief, cash is not always asliquidasyouthink.

Businessisglobal.Manybusinesess produce salesoverseas in foreigncountries,and keep that cash in thecountry that earned the sales.

Theydothisinordertoavoidgood‘oleUncleSam(akathe“taxman”).Manybusinesseshavelockedthemselves in a cornerbecause they wanted to putthe cash to work during theperiod of growth in the U.S.from2009-2015.However, ifthey repatriated the cash toinvestintheU.S.itwouldbetaxed.

For example, in 2014,

Apple(AAPL)hadover$100billion in cash overseas.Apple would have to paytaxes of up to 35% if itwanted to use the cash forinvestments in the U.S. oreven for stock buybacks.That’swhymuchof thecashon businesses conductingbusiness internationally,should be discounted for thetaxesitwouldhavetopay.

Of course, Congress

seems to be setting up taxholidays to allow thesebusinesses to repatriate thecashbacktotheU.S.ataratebelow10%.So this could allbe a moot point, but it’simportant to recognizenonetheless.

U.S. businesses are alsotaking advantage of aloopholecalledtaxinversion,which allows them topurchase foreign

corporations, and thendomicile the U.S. basedbusiness in the foreigncountry. The foreign countryusually has lower corporatetax rates, which provides animmediate ROI to the U.S.basedbusiness.

Whether thosegainswillprove to be sustainable overtime, is a topic for anotherday. Corporate tax inversionseems to be the “craze”with

upper management andactivist investors in the U.S.right now.However, I’m nottooconcernedwithit.

Long-term, I do believeit’s bad business practice bythe leadership of the U.S.basedcorporations.However,I also understand why theyfeel they need tomake thosetypesofdecisions.

Like I said before,businessisglobal.TheU.S.is

“flat out” getting beat bybetter competition right now.The U.S. has one of thehighest corporate tax rates intheword,andasaresult it isleaving opportunities forother countries to attract bigbusiness. I guess it’s just thecost of doing business in acountrywithexcellentruleoflaw.

Eitherway, capitalism isa complex adaptive system,

andit’smybeliefthattheUSwillconformandadaptagainto become competitive withthe rest of the world. Taxinversion just seems like agreat deal of work to sneakaround and save a buck ortwo.Thereareeasierways…

BOTTOM LINE:Additional discounts to thecashonthebalancesheetmaybeneededifthecashisbeingused for upcoming

contractual obligations suchas the purchase of inventoryorproperty.AccountsReceivableAccounts receivable isconsiderably important forbusinessesthatsellgoodsandservicesoncredit.Inordertounderstand how quickly abusiness will be able tocollect its accountsreceivables, youwill need to

calculate receivablesturnover.

Thiscalculationprovidesthe time required to convertreceivables into cash. Thehigher the receivables ratio,the more advantageous it isfor the business. This meansthe business is collecting

payments more oftenthroughouttheyear.

Whodoesn’twant togetpaidmorefrequently,right?

Forexample,aratioof4tells us that the businesscollects receivables4 timesayear. In other words, it iscollected every 3 months.Businesses that are able toachievehigherturnoverratiosthan others in their industry,have a distinct advantage

overtheircompetitionfromacash flow standpoint. Thefaster a business collectspaymentsfromcustomers,thequicker itwillbeable topayforitsobligations.

Bydividing365daysbythe turnover ratio of 4, youareablecalculatethenumberof days it takes for accountreceivablestoturnintocash.

This is called the days

salesoutstanding(DSO).Thelower the number, the better.Thiscanbeextremelyhelpfulfor an investor trying todetermine whether thebusiness might face short-termliquidityissues.

In our current exampleabove,ittakes91.25daysfor

abusinesstoturnreceivablesintocash.Atthesametime,ifthe business had short-termdebtcomingduein45days,itcouldbeamajorproblemandcould lead to short-termliquiditycomplications.

Essentially the businesshas nomoney to pay for thebillsthatarecomingdue.

You can use the dayssales outstanding todetermineifabusinessisable

tomeetshort-termdebtissuesand avoid potential liquidityproblemswiththebusiness.

Inventory

Inventory turnover cangive an investor anunderstandingof how long ittakes for inventory to beturned into cash. This iscalculated by dividing theCOGSbyaverageinventory.

Thenwewanttoascertainthenumberofdaysittakestosellthe inventory. We get thatnumberbydividing365daysby the Inventory TurnoverRatio.

Inventoryturnoverisone

of the main ways a businessproduces revenue. Thismakes it a very importantasset,andonewemustknowvery well (especially wheninvesting in deep valueinvestments).

REMEMBER: If abusinessisunabletopurchaseinventory or doesn’t haveenough inventory on hand it

will lose potential sales.Conversely, too muchinventory for extendedperiods of time isn’t goodeither. There is a balancingact that must occur withinventorylevels.So,wewantto make sure management isdoing a good job withinventoryturnover.

Failing to off-loadinventory can lead to extracosts such as the product

becoming obsolete(electronics), the productdecreasing in price (oil andgas) and even having to paytostoretheinventory.Check The Long-TermLiquidityOfTheBusiness

It’smucheasier tomakea reasonable prognosis ofshort-term liquidity(compared to the long-term).Using the current ratio and

the quick ratio will helpimmensely in yourdetermination of the short-term liquidity needs of thebusiness.

However, over the longrun there are variables thateven debt-equity ratios couldneverpredict.

An investor would needtounderstandabusiness(andits industry) intimately inorder to reasonably predict

the financial strength ofhighly cyclical businesses attheir peaks and troughs.Ratios and other methodsused to evaluate the long-term liquidity of a businessarelessprecise.

Therefore, specializedknowledgeof thebusinessoritsindustryisideal.However,there are ways to makereasonable projections tolong-term liquidity, even

when you don’t necessarilyhave that specializedknowledge.

A business that usesforms of permanent capitalinstead of short-termfinancing to run its business,is likely to have better long-termliquiditythanmost.

For example, PershingSquare(AMS:PSH)raisedupto $2.7 billion in permanentcapital with its IPO on the

Euornext Amsterdamexchange. For those notfamiliar with PershingSquare, is the hedge fund ofMr.BillAckman.Personally,I have a tremendous amountof respect andadmiration forwhat he does and how heconductshimself.

Permanent capital is thedream of any business orinvestor. So I know he waschomping at the bit for this

opportunity.Thisiscapitalthathasno

margin calls, doesn’t comedueanddoesn’ttradeforlessdue to extraneous orexogenous events outside itscontrol. The ability to addpermanentequity toacapitalbase strengthens a balancesheet immensely. It canprovidesafetyand theoptionto take advantage ofopportunities that present

themselves.In 2009, Ackman did

impeccable work with hisinvestment in mall ownerGeneral Growth Properties(GGP) as itwas teetering onthe edge of bankruptcy.Ackmanhadalreadyinvestedasignificantportionofcapitalinto GGP, and he wanted toallocatemore.

There was a problemthough…

His investors werespooked by the recentfinancial and economic crisisand started asking for theirmoneyback.Asaresult,Billhadtokeepmorethan50%ofhisfundincashtosmoothoutredemption requests. Hewantedtoputmoremoneytowork in his best idea withGGP, however hewas hand-cuffed.

Fast forward to present

day, and GGP is trading at150timesthemarketvalueitwas trading at in 2009.Ackman still regrets notbeingabletoallocatemoretohisinvestmentinGGP.

FIG: 35 General GrowthProperties(GGP),2007-2015Full Disclosure: Heldpositions inGGPfrom2009-

2011. No longer holdpositions.

“I had one hand tiedbehind my back,” Mr.Ackman says. “In 2009, wewanted to go on theoffensive. But even thoughwewere up a lot that year Istill felt like we missed out.Because of the possibility ofmassive redemptions we hadtoholdtoomuchcash.”

Now with access to this

permanent capital, Ackmanwon’t have to feel held backwhenanopportunitypresentsitself.

This particularinvestment vehicle offersinvestors the ability to “ridealong” with a great capitalallocator in Bill Ackmanwhich has produced returnsover 20% per annum sinceinception. And it also offersinvestors better rates on

management fees comparedto that of his actual hedgefund(Iwonderhowhishedgefundinvestorsfeltaboutthat).

Permanent capital cancome from various sourcessuch as management makingopportunistic stock saleswhen stock prices areelevated (equity raise) orconverting debt to commonshares. The most favorablealternative to permanent

capital would be long-termdebt at very favorable rates(Costco).

Here are some quickcheckstohelpyoudeterminewhether a business haspotential liquidity issues onthehorizon:Is The Debt Recourse orNon-Recourse?

There only only twotypes of debt: recourse and

nonrecourse.An investor is interested

in non-recourse debt becausethis isdebt that issecuredbycollateralandassets.Itallowsthelendertopursueonlythatcollateral. It doesn’t put therestof thebusinessindanger(barring certain otherexigencies).

This can be veryimportant because instead ofan outright default with

potential legal and liabilityproceedings in the future, abusiness could simplyexchange the asset orcollateral to the lender inexchange for forgiveness oftheloan.As long as the asset isdeemedtobeanon-coreassetto business operations, thenthe business may be able toescape potential liquidityissues.

What are the LoanCovenants?

Loan covenants are thetermsof the loan.The lendertypically sets the terms, andthey are put in place bylenders to protect themselvesfrom the borrowing businessdefaulting.Ifabusinessdropsbelow certain ratios orthresholds set forth in thecovenants, the lender usually

has the right to call back thedebtfromtheborrower.

Thisisaveryrareevent.Unless the business isdestined for obsolescence orrattledindebt,thelenderandborrower typically adjust thecovenants or refinance theobligations.

Examples of loancovenantsinclude:

CurrentRatio>1.2

CoverageRatio>3Maximum dividendpaymentsCertain amount ofworkingcapital

Understanding the loancovenants set by lenders canbecrucialtoabusinessbeingeconomicallystressednoworin thefuture.Itcanbeasignthat a business is becomingfinanciallystressedif itnearscertain limitsor fails tomeet

the stipulations of thecovenants.WheretoFind:10K and other financialfilingsSearch: “loan covenants” /“loan”

What’s The Debt-MaturitySchedule?

Investors need to knowwhen certain debts and

obligations will be comingdue to adequately assess theliquidity riskof thebusiness.The ability to default or theinability to refinance is amajorrisktoabusiness.

Search for the debtschedule and ascertain whenthe dates are due. These arethe types of questions youshouldask:Are there big obligationscoming due soon or in the

next 2-5 years that will putthebusinessatrisk?

Will they be able torefinanceit,insteadofpayingit off (dependent on thebusiness’sfinancialhealth)?

Are the credit marketsfunctioningproperly to allowfor financing (circa2008/2009)?WheretoFind:10K and other financial

filingsSearch: “maturities” / “debtschedule” / “short-termdebt”/“long-termdebt”Are Interest Rates On TheDebtFixedorVariable?

Variable rates canwreakhavoconabusiness.

Investors shoulddetermine if the obligationsare fixed or variable becausevariable ratesaddanelement

of uncertainty during periodsofincreasinginterestrates.

Fixed rates give us abetter ability to plan forliquidityissues.

For example, Costcocarries over 90%of its long-term debt at very favorablefixed rates ranging from0.65%-5.5%.

WheretoFind:10K and other financial

filingsSearch Footnote titled :“Debt”/alsosearch“loans”So…Doesyourinvestmenthavea“Fortress”BalanceSheet?

Step5ofMECOM™:Management--Canyou

trustthem?

In 1960, a business wasbuilt from scratch by a manraised on a small ranch nearHaslet, Texas (northwest of

FortWorth).Hewouldgoontogrowthisbusinessthroughmultiple recessions into aglobalpowerhouse.

Over almost threedecades, he returned anoutstanding 20.4%compoundedannual return toshareholders (S&P returned8%)!!! During his tenure, heskillfullyrepurchased90%ofthe company’s sharesoutstanding. There is little

doubt; he will go down inhistory asoneof thegreatestmanagers and capitalallocatorsofall-time.

Have you guessed whothispersonisyet?

And no --- it’s notWarrenBuffett.

His name is HenrySingleton, and the companyhe built was Teledyne, Inc(TDY).

"HenrySingletonofTeledynehasthebestoperatingand

capitaldeploymentrecordinAmericanbusiness."WarrenBuffett

Singleton’s broad

strategywastwo-fold:

1) He would makeacquisitions usingcompany stock when its

pricewashigh.2) He would buybacksharesrepeatedlywhenthesharepricewaslow.Of course, this was

contingent on his ability toproperly choose the rightbusinesses and operate themefficiently.

So many individuals(professionals and amateursalike) try tomake something

that’sinherentlysimpleintoacomplexmatter. I used to doit all the time.And I still dotillthisday.

The human brain wantstomakeshortcuts,however,italso has a difficult timebelieving certain things canbe done simply. It looks forcomplexity. As humans wesometimes think it has to becomplex in order tounderstand.

We make it so hard onourselves sometimes bymaking simple situationsincredibly complex. We willsay things like, “It can’t bethateasy,right?

YesItCan.There is no shortcut to

successinanything.Talentisgiven to some people, butskillisacquiredthroughworkethic.This doesn’tmean thatyou can’t use simple models

andconceptsinacquiringandexecuting on that skillthough.

“Ifonetookthetop100

businessschoolgraduatesandmadeacompositeoftheirtriumphs,theirrecordwouldnotbeasgoodasthatof

Singleton,whoincidentallywastrainedasascientist,notanMBA.Thefailureof

businessschoolstostudymen

likeSingletonisacrime.Instead,theyinsistonholding

upasmodelsexecutivescutfromaMcKinsey&Companycookiecutter."

WarrenBuffett

Singleton was anincrediblysavvymanagerandoperator.Whenhisstockwaspricey (40+ times earnings),hewouldessentiallyuseitasa currency to acquire

generally sound businessesselling at low earningsmultiples. When his stockwas selling at low multiplesto earnings, he wouldaggressivelybuybackstock.

Nothing in the world iscertain. However, by usingthis simple strategy, it seemshighly probable that goodthings will happen over thelong haul. When it was allsaidanddone,hereducedthe

share count more than 90%.He repurchased stock in the$6 per share range in theearly70s.Thestocktradedatmore than $400per share bythelate80s.

Itproveshowabusinesscangrowbygettingsmaller.

"Americanbusinessisstillgrippedwithamaniaforbigness.Companieswhosestockssellforfivetimes

earningswillthinknothingofgoingoutandpaying10or15timesearningsforanicebigacquisitionwhentheycouldtenderfortheirownstockathalftheprice.Shrinking--àlaTeledyne--stillisn'tdoneexceptbyahandfulofshrewdentrepreneurialcompanies."

HenrySingletonThetopicofmanagement

begs the question then, “Do

you bet on the horse or thejockey?”

As we discussedpreviously, you always wantto look for great businessesfirstandforemost.

“Goodjockeyswilldowellongoodhorsesbutnotonbroken-downnags.”

WarrenBuffett

However,wemustnever

forget that management isresponsible for the directionof the business. Essentiallywe are partnering with themanagement of the businessto invest our money.Management could make orbreakyourinvestment.

It only makes sense toseekoutandfocusonqualitymanagementteamswhichcanbestewardsofyourcapital.

Truth be told, most

investorsoverlookthehumanelement of operating abusiness. In a world ofalgorithms and quantitativescreens it’s easy for aninvestor to ignore thequalitative aspects ofmanagement quality.However,it’sthoseintangiblemanagement qualities thatcanusuallybe the reason forfuture success or failure ofthe business. Ignore the

quality of management atyourownrisk.

Remember, capitalism isa brutal arena. I don't knowaboutyou,butIwantthebestofthebestinmycorner.Evenif you find competitiveadvantages in a business,those competitive advantageswill be attacked. Theadvantages will be clonedovertime.

Ifyoudon'thavetalented

management in place tocontinually innovate andcreate value for ALLstakeholders, a seeminglyrisk-averse investment maynot look great anymore ifmanagement deterioratesyour supposed margin ofsafety.

As the investor,management works for you.Neverforgetthat.

As a person looking in

from the outside, it’simpossible to know everysingle thing that's going oninside the business. Thevariety of variables anddecisions that aremade on adaily basis ensures that youwill never know everythingaboutthebusiness.Andthat'sok. That's why we focus ononly the most importantfactorsforinvestmentsuccessin this book. Everything else

isjustnoise

“It’snotgiventohumanbeingstohavesuchtalentthattheycanjustknoweverything

abouteverythingallthetime.”

CharlieMunger

Thetrustofmanagementis vital for your investmentandemotionalstability.Thereare 5 main questions you

need to answer to help youpinpoint quality andtrustworthymanagers:

1. Whatismanagement'strackrecord?

2. Does managementhave an ownershipstakeinthebusiness?

3. Is managementincentivizedproperly?

4. Is managementkeeping costs under

control?5. Isthereagreatculture

withinthebusiness?We will go into each of

theseindetail.WheretoFind:LexisNexisDowJonesFactivaWallStreetJournalNewYorkTimesFinancialTimes

OtherTradejournalsInterview services: 60minutes, Charlie Rose Show,WallStreetTranscript.10Ks

WhatisManagement’s

TrackRecord?

"Ihavenousewhatsoeverforprojectionsorforecasts.Theycreateanillusionofapparent

precision.Themore

meticuloustheyare,themoreconcernedyoushouldbe.Weneverlookatprojections,butwecareverymuchabout,andlookverydeeplyat,trackrecords.Ifacompanyhasalousytrackrecord,butaverybrightfuture,wewillmissthe

opportunity..."WarrenBuffett

JonCorzinemadepartner

at Goldman Sachs in the

1980s as a government bondtrader. He was known inmany prominent circles as abrilliant man, and quicklymade his way up the ranksmanaging the entire bondtradingoperationatGoldman.

An unexpected rise ininterest rates in 1994 putmany fixed incomedepartments on the verge ofcollapse. Because ofsurmounting losses, this one

division at Goldman was adirect threat to its verysurvival. Goldman Sachssurvived, and instead ofletting Corzine ride off intothesunset,thepartnershipfeltit had to give him a raise toChiefExecutive!?!?

No one else knew thosepositions to the extent thatCorzinedid.Hewas thebestperson to unwind all theexcess risk that he put in

place from the verybeginning. Goldman couldnot losehimbecauseof theirexposuretotherisinginterestrates.

If you owe the bank$100,000, they own you. Ifyou owe the bank $100million, you own them,right…?

This financial aphorismringstrueagain.

Fast forward through

under-dealingsatGoldman,acoup of leadership atGoldman, and unremarkablestints as Senator andGovernor of New Jersey,Corzine landed the “headhoncho” position at MFGlobal (medium-sizedbrokeragefirm).

After his appointment toCEO in 2010, it didn’t takelong for his excessive risk-taking to take hold.

Ultimately, his bets onEuropean sovereign bondspushed the firm into chapter11bankruptcy.

*It’s important to notethat these bets were correctoverthelongterm.However,leveragedoesn’tgiveyoutheability to be patient.Impatienceandexcessiverisktaking (with leverage) aren’tqualitiesaninvestorlooksforintop-tiermanagers.

Up to $1.6 Billion incustomer funds were also“misplaced” in the finaldaysofMFGlobal.

How’s that for aninteresting corporate ladderride?

His triumph of failingforwardeventuallyledtohimbeing charged by theCommodity Future TradingCommission (CFTC) inconnection with MF’s

bankruptcy.Now, knowing his

history, would you haveinvested in MF Global withthis type of manager at thehelm?

That’s why we gothrough some basic researchon the management of thebusiness.

BOTTOM LINE: Thesmartest person in the worlddoesn't mean a great deal to

aninvestorifhe/sheisn'tableto convert that intelligenceintoreturns.Itisessentialthatyouascertainthetrackrecordof management to determinewhether they will be able tocontinueinthesuccessofthebusiness.

In Corzine’s case, therewereredflagsthatverybasicresearchwould’verevealed.

Hereare someareasyouwanttofocusontodetermine

whether management's trackrecord is acceptable forinvestment:Howdidthemanagergettotheposition?

Inorderforaninvestortounderstand a managementteam and its background,construct a time line of theCEO. We typically like tolook at the top 5 managersandtheboardofdirectorstoo.

Thatiscompletelyuptoyou.However, its imperative thatyouhaveanunderstandingoftheCEO’shistory.

You want to be able tomap out the professional lifeso you can easily seesuccessesand/orfailuresovertime. You want to go as farbackaspossible.Bioson thecompany’s website may notbe enough.Youmayhave towork a little harder to find

information. This shouldn’tbe toodifficultgiven theageof technology andinformationweliveintoday.

For example, I used acombination of articles,historicalproxystatementandWikipedia to compile thecareerofJonCorzine,shownbelow:

1975 - Begins working forGoldman Sachs as a bond

trader.1980-IsnamedapartneratGoldmanSachs.1994 – Makes risky betsthreateningGoldmansSachssurvival.1994-1999 - Chairman andchief executive of GoldmanSachs.1998–AttemptstopurchasedistressedLTCMfromundertheFedandtherestofWallStreet.

1999 – Loses a powerstruggle at CEOwith HankPaulsonleavesGoldman.1999 – Still makes ~$400milliononGoldmanIPO.November 7, 2000 - Iselected to the United StatesSenate.2001-2006 - United StatesSenator representing NewJersey.November 8, 2005 - Iselected governor of New

Jersey.January 17, 2006-January19,2010-54thGovernorofNewJersey.July 1, 2006 - Orders agovernment shutdown amida budgetary impassebetweenthestatelegislatureand his office. It ends onJuly8th.November 3, 2009 - Isdefeated in his re-electionbid by Republican Chris

Christie.March23, 2010 - Is namedCEOofMFGlobal.October 31, 2011 - MFGlobal files for bankruptcyafteritisrevealedthatmorethan $600 million ofcustomermoneyismissing.November4,2011-CorzineresignsfromMFGlobal.December 2011 - Corzinetestifies multiple times tovarious government

Committees, claiming hedoes not know where themissing customer moneywent.November 15, 2012 - TheHouse Financial ServicesSubcommittee on OversightandInvestigationsreleasesareport saying thatCorzine'srisky decisions led to thelossofcustomerfunds.April4,2013-LouisFreeh,bankruptcy trustee for MF

Global and former head ofthe FBI, releases a reportblaming the demise of thecommoditiestradingfirmonCorzine.April23,2013-LouisFreehfiles a lawsuit againstCorzineand two lieutenantsat MF Global saying theirrisky decisions led to thecompany's bankruptcy andthe improper use of theclient's money to cover

losses.November 5, 2013 - Abankruptcyjudgeapprovesarecoveryplanthatwillallowalmost 26,000 customers tocollect 100 cents on thedollar of a combined $1.6billion in lost investmentsfromMFGlobal.March11, 2014 - Corzine'syoungest son, JeffreyCorzine,31,commitssuicideinaMexicoCityhotelroom.

December23,2014-ANewYork federal court ordersMFGlobalHoldings topayrestitution in the amount of$1.212 billion, plus a $100million civil penalty for itssubsidiary'smisuseoffunds.

This is a very detailed

biography. If we had justused thebioon the companywebsite, we wouldn’t reallyhave an understanding of the

manager’s career andprevioustrackrecord.

By building this detailedtime line of a manager’scareer, an investorwillbeginto understand how themanager rose through theranks, who they worked forand the kinds of jobs theyheld. For example, Corzinemade his way through theranks from bond trader.Traders are typically short-

term oriented and have noproblemusing leverage.Thiscould’ve set off some redflags.

Thesearesomequestionsyou want to start askingyourself as you look at thetimeline:

1. Is themanager loyal?

Did they go from jobtojob?

2. Are there gaps in the

manager’s jobhistory?Ifso,why?

3. Whatisthemanager’sbackground?Marketing/Sales,Finance,Operations?

I typically pay a great

deal of attention to themanager’s proximity to allstakeholders (customer,employees, suppliers, etc.).For example, a CFO or

Treasurer that makes thejump toCEO is likely to nothave the background or skillset of dealing with thecomplexity of operating abusiness as a whole. Theextentoftheirexperiencehasbeen number crunching in acorner office. Do they reallyunderstand the business andtheneedsofallstakeholders?

WheretoFind:

HistoricalproxystatementsWhat is the Manager'sexperience with theCustomerbase?

An investor shouldtypicallyavoidmanagers thathave served customers in adifferent industry or havespent most of their careerdisplaced from the customerbase. This matters a greatdeal in retail and restaurant

type businesses whereunderstanding yourcustomers’ buying habits isessentialtothesuccessofthebusiness.Does theManager have anOperationsbackground?

