Two Golden Rules of

Sensible Stock Investing

Learn how to pick strong companies and find sensible buy and sell prices.

Contents

I. Make your money work for you, Always!

II. First Golden Rule

1. Five Significant Variables

1.1 Earnings Per Share (EPS)

1.2 Sales

1.3 Book Value Per Share (BVPS)

1.4 Return on Invested Capital (ROIC)

1.5 Debt to Profit Ratio

2. Assessing the Company

III. Second Golden Rule

1. MRP
2. Discount Price

3. Rate of Return

4. How do we calculate the MRP?

5. Using Price Calculator @ MoneyWorks

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IV. Summary
By

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Enabling Sensible Stock Investing

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 I. Make your money work for you, Always!

We all invest our hard earned money to get good returns. Are the returns always up to our expectations?
Sometimes they are. Sometimes they are not.

Have you imagined a life where your money works 4 you, Always? It is possible, if we invest a part of our
earnings sensibly. We all know that Inflation eats up most of the returns from different investment sources.

To beat the inflation you need to invest some of your money in stocks, Sensibly!

MoneyWorks
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Works4me.com enables you to sensibly invest in stocks so that you can take charge of your stock
investments.

But what is sensible investing?

It is a method by which you buy into a business that is worth owning forever at an attractively low price and sell
it, obviously at an attractively high price.

This sounds sensible, but is it possible?

As according to the Oracle of Omaha Warren Buffet

“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside
information”

All you need is to be sensible and follow two simple Golden Rules:

1st Golden Rule: BUY WHAT’S WORTH OWNING FOREVER

2nd Golden Rule: B UY AT 50% DISCOUNT OR LOWER, AND SELL AT MRP, PROVIDED IT GIVES MINIMUM
20% COMPOUNDED ANNUAL RETURN.

Start making your money work for you by following these Golden Rules of Sensible Investing.

And it’s all very easy @ MoneyWorks

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and at what price.

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 II. First Golden Rule

The first golden rule says: ‘Buy what’s worth owning forever’. This is beautifully said by Warren Buffett “Our
favorite holding period is forever” and to avoid the temptation about buying stocks which don’t meet this
criteria he said ‘If you don’t feel comfortable owning a business for 10 years, then don’t own it even for 10
minutes’.

The major questions here are:

1. Does the company have a sustainable competitive edge that will enable it to grow its profits in the future
even through tough times?

To answer the first question, check if the company

Own great brands

Has an edge in terms of trade secrets like patents, secret formula, technology etc.

Operates in an industry that is difficult for other players to enter

Provide products that consumers find it difficult to switch away from

Sell products that have specific advantage in terms of price/quality etc.

The Company which gets maximum number of “Yes” to the above parameters is the company to invest
in. To know such details about a company you can view the ‘Wiki Reports’ available at
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4me.com

2. Does the company have great financial track record that proves beyond doubt that it has been able to
grow its profits in the past?

We, at MoneyWorks4me.com have created the ‘10-year X-ray’ to help you answer this question with
ease and without being deluged by financial data, that would make your head spin

The Five Significant Variables are necessary to be understood and applied thoroughly to answer this
accurately.

And what are these Five Significant Variables? Well, just common sense explained in financial lingo!

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 1. The Five Significant Variables

The five significant variables refer to the five crucial financial parameters of the business. In order to invest
sensibly and to get the best stock you need know the five significant financial variables:

 Earnings per share (EPS),

 Net sales,

 Book value per share (BVPS),

 Return on investment capital (ROIC) and

 Debt to profit ratio.

Let’s see each one of them separately.

Good Consistent Growth Rate

A company worth owning forever must be able grow its profits at a good consistent rate. Hence while we check
out each of the significant variables, we need to see if they have been growing consistently year on year. And
what is that consistent growth rate? In the last ten years, Inflation has been growing at a CAGR of 6%. Hence, we
put our lower limit as twice that at 12% as Good Consistent Growth.

