Sunday, January 5, 2014

Book review- "The Five Rules for Successful Stock Investing" by Pat Dorsey

I spend the past week finding whatever free time I had to read the book, which is recommended by musicwhiz.

It is amazing how easy it is to navigate the book. The author should really be given credits for able to explain complex concepts in a clear and simple language.

First of all, I always have difficulty understanding the concept of DCF, and also is skeptical of the discount rate and growth rate assumption. After reading the book, I found the whole framework clear and meaningful.

The first chapter of the book talk about economic moats, which is really enlightening after the porter's 5 forces framework. They talk about dept and width of economic moat by looking at cashflow numbers, ROA, ROE, ROIC, and also identifying the source of Moats. Product differentiation, Brand, Cost competitiveness, Locking customers through high switching costs, high barriers to success and thus locking out competitors.

Thereafter, if you already know the basic, you can go straight into chapter 11, on how the quantitative data and qualitative numbers merged.

I found the whole concept by Pat Dorsey, while not new, is an excellent framework to anchor all the nuggets of knowledge I already have.

For example, the qualitative analysis of company will affect the assumption you made on the discount rate, and also the growth rate. Since I am investing for yield, some of the reits and trusts have rather stable and predictable cashflow, so it really made sense to make use of DCF to calculate the intrinsic value.

I will use this framework to review all my purchases to see if I overpay for any of them. But first, I would like to work backwards with SPH, I see SPH having a fair value at $4. Maybe not a price with MOS, but with $4, what discount rate would it be at, if I set growth at 1%, 2% and 3%. So that I will give a higher discount for companies with lesser moats. (although the book mention 10% as average, and higher than 10% for lesser companies, and below 10 for companies with significant moat)

I should then be able to come up with a range of intrinsic value. Watch out for my subsequent review result of the companies in my portfolio.


  1. Hi Silly Investor,

    Dropping by to say Hi to you :)

    This book by Pat Dorsey remains one of my favourite. Every now and then, i will still flip the book to refresh some fundamental concepts.

    There is another book by Pat Dorsey published a few years ago. "The Little Book That Builds Wealth, " This book explains more in depth into economics moats and competitiveness advantages. It is something which i believe you have great knowledge in based on the articles you have written and the comments you have given in fellow finance blogger's blogs.

    I look forward to your future post, on how you applies Discounted Cash Flow models on the various companies. I very often, i do ponder how much discount i should use for DCF model and whether my assumption is correct. I am sure we can have fun time discussing and exchanging pointers about DCF to give rise to a good intrinsic value with good safety of margins, hahaha. :)

  2. Hi solace,

    Happy to see u here at my "humble house", we already met at AK bungalow, muhahaha

    I have both, I cheapskate.. I reserve both books from the library. Haha. I want to be sure of the content, before I buy it.

    Btw, since u are my senior when Pat Dorsey framework is concerned, have u actually tried putting negative 1 for growth? It is mathematical plausible?

    Look forward to our discussion!! We can share how we translate the qualitative info into discount rate. But some companies, may not even have growth..

    I hope I can keep up with my work, and have time for blogging. My holiday is over

  3. Hi Solace,

    I tried various permutation for SPH, to get $4, SPH should be generating 185mio FCF with discount rate at only 6% and growth at 3%... Whoa so high??? SPH worth so much? Granted it is a monopoly...

  4. Hi Mike,

    What humble house and bungalow, hahaha, i have a big laugh at this description :)

    First of all, i need a stock to have free cash flow and predictable future earning before i use this model. If free cash flow is missing or unpredictable, i find DCF model to be unreliable. If i still want to calculate, i will assign a higher discount rate. See the example of AMD on page 156 - 164. I would normally give DCF a pass and look other valuation methods.

    I believe negative growth still be mathematical possible.Assume negative growth in cash flow, Free cash flow will decline over 10 yrs projection. Assume negative growth for perpetuity growth rate, perpetuity value will decrease.

  5. Hi Mike,

    I have not seen the past 5 yrs FCF of SPH. I would give a discount rate of about 8% (Kaisu a bit), growth at 3% is reasonable and possible.

    If the intrinsic value is close $4, it would be what many people has believed. Give it a safety of margins of 10 - 20 %, people should be rushing in to collect at $3.60 and below. At least i know i will hahaha, lol

  6. SPH FCF is kinda of patchy, I have a tough time computing.

    I am working of Lee metals now, will share soon, when I have the numbers.

    I find the DCF reasonable easy to navigate, it is accounting for the business strength in qualitative measures that is difficult.

    Given I will only have about an hour each night, no sure how long this "research assignment" will last. Lee metals is in a lousy industry, I will need to be fairly convince that it is a star, and we are at the right market cycle before I compute....

    Hmm.... But my hunch is it might not be as strong as I thought, although preliminary numbers look good.

    Silly Investor

  7. Using your discount rate and growth, and FCF of 185 mio (Not conservative but liberal btw), SPH is worth much less than $4.

    Hence, I think the certainty of dividends yield due to the certainty of market (monopoly), does matter in valuation.

  8. This is a very good book. I also read it every few years or so to refresh some concepts. I think I've read this at least 3 times already. Another book that you might want to look at might be "Buffetology". Another one of my favourites too ;)

  9. Thanks LP,

    Will pick it up. Hmm.. Or have I already read it somewhere ... I start with warren, read a lot about him, but was rather superficial learning since my base is small then. Will revisit them.

    Have a good 2014.

  10. To be honest, I prefer qualitative analysis to quantitative analysis. The latter can be manipulated to some extent. Nevertheless, good article and will check out this book.


  11. There is plenty of qualitative data to analyse that is mentioned in this book. In fact, it did quite a bit of spoon feeding, and some very good qns and guideline to bother over.

    But as usual, there is no magic bullet. I am trying to work out an concrete example with industrial. Since I have build some bases researching on metal companies. Guess it will need some big discount thou.

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