Investors should becautious of managers thathave risen through thecorporate ladderand lack thenecessary operations

background. Typically,managers that have spenttheir careers in corporatetowers lack the day-to-dayoperations experience to leadthebusinessintothefuture.

Usually it'sacaseofnotbeing able to see the forestthrough the trees with thesetypesofmanagers.Theyhavebeen taught to see things acertainway their entire lives,so they are unable to see or

thinkoutsideofthatbox.

“Ifyouonlyhaveahammer,youtendtoseeeveryproblem

asanail.”AbrahamMaslow

If amanager that’s been

responsiblefortheaccountingof thebusinesssuddenlygetspromoted to CEO, how canwe know if that person can“really” operate the business

in the interest of multiplestakeholders?Typically,thesetypes of managers have avery a narrow focus of thebusinessbecausetheyviewitfrom a very specialized lens.And there’s nothing wrongwith that per se. But as theleader of the “entire”business,onemustbeabletoseethebiggerpictureinorderfor the business to growlongerterm.

Alex Taylor wrote agreat book about the declineof GM, Sixty to Zero: AnInside Look At The Collapseof GeneralMotors - and theDetroit Auto Industry. Hedescribes how GMs bestyears were when HarlowCurtice was leading thecompany. Curtice was aninnovator inhis fieldand ledGMasCEOfrom1953-1958.

Oddlyenough,hestarted

his career as a bookkeeper,buthequicklymadehiswayto the sales side of thebusiness. It was during thistime that he started to learnhow vehicle design createdthe ability tomarket and sellthe cars. He truly had anunderstanding of how thebusiness was operated andhowitcouldgrowbecauseheknew what buyers wereinterestedinthemost.

After Curtice's tenure asCEO, the accountants tookcontrol.Thesemanagersweremore concerned with cuttingcosts instead of finding thenext great vehicle design forconsumers. As you canimagine,yearsofthistypeofmanagement left GM inshambles and ultimately ledto its bankruptcy with amassivecapitalinjectionfromtheU.S.governmentin2009.

CFO type managerstypically have incredibleexperience, deep businessknowledge, and are great forrecommending and executingon mergers and acquisitions.The distinction lies in howthe manager is able to growthe business. CFOs typicallylookinward,whereasthebestCEOs focus outside of thebusiness to innovate. Thiswill ultimately lead to more

sales and customers if donecorrectly.

Every situation isdifferent. Sometimesinnovatorswillmakethebestmanagers.Othertimesitmaymake sense for a morefinancially-mindedCEOtobeincharge.

Ideally,aninvestorwantsa CEO with understandingandexperiencefromdifferentportions of the business (i.e.

Finance and Sales).Obviously these kinds ofmanagers are few and farbetween, but it doesn’tmeanwedon’tstayonlookoutforthatrareoccurrence.

Has themanager producedresultsbefore(orbeenpartoftheresults)?

As an investor you willhave to determine whetherthe manager has been a

successful operator of thebusiness. If a manager haspreviously lost money ordriven a company tobankruptcy, that’s obviouslya major red flag. Forexample, Corzine's resumeshould have been reasonenough for MF Global'sBoard of Directors toquestionhisabilitytoleadthebusiness.

John Malone, Chairman

of Liberty Media, is a greatcapital allocator, and rivalsWarren Buffet as one of thebest of all time. Althoughtheir styles differ somewhat,it cannot be denied that hehas created a tremendousamountofshareholdervalue.

Itgets tricky tocalculatehis returns because heessentially took a “vacation”after he sold his business,TCI,toAT&Tin1998.Inthe

first trackingperiodof1973-1998, he produced a CAGRof 30%. In the secondtrackingperiodof2006-2014,heproducedaCAGRofover30%again.

Quite impressive,wouldn’tyousay?

As thepreviousexamplehas showcased, it cannot bestatedenoughjusthowvitalitis to focus on a manager'sabilitytoreinvestexcesscash

flows at reasonable rates ofreturn. Great capitalallocations are few innumber. So when you findthem,makesuretotakenote.Keep them (and their topexecs) on your radar orwatch-list for potentialinvestmentinthefuture.Holdontothemfordearlife.

Management needs todecidehowitwillreinvestordistributeexcesscashflowon

a consistent basis. There areessentially only five ways amanagement team canallocateexcesscashflow:

1) Do nothing (hold cashonthebalancesheet)2)Buybackstock3)Paydividends4)Makeacquisitions5) Reinvest capital backinto the business (newlocations,expansion,etc.)

There is an important

distinction to be made heretoo. There is a differencebetween great operators andgreatcapitalallocators.

Typically you will haveone or the other in a greatmanager. In fact, the bestcapital allocators are usuallyremoved from theday-to-dayoperationsofthebusiness.

This gives them more

time and energy to focus oncapital allocation instead ofthe operations. Suchmanagers include JohnMalone(ChairmanofLibertyGlobal), Warren Buffett(CEO of BerkshireHathaway),BruceFlatt(CEOof Brookfield AssetManagement), Peter Carlino(CEO of Penn National),JamesTisch(CEOofLoews),Henry Singleton (CEO of

Teledyne) and Tom Gaynor(PresidentofMarkel).

Thesemanagerstypicallydelegate the day-to-dayoperations to a ChiefOperating Officer (COO).Thisallows themtofocusonthebiggerpictureofgrowingthebusinessandfindingareasofopportunity.

An investor that focuseson historical decisions suchas acquisitions and buybacks

will have a tremendousunderstanding of how amanager makes capitalallocation decisions.Answeringquestionssuchas:

Does the manager makebuybacksathighmultiplestocash flow or buyopportunistically when theyarebelowintrinsicvalue?

Does the manager makeacquisitionsathighmultiplesto cash flow and book value

or buy when they are pricedlowerforbetterROI?

Forexample,JimSinegal(CEOofCostco)isrenownedfor being very shrewd andsavvywhenhemakescapitalallocation decisions. Onedecision that sticksout is hisdecision not to enter therapidly growing Chinesemarket.

Almost every other bigretailer is entering China as

quickly as possible. Andmanyofthesebigretailersarehaving a very tough time inChinarightnowbecausetheydid not understand theChinese market, and itsculture very well. The pull-back in China’s retailspending was a big red flagfor Costco. As a result, theytook a “wait and see”approach.

Costco’s capital

discipline is incrediblyconservative. They neverwant to stretch managementtoo far where they can’t dobusinessthewaytheychooseto run it. Costco’s feeling isthat China will always bethere. So there’s no rush tojump in if they believe theywill be over-extendingthemselves and theircompanyculture.

HowmanyCEOswould

be willing to wait on thesideline while theircompetitorswere entering anemerginggrowthmarket?

Notmany.This speaks volumes to

the discipline of Costco, andthe types of decisions theymake on a consistent basis.This is a business you cantrust to be stewards of yourcapital.

As mentioned earlier,

there aren't that many JohnMalone'sandJimSenegal'sintheworld.Theydoexist,butthey’re certainly few and farbetween. But therein lies thebeauty.

Becausetherearesofewgreat capital allocators in theworld, you can find themquicklyandeasily.Theywillstand out by their consistentreturnsoncapital.

Quick Tip: By focusing

on managers with provenconsistentreturnsoninvestedcapital (ROIC) and return onequity (ROE) you canpinpoint great capitalallocators.WheretoFind:10-K

DoesManagementActAsAnOwner-Operator?

Ifmanagementandtheboardhavenomeaningfulstakeinthecompany–atleast10to20%ofthestock–throw

awaytheproxyandlookelsewhere.”

MartinSosnoff

"Acting" as an owneroperator doesn't mean themanager needs to be thefounder/owner.

It means that themanager (owner or not) actsin the best interest of thebusinessasiftheyownedtheentire company. An investor

wantsmanagerswith“skininthe game” or that haveincentives that line up withshareholders.

Typicallythesemanagershave the followingcharacteristics:

EntrepreneurialmindedOwnalargestakeinthebusinessBuy stock and

businessesopportunisticallyPay dividends whenthere are noopportunities forinvestmentProduce reasonablerates of return oncapitalTake a long-termperspective on thebusinessPassionate about the

businessEquate personalsuccess with thesurvival and growthofthebusinessInterests alignedwithshareholders

BelowIwillelaborateon

someof theareasyoushouldfocusonthemost:Are the managers

increasing their ownershipstakeintheBusiness?

Investors should alwayslook for managers thatmaintain or increase theirownershipinthebusiness.

I don't know about you,butifI'mgivingmymoneytosomeone,Iwanttomakesuretheyhaveavested interest inthe future success of thebusiness. For example, thesemanagers have kept or

increased their stakes duringtheirtenures:

Henry Singleton,Former CEO ofTeledyneWarren Buffett,CEOofBerkshireJimSenegal,CEOofCostcoDave and SherryGold, founder of 99CentOnlyStores

Bruce Flatt, CEO ofBrookfield AssetManagementJohn Mackey, CEOofWholeFoodsJeff Bezos, CEO ofAmazonCarl Icahn, CEO ofIcahnEnterprisesJeffrey Katzenberg,CEO ofDreamWorksAnimation

There are a number of

reasons someone may sell astock, but there’s only onereason to buy a stock -- youthinkit’sgoinghigher.

Investors can usewww.insidertrading.org tofind insider trading activity.Note how the shares wereacquired (direct purchases oroptions),andiftheownershipinterest is increasing or

decreasing.It's ok if the manager is

selling small or scheduledportions of their ownershipstake. However, it's time topotentially worry when amanager begins to dump asignificant portion of theirownershipinterest.

It's important to weighthe ownership stakecomparedtothatperson'snet-worth. A manager who buys

$1millionworthofstockandisworth$100million, isn't agreat indication that thismanagerhasconvictioninthebusiness's future. Anythingfewer than10%ofaperson'stotal net worth invested in abusinessisjustnoise.Examples of strong insiderbuying indicators bymanagersandinvestors:

In 2012, Dan Loeb

(ThirdPointLLC) purchasedup to 73 million shares inYahoo (YHOO) making himthe largest outsideshareholder (6%). Theposition represented around15% of his investmentportfolio. He initiated anactivist campaign on thebusiness because of itsunderperformance.Hepushedfor a new board of directorswith relevant industry

experience and properalignment of the board withshareholders.

He also believed thebusiness was significantlyundervalued with aconservativesum-of-the-partsvaluation around $20 pershare. His cost basis on thestock was around $13 pershare.Hesoldthemajorityofhis position at $29.11 pershare.

Whenever you see anactivist investor acquiringsignificantportionsofhis/herportfolioinasinglestock,it’sa strong buy signal if thebusinessistradingwellbelowitsintrinsicvalue.

FIG 36: Yahoo (YHOO)Chart,2010-2015

In early 2000, JamieDimonboughtsharesinBankOne before he officiallyjoined the bank. His stakewasalmost$60millionofhisown money. When he wasasked why he made such alargepurchase, his replywassimple: he felt that a CEOshould “eat their owncooking.” And I couldn’t

agree more. The stock was~$30 per share when hejoined the company. By thetimeBankOnewassoldtoJPMorgan in 2004 it wastradingat~$50pershare.

In early 2012, BillAckman (Pershing Square)initiatedanactivist campaignagainstCanadianPacific(CP)by purchasing 14.2% of thebusiness. The stakerepresented ~16% of his

portfolio.His reasons for theactivist campaign were thepoor operating performance,poor strategic decisions, andbalance sheetmismanagement.

He believed newmanagement could act as acatalyst to convergewith thebusinessestrueintrinsicvalueof~$140pershare.

FIG 37: Canadian Pacific(CP),2010-2015

In late 2013, Carl Icahndisclosed Apple (AAPL) asthe largest position in hisportfolio outside of hisholding company. Hebelieved the company wasmismanaging its capitalallocation, and needed to putitsamplecashsupplytoworkby repurchasing its ownshares.

“I’m not against themanagement of thiscompany,” Icahn says. “Butthey’ve just got too muchmoney on their balancesheet…Appleisnotabank.”

FIG 38: Apple (AAPL)2010-2015

Examples of strong insidersellingindicators:1) If you see an insidercontinuing to sell theirownership stake as thestock continues to drop --be very cautious. Forexample, Borders Group(BGP) saw majorshareholders and officers

sellingsharesevenasstockpricesdroppedfrom$25to$13 per share. Insiderscontinuedtosellsignificantportionsoftheirownershipuntil the companyeventually filed forbankruptcyinearly2011.2) If you see a largeownerormultipledirectorsof the business sellingsignificantportionsoftheirownership stake, it could

beasignalthattoughtimesare ahead. For example,from 1999 through mid-2001 29 Enron insidersbegan to sell significantportionsoftheirownershipstakes. During this time,17.3 million shares weresold for a grand total of$1.1billion.Ofcourse,thiswas right before theeventual collapse in stockprices, and the company

ultimatelyfilingforchapter7bankruptcy.

Are The Managers BuyingBack StockOpportunistically?

If a manager is able toopportunisticallybuybackitsown stock, it can drasticallydecrease the share count ofthe business. All else beingequal, this decrease in sharecount increases the value of

thebusinesswhilegiving theinvestoragreatpercentageofownershipstake.

As seen by HenrySingleton and the Teledyneexample, opportunistic stockrepurchases on undervaluedstocks can add incrediblevalue to the business overtime.

The number onedeterminate on the timing ofstock repurchases is its

relation to the underlyingvalue of the business.Typically, managementshould repurchase shares intheir undervalued stockduringtimesofuncertaintyorfear. Managers should becautious repurchasing sharesintheirstockwhenit'stradingathighmultiplestocashflowor during times of euphoriasuch as stocks trading atmulti-yearhighs.

There are two mainmotivations for managementrepurchasingstock:1) To takeadvantageofan opportunity the marketiscurrentlypresenting.2)Tooffsetsharedilutionfromissuingstockoptions.Let'sdiscussthisbelow.

How Opportunistic StockBuyBacksAddValue

Imagine an investor isinterested in making aninvestment. The stock istrading at $40 per share andshowscharacteristicsofbeinga high quality, long-termbusiness. Through furtheranalysis, the investor is abletoconservativelyestimatetheintrinsicvalueofthebusinessbeing worth $100 per share.During this time, themanagement team initiates a

sharerepurchaseprogramandpurchases20%ofitssharesatan average price of $50 pershare.

Theopportunisticactionsof the management teameffectively increased theintrinsicvalueofthebusiness10% to $110 per share ($50per share multiplied by 20%equals$10pershareplus the$100 per share). Themanagement team wouldn't

decreasetheintrinsicvalueofthe business with anypurchases above the intrinsicvalue. Management willcreate more value forshareholders the lower it isable to repurchase sharesfromtheintrinsicvalueofthebusiness (all else beingequal).

Undoubtedly, there arecritics who argue that stockbuybacks add no value to a

shareholder. Theirconclusionsmay lookcorrectwhen the data set is takenacross the entire spectrum ofall business that repurchaseshares.

“Thereisonlyone

combinationoffactsthatmakesitadvisableforacompanytorepurchaseits

shares:First,thecompanyhasavailablefunds--cashplus

sensibleborrowingcapacity--beyondthenear-termneedsofthebusinessand,second,findsitsstocksellinginthemarketbelowitsintrinsicvalue,conservatively

calculated.”WarrenBuffett

However, they leave out

one very important element:mostmanagersmakehorriblytimed share repurchases in

relation to intrinsic value.Some managers make sharerepurchasesopportunistically,and many make irrationaldecisions that causeshareholdervaluetoerode.

I fail to see howrepurchasing shares in asignificantly undervaluedbusiness with sustainablecompetitive advantagesdoesn't add value to aninvestor. I will humbly

disagree with the critics ofshare repurchases all daylong. Managers that makeopportunistic sharerepurchases in undervaluedshares will createextraordinary shareholdervalueoverthelongrun.The best way to determinewhether a business isopportunistic in its decisionmaking process is to look atits history. For example,

Berkshire Hathaway rarelyinitiates stock buybacksbecause it uses cash topurchase other business withbetterlong-termpotential.

However, the law oflarge numbers has caught upto Berkshire. In order forthem to grow at the rate thatthey once did, they wouldneed to acquire mega billiondollar companies that exhibitthe type of high quality

businesses they want toacquire.Thisonlyproblemis--- there aren’t that manybusinesses that meet thesequalifications. This is wherethe stock buy backs can addtremendous value toshareholders if doneopportunistically.

As a result, theyinstituted a share repurchasepolicy in 2011, to onlyrepurchase shares in

Berkshire when the stocktrades at less than 1.1 timesbookvalueofthebusiness.Itwas increased to 1.2 timesbookvaluein2012.Thistypeofpolicydoes two things foraninvestor:1) It tells the investorwhat a fair orundervalued price is ofthe business. It isimportantthatyouevaluate

theprice todetermine if itis in fact a fair orundervalued price for thebusiness. Don’t just takemanagement’swordforit.2) Essentiallymanagement is saying 1.2times book value is a fairvalue for the business. Iwould have to agree withthem considering thequality of businessesproducingexcess freecash

flow at very high returnsoninvestedcapital.3) The true value ofBerkshire at any point intimeisprobablyaround1.5to2timesbookvalue.AndBerkshire’s book value islikely to increase overtime, so this sounds like avery rational and logicalplanforshare repurchases.Most businesses andmanagers would be smart

and forward-thinking toinitiatesuchpolicies.4) Effectivelyactsasanarea of support for thebusiness to begin buyingitsownstock.Asyoucanseeinthefigurebelow(fig.37),Berkshire’s stockwasunderpressureandnearits52-week lows until theannouncementof thestockbuyback program.Berkshirewasonlyableto

purchase less than $100million in 2011 becausethatareaactedasassuranceto investors that Berkshirewas right behind them inpurchasingshares.Thiscanhave an enormouslypositive psychologicaleffectoninvestorswhoareswayedbythevolatilityofstockprices.

FIG 39: Bershire Hathaway(BRK.b)Chart,2010-2015

I think we’vementionedenough how important it isfor a manager to buy backopportunitically, but I can’tstress that point enough.Unfortunately, it’s a mistakethat managers make on aregularbasis.

For example, in 2011,Netflix’s (NFLX)management team openly

stated that their stockbuyback program was not“pricesensitive.”

Asaninvestor,thisistheexact opposite of what youwant to hear from amanagement team that issupposed to allocate capitaleffectively and efficiently.However,thisseemstobethenorm.

As you can see in thefigurebelow(fig.40),Netflix

achieved great successleading up to 2011 as theirsubscriber base increasedwith revenue and profitsfollowingsuit.Unfortunately,management felt they hadmore cash on the balancesheetthantheyneeded.

So, they initiatedasharerepurchase program, andbegan repurchasing sharesregardlessof thevaluationorprice paid. This is a clear

violation of a managementteambeingopportunisticwithsharerepurchases.

Netflix spentapproximately $200 millionto repurchase 900,000 sharesofstockatanaveragepriceof$221.90persharethroughthefirst three quarters of 2011.Managementwasveryproud,especially as the stock priceincreasedto$280pershare.

However, new price

increases to subscribers,future content issues, and aless than ideal internationalexpansion campaign rattledshareholders. Subsequently,share prices crashed from ahighof$280to$55pershareinthesummerof2012.

Management wasrepurchasingsharesinastockthatwaspricedforperfection,andas a resulthasvery littlemargin of safety. As we

know, stocks that are pricedfor perfection can perfectlycorrect violently and fasterthanyouthink.

If an investor did theirhomework, they would haveseen Netflix’s questionabletrack record of sharerepurchases. Between 2007and mid-2011, Netflixgenerated over $500 millionin FCF, yet they purchasedalmost $1 billion worth of

shares (mainly by issuingdebt).

This was not a soundpolicy,andquitetheoppositeofwhatwe look for in greatcapitalallocators.

It gets more interestingthough. Not only were theynot opportunistic with theirshare repurchase program.,they were also forced to sell2.86 million shares at$70/share in order to raise

$200 million for obligationcomingdue.Byrepurchasingstock at horrible prices tointrinsic value and during aeuphoric period, Netflix wasforced to raise capital atextremely bad terms andultimately cost shareholders~$1billion.

Managementconsistentlypurchased shares at highmultiples to cash flow, yetissued stock at lowmultiples

tocash flow.Not the typeofdecision making and capitalallocation we want aspartnersinourinvestment.

Imagine where thebusiness would be today ifmanagement was moredisciplined and opportunisticwithitscapitalallocationandshare repurchases. Wherewould the stock price betoday?

Of course, the future is

not dictated by the pastactions of management(however bad theymay havebeen). It’s helpful; but it’snever a panacea for makinghighqualityfuturedecisions.

Oddly enough, CEOReid Hastings is a greatoperator;however,heprovedhe had a lot to learn aboutcapital allocation. And it’seasy for us to judge hisdecisions from the outside

looking in. But he seems tobemuchbetterinhisstrategyforcapitalallocation.

As a result Netflix hascontinued it’s current growthtrajectory. Sometimes youcan learn a great deal fromyour failures, so it’simportantforinvestorstostayflexibleintheirdeterminationofthemanagementteam.

FIG 40: Netflix (NFLX),2010-2015

Anexampleofabusinesswhosemanagement teamhasmade many opportunisticpurchases is IBM. IBM’searningspersharefrom2006-2014grewatarateofalmost100%, while its net incomegrewatarateof27%.Asyoucanseefromthefigurebelow(fig.41), themain reason forthisdifferencewasbecauseof

the shares repurchases theIBMmadeduringthisperiod.Theshare repurchaseshelpedto lower shares outstandingfrom 1.553 billion to 995million over the same period(or36%).

Figure 41: IBMRepurchasingHistory from2006to2014

FIG 41: IBM Repurchasing,2006-2015

Had IBM notrepurchased any stock, theEPS would have grownminimally over this 9 yearperiod. Surely this wouldhaveresultedinalowerstockprice. However, as you cansee in the figure below (fig.42), IBM more than tripled(trough to peak) during thisperiod.

As you can see, gettingsmallertogrowworks!

FIG 42: IBM Chart, 2005-2015

Be Cautious Of Share BuyBacks Used To Off-SetOptionsDilution

Thebulkofan investor'sfocus should be on amanagement's decision andtiming of opportunistic stockrepurchases. However, aninvestormustalsoestablishifshare repurchases are beingused to offset options

dilution,andwhether there isenough left over to provideshareholder value. Aninvestor can create a tablelikethefigurebelow(fig.43),to see how stock buybacksarebeingusedtooffsetstockoptiondilution.

For example, Oracle(ORCL) openly uses stockrepurchases to reduce thedilutive effect of their stockoption plan. The average

amount of share repurchasesto offset options dilutionaverages 16%. This leaves84% for opportunistic sharerepurchases. So there’s stillplenty of room to add valueto shareholders withbuybacks even as it is beingpartially offset by optiondilution. Shares outstandingarestilldecreasing.

FIG 43: Oracle StockRepurchases vs. Issuance ofStock,2012-2014

Properly executed stockbuybackscreateatremendousamount of shareholder valueoverthelong-term.However,as we have shown, poorlyexecuted stock buybackprograms can erodeshareholdervalueaswell.

Aninvestorshouldfocusonthemanagementteamandtheir strategy for share

repurchases. Are theyopportunistic? Do they haveamplecashonhandforfutureoperations? Are theypurchasing at discounts totheirintrinsicvalue?Doesyourmanagerpossess

theadequatecapitalallocationskillsand

strategies?WheretoFind:

10-K -- search“StockPlans”/ “Repurchase of CapitalStock” / “IssuanceofCapitalStock”

ForTheLoveOfTheGame

“Welookthemintheeyesandask,‘Dotheylovethebusinessofthemoney?”

WarrenBuffett

As an investor you cansometimes overlook certainqualitativefactors.

Among these qualities ishow passionate the manageris for the business. If youthink about how are youmotivated in life, internalpassion and motivation isway more powerful thanfinancialincentive.

Now, don't get mewrong, as humans we are

incentivized by a greatmanythings. Money is certainlynear the top of that list formost. However, it's been myexperience that the bestmanagers are extremelypassionate about theirbusiness.

It's an important job ofan investor to weight how amanagerismotivated:moneyand power or growth andpassion?

Why should an investorcare about passionatemanagers?

In one word --Motivation!