1.1 Earnings per Share

If you are considering investing in a company then what is the first thing that you will look for?

Profit, right! You will check if the company is making a Profit. Since we intend to buy only some shares of the
company, we look at the profit it earns per share. That is exactly what is Earning (profit) per share, EPS.

EPS is a company’s Earnings (Profit after Tax) / No. of shares.

Please remember it is not the overall Profit of the company but Profit per Share.

EPS = PAT/No of Shares outstanding

Suppose, Company XYZ’s profit after tax is Rs.100Cr and it has 10Cr shares outstanding, then its EPS is Rs.10 (EPS
= PAT / No. of Shares Outstanding =Rs.100Cr/10Cr)

Check the EPS of the company for the last 10 years and see if it has grown consistently at more than 12% year on
year.

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 1.2 Sales

Now, what would give you the confidence that the company would be able to increase its profit consistently year
after year? That is easy ….profits will increase consistently only if the sales of the company increases consistently.
So we need to check Sales.

‘Sales’ of a Company is the total worth of goods or services sold by a company in a year. And when we deduct
excise from Sales, we get the net sales of the Company.

Therefore, Net Sales = Sales – Excise Duty

Suppose Company XYZ’s Sales turnover in the current financial year is Rs.20, 000Cr and it paid Rs.2, 000Cr as
excise duty, then its net sales is Rs.18, 000Cr

(Net sales = Rs.20, 000Cr – Rs.2, 000Cr = Rs.18, 000Cr)

Check out the sales or revenue numbers for the last 10 years and check if it has grown by a good consistent rate,
i.e. 12% year on year.

1.3 Book Value per Share (BVPS)

A company can grow in long term, only if it builds its capability i.e. invests in growing its assets. We come to
know this by looking at Book Value per Share (BVPS)

Book Value is what a business is worth when it’s sold off completely. If the company is sold (Liquidated), after
paying all its debts, whatever is left is the Book Value of the company. And after dividing it by the number of
shares, we get Book Value per Share.

Therefore, BVPS = Book Value / No. of Shares Outstanding

Suppose the book value of Company XYZ is Rs.800Cr and it has 10cr shares outstanding. Therefore, BVPS of the
Company is Rs.80 (BVPS = Rs.800Cr / 10Cr = Rs.80)

A growing BVPS shows that the company has a track record of investing its earnings back into the company and
building its capability to keep growing profitably.

Hence we need to check if it has been growing faster than 12% year on year.

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 1.4 Return on Invested Capital (ROIC)

Now as an investor, we look for a company that grow through both good and tough times. And that company
must be efficient in utilizing its capital, both company owned and borrowed. In other words, what is the Return
on the capital invested by the company or ROIC?

ROIC is the return a business makes on total investment. It is calculated as the Net Operating Profit after Tax
(NOPAT) divided by the capital invested.

Therefore,

ROIC = NOPAT / Total Investment

where, NOPAT = Net Profit + Depreciation + Interest payment

and Total Investment = Equity + Debt

Now we have to decide a benchmark for ROIC.

If the company maintains a return on total investment more than that on other investment options, then that
company might be worth owning forever. In India, return on a 10-year fixed deposit is 10%; so we will keep our
benchmark for ROIC as a minimum 12% every year for 10 years.

1.5 Debt to Profit Ratio

Don’t you feel that it’s very important for a business enterprise to repay its debt at the earliest if it wishes to
remain financially sound?

As an investor you can make out the number of years the business will take to repay its debt.Debt to profit ratio
tells the number of years by which the company will be able to repay the debt if it continues to earn profits at the
current rate.

Debt to Profit Ratio = Total Debt / Net Profit

Suppose Company XYZ borrowed Rs.200Cr for making investment and made Rs.100Cr in the end of the year, it
would be able to repay its debt in 2 years. (Debt to Profit Ratio = Rs. 200Cr / Rs.100Cr = 2)

You would want your chosen company to dispose of its debts as soon as possible right?

