About RISK from FPM

1. True RISK is not about price changes; it is about permanent loss of investment value. We denote it Risk(t)
2. "Fake Risk" that is triggered by mere price changes can be completely eliminated through a longer investing time horizon. With a well informed investing decision and prepare to stay for a longer time zone, we can keep the return high without such "Fake Risk". This definition of risk is being used by academics and professionals. We denote it Risk(a).

("Fake Risk", at FPM, is what Buffett referring to as "academic's definition of risk--the volatility of the share price". I know by labelling such academic and professional definition of risk(a) as "Fake Risk" I can be rediculed by many. But if you able to think logically you will understand volatility does not create risk nor does it create possibility of loss, if you are able to hold a good stock for long term.)

This is one of the most important sections of the book--The Essential Buffett, by Robert G. Hagstrom.

Buffet's View of Risk
In modern portfolio theory, risk is defined by the volatility of the share price. But, through out his career, Buffett has always perceived a drop in share prices as opportunity to make additional money. In his mind, then, a dip in price actually reduces risk. He points out, "For owners of a business--and that's the way we think of shareholders--the academics' definition of risk is far off the mark, so much so that it produces absurdities." (Berkshire Hathaway Annual Report, 1993, p.13)

Buffet has a different definition of risk: the possibility of harm or injury (in other words, permanent loss in the value of investment). And that is a factor of the "intrinsic value risk" of the business, not the price behavior of the stock. ...harm or injury comes from misjudging the future profits of the business, plus the uncontrollable, unpredictable effect of taxes and inflation.

Furthermore, risk, for Buffett, is inextricably linked to an investor's time horizon. If you buy a stock today, he explains, with the intention of selling it tomorrow, then you have entered into a risky transaction. ...But in Buffett's way of thinking, buying Coca-Cola this morning and holding it for ten years puts the risk at zero.

These two points are the basis of FPM's investing philosophy. When we assessing the risks of investment, remember to differentiate true risk, risk(t), from fake risk, risk(a).

Stocks selection: Fool's criteria

Ok, this is from Motley Fool.

Their 7 simple triats in selecting stocks.

"...
1. Capitalized under $2 billion
2. Extremely well managed
3. Run by executives that own loads of stock
4. Heavy on assets, light on debt
5. Valued at less than the market average

Most importantly, every one is (6) cash flow positive and (7) operates a successful business in a profitable niche market."

Check out the full text here...

FPM's stock selection criteria

Introduction

Stock selection criteria: Sustainable dividend income with dividend returns over investment exceed 10% per annum.

Do you think this is impossible? With current maximum dividend yield is only about 7%, how do you get one that exceed 10%?

This is the stock selection criteria that base on FPM's financial planning principle.

FPM’s financial planning principle

Stock selection begins with knowing the strategies you adopt for financial planning. The heart of financial planning is to build assets that generate sustainable income.

Explanation

Many think stock is a bad example of “assets that generate income” or assets(i). Generally average dividend yields for Malaysia stocks, in a good market conditions, range below 8%. Should Malaysia’s market moves toward what U.S. is heading, dividend yield could be lower in future. The dividend would be too little as a source of income as compare to the investment, it seems.

But the key is not dividend yield (dividend over current share price); the key is dividend over your original investment cost.

You bought a stock at RM1,000 five years ago which gave net dividend yield of 6% or RM60. Today, due to real organic growth both of its earnings per share (EPS) and dividend per share doubled. Share price increased. Let’s say its net dividend yield stays at 6% (It doesn’t matter, actually). Fund managers say, “The yield is reasonably attractive.” But for you, who bought the share at RM1,000, now enjoy an annual dividend of RM120, which is annual return on investment of 12%!

When you buy a share, your investment cost is fixed. With growth, good financial policy and consistent dividend payout policy, your dividend per share would increase as time goes by. Your annual ROI, over time, increases even if the stock dividend yield remains low (if the share price goes up.)

First set of criteria: growth stock that gives or will soon give sustainable and consistent dividend payout

This lays down the first set of FPM’s stock selection criteria,
1. The business and earning per share must grow
2. It is real growth. Such EPS growth must be translated into real hard cash or reduction of net debts. (real earning growth)
3. The management is willing to pay out the earnings as dividend. Dividend will grow in tandem with earnings. So, it should lead to a better dividend pay out per share.

4. What is not:
EPS grow without real incoming cash that lead to increase of cash or reduction of borrowings. Dump those shares that show profit but with a much higher increase in Stock, Trade Debtors less Trade Creditors. (compare to sales). Such company is either suffering a temporary operational inefficiency or outright cheating in their accounting.

5. Exceptions
On dividend payout there are exceptions. We can disregard dividend payout, IF and only IF
a. we are convinced the company is going through a high growth phase that required cash.
b. In the case of Second Board’s counters, if the company need to accumulate sufficient reserves to upgrade to main board.

Other than a. and b. we shall not buy into any company that does not fit into the four criteria above.

Second set of criteria: well managed cash cow

Well managed cash cow that generating hard cash profit, employing little assets and with certainty for growth. All profits turn into cash and with high dividend payout ratio.

Conclusion

We basically disregard what the share prices are or going to be but solely focus on the growth of its business earnings, the ability to generate hard cash profit and dividend payout. We accumulate assets (stocks) that generate consistent good income (dividend) which we call it assets(i), remember?

The key, dividends grow, but your original COST of investments does not. (Business grow, value grow, share prices may or may not increase) So if you select a stock with business that grows, does well and has cash to give out consistent dividends, your income increase and your return over your investment (ROI) increases over time.