When I hear the wordmotivationIthink“toughandhard working.” However,whatcomestomindthemostis they will do whatever ittakes for the business tosucceed long-term (within amoralandlegalframeworkof

course).If you talk to successful

businesspeopleandaskwhatmade them successful, mostwill say they love what theydo. They are incrediblymotivated tosee thebusinesssucceed long-term. They seethesuccessofthebusinessaspersonal success. This is avery powerful motivator inanyprofessionorbusiness.

“Attitudeofthebusinessisadirectreflectiononthe

leadershipofsaidbusiness.”LukasNeely

There is averypowerful

positive feedback loop thatexhibits itself with peoplepassionate about life orbusiness. These people tendbe happier, smile more andenjoy life.They bring a verypowerful life force that can

brighten the days ofindividuals. This can causepeople to like you more,societywillrewardyoumoreand the business will makemoremoneyeventually.

Managerswill do a poorjob of operating the businessand properly allocatingcapital if they are notpassionate about what theydo. Itcanbea laborious taskin trying to build a business

forthelong-term.Ifmanagersaren't motivated properly orgenuinely interested in thebusiness, how will they beable to see their strategiesthroughuntiltheveryend?

“…theonlywaytodogreatworkistolovewhatyoudo.”

SteveJobs

Passion turns intomotivation. And motivation

breeds a person withperserverance. And greatthings happen to peoplewhoexhibit perseverance whilelearning from theirexperiences.

SoHowDoYou IdentifyPassion?

Here are some questionsyou should ask yourself indeterminingwhether theyarein the business "for the loveofthegame":

1) Would the CEO sellthebusiness?2) Are the managerslifelong learners with anemphasis on continuedimprovement?3) Is philanthropy aboutattainingsocialstatusordotheygenuinelycare?4)Isitajoborcareerforthemanager?5)Arepublicappearances

importanttothemanager?6) Is the managermotivatedbythemoney?

Isyourmanagerinitfortheloveofthegame?

WheretoFind:Recent and historical articlesfromarticlearchivesLexis-NexisGuideStar

IsManagement

IncentivizedProperly?

Aswementionedbefore,passion motivates more thanmoney.However,itwouldbefoolish for us to ignore our

behaviors and how they areaffected by certain scenarios.As humans, we have apsychological bias towardsmaking decisions based onhowwewillberewarded.

In this case, an investorshould determine if themanager is incentivized andaligned properly with theinterests of the shareholders(all stakeholders for thatmatter).

Aninvestorshouldspendsome time reviewing theownership interest andcompensation ofmanagement. By reviewingthe proxy statement, you cangain an understanding of thecharacterandincentiveofthemanager and how they willmakedecisions.

Here are some areas aninvestorshouldfocusedontoascertain whether a manager

is focus on the long-term ofthebusiness:

1)Lookformanagersthattake little to no stockoptions and instead offeroptions to employees orotherstakeholders.2) Look for long-termperformance goals incompensationplans.3)Lookformanagersthatown a large percentage of

the business and take lowsalaries.4) Look for businessesthat require ownershipinterestinthebusiness.5) Look for restrictedstockandbonusawards.Here are some areas

whichcouldbe in conflict tomanagement being able toexecute on its job over thelong-term:

1) Be cautious ofbusinesses thatoffermajorequity grants toCEOs andothermanagers2) Be cautious ofmanagers that hold sizableamountsofstockoptions3) Be cautious ofmanagers continuallyselling large portions oftheir ownership interest inthebusiness.

4) Be cautious ofbusinesses that establishcontractsforemployees.5) Be cautious ofbusinessesthathireoutsideconsultants to help incompensationpackages.

Isyourmanageralignedwiththebusinesslong-term?

WheretoFind:10-K

IsManagementKeepingUnnecessaryCostsUnder

Control?

“Wereinvestedinourpeople,wereinvestedininnovation,

andwereinvestedinthevaluesofthe

company.”HowardShultz

There is a delicate

balance between cost-cuttingbecause it looks good onpaper, versus trulyunderstanding the secondorder effects of those cutsover the long-term.My wifeis a Senior Director ofoperations improvement atHospital Corporation of

America (HCA), so this is atopic that comes up quiteoftenintheNeelyhousehold.

We are usually inagreement with this topicthough:

Thrift is not a goodstrategy when the businessdoesn't spendmoney (invest)tobenefitallstakeholdersandtheirexperience.

I used to believe thateverycostthatcouldpossibly

be cut, had to be cut -- noexceptions. I look back nowandseethatIwasverynaïve.Over time I have come tobelievetherearesecondordereffects from trying to cutevery single cost in thebusiness. The best managersknowthisalready.

On the other hand,investinginthecorebusinesscontinually while cuttingunnecessary costs is best.

Thereisanenormoustrickle-down effect with significantpositivefeedbackloopswhenmanagers treat all theirstakeholders well, whilecuttingtheunnecessarycosts.

For example, if you’vevisited a Costco store, youwould say “What’s the bigdeal? There’s nothing toospecialwiththisstore.”Fromthe outside it may look“barebones” and basic, but

thereinliestheappeal.Theproductsinthestore

are stacked on largewarehouse-style pallets,which offers little visualappeal. However, this stylealso allows the customer toseemoreproductswhen theyvisit. They come into thestore to buy 3 months worthof goods, and they come outwith a flat screen TV andcasesofwine.

This basic layout of thestore allows them to cutunnecessary stocking andmarketing costs that thecustomer ultimately doesn’tcare about. Instead, Costcoinvests in things that benefitthe customer and make sureits customers find the lowestpricesongoods.

An investor shouldconsider it a red flag ifmanagement constantly

announces cost-cuttingprogramswithlittletalkofre-investment in thebusinessoritspeople.

For instance, retailerstypicallydecrease labor forceas a way to cut costs duringtimes of uncertainty. Theybelieve that this isoneof thebest ways to raise profitmargins. Their philosophy isoneofemployeesbeingacostthat can be minimized. This

type of cost-cuttingphilosophy can haveenormously negative trickle-downeffect.

Thinkaboutitthisway--managementdecides tomakelabor cuts. The currentworkers start to becomeworried and nervous, eventhough management hasassured them that there willbe no more layoffs.Employees are stressed and

customer service begins towane.Thiscausesoperationalissues in the stores, and thisleads to a decrease in repeatcustomers, which then leadsto a decrease in sales. Lowsales leads to another roundoflayoffs.It’savicouscycle.

For example, in 2008Starbucks (SBUX) wasforced to close 100unprofitablestores.Insteadoflaying off more employees

across their profitable stores,theymaintained thegenerousemployee benefits andcommitted more assets toemployeetraining.

They didn’t just searchforcost-cuttingthroughlabor.Theylookedforinefficienciesin the supply chain, supportand waste. As a result,customersatisfactionactuallyincreased in 2010 to thehighest level ever. The

earnings and stock pricefollowedsuit.Asyoucanseeinthefigurebelow(fig.44).

FIG 44: Starbucks (SBUX)Chart,2006-2015

Cost cutting the rightwayisvital.It’simportantforan investor to evaluate howmanagement is able tobalance the necessary costcuts with reinvestment ingrowth.Isyourmanagerkeepingcostsundercontrol?

WheretoFind:10-KRecentArticles

IsthereAGreatCultureWithinTheBusiness?

“Cultureisnotthemost

importantthing,it’stheonlything”

JimSinegal

Early in my investingdays, I would focus only onthings that I could measure.Mainly buying stocks at asignificant discount toquantitative values. If Icouldn’t see it on aspreadsheet --- I didn’t payattentiontoit.

However, the older Ihave gotten, I have come tothe belief that culture andhuman quality of a business

should be emphasized morein thedecisionofwhetherornottoinvestinabusiness(allelse being equal). I’ve foundit tobefareasier to invest ingreat businesses and partnerwith great people who haveinstituted a culture ofexcellenceandhardwork.

Because a business’sculture cannot be readilycalculated, it’s commonlymisunderstood and often

overlookedbythemajorityofprofessionals. As with mostthingsintheworld,ifitcan’tbemeasured in numbers, it’soften cast aside in theanalysisofabusiness.Ihopeto shed some light on thisvery important segment ofyourinvestmentanalysis.

Here are some areas tofocus on to determine thetype of culture in thebusiness:

1)Decentralizationinthebusiness.2)Businessismanagedtobenefitallstakeholders.3) Management isfocused on day-to-dayoperations and not a“masterplan”.4) Management is trulylong-termfocused.5) Employees are beingrecruited heavily from

competitors.6) Management isfocused more on thebusinessthanappearances.7) Management istransparent and clear intheir communication withallstakeholders.8)Employee/managementturnover.

Decentralization in thebusiness…

“Thereisafundamental

humilitytodecentralization,anadmissionthat

headquartersdoesnothavealltheanswersandthatmuchoftherealvalueiscreatedbylocalmanagersinthefield.”

WilliamThorndike

There’s an interestingintangible,culturecomponentwithin a business that is run

in a decentralized manner.Things get done quickly andefficiently because decisionsare being made in real-timeby those closest to thecustomer.

With decentralizedbusiness structures, there is alack of bureaucratic, top-down hierarchy with rigidstructures. Decentralizedbusinesses tend to makedecisions thatdirectlybenefit

thecustomerbecausetheyarethe closest to the customer.They have a betterunderstanding of what thecustomerwants.

A decentralizedmanagement structure allowsfor easier information flow,whichmeansbetterdecisionscanbemadeforthefutureofthebusiness.Someofthebestperforming stocks are setupin a decentralized manner

because of these numerousbenefits.

For example, Costcoemployees normally start atthe bottom, and for thatreason they understand thebusiness explicitly from theground up. Each of theirmanagers also gets to maketheir own decisions. Byletting the employee whosweeps the floor pick whichbroom to use, it means jobs

get done better and moreefficiently. Employees andmanagers both are happierand feel better aboutthemselves.“Wewouldratherhaveouremployeesrunningour

business.”JamesSinegal

Howard Schultz (Starbucks)also believes it is very wise

for store managers to makedecisions about that store. Iftrained properly, thesemanagers know what’s bestfor that store location, ratherthan the executive team thatis located 1,000s of milesaway (and in many cases,disconnected from the actualcustomers).Business is managed tobenefitallstakeholders…

“Paradoxically,thebestwaytomaximizeprofitsoverthelong-termistonotmakethem

theprimarygoalofthebusiness.”

JohnMackey

As an investor, we areconstantly focused on thingsthatwill increase shareholdervalueorbuyingatadiscounttointrinsicvalue.It’seasyto

forget that customer service,culture,andbenefittosocietyare the factors that will helpmost tomaxmizeshareholdervalueoverthelong-term.

Themaster book on thistopicisConsciousCapitalismby JohnMackey (co-founderof Whole Foods). ConsciousCapitalism is a term coinedby John Mackey. Thisconcept refers to businessesthat serve the interests of

ALL major stakeholders:customers, employees,investors, communities,suppliers, and theenvironment. Consciouscapitalismisamorecomplexformofcapitalismbecause itdoesn’tallowyoutofocusonjust one part of a businessoperation.

In thebook, his researchpartner, Raj Sisodia,showcases how the

businesses that practicedconscious capitalismachieved investment returnsof 1,025% over the past 10years, compared to only122%fortheS&P500.Beingmindful of these types ofcompanies can help aninvestor deliver superiorreturnsovertime.

“Long-termprofitsaretheresultofhavingadeeper

businesspurpose,greatproducts,customer

satisfaction,employeehappiness,excellent

suppliers,communityandenvironmentalresponsibility

—thesearethekeystomaximizinglong-termprofits.Theparadoxofprofitsisthat,likehappiness,theyarebestachievedbynotaimingdirectlyforthem.”JohnMackey

www.GuruInvestorEdge.com

&www.ValueInvestorConfidential.comare run entirely from thisconcept,andwegive10%ofour revenue every year tovarious non-profitorganizations. And we give50% of all book sales to theFamily Resource Center inmy hometown to helpstruggling families get back

ontheirfeet.We believe and support

this Conscious Capitalismmovement whole-heartedly,and believe that all greatbusinesses will survive andgrowthroughthepracticesofconsciouscapitalism.

Sohowdoyouidentify

thesetypesofbusinesses?Typically these

businesses have 4 maincharacteristics:

1)HigherPurposeThis means that a businessneeds to be about more thanjustmakingmoney. Throughthehigherpurpose,abusinesscan inspire, engage andenergizeitsstakeholders.2)StakeholderOrientationBy recognizing that a

business will only succeedand survive within itsecosystem.Itmustensurethatall of its stakeholders aretreated with the highestdegreeofservice.3)ConsciousLeadershipThese leaders embrace andunderstandthehigherpurposeof thebusinessand thevalueit can create for allstakeholders.

4)ConsciousCultureThese are the practices,principles, and values of thebusiness. It’s who thebusinessisandhowtheytreatalltheirstakeholders.

Whoknows…thiscould

bethetrueevolutionofcapitalism.Management is focused on

day-to-dayoperations–nota“masterplan”…

“Therehasneverbeenamasterplan.Anyonewhowantedtodoit,wefired

becauseittakesonalifeofitsownanddoesn’tcovernew

reality.Wewantpeopletakingintoaccount

newinformation.”CharlieMunger

What’s so wrong withmasterplansyouask?Isn’titessential for a managementteamtohaveastrategiclong-termplanforthefutureofthebusiness?

Inasense--Yes.However, we also know

from history and experiencethat a great many businesseshave been hurt by theirinability to be adapt to thesituation around them at that

onemomentintime.Theissueswithmasteror

strategicplansstemsfromthehuman brain deviating fromprior commitments. RobertCialdini wrote about the“commitment andconsistency principle” in hisbook, Influence: ThePsychology of Persuasion(highly recommend thisbook).

The commitment and

consistency principle simplystates that if a personcommits(orallyorinwriting)to something (idea or goal),they are more likely tofollow-through on thatcommitment because to dootherwisewouldbeablemishontheirself-image.

Charlie MungerdescribeshowIBMcameintoexistence without a masterplan during the Wesco 2004

annualmeeting.He states, “Look at the

guy who took over thecompany that became IBM.Atthetime,ithadthreeequalsized business: [a divisionthatmade]scales,likethoseabutcher uses; one that madetimeclocks (theybought thisforablockofshares,makinganobscure familyvery rich);and the Hollerith MachineCompany, which became

IBM. He didn’t know thiswould be the winner, butwhen it took off, he had thegood sense to focus on it. Itwasenlightenedopportunism,notsomemasterplan.”

“I happen to think greatcities develop the way IBMor Berkshire did. I thinkmaster plans do more harmthangood.Anyway,wedon’tallow them at Berkshire, soyou don’t have to worry

aboutthem.”

“Ourmainbusinessisnottoseewhatliesdimlyinthe

distancebuttodowhatliesclearlyat

hand.”ThomasCarlyle

The point of this section

is not for an investor todisregard all strategic andmaster plans. Simply, an

investor should be cognizantof historical or future biasesthat could keep amanagement team fromacting opportunisiticallywhenthesituationcallsforit.

Masterplansfailbecausewhen opportunity presentsitself, and it doesn’t fit withthe strategic vision of thecompany, then it isdisregarded as “non-strategic.” Management

teams that shut outopportunities that weren’texpected,willputthemselvesat a severe disadvantageagainst nimbler and moreflexiblecompetition.Doesyourmanagerfollowa“masterplan”?Orarethey

focusedontheday-to-dayoperations?

Management is truly long-

termfocused…

“Managementisallaboutmanagingintheshortterm,

whiledevelopingtheplansforthe

longterm.”JackWelch

Long-term planning and

goals shouldn’t be confusedwith master and strategicplans. Long-term planning is

the vision of the businesslong-term. Quarterly andshort-termresultsdon’tmeanagreatdealunlessitseverelyerodes the future of thebusiness.Theywillgladlygothroughthepainoftoday,fortherewardoftomorrow.

Inplanning for the long-term, these managerstypically never use hardfinancial figures todeterminetheir success long-term. For

instance, the business willseek to become the lowestcostproducertotheconsumeror seek to become thebusiness with the highestranking for customer servicesatisfactions.These are long-term plans that will directlyaffect the top and bottomlinesofabusinessifexecutedcorrectlybymanagement.

It’s better than reachingfor some arbitrary number,

whichcancauseamanagertodo things that jeopardize theculture and future of thebusiness.

Oneof the toughest testsa manager will face duringhis/hercareer is theability tosit still and do nothingwhileothers are gaining mightilyaroundyou.

For example, John G.Stumpf,CEOofWellsFargo,didn’tparticipate in the risky

and leveraged activity of hiscompetitorsastheywentafterpoorqualitymortgagebackedsecurities in hopes ofincreasingandmeetingprofitnumbers. Leading up to theeventual crash in 2008,Stumpf was questioned byWall Street and shareholdersfor being too conservative,and that theyneeded togrowin order to keep up with thecompetition.

Asweknow,Stumpfwasone of just a fewCEOswhomanaged to not onlymake itout of the chaos relativelyunharmed, but Wells Fargostrengthened its businessduring this time ofuncertainty.

Many of Wells Fargo’scompetitors threw out theircompany values and risk-management policies to hitnumbers that were part of

theirlong-termstrategicplan.Instead of seeing thesemortgagesforwhattheywere(trash),theyfeltitwasawayforthemtogettotheirmasterplan.

Stumpf was willing toforego an underperformancein earnings short-term,because he believed thatpurchasing these low-qualityassets weren’t part of WellsFargo’slong-termplan.

Ismanagement“really”focusedonthelong-term?

Employees are treatedincrediblywell…

This is another area offocus that can be a directwindowintothecultureofthebusiness.

In many businesses,employees are treated asshort-term commodities

instead of long-term assets.Just like great long-termassets, great employees needto be maintained andupgraded to maximize theirvalue.As we discussed previously,there is a positive feedbackloop from employee moraleandhappiness.

When employees are

passionateaboutthebusiness,andfeelliketheyarepartnerswith their managers, moraleand customer serviceincrease.Higher profits are abyproductofthisinthelong-term.

Here are some areas tofocus on to determine howmanagement treats itsemployees:

Employeesarepaidator near the top oftheirindustryEmployees receiveexcellentbenefitsEmployees aren’tlaid-off duringrecessions

Employessaretrainedextensively at theirpositionsManagement talksabout the employeescontributionsManagementhasverylow employee lowturnover

Doesthebusinesstreatits

employeeswell?

Management is transparentand clear in theircommunication with allstakeholders…

Youlookforthreequalities:integrity,intelligence,and

energy.Andifyoudon’thavethefirst,theothertwowillkillyou.Youthinkaboutit;

it’strue.Ifyouhiresomebodywithout[integrity],youreallywantthemtobe

dumbandlazy.”WarrenBuffett

The best managers

communicate to stakeholdersinaclearandconcisemannerthat is easily understood. Ifmanagement makes itdifficult to understand it’slikely theywant it to be thatway for a reason. Confusingand complicated financialstatements or press releases

should be a red flag forinvestors.

Accountable andstraightforward managementteams are incrediblytransparent. They normallyconfront adversity andmistakes head-on, leavingvery little room foruncertainty and speculation.These types of managersnevermake excuses, own upto the mistake and try to fix

the problem. There is littlewasted energy dwelling onthepast.

Truth and humility aretraits to be coveted in amanagement team. It goes averylongwayindeterminingthe character and culture ofthemanagerandthebusinessingeneral.

A trick to findingtransparent managementteamswould be to see if the

management team takesquestions for an extendedperiodoftimewhenquarterlyand annual reports arereleased. This shows thatmanagement wants to be asaccommodating as possible.ThereisverylittletohideinatrueQ&Asession.

Is management beingcompletely transparent in itscommunication with allstakeholders?

Ultimately, a business’sculture sets the tone for howemployees and managementinteract and treat thestakeholders they come intocontactwithonadailybasis.Determining a business’sculturecangiveaninvestoragood idea if this business islikely to continue providingvalue to its customers. Thiswill have a direct impact onthe success or failure of any

investment.Doesyourbusinesshave

greatculture?

In this section, we learnedhowto:1) Find businesseswithsustainable competitiveadvantages,2) Ascertain the “real”earningsofabusiness,

3) Pinpoint and identifycatalysts,4) Determinewhether abusinessestablishesproperdebtcontrol,and5) Determine whethermanagementwillbeagreatpartnerinyourinvestment.

Inthenextpartwewill learnhow to Master Your Marginof Safety (valuation andinvestment).

Let’sgetstarted!

PART5:MARGINOFSAFETYMASTERYIsThereADifference

BetweenPerceptionAndReality?

“Themarginofsafetyisalwaysdependentonthe

pricepaid.Foranysecurity,itwillbelargeatoneprice,smallatsomehigherprice,

nonexistentatsomestillhigherprice.”

BenjaminGraham

Ittooktwoyears,buttheconstruction of the 40-storyHyatt Regency Hotel inKansas City was finallycomplete. Everyone wasecstaticthatallthehardworkandperseverancehadpaidoffon building this remarkablestructure.

One of key definingfeatures of the hotel was thelobby, which showcased anatrium with walkwayssuspended from the ceiling.The walkways weighed~64,000lbs.andwere120ft.in length. Little did theyexpectthatdisasterwasabouttostrike.

On the evening of July17, 1981, the unthinkableoccurred:

The walkway collapsed,killing 114 people andinjuringmorethan200othersduringateadance.Itwasthedeadliest structural collapseinU.S.historyatthetime.

Constructiondeficienciesand calculations led to asmall, but flawed design thatdoubled the load on thewalkway leading to itsensuing collapse. The designcould barely hold the weight

of the walkway itself. Whenthe hundreds of spectatorsstood on the walkway, theirfatewasnearcertain.

Investment transactionsand decisions are eerilysimilar to the processes ofengineers. I have atremendousamountofrespectfor engineers and theirthought processes. Somaybeit’s just my way of hopingthatIcanbeputonthesame

platform of engineers. Eitherway, it is difficult to ignorethesimilarities.

Normally, engineersbuild in a significant marginofsafetyinanystructuretheybuild. If you are building abridge that will normallycarry15,000poundsacrossit,you insist that it can carry50,000 pounds for extrasafety.

The same rule exists for

investing. As investors, wealwayswanttomakesureweare buying at a margin ofsafetyfromtheintrinsicvalueofthebusiness.

Ignore the margin ofsafety principle, and yourinvestment could end up likethewalkwayinKansasCity.

Value investing entailspurchasing a security at adiscount from its currentvalue and then holding that

security until that value isrealized (or somethingchanges). Because we, asvalue investors, are alwayssearching out bargains, wehave built in the margin ofsafety principle into ourmental models already. Wejust need the discipline andthepatiencetofollowthroughonthestrategy.

No one wants to buy adollar for a dollar. We are

tryingtobuyadollarforfiftycents. Essentially, that’s allwe are trying to do asinvestors.Wedothisthroughconservative analysis of thebusiness.

However, there isanother feature to investingthanmerelyvaluingsecuritiesconservatively. This practicemust be combined with thepatienceand thediscipline topurchase that security at a

significant margin of safetyfrom the conservativevaluation.

There are times wherebargains are everywhere(consideryourself lucky) andthere will be times when itseemsyoucan’tfindanythingwith amargin of safety (andthatisok).

Themarginofsafetywillalso vary. Sometimes thedifference between price and

value is wide and there willbetimeswhenitisnot.Therewill be times when youresearch 10 businesseswithout finding a single onewithamarginof safety.Thisis part of the discipline andpartof theprocessof findingthebargainswithamarginofsafety.

Persistence is not onlythesecretof life,but it is thesecret of investing as well.

No one will tell you aboutthem.Youhavetogooutandfindthemyourself.

The very process ofvalueinvestingitselfmakesitaveryriskaversestrategy.Ofcourse this means nothing ifwearenotdisciplinedenoughto stay within the system.Beingavalueinvestormeansitwillbelonelyattimes.

However,youmusthavea streak of contrarianism in

you during certain periods ifyouare to succeed long-termatinvesting.Itishowitmustbe. It is the law of numbersthat if you are doing whateveryone else is doing, youwill revert to the average.Andwedon’twantthat.

If you run a focusedportfolio, performance maybebumpy from time to time.Thisneverbotheredme,butIknoweveryonehastheirown

thresholdforvolatility.I would rather a bumpy

rideof15-20%returnover15years,thanamediocre8%orless.Iamabletoremaincalmand see these types ofstrategies through because asvalue investors we knowstockprices tellusvery littleabout the performance of thebusinessoritsintrinsicvalue.

I will no doubtunderperform for certain

periodsof timeanditwillbedifficult to watch as othersrevelintheirglory.