3 years…..is that a short enough span to clear its debts?

So, if the Debt to Profit ratio is less than 3 you could consider it reasonable. What if it’s not? Then you need to
study more. See where all the company has invested? Check out why and reassure yourself there is indeed a valid

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reason e.g. the company has recently raised debt to acquire a business which is synergetic with its long term
goals and is likely to pay off in future.

2. Assessing the Company

It is important to assess a company based on the Growth rates of Five Significant Variable, and remember them
as well. MoneyWorks4me.com has simplified this process by colour coding the year on year growth rates as
Green, Orange and Red.

Growth rates above 12% are marked Green, indicating Very Good performance

Growth rates from 10 – 12% are marked Orange indicating Somewhat Good performance

Growth rates below 10% are marked Red indicating Not a Good Performance

If all or most of the growth rates are green, you could assess the company as Green indicating that it is a
company with Very Good Financial Track Record.

If all or most of the growth rates are Red, you could assess the company as Red, indicating that it is a company
with ‘Not so Good performance’.

To Sum Up

These five financial figures are vital to our Investment decisions and should be analyzed in depth to get the
expected returns from a business.

Now the answer to the 2nd question of the 1st Golden rule, Does the company have great financial track record
that proves beyond doubt that it has been able to grow its profits in the past is found by

Checking whether its EPS, Sales and BVPS, is growing consistently @ 12% or more, for 10 years,

It maintains it’s ROIC higher than 12% for 10 years, and its latest Debt to Profit ratio is less than 3 (if it’s
not? Then you need to study more. See where all the company has invested? Are those ventures
profitable according to you? )

Assess the company as Green, Orange or Red, based on our ‘Colour coding’ of year on year growth rates.
This will help you remember the result of the ‘Analysis of Financial Track Record’, done by you

If the company fulfils all these criteria then it’s really worth owning forever.

But the important question is how to get the data in an organized way to analyze each company/industry in
detail?
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Stock Brokers will never be able to tell you all this accurately. Yes internet is there but even there the
information is not available in an organised way. What to do now?

Don’t worry all this and even more is available on the click of a button at MoneyWorks4me.com Here you can
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analyze each company in detail and then decide on your investments.

Now we will move to the second Golden Rule of investing which emphasizes on the price at which an investor
should purchase the stock to ensure 20% return in the long run.

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 III. Second Golden rule

2nd Golden Rule: Buy at 50% discount or lower, and Sell at MRP, provided it gives minimum 20%
compounded annual return.

That is common sense, isn’t it?

The Stock Market is a market that always puts up a sale if you wait long enough.

If you look at 52 week high & low prices of every stock, you will notice that all of them were available at a fraction
of their 52 weeks high. The ratio of lows & highs for the BSE Sensex stocks is about 1:3!

So now that you are convinced that this is possible; let’s learn how to take advantage of this.

1. MRP
MRP: When we buy any product we are careful to check the maximum retail price printed on it and we will not
pay more than that. Shares don’t come with the MRP printed on them; however we can understand the benefit of
such a price guideline. MRP is a measure of the real worth of the share -. This is the price above which we should
consider selling the share, provided we have got over 20% Compounded Annual Return.

2. Discount Price

Discount Price: We all know there are risks in investing in shares. So we would like to buy shares at a hefty
discount on the MRP. The Value Investing Guru Benjamin Graham insisted on a 50% discount and we use this to
guide our Discount Price – the price at which we should buy the shares. The good news is that the Stock Market
does provide opportunities to buy at heavy discounts, however for that you must have patience to wait for the
right moment.

3. Rate of Return

Why 20% returns: You know the power of compounding. At 20% our investment will double in about 3 and a
half years which is a pretty sensible expectation for the kind of companies we want to invest in. Hence to make
the investments reach to our expected level you should opt for that rate.