However, I know fromexperience that valueinvesting through 5M™ willwork very successfully overthe long-term. Valueinvestingisbothpracticalandlogical. There are very fewthings I will never abandon:my wife & family and the5M™MentalModelofvalue

investing.Waiting For The FatPitch…

“Ininvestments,there’snosuchthingasacalledstrike.Youcanstandthereattheplateandthepitchercan

throwtheballrightdownthemiddle,andifit’sGeneralMotorsat$47andyoudon’tknowenoughtodecide

GeneralMotorsat$47,youletitgorightonbyandnoone’sgoingtocallastrike.

Theonlywayyoucanhaveastrikeisto

swingandmiss.”WarrenBuffett

WarrenBuffettisanavid

baseball fan and loves tousethe analogy of TedWilliamsto describe how an investormust have discipline to wait

fortherightopportunity.Just as great hitters like

Ted Williams had infinitepatience towait for the rightpitch,somustvalueinvestorsbe willing to wait until theright opportunity when asecurity is trading at asignificant discount to itsunderlying value. The bestpart about investing is thatthere are no called strikes.You canwait as long as you

like for the right pitch andthenswingaggressively.

Investing within yourcircle of competence isobviouslyessentialaswell.Ifyou cannot understand abusiness or have a difficulttime valuing it, then walkaway.Throwitinthegarbagebin,andmoveon to thenextopportunity.

There is no shame inknowingwherenot to invest.

Infact,itmaybethebesttraitas an investor. Most valueinvestors shy away fromtechnology companies andfinancial services businesses.I for one, feel I have a verygood understanding of a fewtechnology and financialservicesbusinesses,soIhaveno trouble investing in thesebusinesses if given the rightopportunity.

The great thing about

beingavalue investor is thatyou do not need to be fullyinvested all the time. Mostinstitutionalinvestors(eveniftheyarevalueinvestors)havean obligation to theirinvestors tobeinvestedatalltimes.

This puts an enormousamount of stress on aninvestor to have to swing atpitchesyouhavenobusinessswingingat inthefirstplace.

Likewise for amateurinvestors, they will swingwildlyatpitchesbecausetheycannot discern a good pitchfrom a bad one. Thispropensity to constantlyswingwildlyatpitchesis thenorm in the stock market.Thisiswhysomanyfabulousopportunities can presentthemselvesatanymoment.

"...that'sexactlythe

philosophyIhaveaboutinvesting...Waitfortherightpitch,and...waitfortherightdeal.Anditwillcome...It's

thekeytoinvesting."WarrenBuffett

If you are not “really”

compelled by an investmentopportunity,there’snoreasonto lift that bat off yourshoulder. It needs to justjump out at you. And after

knowing what greatinvestmentopportunitieslooklike, you will know whenthese kind of situationspresentthemselves.

Never invest just for thesake of investing. You needtohavesomeinklingofwhatyou are doing. 5M™ andMECOM™ Method helpwiththis.

Even the cheapestsecurity in an overvalued

market can be a badinvestment, if you believethat it could become muchcheaper if the marketcorrects. So it’s important toweigh all options in yourcurrentenvironment.

OpportunityCost…

“Abirdinthehand,isworth

twointhebush.”Aesop

Asaninvestoryouknow

youmust buy at a price thatyoubelieveisadiscountfromtheunderlyingvalue.

Butwhathappensifthereare multiple bargains at thesame time? How do youdistinguish which ones offerbetter value than the otherones?Do I invest in the onetrading at 60% of theunderlying value or the one

that is trading at 30% of theunderlying value? What ifone of the investments has agreater probability of valuerealizationthantheother?

This is the ongoingquandary that an investormust face as they search outopportunities andinvestments.

And the best absolutevaluemaynotalwaysbeyourbest investment choice. As

focused value investors, wewant no more than 10-15investments in our portfolioatanyonetime.Asyoubuildup to that number ofinvestmentsinyourportfolio,everydecisionyoumakewillbe based on whether it’s abetter investment incomparison to any of yourcurrent holdings. This isopportunity cost at its finestinaction.

With every investmentdecision youmake youmusthave an understanding of theopportunity cost. Greatinvestors only think inopportunitycosts.

Constantly comparingnew investments with yourownpositionsinordertofindthe best portfolio ofundervalued businesses isgreat investment practice.Asan investor you shouldnever

be scared to scrutinize andcritique your currentholdings.

Themostdifficultpartofthisprocess is sellingcurrentpositionsatalossbecausethenew investment offers bettervaluerealization.However,inmyopinion,thisisasignofagreat investor. One that isboth rational and un-emotional when it comes tomakinginvestmentdecisions.

For example, I wentthroughthisexactscenarioinlate 2011/early 2012. Duringthis time, I wanted to knowmore about the oil and gasindustryand its fundamentalsand industrydynamics. I hadjustcompletedagreatdealofresearch on the natural gassector, and was interested inthe industry’s futurepotential.

All that was left was

picking a likely long-termwinner in the group. Despiteits current issues, thecompany that I believed hadthe biggest risk/rewardpotential over the long-termwas Chesapeake Energy(CHK).

After going through my5M™ and the MECOMMethod, I knew this was abusiness Iwanted toown forthelong-term.WhenIfinally

made the decision to startaccumulatingaposition,Ihadsome decisions tomakewiththerestofmyportfolio.

“Anyyearthatpassesin

whichyoudon'tdestroyoneof

yourbestlovedideasisawastedyear.”

CharlieMunger

After much deliberation

(with myself), I made roomfor Chesapeake by selling agreat deal of my portfolio.Mainly investments at (ornear) my calculated intrinsicvalues, or investments thathad probable risk/rewardscenarios less thanChesapeake’s.

Butthemostpainfulpartwas selling certaininvestmentsatalosstomakeroom for my investment in

Chesapeake. These positionswere sold even though I stillbelieved they would makegreat investments long-term.However, I felt Chesapeakeoffered better potential long-term.

Chesapeake comprisedover 20% of my portfolio atone point. These are thetough decisions that must bemade at times to achievesuperior absolute returns.No

one investment should be‘untouchable’ if a betteropportunitycomesalong.

BOTTOM LINE: Aninvestor must maintain afocused discipline to thevaluation process whilecomparing opportunities toyour current holdings. Thismust be done whenopportunities are scarce, aswell as when they areplentiful. Being honest and

conservative through theentire valuation process canbe a difficult endeavor whenopportunities are scarce. Soinvestors must stay true tothemselvesandtheirprocess.

If you remember, in thelastsectionweexplainedTheMECOM™Method,andhowitprovidesa simple, step-by-step method for analyzinganybusiness.

Since you now have

masteryofTheMarket,YourMindset, Your Morals andTheMECOM™Method, wewill now dive into detail onMastery of Your Margin ofSafety.

Inthispart,wewilllearnhowtovalueabusiness.

By the end of this partyouwillknowhowto:

1) Practice the Art ofValuation

2) Usearangeofvaluesin your calculation ofintrinsicvalue3) Use discounted cashflowvaluation(DCF)4) Use liquidationvaluation(LV)

TheArtofValuation

"Organizedcommon(oruncommon)senseisan

enormouslypowerfultool.Therearehugedangerswithcomputers.Peoplecalculatetoomuchandthinktoo

little..."CharlieMunger

Let’s get this very

important concept out of thewayrightnow:youwillneverknow ALL the facts andfigures that will lead to thebest investment result. It’sinherentlyunknown.

Many investments arereliant on outcomes that arenot fullyknownorpredicted.

Comingtogripswiththefactthat you won’t knoweverything about a businessbeforeyouinvestcanbeverydifficult for many investors.This iswhy it’s so importantto have a mental model ofchecklists that help you zeroin on the most importantvariables to investmentsuccess.

So how can youaccurately value a security

then?Well the simple answer

is you can’t value anysecuritywith100%accuracy.The best you can do iscarefully and conservativelyvalue securities if you are totruly achieve a margin ofsafetyoverthelong-term.

This is where manyinvestorsgive-up,andrunforthe hills. Don’t stress.Conservative templates for

valuation are provided in thefollowing pages, and at theend of this book. These willgiveyouabaselineonhowtovalue businesses using arange of conservative valuesandoutcomes.

Even if you kneweverything about a business,it wouldn’t give you theability to value that businessperfectly. It is virtuallyimpossible. Investing would

be much easier if businessesmoved in a static andpredictable manner over thelong-term,but thiswillneverhappen.

Businesses within acapitalist system are verydynamic and constantlychangingandevolvingduetocompetition.Thebestyoucando as an investor is toapproach valuation of abusinessinaverysimpleand

conservativeway.There are three major

factors that can causebusiness values to fluctuatewildly because of forcesoutside the operation of thebusiness:

1)InterestRates,2) Trends InInflation/Deflation,and3)CreditCycles.

1)InterestRates:

An interest rate isessentially the cost someonepays for the use of anotherperson’s money. So thefluctuations in interest ratescan greatly affect thebehavior of consumers andbusinesses. This willultimately affect the stockmarketanditscomponents.

Typically, lower interest

ratesmeansmore borrowing,which means people havemore money to purchasethings.Whichmeans inflatedprices.

Typically,higher interestrates mean less borrowing,whichmeanspeoplehavelessmoney to purchase things.Whichmeansdeflatedprices.

It’simportanttonotethatthereisusuallya“lag-effect”tothetimingof thescenarios

above. Normally, there’s anunderlying cycle associatedwithinterestratesthatisverysimilartocommodities:

High prices tend to leadtolowprices.Andlowpricestend to lead to high prices.Thetimingisthemainissue.

For example, if interestrates begin to decrease fromhighlevels,it’slikelythattheeconomyandconsumeraren’tdoing as well as previously

thought. It could be a signthatvaluationandassetpricesare fully valued. Conversely,if interest rates start tostabilizeorincreasefromlowlevels,it’slikelytheeconomyand the consumer are doingbetter thanexpected. It couldbe a sign that valuation andasset prices are undervaluedorstable.

As we will discussshortly, interest rates effect

the discount rates for theDiscounted Cash Flowcalculation.2)Trends in Inflation /Deflation:

Inflation / deflationtrends can have a drasticoutcome on the value ofbusinesses.

During an inflationaryenvironment,investorscandoverywell.Thinkaboutit--as

valueinvestorswearealwaystrying topurchasefuture freecash flow or assets at adiscountedvalue.Ifthevalueofgoodsandservices,aswellas tangible assets increaseover time (which they morethan likelywill), youwill bein a great position and itaffords you an even greatermarginofsafety.Realestate,as well as variouscommodities,tendtoincrease

overtimewithinflation.Thus,ifyouarebuyinga

business that is trading at a60% discount from itstangible book value, yourmargin of safety could begreater if you expect aninflationary typeenvironment. Of course, it’sduring such periods ofinflationthatmarketfollycantakeoverand the reptilianoranimalbrain takesover.This

iswhy it’salwaysprudent tovalue securities in a veryconservativemanner.

Personally, I have foundinteresting opportunities incompanies that are tradingbelow tangible book values,butalsohaveanaddedkickerin the form of “hiddenassets.” Peter Cundill, in hisbook There’s AlwaysSomethingtoDo,talksopenlyabout investing in securities

with hidden assets. Hisapproach intrigued megreatly, and I highlyrecommend the book.Althoughmy philosophy hasshifted more to greatbusinesses at reasonableprices, I continue to searchout hidden assets to providean even greater margin ofsafety.

During deflationaryenvironments, assets and

markets tend to decrease invalue.Sobuyingasecurityata60%discountfromtangiblebookvaluemaynotgiveyouthe margin of safety youexpectifassetsaredecreasingin value. Of course, thisdependsonhowtheassetsarerecognized on balance sheetaswell.

In deflationary times,thesehiddenassetscaneasilybecomeimpaired.Realestate

carriedonthebalancesheetathistorical cost coulddecreasebelow historical cost, overfunded pensions can beeroded and subsidiarieswithin the parent companycan encounter difficultbusinessenvironmentsduringadeflationaryperiod.

Aprolongeddeflationaryenvironmentcanwreakhavocon the market. This isnormally an investor’s worst

nightmare.This is always a

possibility as an investor.Anythingcouldhappeninthemarkets at any time. In amanner of speaking, aninvestor should expect theunexpected.

The best case scenariosfor long-term investors arebouts of deflation. It is notfun to be in the middle of adeflationary market

environment.Noonewins ina deflationary environmentshort-term.

However, it’s duringthese periods that investorscan accumulate positions ingreat businesses at incredibleprices.Theonlywaytoinvestduring deflationaryenvironments is with asignificant margin of safety,and even then it may not beeasy.

This is the essence ofvalue investing. We have tocome to grips with the factthat there are many thingsthatwewillnotknowwhenitcomes to investing. Are weentering a period ofinflation/deflation? Howlarge should the margin ofsafety be in an inflationaryenvironment versus adeflationaryenvironment?

Thereisnohardfigureor

answer to these questions. Ifyou believe there could befurthererosioninprices,thenmaybe you want a greatermarginof safety.Maybeyoulet more opportunities go bybecause you feel you mayhave better opportunitiesdowntheroad.

Therearemanyquestionsto which the answers areunknowable.

The only prudent act of

an investor is to performsecurity valuation in a veryconservative manner. Givepreference to liquidationvalue (worst case scenario)and then free cash flow.Specifically, you wantbusinesses trading belowliquidationvaluewithhiddenassets.

These are more of your“activevalue”or“cigar-butt”typeof investments,however

theyyieldaverylargemarginof safety because they aretrading as if the business isdead. Even if the business isdead, you can still reapinvestment gain because ofthemarginofsafety.

Next, you givepreference tobusinesseswithsustainable competitiveadvantages that produce freecashflow.Thesearethehighqualitybusinessesthatwillbe

able to withstand prolongedperiodsofdeflationaryforces(andinflationarytoo).Infact,many of these businessescome out better in the longrun because they are able toincrease market share aslesser quality businesses endupinsolventorboughtoutbythehigherqualitybusinesses.

This is another reasonwhy theMECOM™Methodfocusessomuchoncatalysts.

The ability to invest inbusinessesthathavecatalysts,helpsincreaseyourmarginofsafety and bring about valuerealizationoverashortertimeperiod. In a deflationaryenvironment, this can meanthe difference betweensuccessandfailure.

BOTTOM LINE: Neverrelax your conservativestandards of valuation, andalways insist on a wide

marginofsafety.Practicethisin any environment, and youwill certainly be betterprepared than your peers.Over the long term, it willserveyouwell.3)CreditCycles:

Credit cycles dictate theamount of available creditthat enters the market. Thetightening of credit (lesscredit)candecreasevaluation

andmarketlevels.Theeasingof credit (more credit)availability can help toincreasevaluationandmarketlevels. In a sense, creditcyclescangiveyouanideaofthepsychologicalstateof themarket as well. See thesimplified credit cycle below(fig.44).

FIG 45:SimplifiedMarket /CreditCycle

It’s important tohaveanunderstanding of potentialinflection points in a creditcycle.Youneedtobeabletoknowwhereyouare:areyouin a period of tighteningcredit, or are you in anenvironment of easy credit?Nextyouneedtoaskwhetherthatenvironmentwilllast.

Generally, buyers are

willing to pay highermultiplesiftheyreceivelow-rate financing (nonrecourse).Of course the paying ofhigher multiples with easycredit can lead toovervaluation, potential follyand irrationalbehavior in themarket place. Credit cyclesarearesultofthefed’sfiscalpolicyregardinginterestratesandthebanks’abilityto lendthatavailablecredittoworthy

borrowers.Howard Marks, founder

of Oaktree CapitalManagement, discusses thissubject inhisbookTheMostImportantThing.Inthebook,he discusses howunderstanding where you arein the credit cycle is vital tocreating a competitiveadvantage for yourself as aninvestor. He says that thereare “no structural

inefficiencies anymore…Icall this process ‘efficient-isation’, and it’s the norm.”However,hedoesbelievethatcyclical inefficiencies stillexist. He says, “People dopanicat the lowsandsell,oratleastfailtobuy.”

This is a very importantconceptbecausethesamecanbe said for the market’saction during market highs.Having an understanding of

credit (psychological) cyclescanhaveaprofoundeffectonyourinvestingresults.FocusontheDownside…“Focusonthedownside,andtheupsidewilltakecareof

itself.”MarkSellers

As an investor, your

primary goal is to eliminate

the possibility of permanentloss. Thismeans I spend themajority of my timecalculating thevaluationofabusiness in its worst casescenario before I ever thinkaboutbuying it. I hate losingmoneymorethananything.

So how does oneeliminate the possibility ofpermanent loss while tryingtogrowyourwealth?

NEVER purchase a

security that is trading aboveits conservativeestimationofintrinsicvalue!

Of course, permanentloss doesn’t mean paperlosses from stock pricevolatility. A stock couldeasily decrease further in thestock market after youpurchase. If you invest longenough,youknowthatthisisa foregone conclusion(usually instantly). Bruce

Berkowitz, calls this‘prematureaccumulation.’Hesays he’s always sufferedfrom it. It makes me laugheverytime.

In value investing, youmust grasp the fact that asecurity will probably godownfurtherafteryoubuyit.Tryingtotimethemarketisafool’s errand.Very few havebeen able to time themarketconsistently over the long-

term.Asaninvestor,youcanlook very silly for a longperiod of time beforeultimately being provencorrect.

Permanent loss occurswhenyoupurchaseasecuritywithnomarginofsafety,andthestockgoesdownandstaysdown, never to come upagain, due to poor businessfundamentals. I know thisdoesn’t fit the classic

definition of permanent loss,but I also define it as asecurity that has a highlikelihood of not increasingfor many years. Theopportunity costs are toogreat if this is a realpossibility. So I include it inthepermanentlosscategory.

In these cases, it’s likelyan investor purchased abovethe conservative intrinsicvalue of the business or

miscalculated the underlyingcompetitive dynamics of thebusinessorindustry.

However, this isn’t theonly scenario in whichpermanentlossoccurs.

The scarier scenario isthat you purchase at a pointthat you deem a margin ofsafety, and the stockcontinues to fall. And uponfurther analysis and re-valuationofthebusiness,you

realize the valuation hasfallen below the new stockprice (I hate when thathappens).

This can have disastrouseffects emotionally andfinancially,whichiswhyItryto focus on the worst casescenarios when valuingbusinesses.

REMEMBER: Day-to-day, week-to-week, month-to-month and year-to-year

volatility is not risk.Volatility is classifiedas riskifyouknownothingaboutthebusiness(beta),oryouhaveashort-term time frame. Thefundamentals of the businesswillshowyouthetrueriskofyourinvestment.

By purchasing securitiesat a discount to their readilyascertained liquidationvaluesor highly predictable (andsustainable) future cash

flows, an investor is unlikelyto experience permanentlosses. This purchase at adiscounttotheintrinsicvalueof the business says that youdemand a margin of safety,and that you are very riskaverse. Adhering to thisstrategyovertimeislikelytoproduceoutsizedreturnswitha low probability ofpermanentloss.

“Manyshallberestoredthatnowarefallenandmanyshallfallthatnowareinhonor.”

Horace

Because investing isimprecise, more art thanscience,itisonlylogicalthatinvestorsALWAYSseekthateverelusivemarginofsafety.Thismargin of safety in anyinvestment allows for theimprecision that is investing.

Anditallowsforbadluck,oreven analytical errors inunderstanding the underlyingbusinessfundamentals.

Unlessyouhaveacrystalball or live inDisneyWorld,the future will always beunpredictable. Although youmaybeabletouseprobabilityin a number of differentscenarios, it is most prudentto always seek a margin ofsafetyinanyinvestment.

Although most of thetradingtodayisaccomplishedthrough algorithmic trading,these algorithms arecontrolled by humans. ANDHUMANSMAKE ERRORSAND MISTAKES.Opportunities will happenmorequicklyandmuchmorefrequently because of thespeedof technology.Mostofthese mistakes are more outof temperament than

intelligence, but mistakeshappennonetheless.

This Margin of Safetyphilosophy is probably themost common characteristicof EVERY great investor.They know that valuation isimprecise, and that marketsare controlled by emotion.They are willing to wait forthatelusiveMarginofSafety--- that moment when theysee the difference between

perceptionandreality.Appropriate Margin ofSafety…

The appropriate marginof safety can vary frombusiness to business, andfrom investor to investor.There are higher qualityvaluationsthanothers,justasthere are higher qualitybusinessesthanothers.

Ideally,abusinessthatis

in Chapter 7 Liquidationproceedings, and is tradingbelow liquidation valuewould be the highest qualitymarginof safety.Thiswouldbe followed by businessestrading below readilyascertainable liquidationvalueintheopenmarket(andnot bleeding cash), and thenwouldbepurchasingbusinesstrading at a discount topredictablefreecashflowsof

high quality businesses. Thelatter is where I focus themajority of my energy.However,alloftheseprovidevery sound value investingphilosophies for an adequatemarginofsafety:

1) Businesses tradingbelow liquidation value inChapter 7 Liquidationproceedings2) Businesses trading

belowreadilyascertainableliquidationornet-netvalue(notbleedingcash)3)Businessestradingatadiscounttopredictablefreecashflowsofahighqualitybusiness

*Allotherbusinessesfallunderneaththislistregardingthequalityofthemarginofsafety.

It’s not commonplace in

thestockmarkettodemandamarginofsafety.Thissimpleconcept escapes the greatmajority of marketparticipants, sometimes eventhe great investors as well.Index Funds and MutualFunds all fail to achieveadequate levels of margin ofsafety because they feel theneed (or pressure) to beinvestedatalltimes.

Many hedge funds and

private equity funds fall intothis category as well.Investors that trade or investin momentum and ultra-growthbusinessesalsodonotemploy an adequate marginof safety in their portfolios.They view their holdings aspieces of paper to be tradedon a regular basis, regardlessof underlyingvalue.There isusually very little margin ofsafety surrounding Wall

Street underwritings andinnovations. After all, theyget paid commissions bycreating buying interest andhypearoundtheseproducts.

At times,value investorscanhaveissuesunderstandingwhat constitutes a reasonablemarginof safety.There isnohard line in the sand. Everysituation is different.However, approachingvaluation in a very

conservative manner willcertainlyhelp.

Many investors now useintangibles in their rationaleofwhatconstitutesmarginofsafety.Moatinvestorsbelieveit’s through intangibles, suchas culture or proprietaryformulas and processes, thatthe business is able toproduce outsized free cashflow and returns on capitalover long periods of time.

Thus,itmakessenseforthemto incorporate thesesustainable competitiveadvantages into whatconstitutesapropermarginofsafety.

Itendtoagree.However,I still want the tangibleelementstoo.Iamalwaysonthe lookout for moatbusinesses that are tradingbelow liquidationvalue.Thisgives me an incredible

margin of safety, and allowsme to invest heavily becauseof low probability ofpermanentloss.

The problem withintangible assets is that theycanleadtosubjectiveopinionat times. In addition, moatscan be penetrated due to thecompetitive nature ofcapitalism.

For example, right nowTesla Motors (TSLA) trades

atincrediblyhighmultiplestobook value and cash flow. Iwould venture to say Tesla’smostvaluableassetrightnowisitspeople(ElonMusk),anditsnewexcitingentryintotheelectriccarbusiness.

What if somethinghappened to Elon Musk?Whathappenstothemultiplethe market is willing to payforthestockwhenotherautobusinesses, which are just as

competent,begin toenter thecategory and take back theirmarketshare?

Something could gowrong quite easilywhen youpaythathighamultipleforabusinessasit’salreadypricedfor perfection. There’s nomargin of error. Customers’perceptions can change veryeasily and quickly, andcompetitors are alwayslooking to storm the castle.

Anything less than perfectexecution from the companycan result in permanentcapital loss from investorswhen you pay extraordinarymultiples to tangible bookandfreecashflowlevels.

In this case, the marginofsafetywouldnotexist.

If you want a greatermargin of safety frompermanent loss, tangibleassets can provide you with

theprotectionyouseek.In addition to tangible

assetsbeingusedfortheday-to-day operation of thebusiness, tangible assets canserve another role aswell. Ifsomething unforeseenhappens to the business, realestatecanbesold,receivablescan be collected andinventories can bewholesaled. If customerssuddenly lost their taste for

electric cars made by Tesla,its tangible assets would notbeabletosaveinvestorsfrompermanentcapitallosses.

This begs the questionagain: how can you be sureyou are receiving anadequatemarginofsafety?

By alwayspurchasingsecuritiesat substantialdiscounts from

conservativevaluation levels (atleast 50-60% ofconservativeestimatesofintrinsicvalue).By thinking worst-case scenario firstand foremost forvaluation. Thismeans puttingemphasisontangibleassets and

purchasing belowliquidation level(non-cash burnbusinesses).Next, you putemphasis on moatbusinesses withsubstantial free cashflowgeneration.Always reviewcurrent holdingsagainst new ideas,andonlysellwhena

betterbargaincomesalong, the securityhas reached fairvalueorthebusinessdeteriorates to apoint where youcould sustainpermanent capitalloss.Never be scared tohold substantialamounts of cash.Opportunity favors

thepreparedmind.Ifthe market is tooeuphoricandyouarenot able to findmany ideas, holdcashandwaitfortheright pitch. It willcomeeventually.Diversify enough toreduce risk. Thismeans nomore than10-15 of your bestinvestments in the

portfolio at any onetime.Purchase cheap out-of-the-money putoptions to hedgeyour portfolio whenit’sappropriatetodoso (i.e. during longand/or extreme bullmarkets). Thisshould comprise nomore than 1-2% ofyourportfolio.Iwill

explainthislater.

SecondLevelThinking…

“First-levelthinkingsays,‘It’sagoodcompany;letsbuythestock.’Second-levelthinkingsays‘It’sagood

company,buteveryonethinksit’sagreatcompany,andit’snot.Sothestock’soverratedandoverpriced,let’ssell.”

HowardMarks

Once you find an

undervalued security tradingat a substantial discount toyour estimate of intrinsicvalue,yourjobisnotover.

The next question youmustaskyourself is“Why isthe security trading at thislevel and what catalysts willleadtoitseventualreversal?”

Ifyoucannotanswerthisquestion, you should not be

investing in the stock.Howard Marks calls thissecond level thinking, and itwill keep you from fallingintoavaluetrap.

To see the margin ofsafety concept and secondlevel thinking in action,consider my investment inChesapeake Energy in2010/2011. Itwas backed bythelargestoilandnaturalgasacreage in the U.S., and its

various profitable subsidiarybusinesses in the oil and gassector which could be spun-off. Chesapeake was on mywatch-list for a very longtime, but now it was tradingbelow my back of theenvelope value of thebusiness based on its oil andgasassets.Sonowitwastimetodiginalittlemore.

There was muchuncertainty surrounding the

company, from its extremedebt load to plummetingnatural gas prices. Also, itsCEO, Aubrey McClendon,grabbed headlines on a dailybasis for all the wrongreasons. My main concernwas the debt level and thenatural gas prices. I knew Ihad to be careful in thisinvestment because it is acommodity company, and issubject to the whims of

naturalgasprices.I beganwith natural gas

prices because it wouldn’tmatter how great the assetswereiftheywouldhavetobewrittendownforanextendedperiodoftimebecauseoflownaturalgasprices.

The natural gas shalerevolution had taken hold.Supplythatwasthoughtofaslost forever, suddenly wasavailable because of new

technology in horizontaldrilling and fracking. Thisincrease in supply drovenaturalgaspricesfromahighof$13.50in2008to$2.00in2012. See the figure below(fig.46)

FIG 46:Natural Gas (NG1)Chart,2006-2015

The continued drop innatural gas prices caused apanic in the natural gassector.Thisallowedmetodoevenmore homework on thesector as everyone was busysellingaroundme.

First-levelthinkingsays,‘Theoutlookcallsforlowgrowthandrisinginflation.Let’s

dumpourstocks.’Second-levelthinkingsays,‘The

outlookstinks,buteveryoneelseissellingina

panic.Buy!’HowardMarks

My findings were quite

interesting:naturalgaspriceswere trading at an extremelevel,wellbelowtheaveragecost of production. Thismeans businesses would be

losing money hand over-fistif they continued to produceat those natural gas pricelevels. I reasoned that overtime,itwaslikelythatnaturalgaswouldtrendbacktowardsitsaveragecostofproduction.AndChesapeake,beingalowcost producerwith incredibleassets, would be able toweatherthestorm.

Not only did theproducers decrease drilling

andproduction,buttherewasan uptick in demand aswell,because natural gas wascheaperthanoilandcoalonaBTUbasis.

Utilitiesstartedswitchingfromcoaltonaturalgas.Andthe transportation sectorstarted to take strides toconvert tonaturalgas. Itwasa cascading effect whichhelped to increase andstabilizenaturalgasprices.

Once I was able to getmy head around itsobligations and its incredibleportfolio of acreagethroughouttheU.S,Ideemeddownside permanent capitalloss to be near zero. I soonrealized that Wall Street’sconcernsover thedebt issueswere massively overblown.Uncertainty about the future,and exact execution of thebusiness, created an

incredible opportunity forinvestors who were contentwith a substantial margin ofsafety.

FIG 47:Chesapeake Energy(CHK)Chart,2010-2015

With all the negativityand uncertainty surroundingthe stock, I was certain Iwouldseetemporarylossesinthe portfolio as sharescontinued their decline.However, these lower priceswould only render the sharesa better buy. And that’sexactlywhathappened.

I began accumulating

shares below $20.00, andcontinued to purchase moreas the stock continued todecline below $15.00 pershare. My average pricewould end up being under$20.00 with a weighting ofover20%oftheportfolio.Asthe stock rallied in thecoming months, I wasfortunateenoughtosellsomeof the position in the lower30s (near my estimate of

intrinsicvalue).As you can see, I could

have simply stopped by justvaluingthebusinessbasedonitsbookvalue,ormodeleditsfuture like most of WallStreet with the continueddeclineofnaturalgasprices.

However, an investormust always keep asking“why?”

“Whyisthisoccurring?”“What’s the overarching

reasoning or justificationbehindthisparticularscenariooroccurrence?”

And when you havethose answers, you need toascertain why the other sidemay (or may not) be wrong.Thiscanbefromanynumberofthings,buttheothersideisusually wrong frompsychological or analyticalmisjudgments (sometimesboth).

It eventually led me tosee that there was amispricing here, and thattherewasamajordisconnectbetween perception andreality -- between the stockprice and the intrinsic valueofthebusiness.

The jury is still out onthisone,especiallyasoilandnatural gas hover nearmulti-year lows. I still believeChesapeake Energy’s better

days lie ahead, and I lookforward to what thiscompany, and this countrylooks like as it approachesenergyflexibilityintheyearsanddecadestofollow.Value Investing In BullMarkets…

“Youneverknowwho'sswimmingnakeduntilthe

tidegoesout.”

WarrenBuffett

In rising markets (bullmarkets) there are manywinners.Asaresult,thistypeofenvironmentmakesitverydifficult to distinguishbetween investment acumenandjustplainluck.

It seems profitableinvestments are everywhereduring these times. And ifyou aren’t making the

profitable investments, thensomeoneelseis.Thiscanaddto an investor’s feelings ofgreed and envy, which canlead to mindset errors andbiases.

Mistakes in theseenvironments seem rare, andeverythinglookslessrisky.Infact, the riskiest businessesare paying off bigger thanever.Thiskindof risk-takingcan even make the decisions

seem justified in retrospect.Investinginriskierassetsandhavingsuccessjustreinforcesto themarket participant thatthisbehaviorisok.

Oddly enough, it’sduring these times when it’seasy to let your standardsdownandjointhefollythat’sall aroundyou in themarket.Itmay seemcounterintuitive,however, during marketeuphoria and extended bull

markets it could prove veryprudenttoraisecashlevelsifthe risk does not support thereward. Stick to yourphilosophy of alwaysdemanding an appropriatemargin of safety in everyinvestment.Neveryield.

Of course, as themarketis rising, value investing canbecome out of favor. Themedia consistently seeks outpopular stocks to parade on

the televisionoronlineaboutwhythestockis“doingwell”on that particular day basedon that one particular story.In a rising stock market, theenvironment is constantlyparaded with momentumstockswhicharenotbasedonthe fundamentals of theunderlyingbusiness.Thisisadangerousgametoplay.

Most of the time, themedia uses confirmation bias

topickthesestoriesbasedonhow the stock is doing aparticular day. It’s best toignorethenoiseontelevisionand create your own opinionof businesses based on in-depthfundamentalanalysis.

Indeed, when the stockmarket is making new highs,a value investor will facetheir toughest challenge yet:the decision whether toforego the margin of safety

principle in hopes ofparticipating inabroadstockmarketrally.

A value investingapproachcanbeahandicapinsuch an environment, as out-of-favor value stocks tend torise less than the public’sfavorite momentum stocks.Thiscanalsobeatimewhenthe value investor sells tooearly as the stock marketmakes its way from

undervalued to overvaluedterritory.

The prudent thing to doin this environment is torememberwhatgotyouhere.Was it theconservative, risk-averse approach to investing,oramomentumapproachthathelped you achieve yourgains?

It’s vitally important forinvestors NOT to participatein these stock market

shenanigans that consistentlyreel people in. You arecertain to encountermany ofthese extended bull marketcycles in your lifetime. Youmust be patient and stick toyour prudent risk-averseapproach to investing that isencompassed in the 5M™MentalModel.This iswheresomany investors gowrong.Unfortunately, it’s happenedbefore and it will most

certainlyhappenagain.For example, Stanley

Drunkenmiller gave us anincredible gift to learn fromhis mistakes without havingto live through themourselves.

Stanley Drunkenmillerwas a protégé of GeorgeSoros. And he is consideredto be a legendary investor inhis own right as hecompoundedreturnsat~30%

annualizedsince1986,beforeannouncing in 2010 that hewould return investor capitalandcreateafamilyofficeforfutureinvestment.

Stanley’s lesson to usoccurred during the famousrise of tech stocks throughearly 2000, when theyultimately crashed. To date,Stanley was one of the bestperforming hedge fundmanagersofall-time(stillis).

And he routinely warned histeam of investing in thesetech stock stocks that werebacked by little more thanhypeandanimalspirits.

However, apsychologicalshiftwasabouttooccur.

He couldn’t stand thateveryone around him wasmakingmoneywhilehestoodon the sidelines.Hisemotiongotthebetterofhimandinan

“emotionalfit”boughtthetopof the market during marketeuphoriabecausehewastiredof not participating in thisragingbullmarket(regardlessofthefundamentals).

With no regard of thefundamentals, he put billionsin the tech market withinhours of the top of themarket. And it didn’t endwell. When all the losseswere tallied, in April 2000,

theQuantumFundwasdown22%andtheQuotaFundwasdown32%.

Remember Stanley’sstory when you think aboutabandoning your margin ofsafety principle during bullmarkets.

Stanley is one of themost intelligent andknowledgeable investors intheworldtoday.Andevenhesuccumbed to the

psychological pressures andbiases around him. It’s justanotherexamplethatwemustalwaysbeawareofourbiasesandreasonsforinvestment.

Having a margin ofsafetycanhelptoensureyouare constantly staying true tothevalueinvestingapproach.Value Investing in BearMarkets…

"Bullmarketsarebornonpessimism,growonskepticism,matureonoptimism,anddieoneuphoria.Thetimeof

maximumpessimismisthebesttimetobuy,andthetimeofmaximumoptimismisthe

besttimetosell."SirJohnTempleton

Ofcoursetheoppositeof

arisingmarket,isadeclining

market (bear market). Manydonotknowitatthetime,butthis is the most beneficialtime to be a value investor.The bigger the decline, thebetter it is for us as valueinvestors.

What?!?! What do youmean more decline thebetter…?

The decline in the stockmarket, and in individualstocks can create the margin

of safety that we seek aslong-term investors. Stockmarket declines weed outweak traders and investorsfrom the market ---essentially creating a greatentry point and runway forthe long-term risk averseinvestor.

The majority of marketparticipants are momentumseekers.

Momentum stocks

usually have the highestexpectation built into theirstockprices.Iliketosaytheyare priced to perfection. Asexpectations are notmet (i.e.missedearningsreport),thesesecurities can plunge. It isduring market declines thatmomentum players, whowere only concerned aboutwhatcouldgo right,begin topanic when stocks decline(and only think aboutwhat’s

goingwrong).As the market continues

to decline, the momentumplayerswhobidupstocksdueto excessive optimism, startto become panic strickenbecauseofthedeclinesinthestock portfolios. They startdumping stocks because theyfailed to know or understandtheunderlyingbusiness.Thisis a consequence of notknowingabouttheunderlying

business, and failing toadheretothemarginofsafetyconcept.

Value investors don’thave such unreasonableexpectations when theypurchasesecurities.

In fact, value investorsusually invest in businessesthat the market has noexpectations of at all. Theycouldn’t give them away ifthey wanted too. These are

the moments that createopportunity for investors. It’sthatmomentwhenthemarketprices these businesses asmoredead,thanalive(sellingbelow liquidation value orextremely low multiples tocashflow).

A portfolio of valuestocks can withstandsignificant pressure duringgeneralmarketdeclines.Yourmarginofsafetyincreasesthe

less the market is concernedwith the underlyingfundamentalsofthebusiness.The general market couldexpect continued decline andpoor operating results;however securities purchasedat depressed prices with amargin of safety are unlikelyto fall further. Or at leastthey’ll fall to levels whereyouhavealowprobabilityofpermanentcapitallosses.

Securities that arepurchased with little-to-noexpectations can benefitimmensely from a smallchange inmarket perception.Just a switch in focus fromthe negatives to positiverealities of the business canresult in increased securityprices. The recovery infundamentals is the addedkicker to the change inperception. As the

fundamentals recover,investorscanbenefitfromtheincreasedmultipleattachedtothe security as well as fromthe actual recovery infundamentals.

Amarketthatdeclinesinvalue is the ultimate test ofyour investment philosophy.Itisvitalthatyouadheretoaprovensystemofinvestingtokeep you focused on thefactors that matter most. It’s

duringbearmarketsthatgreatinvestors differentiatethemselvesfromthemediocreinvestorsandaveragereturns.I, for one, become veryexcitedduringbearmarkets.

By always searching forthat margin of safety, valueinvestors can protectthemselves from massivelosses in any marketenvironment, both increasingordecreasingmarkets.

Of course, if you canpredict the future -- by allmeansparticipate fully in themarket at all times. Ride thebull market to the top, andsellorsell-shortatthemarkettop. Crystal balls are anincredibly powerful tool. Imyself have yet to comeacrossone.Moreimportantly,Ihavenotmetasinglepersonthat can predict the marketcyclesinatimelymanner.

That iswhy I focusonlyon things that areIMPORTANT ANDKNOWABLE.

Sure, knowing marketcycles is important, but it isimpossible to know it in atimelymanner. The best youcandoitalwaysinvestwithamargin of safety. This willprotectyouovermanymarketcycles.

Bull markets and bear

markets will come and gothroughoutyourlifetime.Theonly thingyoucan control isusing a proven, repeatablesystemthatalwaysdemandsamarginofsafety.

With this philosophyinvestors increase theirchances of doing very wellovertime.The Search for the PerfectInvestmentSystem…

"Inbusinessweoftenfind

thatthewinningsystemgoesalmostridiculouslyfarin

maximizingandorminimizingoneorafew

variables."CharlieMunger

What you see in the

5M™ Mental Model is notthe perfect system or theperfectformula.

AndIhatetotellyouthis---butthereisnosuchsystemorformula.

I don't live in DisneyLand, and we don't buybridges to 'nowhere’ andneithershouldyou.

Throughout financialhistory, individuals havegreedily searched for theperfect investment formula.It’s only normal that we, ashumans, seek to find

shortcuts to complexproblemsand situations.Andinvesting can be a complexprocess.

Investment success thatcomesfromaformula…

It sounds enticingdoesn’t it? It’s unfortunate,butitdoesn'texist.

The best an investor cando is create processes andmethods, that help to form arationalsystemthatcanweed

out thecomplex,andprovideyou with the most importantfactors in make greatinvestingdecisions.

5M™ is a set of mentalmodels that helps to make acomplex process simple(simple,noteasy).

There are manyinvestment formulas that areused by Wall Street, andother investmentprofessionals that are purely

backwardlooking:

TechnicalAnalysisTraderscreatealgorithms

andformulasusingindicatorsthatusepastpricemovementsto predict of future prices inthestockmarket.LowPrice-to-Earnings(P/E)

This is a simplistic,backward-looking formula.It’s a sound concept at first

glance -- pay a lowmultipleof profits that the businessproduced. This is great, butthisformulaisstilllookinginthe rear view mirror. Theroad you drive is in front ofyou. P/E metrics can movewildly at times and if youdon't have an understandingof the futureprospectsof thebusiness, it can leave youchasingyourtail.

Usually, most of these

low P/E stocks are priced insuch a manner because themarket is pricing in anearnings drop. If thathappens, you could be leftholdingahighP/Estocknowbecause earnings havedropped. The same goes forlowprice-to-book stocks thatare over leveraged, and canloseassetsveryquickly.Price-to-BookRatio(P/B)

Thisisprobablytheleastdangerous metric for findingpotential ideas. I take itfurther, and only search forbusinesses below tangiblebook value (TBV). It willgive you a larger margin ofsafety, as it doesn’t calculateintangible assets such asgoodwill.

Although thesefundamental and technicalformulascanbeagreatplace

to look, they don’t constituteaperfect formulaora reasonforinvestment.

Youstillneedtohavethementalmodelstoconducttheproper analysis as to whichbusinesses are the bestcompared to all the rest, andtoensurethatyouarebuyingthem at a proper margin ofsafetytotheirintrinsicvalue.

Somuch effort has beenexpended trying tocreate the

perfect formula, but noformula has been proven towork. There is no suchformula that can accuratelycalculate the adaptivecomplexity that is the stockmarketallthetime.

Even if a formulaexisted, it would cease toexist very quickly aseveryonewouldrushtouseitall at once. Essentially thearbitrage between the perfect

formula and the returns itcreated in the stock marketwouldbeclosedinaninstant.

This is why the 5M™Mental Model, and valueinvesting will continue towork over time---because itdoesn'tworkallthetime.

There will be ups anddowns, and there will beperiodsofunderperformance.But ifyoufollowthissystemof value investing (or any

methodofvalueinvesting,forthatmatter),youwillincreasethelikelihoodofhavingmoreups then downs. And thecertain periods ofunderperformancewillsetthestage for even more wealthcreationinthefuture.

5M™ is a proven,repeatable and rationalsystemtoinvestmentsuccess--it’s not a formula. Investorsare better served to focus

their time and effort onsystems and mental modelsthat have proven to besuccessful, and repeatable ininvesting. 5M™ is such asystemandmentalmodel.What a great investmentlookslike…

An importantdeterminant of investmentsuccess is the probability of“risk.”

What do I mean byprobabilityofrisk?

As an investor, you willneed to weed through, andignore news headlines andstockprices.

An investor should onlyfocus on the numbers, andfuturebusinesscharacteristicsof the potential investment.You will come across times

during investment when yourealize the “risk” of thepotential investment is onlyassociated with the market’sperception of it right now,andcontinuedpain.

Just because a stock hasfallen 50% does not make itriskier thanastock that isup100%.Ultimately,the'risk'isthe probability of permanentcapitalloss.

With that said it makes

sense to invest, and investheavily, in higher probabilityinvestments. This willdecrease your risk ofpermanentcapitalloss.So what entails a higherprobabilityinvestment?

Higher probabilityinvestments will have anumber of characteristicsincluding: sustainable

competitive advantages,recurring revenue stream,high FCF, high ROIC,reasonable debt load, greatmanagement, and hopefullytrading under liquidationvalue.

Ofcourse,thisistheholygrail of investments, and ittakesa reasonableamountofpatience for theseopportunities to presentthemselves.

My “Holy Grail” ofInvesting:1) Easily explainedsustainable competitiveadvantages2) Low price to FCF(highFCFYield)--lotsofFCFtothepricepaid3)TradingbelowTBVorliquidationvalue4) Capable owner

orientedmanagers5) Buyingonaone-timeorfixableeventIf you encounter

businesses with most(specifically all) of thesecharacteristics, you must bewilling to ignore what themarket is telling you, andaccumulate significantpositions (if you have theopportunity).

UsingaRangeOfValuesBusinessvaluation isnot

anexactscience.There isnohardnumber

orexactprocessthatproducesthe precise valuation of abusiness. Many investorsrelentlessly seek precise

numbers in an impreciseworld.Youseethiseverydayintheinvestmentworldwhenyouhearspecificpricetargetsonstocks.

Ashumansweconstantlyseek certainty. Analysts andinvestment firms that sellsecurities know this --- and,unfortunately, they use thisnatural human need, to selltheir ideas to the masses tocollect commission fees.

These price targets give theinvestor something to holdonto in a landscape that isconstantly changing andevolving.

BOTTOM LINE: Youneed togiveyourselfa rangeofconservativeestimatesandvaluations. After all, cashflow,earningsandbookvaluearedeductionsbyaccountantsthat follow GenerallyAccepted Accounting

Principles (GAAP). Thisstrict set of principles andpractices are designed toachieve conformity. Theyusually don’t reveal the realfinancial value of thebusiness. This is why valueinvestingissoimportant.

Trying to ascertain theactualvalueofyourhomeoryour car is virtuallyimpossible. So whywould itbe any easier for us to put a

strictvalueonacomplexandever-changing business?There are toomany dynamicvariables in the marketplacetopinpointanexactvalue.

Althoughaninvestorwillnever be able to pinpoint anexact value, he/she mustregularly review estimatesandprobabilities,whichhaveagreatimpactontheintrinsicvalueofabusiness.Estimatesand probabilities will change

over time, which meansvaluationswillaswell.

It’s a futile endeavor tocalculate an “exact” value ofabusiness.Ifyoutrytodoso,it can have significantpsychological ramificationsto your investment success,such as overconfidence andanchoring.

Precise valuation is thewrongwaytoapproachvalueinvesting.

You want to makeconservative estimates thatgive you a range of values,and then have your purchaseprice be so far beneath therangeofvaluesthatyouhavean incredible margin ofsafety.

The confusion withsecurity analysis andvaluation analysis comesfrom the idea that mostinvestors complicate the

proficiency to make exactestimateswiththeproficiencyto make accurate ones. Justbecause you make estimatesbasedonpast events,doesn’tmean they will hold true inthefuture.

One must be able toweigh the actual probabilityof the business achievingthose estimates. This is whyit’ssoimportanttofocusonabusiness’s sustainable

competitive advantagesbefore making decisionsbased on highly dynamicdiscounted cash flowvaluations. We will discussthisshortly.

The illusion of precisionregarding discounted cashflowsisbothablessingandacurse.Asmentionedbefore,itcan cause investors tobecome over-confidentbecause their analysis on an

overly complex spreadsheetsaid it would be worth acertain price. That means ithastobecorrect…right?

This can cause investorstostayanchoredtothatprice,even as estimates and othervariables are changingconstantly around thatbusiness and its industry.Discounted cash flows usingcurrentgrowthratescangiveinvestors a false sense of

security if they do not useconservative estimates andfocus on the sustainablecompetitiveadvantagesofthebusiness.

Discounted cash flow(DCF)modelsworkgreatforsecurities, which arecontractually obligated todistribute cash flows. Forexample, discounted cashflow calculations work moreaccurately with bonds,

because of the higherprobability of cash beingdistributed in a timelymanner.Ofcourse,DCFdoesnot help you in figuring outthe actuality of receivingthose cash flows if businessrunintotrouble.

Stocks, unlike bonds,have no contractualobligation to distribute cashflows. This makes it all themore difficult to value a

businessbasedondiscountedcash flow, however, it mustbedone. It’sverydifficult toaccurately calculate theintrinsic value of a business,let alone the partialownershipofabusiness.

DCFisavitalcalculationof intrinsic value, however,it’s not the only way. In aperfect world while usingperfectestimates,DCFwouldbe the ideal calculation.

However, we live in animperfectworld.This iswhywe must incorporateprobabilities of otherconservative estimates in ourDCFanalysis.

Anotherwaytovaluetheintrinsicvalueofabusinessiscalculating the liquidationvalue. Benjamin Grahamfrequently used a calculationcallednet-networkingcapitalpershare.It isalsoknownas

Net-Current Asset Value(NCAV) or net-net. Itprovidesaquickestimateofabusiness’s readilyascertainable liquidationvalue:

Net-Net=(Cashandshort-terminvestments+(.75*AccountsReceivable)+(.5*inventory)–Total

Liabilities)/CommonShares

The formula essentiallystatesthatcashandshortterminvestments are worth 100%of its value, accountsreceivable shouldbe takenat75% of stated value becausethe full value may not becollected, and inventoriesshould be taken at 50%because it would need to beheavily discounted if thebusinesscloses.