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 4. How do we calculate the MRP

Price is the investment that you make in the share. In return you can get money in two ways

1) ‘Dividends’, till the time you hold the share and

2) By selling it at a ‘Future Price’ eventually.

We all know

The value of the money we pay as The value of the money we will receive 10
a price while buying the share today years later when we sell the share

This is due to inflation.

Considering your expected returns and inflation, MRP is the maximum price you should be willing to pay for
this share today, which will grow in the future at your expected rate of return.

To calculate MRP we need to know the Future Price.

Future Price = Future EPS * Future PE.

Let’s see each one of them.

Predicting Future EPS and Future PE

Future EPS can be estimated from the current EPS and using the compounding formula i.e.

Future EPS = EPS *(1 + expected EPS growth rate / 100) ^10

What is the relation between MRP and this Future Value? In terms of the compounding formula-

Future value = MRP *(1 + expected rate of return / 100) ^10

So MRP can be calculated by the following formula

MRP = Future Price/ (1 + Expected Rate or return/100) ^10

Where Future Price = Future EPS* Future PE

To summarize, to calculate MRP of a share we need

1. Current EPS (which is known)

2. Expected EPS Growth rate
3. Expected Rate of return (what you want)
4. Future PE Ratio

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 5. Using the Price Calculator

On MW4me.com for your convenience and flexibility we have provided you with a ‘Price Calculator’ which you
can use with ease. We have also provided you with ‘MoneyWorks4me Evaluation Guidance’. Let’s take a quick
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look at the MoneyWorks
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We provide you with our guidance of the Future PE Ratio and Expected EPS growth rate.
So you get a MRP based rate of return we expect from the investment in the company’s stocks.
Along with a Discount Price based on a good Margin of Safety to reduce risk.
Remember the 2nd Golden rule of sensible investing - Buy at 50% discount or lower, and Sell at MRP, provided it
gives minimum 20% compounded annual return.

You can save MoneyWorks4me guidance of MRP and Discount Price on all your Managers, to help you make
sensible investment decisions and manage your portfolio sensibly.

You can also choose to calculate the MRP of a stock more actively, based on your understanding and analysis
of the company and industry.

To enable you to take prudent decisions at MoneyWorks 4me.com we have provided the ‘Sensible
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Investors Forum’ where you can discuss about the different industries and companies with likeminded
investors. If you wish to know more about a particular industry or company you can read the ‘WIKI Reports’ for
different Industries and Companies at MoneyWorks
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Based on your enhanced understanding, you can now use the ‘My Evaluation’ section in Price Calculator. Enter
your expected EPS growth rate, expected rate of return, discount rate, and future PE values in “My Evaluation’’
and click Calculate to get the new MRP and the Discount Price. You can easily check out many possibilities till
you get confident about the valuation, and then save it.

Hence it’s very simple to calculate the actual worth of the stock using the Price Calculator at
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Let’s summarize all that we have learnt about sensible stock investing.

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 IV. Summary

1st golden rule

To find a wonderful business that is worth owning forever-

Think of yourself as a co-owner of the company

Invest in a company that has a sustainable competitive edge that will enable it to grow its profits even
through tough times, and that has a great financial track record, that proves beyond doubt that it has
done so in the past.

2nd golden rule

To find the sensible prices to buy and sell such a company, you should:

Calculate MRP of the company using:

MRP = Future Price/ (1 + Expected Rate of return/100) ^10

Where, Future Value is an estimate of the total of dividend and the future price of the share when you sell
it after 10 years.

Future Price equals to Future earnings per share into Future price to earnings per share.

Future Price = Future EPS* Future PE

Future EPS = Current EPS *(1 + expected EPS growth rate / 100) ^10

EPS = Earnings per share

PE = Price to EPS ratio

• Buy it at 50% discount of the MRP

• Sell when the price reaches MRP to ensure returns of more than 20 % CAGR

Visit MoneyWorks
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