BenjaminGrahamwould

occasionally put together abasket of net-net (orNCAV)investments.Hesaidtheidealtime to buy net-nets is notwhen the markets are reallycheap or really expensivethough. And that’s becausewhen the overall market ischeap, the really goodbusinesswill outperform andcompoundyourreturnatafargreaterpacethan“cigar-butt”type investments, which are

onlygoodforonepuff.An example of this

would be when MohnishPabrai purchased a basket ofnet-nets in 2010 in Japanesebusinesses. During this time,the Japanesemarketwasatamulti-decade low. As themarket rallied, behindunprecedented governmentstimulus, the net-nets didn’tmoveagreatdealasinvestorsreachedforthehigherquality

investments in the Japanesemarket. The Blue-Chipbusinesses in the Japanesemarket produced far superiorreturns compared to that ofthelowerqualitynet-nets.

There’s a great site thathas numerous screensincluding NCAV. Eachbusiness needs to beresearched individually;however, it’sagoodplace tostart for potentially

undervalued securities belowliquidationvalue.

www.GrahamInvestor.com

It’s interesting to note:

This type of calculation by alegendary investor likeGraham, goes to show youhowdifficult it is calculate abusiness’s intrinsic valuecorrectly.

Just look at the wide

range of price targets forbusinessesthataretrackedbyWall Street analysts. Forexample, let’s take a look atApple. Price estimates rangebetween $60 to $150 fromover43analystsandresearchfirms. This is a highlyprofiled business, yet theseanalystsaren’tevenclosetoageneral consensus with thebest information provided tothem.

So, how are we toachieve any better withlimited,publicinformation?

By not thinking that wecan precisely pinpoint anintrinsicvalueofabusiness.

Imprecisevalueinvestingismorefunandrewarding!

Ifweapproachvaluationin a very conservative andrational manner, whilewaitingfortherightpitch,wecan give ourselves an

advantage over our slowermoving, incentive-driven andpsychologically biasedcounterparts.

This is what makes amarket, and it’s also whatallowsforopportunity.Therewill always be differences ofopinion in the valuation of acertain business. The maindifferencesareintheformofestimatesandtimeframe.

We can use this to our

advantage (especially whenmost of Wall Street isguessing on quarterlyearnings estimates). Therewould be no volatility in themarket if there was nodifference of opinion in thevaluation or estimates of abusiness. If businesses couldbe valued perfectly, tradingwould grind to very slowspeed.

As value investors, we

always try to purchase asecurityatlessthanitsactualvalue.However, the eventualsaleofthesecuritymustbeavalue to the individual youare selling the security too.The difference in intrinsicvalue between buyers andsellersstemsfromdifferencesof the future growth of thebusiness,futuregrowthoftheeconomy, discount rates,interestratesorpotentialfora

buyout(orifit’satrader,thepricegoinghigherorlower).

Thus, there will alwaysbe a range of values forperspective buyers in themarketplace. Having a rangeof values will help you topurchase with a margin ofsafety. The actual margin ofsafety could be anywherebelowtherangeofvalues(orweighted average of thosevalues).

Forexample,in2014thishappened with HillshireBrands(HSH)(arecentspin-off of Sara Lee). Thecompany started the yeartrading at $33.38. Pilgrim’spride initiated the buyout byoffering to buy Hillshire at$45.00 per share in cash. Aweek later Tyson Foods(TSN) splashed onto thescenewithanall-cashofferof$50.00 per share. In a series

of offers and counter-offers,Tyson Foods eventuallycompleted the merger withHillshirefor$63pershare.

FIG 48: Hillshire Brands(HSH)Chart,2010-2015

TysonwaswillingtopaymoreforHillshirebecauseofthe synergies associatedwiththe deal and the fact thatHillshire has higher marginproducts which willeventually help the bottom-line to Tyson. There willultimately be a difference ofopinion on the final value ofthe business as one finalizes

the acquisition, and theotherwatchesfromthesideline.There are many methods forthe valuation of a business,however, I have only foundTWO that I find useful andlogical. Even sum-of-the-parts analysis (SOTP) usesversions of these twomethods,sowewillfocusonthesetwomethodsthemost:1)DiscountedCashFlow

(DCF)2) Liquidation Value(LV)Thefirstisananalysisof

moat-type businesses, orbusinesses with sustainablecompetitive advantages.Ideally,thesecompanieshavebeen identified already asbeing able to produce freecash flow at reasonable-to-high rates of return into the

foreseeable future. Thisanalysis is discounted cashflow (DCF), or net presentvalue(NPV).

DCF is a projection ofdiscounted future free cashflows to arrive at a presentvalue. Essentially, we aretrying to buy the discountedfree cash flows of thebusiness at a discount whileallowing the compoundingeffects of that free cash flow

totakeoverinthelongrun.The second method is

liquidation value. Thismethod is mainly used forbusinesses in distress orbankruptcy. When usingliquidation value, I expectthat the business will nolonger be an ongoingconcern. I expect that thebusiness will be broken-upand the pieces will be soldoff.Of course, this givesme

optionality if the businessdoes not liquidate andrecovers as an ongoingbusiness.

Thereareweaknesses,aswell as strengths, to each ofthese two methods, howeverneither one will providecorrect values every time.And regrettably, bettermethods of valuation don’texist.

As a value investor that

purchasesbelowconservativeestimates of intrinsic value,youhavenochoicebuttousethem on a regular basis. Thetrick is touse theminaveryconservativemanner.

Now that you knowperfectprecisionwithregardsto valuation is not needed(nor realistic), I will showyou how we can create arange of valuations usingconservative estimates and

probabilities.Inthefollowingtwo chapters, you will seewhy these two valuationstrategies are the ONLYmethodsweuseforvaluation.

These methods andtechniques will be all youneed to accurately andconservatively value abusiness.

Isn’t itnice toknowthatyou don’t have to be perfecttodoverywelloverthelong-

term?Let’sgetstarted!

ConservativeDiscounted

CashFlowValuation(DCF)

“Thefutureisinherentlyunknown.”Unknown

Discounted Cash Flow(DCF) is the best method touse when valuing businesseswith predictable free cashflows. The difficult part, ofcourse, is finding businesseswith predictable free cashflows.

To find these types ofbusinesses, revisit the moatsection in the MECOMmethod to ascertain how toidentify a business with

sustainable competitiveadvantages. Identifyingsustainable competitiveadvantages is theonlywayabusiness will be able toproduceanytypeoffreecashflow over a sustained periodoftime.

DCF is one of the mostprecise types of analysis forvaluation, however, futurefree cash flows are typicallyunclear.Inaddition,choosing

a discount rate can be asubjective endeavor as well.For those two factors alone,DCF can be a tough, andinaccurateundertaking.

Don’t worry. I haveincludedlinkstoallvaluationmethods to help in yourjourney.Andwewillgooverareallifecasestudyshortly.

As we know, capitalismis a brutal place forbusinesses. There are very

few businesses that avoidtheircastlesbeingattackedorburned to the ground overtime. Even the few that areidentified as moat-typebusinesses, will have adifficult time continuallygenerating out-sized returnson capital because ofincreasedcompetition.

The margin of safety inthese types of businesses isusually non-existent because

they are already identified asgreat companies, and themarket bids them to extremevaluations.That’swhyit’ssoimportant to buy these typesof businesses during eventsthat cause mispricing. Wediscussed this previously inchapter2.

Moat-type businesseshave the distinct quality ofcompounding free cash flowover time, however, they’re

typically priced forperfection. In this particularcase, the market is usuallyfairly efficient in identifyingquality businesses. Theproblem usually stems notfrom finding high qualitybusinesses, but in having thepatience and discipline topurchase high qualitybusinesses with a margin ofsafety.

No matter how great a

business is, we have topurchase it at the right priceinorderforittoproducerealinvestmentreturn.

These high qualitybusinesses are typicallypriced to perfection. So, ifone little thing goes wrongwith sentiment or thebusiness, it can have acascading effect on the stockprice as well as otheroperating metrics. And this

willhaveaneffectonprofits.Ultimately, this can bringabout uncertain times. As aninvestor, you want to becomfortable arounduncertainty.Thenyou’llhavenotroublestayingawayfromover-pricedbusinesses.

Yes, some businesseshave a higher probability offree cash flow than others.When you find thesebusinesses put them on your

watch-list and be patient.However, estimating freecash flow is usually quitearbitrary.

Therefore, using a verywide range of highprobability, conservativeestimates is the only way tograspthefuturecashflowsofthebusiness.

Will DirecTV sell moresubscription-based servicesnextyear?Probably.

Willtheysellmoreinthecoming years? More thanlikely.

However, the totalamountisunknown.

What about capitalexpenditures for all theequipmentandsatellites?

Whataboutnon-paymentfromsubscribers?

Pricing, demandsensitivity, competitors andeven geopolitical factors can

have an impact onprofitability. There are manyvariables that go intofactoring the future free cashflowsofthebusiness.

Most of Wall Streetbasesitsinvestmentdecisionssolely on growth. They arewilling to pay incrediblemultiples on earnings andbook value for that growth.As value investors, weunderstand that all great

investing is value investing.We want growth too.However, we want to pay areasonablepriceforit.

The higher the growthrate of the business, thehigher the likelihood ofcontinued free cash flowgrowth. However, there arefar too many variables thatconfront investors that solelyrelyongrowthforinvestmentsuccess:

1) Being able toconsistently estimategrowthinabusinessoveralong period of time isvirtuallyimpossible.2) Small changes ingrowth, up or down, canhave a massive influenceon the valuation of thebusiness.3) When you invest ingrowthcompanies,youare

constantly involved incrowded investments andhighly sophisticatedinvestors. This can causevaluation levels to reachincredibly high limits thatare unsupported by theunderlyingfundamentals.REMEMBER: The

“Street”makes itsmoneyoffof the marketplace beingexcited. When you trust the

“Street” without doing yourdue diligence on a securityand its valuation level, youare opening yourself up tounnecessary risk. Activity ishow investment firms getpaid.

Value investors will beleft to watch from thesidelineswhenthegame,andthecasino,areworkingonallcylinders. The Street makesthe majority of its money

when the public ismotivatedmorebygreedthanfear.Theexcitement and the incentivebiases will cause marketparticipants to overpay formany growth-relatedsecurities over the course ofvarious cycles. It’s just howthegameworks.

A value investor’sperformance will lookcrummy compared to themomentum seekers from

time-to-time. However, Ibelievethereareworsethingsin the world than someonemaking a little more moneythanyoudo.AndI’mwillingtowaitaslongasit takesforvalue to rear itself again. It’sduring these times ofexuberance, when you willfeel the most pressure toabandon your discipline --don’tdoit.

Youhavetwochoicesas

a value investor: waitpatientlyorjointhefolly.

Unfortunately, manymoney managers with valuephilosophies are forced tochoosethelatter.Mostdonothave the institutional supportwhich will allow them todeviate from the crowd for aperiodoftime.

If they don’t play therelative performance game,theyareatriskoflosingtheir

job. Personal preservationtrumpseverythingelseinthisscenario. For those with jobsecurity and patience,opportunities will beeverywhere when theenthusiasmand the jubilationdiminishes, and panic andfearresurfaces.

Most money managersare trapped by their owninstitutional imperatives, andthey don’t even know it. It’s

given to themarket thatonlythe majority of the marketwill achieve average returnsor worse. Therefore, there’svery little value added in theinvestment industry as awhole.

Now, don’t get mewrong, there are plenty ofmanagers that provide valueadded services. However, onthe whole, the industrydoesn’tprovidevalue.That’s

the way a market works. Itisn’timpossible,it’sjustverydifficult in the moneymanagement industry toprovide value add to theircustomers.

The only way tooutperformover the long runis to have the discipline topickyourspots,andhavetheconviction to invest heavilyinhighqualitybusinessesthatwill compound your money

overthelongrun.In order to do this, you

musthaveacontrarianstreakattimes.It’snotnecessaryallthe time, but usually it’swhere the greatestopportunity foroutperformance lies. It’sbeneficial to developcontrarian tendencies duringperiods of extreme euphoriaandpanic.

This means not being

fullyinvestedinthemarketatalltimes.Thismeansholdingcash and waiting patiently ifthat’swhat itcalls forduringextreme bull markets andexcitement. As far as howlongIwillwait?Aslongasittakes.

Anotherinterestingresultof growth businesses, is thatwhenthegrowthisknown,orexpected, it’s usually alreadypriced or discounted in the

security. Anything less thanthat expected growth canhaveadisastrouseffectonthestock price, and the currentvaluation if the businesswaspriced for perfection. Itdoesn’t matter how great abusiness is, if youbuyat thewrongprice.

Additionally, when wetalk about growth, we talkabout it in overly simplisticterms. Saying a business is

growing 7% doesn’t mean agreat deal.What is growing?Revenues?CashFlow?

And not only do youneed to pinpoint where thegrowth is coming from, youalsoneed toknowthereasonbehind thegrowth.Youneedto knowwhy theywere ableto achieve that growth, andthethingsthatwillcausethatgrowthtocontinue.

Likewise, why are they

able to grow in the first-place? What will cause it tocontinue? As you can see,these can be a very difficultquestionstonarrowdownandanswer.

So now you see therewillalwaysexistapermanentparadox: the future is notpredictable,however,inorderto calculate DCF we mustpredictthefuture.

Sowe’veestablishedthat

the future is ‘predictably,unpredictable.” We alsoknowthat,ashumans,weareoverly confident in ourabilities to outperform themarket. And we have thatsame overconfidence in ourabilitytopredictthefuture.

So how do we handlecalculating something that isinherently unpredictable andimprecise?

The ONLY way is

conservatively!All projections have a

high probability of error.There are just too manyvariables.Sousingoptimisticpredictionsputsaninvestorina potentially dangeroussituation. If an investor usesoverly optimistic numbers,permanent losses are a realpossibility, if the optimisticestimatesdon’tturnouttobecorrect.

However, usingconservative estimates, andinvestingonlyatasignificantdiscount from the valuationof those conservativeestimateswill serve investorsextremelywelloverthelong-term.

Youwillneedthreemaininputs in order to calculatethe valuation of the businessfor DCF purposes. Becausewe must be conservative

about the inputs for DCF, Ihave included some “basic”guidelinesbelowtokeepyouaway from the potential forthe ‘garbage in, garbage out’analysis that is prevalent inthiscalculation.Seebelow:

DCFGuidelines:

1. Growth Rate →Typically 3-5% --(nevermorethan10-15%)

2. DiscountRate→Atleast 10-15% --(higher if moreuncertainty or betteropportunities)

3. Starting FCF →LowestLevel of last5years /avg.of last5 years / discountednumber fromcurrentyearorpreviousyear

How Do We Choose The

GrowthRate?We have discussed this

already, however it can’t bestressedenough.

You must be veryconservative with yourestimates for growth. If acompany is growing 15% ayear, all else equal, I wouldprobably use a lowerestimate. Probably 10% orlower depending on thebusiness or industry. I think

this gives a wider margin ofsafety,anditwillalsoprotectyou from paying too high aprice if the business doesbegintoslow.How Do We Choose TheDiscountRate?

The choice of discountrate is one that is not givenadequate attention frominvestors. There seems to bemuchdebateandconfusionas

to what the discount numbershouldbe.Somewill use theWeighted Average Cost ofCapital (WACC), and otherswill simply use the risk-freerateplusanarbitrarynumber.

Truth be told: A singleaccurate discount rate forfuture cash flows doesn’texist.

Thereisnosure-firewayto choose one either. Itdepends on a variety of

different things such as yourinclination for future vs.presentconsumption, theriskprofile in your portfolio, theactual risk or uncertainty ofthe potential investment andthe opportunity cost of otheropportunities.

For some reason,investorscanoversimplifybyonly using one number for avariety of differentinvestments with different

levels of risk.Many just use10% as a baseline discountrate for their valuation.However, there are otherfactorsinhelpingustodecideanappropriatediscountrate.

As a general rule, thehigher the riskof futurecashflow, the higher the discountrate. The lower the risk offuture cash flow, the lowerthe discount rate. And that’swhy our analysis of

sustainable competitiveadvantages is key to beingable to calculate DCF asaccuratelyaspossible.

Obviously, short-termU.S. Treasuries are used asthebaselinefordiscountratesfor near riskless securities.However, in low rateenvironments (which we arein rightnow) it canskew theappropriatediscountratesandvaluations. You should

attempt to use the highernormalized interest rates asyour baseline in finding anappropriatediscountrate.

As you can imagine, thevalue of the business isinfluenced heavily by thediscount rate you choose.And discount rates areultimately influenced byinterest rates. Obviouslyinterest rates move on aregular basis. This brings us

backtothequestion,“WhatistherightinterestrateIshouldbe using to help withchoosingthediscountrate?”

The bottom line is thereisno“right”interestrate.

However,itdoesn’tkeepus from producingconservative estimates. Thisanswer becomes moredifficult during extrememoments of interest ratemoves.

Forinstance,theworldisat or close to 0%on 10-yearnotes right now. Is thissustainableoverthelongrun?Probablynot.

As a general rule, in alow rate environment, I willuse a higher discount rate toprotect against the eventualincrease in interests ratesfrom the economy growingquickerthananticipatedorasadeterrenttoinflation.

Just like other financialmarkets (equity/commodity),there is a cyclicality tointerest rates.High rateswillusuallyleadtolowrates,andlowrateswillultimately leadto high rates. It still doesn’tnecessarily help indetermining an appropriatediscount rate but it helpssome.

You will likely findabnormally highmultiples in

stocksduringlowinterestrateenvironments. Of course, ifyou pay those multiples youbetterhope interest ratesstaylowforanextendedperiodoftime. It’s very importantduring lowrateenvironmentsnot to stray away from aconservative approach toinvesting.

Personally, I nevercalculate ANY businesswithout at least an 8%

discount rate.And that is fortop-rated businesses like aCoca-ColaorCostco.UsuallythediscountrateIuserangesfrom 10-20%. Choosing adiscount rate asconservatively as possible iscritical. DCF can changeconsiderably on smallchanges in discount rates, soalwaysgiveyourselfroomforerror.

How Do We Choose TheStartingFCFNumber?

In order to understandtheprobabilityof futurecashflows, analysis of theunderlying business must beperformed. We havediscussed this process in theMoat section of theMECOM™Methodearlier.

Once the underlyingbusiness is analyzed, anddeemed to be a potential

moat-type company, we canconservatively attempt toforecast FCFwhile assigninga conservative growth anddiscountrate.

NowwecancalculatetheDCFofthebusinessinaveryconservativemanner.

Asweknow,valuationisnotanexactscienceandDCFvalues will fluctuate (wildlyat times). This is why I useDCFinanumberofdifferent

scenarios. This gives me arange of values which helpsmetoconductasensitivityorstress test on potentialinvestments.

I will usually giveprobabilitiesto3-5cashflowpossibilities, and then I gettheDCFvalues.Once Ihavethe DCF values I multiplyeachvalueby theprobabilityof the scenario actuallyoccurring. I then sum up

these numbers which givesme an idea of the “intrinsicvalue” over various likelyscenarios.

Obviously,itcanbeverydifficult to give probabilitiesto certain events which maynot ever happen. Still, I seethisasaprudentexerciseandprocess to see how FCF,growth rates, discount ratesand other scenarios canchange the value of the

business. Ifeven thesmallestchanges to any of the inputscreates significant changes tothe valuation, it could be acauseforconcern.

To help explain theprocess further. Here is anexample of an investment Imade in Cisco Systems(CSCO)inmid-2011:

Ciscoinitiallycaughtmyattention because of itsrecurring revenue structure

and large amounts of freecash flow. However, whatreally drew my interest wasthe market’s perception ofCisco as an “old tech”company past its glory days.Bandwidth will continue togrow and will constantly beneeded.Ciscowas in a greatposition to reap the rewardsbecause of its dominantmarket position, and itsincrediblecapitalallocation.

In valuing Cisco, let’sstartwiththeFCFnumber.

Cisco had Cash Flowfrom Operations of $10.2billion in 2010. Capitalexpenditures for the yearwere$1billion.The“backofthe envelope” net free cashflowwasabout$9.2billion.

From2009 to 2011FCFgrewonaverage15.6%.Andfrom2006to2011FCFgrewon average of 8.1%. Cisco

grew FCF from $6.9 billionin 2005 to $9.2 billion in2010. And in the process,Ciscohascontinuouslygrownearnings while achievingmid-teen returns inROE andROIC over the last 10 years.It also looks like Capex isincreasing slightly, but hasstayed relatively stable overthattime.

Based on these growthnumbers, and to be very

conservative, I will come upwith 3 growth scenarios forCiscooverthenext10years:Scenario#1

0% growth in FCF foryears1-3

5% growth in FCF foryears4-10Scenario#2

10%growthinFCFforyears1-10

Scenario#3

15%growthinFCFforyears1-10

Furthermore, in keeping

with our conservativeestimates,insteadofusingthe2010 FCF figure of $9.2billiontoproject2011FCF,Iwill be conservative, andusetheFCFfigurefrom2009,8.9billion. Just to give us an

evenbiggermarginofsafety.Why did I choose this

number?Because it was a year

during extremely harshconditions. And a numberthat I expected to be acyclical low in earnings forthe foreseeable future. As aresult, it seemed like a veryconservativenumber.

We will use aconservative discount rate of

10%, given the high quality,sustainable nature of thebusiness.

And even after all theDCF, the business is stillworthsomethingattheendoftheday(allelsebeingequal).So we assume that thebusiness is soldat theendoftheyear10ataconservative10timesFCFplusanyexcesscapital in thebusiness.Ciscohad$4.6billionincashatthe

endof2010.Look at the three

scenarios below using thesevarious assumptions, and seehow Iwasable toarriveat afairly conservative estimateof intrinsic value using arangeofvalues.

Scenario #1 - 25%Probability

FIG 49: CSCO DiscountedCashFlow,Scenario#1

Scenario #2 - 50%Probability

FIG 50: CSCO DiscountedCashFlow,Scenario#2

Scenario #3 – 25%Probability

FIG 51: CSCO DiscountedCashFlow,Scenario#3

So,theintrinsicvaluesofCisco range from $19.39 to$38.25.Thestockwastradingatunder$18persharewhichgaveaslightmarginofsafetyto our low-line assumptions.However,Ibelievedthemostlikelyscenariois10%growthin FCF in the foreseeablefuture, which is why Iweighted scenario #2 at 50%

probability.Thisgivesusaweighted

intrinsic value of $28.56 pershare.With shares trading atless than $18 per share, itseemed like a pretty gooddealtome.

FIG 52: CSCO DiscountedCash Flow, WeightedIntrinsicValueCalculation

Inaddition, thecompanyissued its first dividend in2011, so I expected therewould be new capitalallocated to Cisco fromincome investors anddividend funds that wouldneed topurchase thestock inordertotracktheirrespectivebenchmarks, and to complywith their fund mandates.

This would act as anothercatalyst to help Cisco reachitsintrinsicvalue.

Also, calculating thereverse discounted cash flowshowedthatthemarketatthetime was expecting only 4%growth from the business.Giving us furtherconfirmation there was adifferencebetweenperceptionandreality.

I began to accumulate

shares below $18.00 pershare, which was more than40% below the weightedintrinsicvalueofthebusinessof $28.56 per share. Andslightly below the low-linecalculation of $19.39 pershare.

FIG 53: Cisco Systems(CSCO)Chart,2010-2015

Once again, I sufferedfromprematureaccumulationas Cisco propelled right pastmy initial buy points.However, this was a qualitybusiness that I believedwould be around another 10-20years,anditstillproduceda significant amount of freecash flow during a very direperiod. I was willing to pay

upa littleforabusinesswithnumerous competitiveadvantages, and trading atless than 10x free cash flowlevels.Disclosure: I currently holdnopositionsinCisco(CSCO)atthetimeofwriting.

ConservativeLiquidation

Valuation

Forsomeoddreason,thevast majority of individualshave a very difficult timegrasping the concept of

liquidationvalue, andbuyinga security at a significantdiscount to that liquidationvalue.

Itmainly stems from theperception of where thebusinessiscurrently.

If a business is tradingbelow its liquidation value,it’s usually because thebusiness is suffering or hasfailed to meet theexpectations of Wall Street.

Thus, the business is usuallyloathedamongtheinvestmentcommunity for a myriad ofdifferentreasons.

Theveryfactthatpeopledislikebusinesses,evenwhena business is trading wellbelow its liquidation valueshould intrigue you as aninvestor. This type of herdmentalitytowardhatedstockskeeps individuals frommaking contrarian

investments, even though theunderlyingfundamentalsmaypaintadifferentpicture.

Basically, theseindividuals are saying theyknow it’s tradingwell belowits intrinsic value. However,they still wouldn’t touch itwith a 10 foot pole.Personally,I lovethesekindsof situations. This is theperfect example of finding asituation where, for some

reason, there is a greatdifferencebetweenperceptionandreality.

Liquidation value is theconservative estimate of abusiness’s worth by onlyusing the tangible assets ofthe business.Cash flows andintangible assets are notcalculated in this type ofanalysis.

As you can see, thissignals that the business is

worthmore dead, than alive.The liquidation value usuallyconstitutesthelowestvalueinthesaleof thebusiness.Soastock that’s sellingsignificantly below theconservativeliquidationvalueof the business, usuallysignals the potential for aninteresting risk-averseinvestment.

WhenIsayabusiness istrading below its liquidation

value, I’m not saying it’sactually going through theliquidation process. It’s ahypothetical valuation of thebusiness. A business that’strading readily below itsliquidation value merelyillustrates to an investor thatthere is a deep disconnectbetween the underlyingbusiness and the stockmarket. These are themomentswelookforasvalue

investors.And this doesn’t mean

the stock will trade at itsliquidationvaluetomorrowornextweekornextmonth (…or even next year).Anythingcould happen to the stockpriceatanygivenmoment.Abusinessthatistradingbelowits liquidation value pointsout the perception that thebusiness is worth more deadthan alive. And that signals

potentialopportunity.If you believe the

business has ongoingbusiness characteristics, youmay be onto a tremendousinvestment opportunity withverylittledownsiderisk.

Liquidation value isusually the worst casescenario analysis of thebusiness. Typically thisanalysis is conducted onbusinesses that are no longer

agoingconcern.So,ifyou’reable to find

ongoing businesses that aretrading below liquidationvalue you may have atremendous opportunity infrontofyou.

So how do investors valuethe assets in liquidationanalysis…

During liquidationanalysis you try to derive a

conservative value of eachasset component.During thisprocess assets will beconservatively discounted,and debt will usually bevaluedfacevalue.

As a general rule, aforcedsalewillyielda lowervalueoftheassets(firesale).An orderly sale of the assetsusually leads to higherrealization of value of theassets.

Tobeconservativeinouranalysis of liquidation value,we will use mid-lineestimates of discounts in ouranalysis of the assets. It isbettertobeconservativewiththesevalues.Youcanalwaysadjustupwards ifyousee fit.This depends on the qualityof the assets, as well aswhether liquidation occurs inan orderly or fire salemanner. Every situation is

different,andwiththatcomesa different probability ofcertainoutcomes.

Hereisanexampleofthemid-line discounts I give toeach asset in a fire salesituation:

Cash-------------------------95%MarketableSecurities----90%Receivables----------------

75%Inventory-------------------25%PP&E-------------------------50%*SimilartoBenjaminGraham'sSuggestioninSecurityAnalysis

Cash,asinthemoneyin

yourwallet,isvaluedat95%.I just have a difficult timegiving anything 100% value,

soIdiscount it. I likehavingas big a margin of safety aspossible.

MarketableSecurities,orinvestment securities, shouldbe valued at their currentmarket prices. I like todiscount these as well toaccount for market volatilityandtransactioncosts.

Receivables should bediscounted more to accountfor delinquent or

unrecoverable receivables.Sometimes this is alreadyaccounted for in thereceivablesnumber,sochecktomakesureinthe10-K.

Inventory will probablybe the most heavilydiscounted asset on thebalance sheet. Inventory isusually a lower priced itemcompared to PP&E, and canbe moved quickly, sold andturned into cash. Of course

this is only contingent onwhether the asset is still berelevant or something thatconsumers still want toconsume.

Property, Plant &Equipment (PP&E) will beheavily discounted as well.However,thisdependsonthequality of the assets, andwhether there are hiddenassets imbedded within thisasset.Thequalityoftheasset

reallydependsonitsabilitytogenerate cash flow. It alsodepends on percentage ofPP&E is property, plant orequipment.Hiddenassets areusuallyfoundwithinpropertyor marketable securities, butplantcouldbeahiddenassetaswell.

It has been myexperience that PP&E isultimately valued orliquidated at well above the

50% discount. I still like tohave themarginof safety, soI will keep at 50% to beconservative. Again, thisdependson thequalityof theassetandwhenthePP&Ewaspurchased.

With virtually everydiscountedasset,thediscountdepends on the type ofcustomer, type and nature ofthe business andwhether it’sanongoingbusinessornot.

REMEMBER: In a firesale liquidation scenario,youwill need to discount thesenumbers even more. In anorderly liquidation scenario,values will be higher andclosertoactualtangiblebookvalue.So how do investors valuethe debt in liquidationanalysis…

Debt is a little easier to

calculate, however you mustbe aware of hidden off-balance sheet issues as well.These include underfundedpensions, leases, lawsuits orother contingent liabilities.We discussed this previouslyintheobligationssection.

Adjusted Liquidation

ValueCalculation:

(DiscountedAssets-

AdjustedLiabilities)/SharesOutstanding=LiquidationValue

There is also a short-cut

to liquidation value that wasgiven to us by the father ofvalue investing, BenjaminGraham. Net-nets or netcurrent asset value (NCAV)is when you calculate theconservativeliquidationvalueofthebusinessbytakingonly

currentassetsandsubtractingALL liabilities. You wouldtake this number, and divideby the shares outstanding toarrive at a back of theenvelopeliquidationvalue.

(OnlyCurrentAssets–AllTotalLiabilities)/Shares

Outstanding

As you can see, PP&Eand other long-term assets

aren’t even included in thiscalculation. Grahamrecommendedbuyingat66%belowtheNCAVnumber.Heproclaimed you could knowvery little about theunderlying business, and stilldo very well over time byinvesting in these types ofbusinesses.

In fact, many that stillinvest in these types ofbusiness have consistently

produced over 25%compounded for theirportfolios. I know of a fewmyself, but theseopportunities don't comearound too often.When theydo, you need to pouncequickly.

When you buy belowNCAV, you are shieldingyourselfbyusingonlycurrentassets as your estimate ofliquidationvalue.Thisis true

whether the business isconsidered ongoing or not.However, one thingwemustbeverycautiousofistherateof cash burn or overalldeterioration of theunderlyingbusiness.

Business losses canquickly take out currentassets, so we must alwaysgauge the current operatingenvironment of theunderlying business.Andwe

must also be on the lookoutfor off-balance sheetliabilitiesaswell.

If current assets are notover valued or deterioratingrapidly, a business couldtheoretically liquidate theentirebusinesstotakecareofall liabilities and still leavesome left over for investors.There is obviously aMASSIVE divergencebetween perception and

reality.As I have stated before,

bankruptcy and liquidation isusually associated withnegative connotations offailure from a public andcorporate perspective. As aninvestor, this couldn't befurther from the truth(depending on when youinvest).

And therein lies thepotential opportunity. Most

peoplerunfromadversityandfailureanddistress.Mostwillrun from the fires--we willwalk slowly towards itlookingforopportunity.

Liquidation of a publicbusiness makes for aninterestingcase study inhowthestockmarketisnotalwaysefficient. It isoneof the fewinstances when the conceptand philosophy of valueinvesting is revealed to the

market in a very powerfulway.

Isthestockmarketreallyagiganticvirtual casinowithelectronicstocks tobe tradedback and forth in nano-seconds? Or are theseelectronicstockspartofarealbusiness?

The actual liquidation ofa business settles this debateonceandforall.

Investorsactuallyreceive

proceedsfromthesaleof thebusiness. And if an investorpurchases prudently, he/shewill receive a profit if theypurchase shares below thefinalliquidationvalue.Thisisthe very essence of whyGraham called the stockmarketa"weighingmachine"overtime.

The liquidation of adistressedbusinessactsasthemidline of a business's

intrinsicvalue.Thestockwillbecome undervalued orovervaluedonanygivenday.Overtimethestockpricewillhover around its intrinsicvalue.

BOTTOM LINE: If youconsistently purchase stocksof businesses trading belowliquidation value, you giveyourselfan incrediblemarginof safetywith very little riskofpermanentloss.

If you add to thatscenario, with a businessproducing (or likely toproduce) free cash flow in aturnaround scenario, youhave very powerful forcesbehind you as you pick up aleft fordeadcompanyon thecheap that’s now producingfreecashflow.

Ultimately, the stockmarket will re-price thebusiness and its future. This

kindofpricediscoverycanbequite powerful in the futurestock price of a distressedbusiness.

You want to alwayswatch these distressed typesof businesses that startproducing free cash flow.Especially when theirefficiencymetricsstarttotakea turn for the better. It couldbe a sign of potentialturnaround of the business.

And what follows suit soonafterwillbe there-pricingofthe business. You want torecognize this before the re-pricingtakesplace.

To help explain theprocess further. Here is anexample of an investment Imade in Bassett Furniture(BSET) after screening forbusinesses trading belowtangiblebookvalue.

Bassett is a vertically

integrated furniture company(imports, manufactures,wholesalesanddistributes).Itwent through some difficulttimesafter thehousingcrash.However, it seemed thatoperating and efficiencymetrics were stabilizing andimproving.

At the time, Bassettwastrading at less than $5 pershare. What intrigued us themostwas the fact that itwas

trading well below itstangible book value of~$9.00.Ofcoursewewantedtodig infurther tosee if thiswas a true and stableliquidation value for thebusiness.Andwealsowantedto discount the assets on thebalance sheet to see if wecould arrive at an additionalmarginofsafetyforpotentialinvestment. See the figurebelow for our analysis (fig.

54).

FIG 54: Bassest Furniture(BSET)LiquidationAnalysis

This analysis showedlittle-to-no margin of safetywith the adjusted liquidationvalue of the business.However, this was also abusiness trading at less than50% of its tangible bookvalue.Andnotonly that -- Itwas also beginning toproduce FCF, and seemed tohave no threat of bankruptcy

in the immediate future(operations seemed to beturningaround).

As you can see, therewasamajordisconnectinthisstock.

To our surprise it gotevenbetter.

Herecomes thebestpart-- the element that ultimatelyswayed us to invest in thebusiness:

Bassetthadanadditional

margin of safety in the formof hidden assets on itsbalancesheet.Wewerefairlyconfident that PP&E on thebalance sheet was beingcarried at far less than theiractual value. We stilldiscounted these assets at75%totheirbookvalue(justtobesafe).

Ifyou remember,hiddenassetscanbedifficulttofind.However, youwill find them

from time to time. Thesehidden assets get even moreinteresting when businessesare trading below theirliquidationvaluesbecausethehidden assets can act ascatalysts in a spin-offor saleoftheasset.

Thesehiddenassetsofferan added margin of safetythat’snotwildlyknowntothepublic. This can provide anice upside surprise to those

awareofthehiddenassets.This was the case with

Bassett. They owned almost50% of a sizable 3.5millionsquare foot furnitureshowroom that was actuallybeingcarriedonthebooksasa $7 million liability (andthat’s why you don’t alwaystrustGAAPaccounting).

Well, Bassett eventuallysold this asset realizing over$70 million in pre-tax

proceedsfromthesale,whichwas more than the entirecurrent market cap at thetime. Obviously, there was amajor disconnect andmispricinginthisstock.

After the announcementin early 2011, shares shot upover50%inacoupleofdays’time. And over 100% in theensuing months, as themarketcaughtontothevalueof Bassett. After various

special dividends toshareholders andimprovement in operations,shares are trading over $20per share (not includingdividends).

FIG 55: Bassest Furniture(BSET)LiquidationAnalysis

FullDisclosure:Nolongerholdanypositionsasithassurpassedourestimatesofintrinsicvalue.

Asyoucan see from theprevious examples, valueinvestingisasimpleconcept:purchase something for lessthanit’sworth.

However, we knowthrough experience that theimplementation of valueinvesting is easier said thandone. That’s why it isimperative for investors to

have a system or process tokeepthemfocused.

I’m not an overlysophisticated or analyticalperson, and 5M™ is none ofthesethings.We’renottryingto employ rapid tradingalgorithms and models. Weadhere to a simple, easy toremember value investingsystem.That’sit.

Themostdifficultpartofvalue investing is your

patience and your discipline.Andevenifyouhaveendlesspatience towait for the rightinvestment and discipline tostay away from unattractivesituations, you still need tomake the right judgments ofwhen to make the rightinvestment.

Investors shouldALWAYS make decisionsbased on what they wouldpay for the whole business.

Don’t pay what others arewilling to pay or would payforpopularstocks.Behonestwithyourself, andalways tryto ask yourself, “whatwouldI really pay for thisbusiness?”

These two valuationmodels should be used asyour main methods forvaluing business. However,any one model or scenario,in-and-of-itself, does not

mean it constitutes theIntrinsic Value of thebusiness. Using a range ofvalues will help you inascertaining a conservativeand appropriate margin ofsafety.

In this section, youlearned the art of valuation,how to use a range ofvaluations in your approach,how to use DCF to value abusiness conservatively, and

howtouseLiquidationValueto value a businessconservatively.

SoatthispointyouhaveMasteryofTheMarket,YourMindset, Your Morals, TheMECOM™ METHOD, andYourMarginofSafety.

YounowhaveaMasteryofInvesting!

Thepointof thisbookisto condense the mostimportant elements to

investing success, based onyears of real-worldexperience of managingmoney, as well as researchand interviews of the topinvestingmindsoftoday.

An understanding andmastery of this informationputsyoueasilyinthetop2%of other investors in themarketplace.Congratulations! I doesn’tend here though. Keep

learning.Keeptryingtobetteryourselfandothersand…

StayWithinthe5M™MentalModel:1) Know YourCompetition,2) Stay In The ProperMindset,3) Use Long-TermInvestingPhilosophies,4) UseASimpleMethod

ToBusinessAnalysis,and5) InvestWithAMarginOfSafetyAnd you will be

surprised how quickly yourwealth will compound overtime. I look forward tohearingaboutyourjourneyinthe years to come. And Ithankyouforallowingmetobepartofyourjourney.

Now let’s put it alltogether!

PUTTINGITALL

TOGETHER

"Aninvestmentinknowledgepaysthebestinterest"

BenFranklin

The best investing toolyouhaveisyourBRAIN.

Learn as much as youcan.Learntointerpret5M™.And learn to interpretfinancial statements in yourownway.Thiswillallowyouto have conviction in yourowndecisionmakingprocess.You will know what feelsrightandwhatfeelswrong.

Consider the opinions ofothers,butneveractonthem

without confirming theinformation on your own.Investingisn’teasy(anythingin life worth attaining rarelyis).

However, it can besimple if you follow asystem. The mental modelsand the system that you useand develop will compoundwith knowledge over time.It’s the ultimate snowballeffect.

Let your instincts andyour brain take over. Don’ttrust suggestions. Alwayslook for the truth in thenumbers.Learningtobeself-sufficient with yourinvestment decisions willgive you a huge advantageover the other 99% ofindividuals in themarketplace.

As faras investinggoes,NOTHINGwillpayoffmore

than educating yourself.Before any investmentdecisionismadeyoumustdothe necessary research andanalysis. 5M™ guides youthroughjustthat.

Be happy and excitedabout investing, but NEVERbecome complacent. Alwaysbe prepared to sell duringhigh, exuberant markets, andbuy in low, depressedmarkets.

There will definitely betimeswhen youwill have tostepoutofyourcomfortzone--that'snormal.

It'scalledinvesting.Youwill need to do this

over the long term to realizesignificantgainsanddistanceyourself from the rest of thecompetition. It’s vital thatyou know the boundaries ofyoucomfortzone.Sopracticestepping outside of it every

once in a while in smalldoses.

First and foremost, youneedtoknowyourselfbeforeever stepping on the field oftheinvestmentworld.

Not many people canhandle being contrarian. Ittakes a lot of knowledge,experience, and guts to jumpinto an investmentwhen youknow others are selling. Thesame goes for selling when

you know others are buyingmomentum stocks atridiculousvaluationlevels.

The best system in theworld can't help you if youdon’t have the discipline toseeitthroughtotheend.Andthe same goes for investing.If youdon’t have theguts tosee it through based on youroriginalinvestmentthesis,thebest investment idea couldturndisasterous.

Can you really see itthroughtotheend?

There will always berecessions, depressions, andstock market declines.Always be ready for them:thisisusuallythebesttimetoinvest.

When declines in thestockmarketareaneverydayoccurrence, it’s critical thatyou stay true to the 5M™Mental Model of value

investing (or any rationalsystemforthatmatter).

You must stay thecourse! There is a cyclicalnature to most things in thisworld --- the economy andfinancial markets are noexception. There will alwaysbeebbsand flows.Expect it.Welcomeit.Thiswillalwaysput you in the right frameofmindtotakeadvantageoftheopportunities that others

create from irrationality orfear.

The great part is ---You’llneverbealone.

You have this system,andthiscommunitytoalwaysfall back on when times aretough. This is something Iwish I had in my early daysasaninvestor.AndItreasureit even more now as aseasonedinvestor.

BeingpartoftheEndless

Rise Investor group is likebeing part of one biginvesting mastermind group.It can keep you focused onyour long-term goals ofcompounding your wealthwithoutalltheoutsidenoise.

Before I send you onyour investment journey, Iwant to thank you for takingthe time to invest inYOURSELF. Not manypeople have the discipline

and courage to learn moreandcontinuetogrow.

Wealth is something weallseekasindividuals.Anditcomesinmanyforms.

Buthowisitachieved?It starts with having

something you’re passionateabout. Invest in yourself bywhatevermeansnecessarytobe the best at what you do.When you are on that path,find a way to use this to

produce income-generatingendeavors and invest alongthe way. The way to wealthcreationreallyisthatsimple.

"It'snothowmuchmoneyyoumake,buthowmuch

moneyyoukeep,howharditworksforyou,andhowmanygenerationsyoukeepitfor."

RobertKiyosaki

I have a simple formula

forinvestmentsuccess:

Workpassionatelywhilealwayslearning+Payoffhighinterestratedebtandkeepdebtatlowrates+MonthlySavings+RiskAverseInvesting=InvestmentSuccess

I know it’s a simple

formula --BUT it’s a simpleconcept.

And there’s no need tocomplicate simple concepts.The problem arises whenindividualstrytogainwealthtoo fast. Getting rich orwealthy slowly neverbotheredmetoomuch.

Financial peace isn’taboutacquiringmorestuff inrapid succession. Using asimple system with simpleprocesses and methods helpsto get rid of that mindset

whiledeflectingtheclutter.Learn to live a great life

withlesscomplication.It’sallabout livingon less thanyoumakeandsavingtherestinarisk averse manner. Byinvestingandbeing thrifty inyourspendingonunnecessarythings, you can ensure thatyouwillhaveenoughmoneyfor your retirement, yourfamily, your dream car ordreamboat.

Once again, this doesn'thappenovernight.Ifyouwantto gamble, then you shouldgo toVegas.Value investingrequires work and patience.However, the gains you willsee over timewillmore thanmakeyouabeliever.

Youneedtogetyourfeetwet and have confidence inyour investments on yourwatchlist. Once you getcomfortable you can make

adjustments to your portfolioto make better and biggerinvestment decisions overtime.

Ifyoufollowthissystem,you do the research, youcompileawatch-list,andyouawaitpatientlywhilekeepingyour temperament in check,your chances of investmentsuccessincreasedramatically.

In fact, they continue tocompoundasyou learnmore

andmoreaboutinvestingandthe businesses that interestyou. And 5M™, and itscomponents (as well as thecommunity), will always behere for you to reference orfall back on for confirmationorinsight.

MyMentor

You’ve heard myjourney, my story, mydreams, my process and my

philosophies, my vision andmy passion for the future ofinvesting, and the future ofYOURinvestingjourney.

I always had a passionforhelpingpeoplebeasgreatas they want to be. And it’sno different with investing.However seemingly young Iwasforthefinancialindustry,I’ve always wanted to helpmy junior traders, analysts,and colleagues invest better.

And I want to pass on thismentorship and coaching toothers. It is a passion thatdrivesme,andit’ssomethingI feel I need to give back toothers because I have seenand felt the impact ofcoaching and mentorshipfirsthand.

Forfartoomanynights,Iremember laying in my tinyapartment wondering how Iwas ever going to be

successful at investing.Would I ever have a realunderstanding of thesebusinesses?Would I ever beabletograspinvesting?

Then one day I saw aman on TV talking aboutvalue investing. His rhetoricandaptitudeforinvestingwasbeyond anything I had heardbefore. He was passionateabout investing and seemedto speak my language. I

thought tomyself, “Iwant tolearneverythingthat thisguyknows.”

His name was WhitneyTilson, Portfolio Manager ofKase Capital (formerly T2Parners).

Although I am usuallyquite skeptical ofpersonalities on television orthe internet, this guy trulycomes from the heart. He isan incredible investor and

educator, but he’s an evenbetter person. And I saw itfirst-hand.

It wasn’t what he wassaying; it was how he washelpingpeoplewithinvesting--- And helping them havebetter lives as a result. Iwantedtodothesamething.

That night I convincedthe Investment Firm I wasworking for at the time togivemetimeofftoattendthe

Value Investing Congress,and the advanced valueinvestingclasswithWhitney.I was in my early 20’s anddidn’t have a great deal ofmoneyatthetimeasayounganalyst, so I told them all Ineeded was the conferenceticket and plane ticket, and Iwouldfindaplacetostay.

They agreed, and I wasable to see Whitney inperson. I got to ask him all

kinds of questions, whichhelped clear things up. Ithelped me focus on thecomponents that matteredmosttoinvestingsuccess.

The advanced sessionwalked through eachinvestment they had made,and why certain decisionswere executed. It openedmyeyes to investing. Moreimportantly, it made merealize that I wanted to do

thisforotherpeople.I can say without any

hesitation, that this oneseminarchangedmylife,andput me on the path to valueinvesting. It’s what I wantedtodotherestofmylife.Ijustdidn’t know exactly how togetthereatthetime.

Throughouttheyearsthatfollowed, I listened to andreadmessagesfromthegreats--- from Benjamin Graham

andWarren Buffett, to PeterLynch and Charlie Munger,to Seth Klarman to LeonCooperman to MohnishPabrai.IdidanythingIcouldto improve my investingprocess and philosophy.Because of these incrediblehuman beings, I was able togainthewisdomtobeabletoshow others how to invest.AndIwillbeforevergrateful.

These investors have

helped so many peoplethroughouttheworldtobetterunderstand investing. So Isupposeit’sacommonstory.

When Iwas creating the5M™MentalModel inmid-2009,itwasinitiallymadetohelpmeandeducatepotentialinvestors in my fund aboutmy process of selecting andinvesting in stocks. It painsme to say it, but I initiallycreated a system like this for

selfishreasons.As I finalized the

process, I asked friends andfamilytolookatitandletmeknow what they thought.Would they invest in thefund? They respondedresoundinglywith, "Not onlywouldIinvestinthefund,butI learned more aboutinvesting through the contentand material than I have inmyentirelife."

Theyopenedmyeyes tothe possibilities that werethere to help educate peopleabout investing. They said,"You should offer this toeveryone, not just potentialfund investors." I thoughtaboutthatforafewdaysanddecided to open it up to themasses. It was at this pointwhen I thought everyoneshould have this system andthementalmodels associated

withit.Ultimately, the potential

to touch millions of people'slives and impact them andtheir families in a positivewaywastoomuchtopassup.Afteryearsofworkingonthisbook and putting 5M™together,Iquitmycushjobatthe hedge fund, and decidedto create Value InvestorConfidential and this bookyouarereadingtoday.

It was quite difficult toget off the ground with thisproject,butitwasworthit intheend.Seeingpeople'sliveschanged forever is worthALL of the trials andtribulations it took to gethere.

BOTTOM LINE: Oursociety has discounted thevalue of mentorship andproven processes (orsystems).

I would love to be amentor or coach to you, likeWhitneywastome.Sendmeyour stories of the 5M™Mental Model andMECOM™Methodinaction.

Ilookforwardtohearingaboutyourjourney!TheTimeisNow--Action isrequired

"Howmanymillionairesdo

youknowwhohavebecomewealthyby

investinginsavingsaccounts?Irestmycase.y

RobertG.Allen

The earlier you getstarted investing, the betterchance you have ofcompounding wealth overtime.

If you follow thesesimple recipes: 5M™ and

MECOM™ specifically, itwillbeVERYdifficultnottomake money over time.Peoplehavemadeunncessarymistakes because they werein a rush to be rich tooquickly.Youdon'tneedtobein a hurry to be wealthy. Itcan happen faster than youthinkwithvalueinvesting.

Therearemanyouttherethatequatevalueinvestingtowatching grass grow. My

response is, “Yes, but haveyouever seenhow fast grassgrows in a month withouthaving to watch it like ahawk?”

Usually an awkwardsilence ensues. To which Ireplywithasmile,“Exactly.”

The beautiful part ofinvesting long term is thatyoudon't have tobebrilliantto be successful. You justhave to keep learning, and

use simple, rational systemsoveralongperiodoftime.

These are not newconcepts; nor are theyrevolutionaryideas.

My hope is the way theideas and concepts areorganized and framed in the5M™Mental Model will beREVOLUTIONARY.

It’sdesigned tohelpyoulearn,visualizeandretaintheinformation more effectively

and efficiently so you canmake the best decisionpossible. I don’t know ofanyone that tries to teachvalue investing with thesemnemonic memory triggers.And you can use it for anybusiness!

I do have an opinionaboutwhosucceedsatwealthaccumulation and whodoesn't. It’s the person thathasacoresetofconceptsand

processes thatallowshim/hertofocusandkeepgoing.ThatwillbeYOU.

There will always bebumpsintheroad.Theremaybe tweaks here and there tothesystem.Butovertime,thecore 5M™MentalModel ofvalue investing will serveYOU well in makingsuccessful investmentdecisions.

Ithasnothingtodowith

how attractive you are. Orhow smart you are. Or howmanyconnectionsyouhave.

Thebestbusinesspeople,and the best investors stickwith a system andphilosophy, and they keepmoving forward.Perseverance and awillingness to learn provenprocesses is the secret tosuccessintheworld.

Iwant to leaveyouwith

one last thingbeforeyougo:It’s VITAL that you takeaction regarding your futurewealth accumulation andcreation.

Whether you use 5M™or use the MECOM™Method or buy a low costfund that tracks the S&P oruse another system; if youlookbackamonthfromnow,and you haven’t tried tounderstand your retirement

situationoryourinvestments,you will look back havingdonenothing.Andthat’stimeyou’llnevergetback.

You’ll be in the sameplace you were beforereadingthisbook.

That’s an importantconcept:nothinggetsdoneinlife without taking that firststep.Nothingwillgetdoneingrowing your money if youdon't take that first step to

investyourmoneysoundly. Ilook forward to taking thatsteptogether.

5M™ is aimed attransforming the thoughtprocess andqualityof lifeofpeoplethatinvestinthestockmarket. It outlines theinvestment methods,strategies and tactics that aregeared toward producing thebestresultsoverthelongrun.If the system and methods

withinthisbookarefollowedin a disciplined manner,prosperity and financialsuccess won’t be too farbehind.

5M™ is a product ofsome 10 years of experienceusing every investment andtrading strategy you couldthink of in the stockmarket.I’mnotasalesperson,Iamaninvestor (not that I haveanythingagainstsalespeople).

The methods, strategies andtacticsset forth in5M™willbring any individual orbusiness into the higherechelonofinvestors.

The methods under5M™ are designed todescribe the primary factorsthat are absolutely necessaryto achieve investmentsuccess!

Howmuchwould it costYOU not to take action to

increase your return oninvestment? How muchwould it cost to have aprocesstohelpweedthroughthe voluminous amount ofdata and noise in the worldtoday?

I know the answer tothis. Forme, it’s priceless tohave a system and set ofmentalmodels like this I canuse over and over again forthe rest of my life. I know

because it’s worked for meandmany others. I valuemytime, and I value mymoneyand how it’s being invested.Myhope is that you use thissystem like I did to makeyour investment journey assimple as possiblewith greatresults.

Make the decision nowandchangeyourlifeforever.

Ifyoudon'twanttodoitfor yourself, then do it for

your family and your futuregenerations.

There is so muchabundance and wealth andopportunity out there in theworld.

The future belongs tothose who are positive andkeep learning to betterthemselvesandothers.

Gogetit!Let’sseewhat’snext!

WHAT’SNEXT

"Thenicethingaboutinvestinginstocksisthat,overtime,equitiesaregoingtodowell.Americanbusinessisgoingtodowell.America

isgoingtodowell.Soyouhavethetidewith

you."WarrenBuffett

Ihopeyouenjoyedgoing

through our 5M™ MentalModel,andlearningaboutthemethods and thoughtprocesses that makes it sospecialandwhythey’vebeensoeffectiveforus.

My only request is thatyou go out and actually usethis stuff to help you investbetter.

Overtime,Ihavelearned

that great investors tend tofocus on the process morethantheactualoutcome.

Because if you have asimple, proven, repeatablesystem with relevant mentalmodels, the results willultimately take care ofthemselves. Having this5M™MentalModelwiththeMECOM™ Method willallow you to focus on thecomponents that matter most

toaninvestor’ssuccess.If you loved the book

and the thought processbehind value investing, oreven if you still don’t havethetimetoputintheworktouse the System and theTemplates, you’ll love whatwehaveinstoreforyou.

REMEMBER:You haveLIFETIME access to ourinvestmentideaengine:

https://GuruInvestorEdge.com/LifetimeAccessFull Disclosure: I don’t

knowhowlongthisofferwillbeavailable.Unfortunately, Itake a great deal of financialrisk by offering lifetimeaccess to an ongoingpublication.TheonlyreasonIam offering this right now isbecauseI trulybelieve itwillhelp tremendously to yourinvestingsuccesswellintothefuture.And Iwant to reward

actiontakers.However, at some point

this offer will expire.Essentially, You make aminiscule investment todayand then you get ALL theideasforfreefortheLifetimeof the publication. It’s anincredible offer and its onlyavailable toour readers for alimitedtime.

SoFeelFreeToCheckItOut.

You’llfindloadsofgreatinvestment ideas. You canusethemtohelpyouonyourpathtoinvestmentsuccess.

Remember themoreyouinvest now, and get to knowtheunderlyingbusinessesandthe stock market, the betteryou’ll be at investing long-term.

Keepinmindthatittakesmore than just reading thisbook or talking about these

concepts at holiday parties.Follow these mental models,and focus on them longenough to create everlastinghabits and positive feedbackloops as you compoundyourknowledge of investing andtheworldaroundyou.

Thanksagainforreadingthisbook.I’mexcitedtohearabout your journey and theresults you have achievedwitheverythinginsideofthis

book. Make sure you shareyour success story once youputallofitintoaction.

BestWishes,

J.LukasNeely

EndlessRiseInvestor.com,CEO

GuruInvestorEdge.com,Co-Editor

ValueInvestorConfidential.com,Co-Editor

WILLYOUDOMEASOLID?

If you enjoyed A Value

Investor’s Journey ThroughThe Unknown, would youmindtakingaminutetowriteareviewonAmazon?Evenashort review helps, and it’dmeanalottomepersonally.

If someone you care

about is struggling withinvesting or growing theirwealth, please send him orher a copy of this book.Whether you gift it to themon Amazon or email a copyof the PDF makes nodifferencetome.

If you’re unable topurchase anewcopy to sendthem, please email me and Iwill send over a copy rightaway.Aslongasit’shelping

someone,Iamallforit.If you’d like to order

copies of this book for yourcompany,school,orgroupoffriends, please send me aquick note toLukas@EndlessRiseFinancial.com

Finally, if you’d like togetfreebonusmaterialsfromthisbookandreceiveupdateson my new content, FreeGiveaways, and futureprojects, you can sign up for

alerts atEndlessRiseInvestor.com.You can also follow me onTwitter @Lukas_Neely orFacebook:www.Facebook.com/EndlessRiseFinancial

Don’t forget yourLIFETIME access to GuruInvestor Edge as a way tothankyouforyoursupport.

You can access yourLifetimeaccounthere:

https://GuruInvestorEdge.com/LifetimeAccessYourJourneyAwaits.

RiseOn!

AcknowledgementsIwould like to thank all

my friendsand family foralltheir support throughout thisprocess: Brandon Consolvo,Andrew Luscz, Conn Davis,Aaron Smith, Jeremy andStephanieParten,DanDavis,Jake Neely, Mike andJeneane Neely, David andDebbie Loewy, Evan and

Jessica Loewy, Linda andCharles Consolvo, MichelleandJohnBannon,andGloriaandAlCassidy.YouareALLan inspiration to me to keepgoing, and to keep providingtruevaluetotheworldandtokeep helping people succeedat their goals investing. I amgratefultoeachofyouforthemany insights, observationsand suggestions. Many ofthese appear in one form or

anotherinthiswork.Also,Iamsofortunateto

haveworkedwithsomeofthefinestsubscribersandreadersa long- term investor couldhave. ALL of themencouragedme toprovideallthisvaluetotheworld.Iwillrespect their privacy by notnaming them here, butwithout their patience,interest, support andmotivation, my investment

success would be anafterthought.

I would never be in thisposition without theopportunity that Rob SckalorandScottGreenberggaveme.They tookachanceonmeattheinvestmentfirmtheyown,and Iwill foreverbegratefulto them for their help andguidancealongthisincrediblejourney.Theworldwouldbea better place with more

people like them. It hasbeenoneofmygreatestprivilegesto be in the same roomwithsuch energetic,knowledgeable and caringpeople. I like to think thattogether we have builtsomethingtobeproudofintothe foreseeable future withthisbook.

My five years at theinvestment firm brought meinto contact with some

incredible analysts, tradersand investors. I am forevergrateful to each of them forputting up with me andteaching me along thisincredible journey. A specialthank you to my colleaguesandfriends--AndrewLuscz,Aaron Smith, Conn Davis,Anwar Lockhart, JustinWheatley, Ed Stinson, MarkStridiron, Sophie NewboldandBoNichols.

Ialsowanttothanksomeinvesting mentors who havehelped me to map out theincrediblevisionIhaveofthefuture and what I hope tobring to the world: CharlieMunger, Whitney Tilson,Mohnish Pabrai, Guy Spier,Seth Klarman, WarrenBuffett,andMasonHawkins.

Last but certainly notleast, I want to thank mywife, Shannon Neely, who I

marriedonJuly12,2014.Sheis the most intelligent,motivated, caring, lovingandambitiouswomanIhaveevermetand,althoughshedoesn'tdo it directly, she challengesme on a daily basis. And Ilove her for that. She wasable to provide thequintessential piece to thisbook: a different perspectivefrom a non-investment-professional.SometimesIget

carried away with all thenumbers and valuations. Theanalytical portion of the5M™MentalModel can getlost in translation sometimes.Infactitisthereasonwhysomany individuals give upwhentheystartoutinvesting.IknowitwasabiggoalbutIwanted this book to beunderstood and used byeveryone--fromHighSchoolStudent to Investment Fund

Manager.IknewthatifIwasable to explain technicalaspects of investing in asimplemannerthatIcouldbeonto something. She readevery word of every chapterand made countless helpfulrecommendations.

Shannon is the personwho challengedme themosttopursuemydreamsandmypassion of investing andcreatingvalueforpeople.She

hasworkedasaconsultantinthemedical field for over 10years in the processimprovement space (lean sixsigma). She believes that thework she does helps otherpeopleandsheisdedicatedtothat cause. When I see hermotivated to do great thingsinherfieldandhelppeople,itremindsmethatIhavetogettothatsamelevelorabove.Iguess that is my competitive

nature,butIloveherforthat;shekeepsmeonmytoesinavery good way. I lookforward to spending the restof my life with her andstarting a family! She willcertainly be a great wife,motherandbestfriend.

I am forever thankful toeachofthepeoplementionedabove.IthankeachandeveryoneofthemfortheirhelpandI will forever cherish their

friendship!Fullresponsibilityofany

errors in this book are borneonlybyme.

BibliographyandGuideTo

AdditionalReading

AlthoughIhavelivedthemodels,concepts,andlessonsof this book for some periodof time, I began researchingand developing these mentalmodels as far back at 2007.During this time, I’ve

archived, collected, and readwell over a thousandscholarly articles and whitepapers, scientific studies,hundreds of newspaper andmagazine articles, and adecent”sizedlibraryofbooksandmaterialsbysomeof themost renown experts andsuper investors in the worldofinvesting.

Every one of the bookslisted below have played a

major part in my life. Notonlyasaninvestor,butmoreimportantly, as a well-rounded person. I simplywanttopullbackthecurtainsto my library of the besttopics across multi-disciplinarysubjects.

They’ve all somehowshapedwhoIamasaperson.And they have helped tocreate not just the book youreadheretoday,butthe5M™

Mental Model of valueinvesting. A mental modelthat I will have with me therestofmylife.Forthat,Iameternally grateful to all theauthors, editors, andcollaboratorsbelow.

Thank You from theBottomofMyHeart.Enjoy!

Psychology

Flow:ThePsychologyofOptimal Experience by

MihalyCsikszentmihalyiInfluence: The

Psychology of Persuasion byRobertCialdini

The Art of ThinkingClearlybyRolfDobelli

The48LawsofPowerbyRobertGreene

Thinking,Fast,andSlowbyDanielKahneman

Willpower:Rediscovering the GreatestHuman Strength by Roy

BaumeisterandJohnTierneyComplexAdaptiveSystems

AtHomeintheUniverse:The Search for the Laws ofSelf-Organization andComplexity by StuartKauffman

Connected: TheSurprising Power of OurSocial Network and HowThey Shape Out Lives byNicholas Christakis and

JamesFowlerDeep Simplicity:

BringingOrdertoChaosandComplexitybyJohnGribbin

Emergence: TheConnected Lives of Ants,Brains, Cities, and SoftwarebyStevenJohnson

Linked: How EverythingIs Connected to EverythingElse and What It Means forBusiness, Science, andEveryday Life by Albert-

LaszloBarabasiSigns of Life: How

ComplexityPervadesBiologyby Ricard Sole and BrianGoodwinSelf-Help

A Simple Act ofGratitude: How Learning toSay Thank You ChangedMyLifebyJohnKralik

Awaken The GiantWithinbyTonyRobbins

GettingThingsDone:theArt of Stress-FreeProductivitybyDavidAllen

HowtoWinFriendsandInfluence People by DaleCarnegie

Manifest Your Destiny:TheNineSpiritualPrinciplesfor getting Everything YouWantbyWayneDyer

The Power of PositiveThinking byNormanVincentPeale

ThinkandGrowRichbyNapoleonHill

Thrift and Generosity:The Joy of Giving by JohnTempletonEconomics

Predictably Irrational:The Hidden Forces ThatShapeOurDecisionsbyDanAriely

The Economy as anEvolving Complex Adaptive

System by Philip Anderson,Kenneth Arrow, and DavidPines

The Rational Optimist:How Prosperity Evolves byMattRidleyBusiness

Mastering theRockefellerHabits:WhatYouMust Do to Increase theValueofYourGrowingFirmbyVerneHarnish

Sam Walton: Made inAmericabySamWaltonwithJonHuey

The Essays of WarrenBuffett: Lessons forCorporate America byWarrenBuffettandLawrenceCunningham

The One MinuteManager by KennethBlanchard and SpencerJohnson

The Power of Full

Engagement: ManagingEnergy,NotTime, Is theKeyto High Performance andPersonal Renewal by JimLoehrandTonySchwartz

ThePowerofHabit:WhyWe Do What We Do in Lifeand Business by CharlesDuhigg

The Startup Game:Inside the Partnershipbetween venture Capitalistsand Entrepreneurs by

WilliamDraperThe Talent Code:

Greatness Isn't Born: It'sGrown, Here's How, byDanielCoylePhilosophy

Man's Search forMeaningbyViktorFrankl

Meditations by MarcusAurelius

The Art of War by SunTzu

StoicPhilosophers

NeuroscienceThe Neuroscience of

Psychology: Healing theSocial Brain by LouisCozolino

Phantoms in the Brain:Probing theMysteries of theHuman Mind by V.S.Ramachandran and SandraBlakeslee

Synaptic Self: How Our

Brains BecomeWhoWe ArebyJosephLeDoux

Literature

Catch-22 by JosephHeller

MacBeth by WilliamShakespeare

TheOdysseybyHomerZen and the Art of

Motorcycle Maintenance: AnInquiry intoValue byRobertPirsig

Physics

“Surely You’reJoking, Mr.Feynman!”:Adventures of aCurious Characterby Richard PFeynman andEdwardHutchings

The Pleasure of FindingThings Out: The Best ShortWorksofRichardP.Feynman

by Richard P. Feynman andJefferyRobbins

Physics of the Future:How Science Will ShapeHuman Destiny and OurDailyLivesbytheYear2100byMichioKaku

Six Easy Pieces:Essentials of PhysicsExplained by Its MostBrilliant Teacher by RichardP Feynman and Robert BLeighton

Biology

HowNatureWorks: TheScience of Self-OrganizedCriticalitybyPerBak

Journey to the Ants: AStory of ScientificExploration by BertHooldobler and Edward O.WilsonMulti-Disciplinary

Damn Right: Behind the

Scenes with BerkshireHathawayBillionaire CharlieMungerbyJanetLowe

TheManWhoBeats theS&P: Investing with BillMillerbyJanetLowe

Latticework: The NewInvesting by Robert G.HagstromValueInvesting

AZebra inLionCountryby Ralph Wanger with

EverettMattlinActive Value Investing"

making Money in Range-Bound Markets by VitaliyKatsenelson

Beating the Street byPeterLynch

Buffett: The Making ofan American Capitalist byRogerLowenstein

Common Stocks andUncommonProfits byPhillipFisher

Fooled by Randomness:The Hidden Role of ChanceinLifeand in themarketsbyNassimNicholasTaleb

Fooling Some of thePeople All of the Time: ALong Short Story by DavidEinhornandJoelGreenblatt

Fortune's Formula: TheUntoldStoryof theScientificBetting System that Beat theCasinos and Wall Street byWilliamPoundstone

Investing: The LastLiberal Art by RobertHagstrom

Investment Biker:Around the World with JimRogersbyJimRogers

More MortgageMeltdown: 6 Ways to Profitin These Bad Times byWhitney Tilson and GlennTongue

More Than You Know:FindingFinancialWisdomin

Unconventional Places byMichaelMauboussin

The New Buffettology:The Proven Techniques forInvesting Successfully inChanging Markets that havemade Warren Buffett theWorld's Most FamousInvestorbyMaryBuffettandDavidClark.

OfPermanentValue:TheStory of Warren Buffett byAndrewKilpatrick

One up on Wall Street:HowtoUsewhatyouAlreadyKnow toMakeMoney in theMarket by Peter Lynch &JohnRothchild.

Pioneering PortfolioManagement: AnUnconventional Approach toInstitutional Investment byDavidSwensen

Security Analysis byBenjaminGrahamandDavidDodd

Seeking Wisdom: FromDarwin to Munger by PeterBevelin

Short Stories from theStock Market: UncoveringCommon Themes behindFalling Stocks to FindUncommon Ideas by AmitKumar

The Dhando Investor:The Low-Risk Value MethodtoHigh Returns byMohnishPabrai

TheManualofIdea:TheProven Framework forFinding the Best ValueInvestments by JohnMihaljevic

The Misbehavior ofMarkets: A Fractal View ofFinancial Turbulence byBenoit Mandelbrot andRichardHudson

The Most ImportantThing: Uncommon Sense forthe Thoughtful Investor by

HowardMarksThe Warren Buffett Way

byRobertHagstromThere’s Always

Something ToDo: The PeterCundill Investment ApproachbyChristopherRusso-Gill

Value Investing: FromGraham to Buffett andBeyondbyBruceGreenwald,JuddKahn,PaulSonkin, andMichaelvanBiema

Warren Buffett and

Interpretation of FinancialStatements: The Search fortheCompanywithaDurableCompetitive Advantage byMary Buffett and DavidClark

Warren Buffett Speaks -Wit and Wisdom from theWorld's Greatest Investor byJanetLowe

Where Are theCustomers' Yachts? Or, AGood Hard Look at Wall

StreetbyFredSchwedYour Money and Your

Brain:How theNew ScienceofNeuroeconomicsCanHelpMake You Rich by JasonZweigReplicatingBuffett’sSuccess

WarrenBuffettinterviewwith Charles Brandes, May1993.

Buffett Partnership Ltd.letter,May29,1969.

Business-LikeInvesting

"Buffett Listed byFortune with Wall StreetWinners," Omaha WorldHerald, July 31, 1983.Quoting from Fortunemagazine,August8,1983.

Janet Lowe. WarrenBuffett Speaks - Wit andWisdom from the World'sGreatestInvestor.NewYork:JohnWiley&Sons,1997,pp.

94-95,p.150.Sam Thorson "Warren

Buffett , Omaha in search ofsocial challenges," Lincoln,Nebraska. Journal and Star,March18,1973,p.6F.

RobertDorr."NewspaperHoldings Kind to OmahaInvestor Buffett." OmahaWorld-Herald,April16,1978,p.6J.Long-TermInvesting

Roger Lowenstein.Buffett: The Making of anAmerican Capitalist. NewYork: Random House, 1995,p.152,p.200

"Warren Buffett TalksBusiness," The University ofNorth Carolina, Center forPublictelevision,ChapelHill,1995.

Andrew Kilpatrick. OfPermanent Value: The Storyof Warren Buffett,

(Birmingham: AKPE, 1994)p.568,QuotingfromForbes,August6,1990.Management

Robert Dorr. "InvestorWarrenBuffettViewsMakingMoney as 'Big Game'"OmahaWorld-Herald,March24,1985,p.11.Assets

Courier-Express v.

Evening News, Testimony ofWarrenBuffett,pp.50-52Inflation

WarrenE.Buffett."HowInflation Swindles theInvestor", Fortune, May 5,1977,p.250ValuingaBusiness

Warren E. Buffett. "TheSecurity I like best", Theecommercial and financial

Chronicle,December6,1951.MarginofSafety

Berkshire HathawayAnnual Meeting, Omaha,May1,1995.Where to Find InvestmentIdeas

Jim Rasmussen."Billionaire talks Strategywith Students." OmahaWorld-Herald, January 2,

1994,p.17S.Joel Greenblatt. The

Little Book that Beats theMarket. Hoboken: JohnWiley&Sons,2010.PortfolioManagement

Berkshire HathawayAnnualLetter,2009.

Berkshire Hathawayannualmeeting,Omaha,May1,1995.

"WarrenEdwardBuffett"

Forbes 400, October 21,1991,p.151.

Berkshire Hathawayannualreport,2009.Mr.Market

Warren Buffett, 1984GrahamandDoddSeminar.

Roger Lowenstein.Buffett: The Making of anAmerican Capitalist. NewYork:RandomHouse,1995.

WarrenE.Buffett."How

Inflation Swindles theInvestor", Fortune, May 5,1977,p.250

"BuffettlistedByFortunewith Wall Street Winners,"Omaha World-Herald, July31, 1983. Quoting fromFortunemagazine, August 8,1983.

Robert Dorr. "Buffett'sRight-hand man," OmahaWorld-Herald, August 10,1986,p.1.

Robert Lazner. "WarrenBuffett's Idea of Heaven: Idon't have to work withpeople I don't like," Forbes400,October18,1993,p.40.

L.J.Davis."BuffettTakesStock,"TheNewYorkTimesMagazines, April 1, 1990, p.16.Cigar-ButtInvesting

Warren Buffett andWalter Schloss, discussion,

New York Society ofSecurity Analysts, December6,1994.

Roger Lowenstein.Buffett: The Making of anAmerican Capitalist. NewYork: Random House, 1995.p.133.

Robert Lazner. "WarrenBuffett's Idea of Heaven: Idon't have to work withpeople I don't like," Forbes400,October18,1993,p.40.

Miscellaneous

The Autobiography ofBenjamin Franklin byBenjaminFranklin

TheChecklistManifesto:How to Get Things Right byAtulGawande

Energy Myths andRealities:BringingSciencetotheEnergyPolicyDebate byVaclavSmil

The Hero with a

Thousand Faces by JosephCampbell

Guns,Germs, and Steel:TheFatesofHumanSocietiesbyJaredM.Diamond

Making the ModernWorld: Materials andDematerialization by VaclavSmil

The Power of Myth byJosephCampbell

Why America is Not aNewRomebyVaclavSmil