Payback Time-Phil Town

6. August 2009

Excerpt from PAYBACK TIME: Eight Steps To Outsmarting the System That Failed You
and Getting Your Investments Back on Track by Phil Town
(Random House, February 2010)
Buying undervalued shares of companies is the most certain way to make a fortune. This
simple strategy has worked for investors for the last 100 years and it will still be making
millionaires and billionaires 100 years from now. Certain millions? Really? If you understand
one simple thing about stocks the answer is ‘Yes’.
What Warren Buffett and a lot of other billionaires know that has made them fabulously
wealthy is that the price of a stock doesn’t always have a whole lot to do with how much that
business is actually worth. To put it another way: To get rich you have to learn how to look
beyond stock price and at a business’s value and if you get it right, you are, in Buffett’s words,
‘certain to make money’.
The one and only secret to fabulous investing is to make sure the value of the business is
substantially greater than the price you are paying for it. I swear to you that’s all there is to it. If
you get this right, you cannot help but get rich. Most investors make the mistake of thinking the
price they paid has some necessary connection to the value of the thing they bought. I don’t
know why stock market investors think that when it’s so manifestly and obviously not true in any
other sort of market they buy in regularly. Surely they bought a used car sometime in their lives.
They wouldn’t confuse the price being asked for a used car with the value of that car, would
they? Just because a guy is asking $5,000 for his old Toyota doesn’t mean it’s actually worth
$5,000. If you‘re reasonably smart, you go look the car over, make sure it’s got an engine that
works, and the body isn’t a disaster. You check to see what similar cars are going for and use that
price as a guideline, but only if it’s reasonable.
Why wouldn’t investors do something similar when they buy stock? Because they don’t
know how to calculate the value of a business the way they do with cars. Well, we’re going to fix
that in this book.
I’m going to show you how to calculate value—and make sure it’s higher than price—in
Chapter 4, but for right now just understand this: price is just the amount you paid. That’s all it
is. It doesn’t mean a dang thing other than that. If you want to know the value of the thing you
bought, well, that’s an entirely different question. Price is what you pay but value is what you
get. Those two things can be and often are quite different. We’ll start our lessons on how to buy
undervalued companies and make millions with this simple phrase: Price is not the same as
Value.
Since I haven’t taught you how to figure out the value of a business yet, allow me to
make my point with an example from my horse farm. I’m not a very good rider but I want to
learn, so I was looking for a horse that knows a lot more than me about what I’m supposed to do.
My partner, Melissa Hyde, got a lead on a 4th Level dressage horse that was for sale because the
owner died. The family is wealthy so they were just looking for a good home for the horse.
Melissa called and found out they’d bought the horse for $60,000 plus shipping from Germany.
They wanted $35,000 for a quick sale. She told them we weren’t interested but they should call
us back if they didn’t find a buyer at that price. Two weeks later they called and offered us the
horse for $10,000. We drove over for a look. We could see why they were having a problem
selling him. He needed to get his feet trimmed and re-shod. He needed to be fed better. And he
hadn’t been ridden for months. I got on him and he tried to toss me, but he was too out of shape
to get into it. I wasn’t impressed. A big, bony, out of shape, cantankerous horse wasn’t what I
was in the market for.
Melissa, however, is the former owner of a horse importing and training business and
she’s been a national champion rider several times. She knows horses. She took a ten-minute
look at this guy moving around the arena, pulled me aside and said, “Let’s take him home. He’s
amazing.”
Where I just saw the superficial problems, she saw a $60,000 horse and a great horse to
teach me to be a better rider. We paid $6,000, loaded him up, and he’s in our barn now, three
months later, with new shoes and all muscled up and looking sleek and handsome. What’s his
value? I’m sure even in this market, he’s at least a $20,000 horse. Maybe a lot more. The lesson?
Superficial problems that have nothing to do with value can have a big impact on price.
Before we get back to businesses and the details of calculating value, I want you to notice
one more thing about the purchase I made: It was essentially risk-free. Melissa knew there was
no way I could lose money on that horse. Even if he died, I’d make money on the insurance.
Think about that for a second. If we know the price of a thing is less than what it’s worth
(its value) then something remarkable becomes possible: We can buy it and be certain we will
make money.
“Certain?” you ask. “Come on. There’s no way to be certain you’re going to make
money.”
Yup, there is a way to be certain and it’s really simple. Just put on your logical, rational
hat and follow me: If the value of the thing you bought is greater than the price you paid, you are
guaranteed to make money. You have gotten rid of the risk of making the investment. The only
question is how long you have to wait for the price to come back into line with the true value.
In the case of our horse, Sherman, we bought him so cheaply we could sell him for a two
to three times what I paid after doing some basic maintenance and training. If I want to sell him
for the maximum amount—his full value as a Level-4, 17-hand, beautiful dressage horse with
amazing action—I’ll have to be more patient and wait for a better market when the price will
come up to the value.
The same thing applies to owning shares of a business. If you buy at a price well below
the long-term value, you may not be able to sell for a profit immediately. In fact, the price may
go down before it goes up. There’s no guarantee that the short-term prices for Sherman won’t fall
lower. But long term, the price will come up to the value. True for a horse. Especially true for a
business.
Businesses have real value based on an estimate of their future cash flow. We’ll talk about
that more in a later chapter as well. With a business you don’t know exactly when you’ll make
money because you have to wait for the price to come up to the value. But because it’s a business
that produces cash, the price will inevitably rise to the value of those future cash flows someday.
So that’s pretty cool, huh?
But it raises an important issue: How long might it take before the price gets back to the
value? What good is “someday” if we can’t cash out when we need to? Well, here’s where my
10-10 Rule comes into play: We don’t buy a business for even ten minutes unless we are willing
to own it for the next ten years. We do the 10-10 Rule for two reasons:
1. It forces us to think long term and
2. We may be in such a bad stock market that we actually don’t expect to see the price
come back up to the value for ten years, and we want to be totally okay with that.
This puts quite a strong requirement on us that we know our businesses the way Melissa
knows horses. You’ll learn what to look for in Chapter 3. In the meantime, in case all this is
scaring you, just remember: I’ve done valuations with both businesses and horses, and
businesses are a lot easier. When you find a business with the price lower than the value, you
can’t lose if you don’t have to sell. But there must be more to it than that, right? What’s the
catch?
You probably saw one issue immediately. The stock price is going down like a brick and
you’re buying it like it’s diamonds? How could you do that if everyone else is selling? Are they
really that stupid and you’re really that smart? Do you have to be a genius to do this stuff?
Maybe that’s the catch.
No, you don’t. And no it isn’t. The guys who are selling aren’t stupid, and you aren’t that
smart. It isn’t about stupid versus smart. If you’ve got a reasonable IQ you’re going to be fine
with this because it isn’t about being clever. It’s about being reasonable. If you are a reasonable
person you can rock the financial world. As crazy as that sounds, it’s so true. Making big money
stockpiling stocks is about Mr. Market’s emotions versus your reason.
We’ll deal with our very emotional partner, Mr. Market, in another chapter. For now just
understand that if you can keep your head while Mr. Market is going through a bi-polar
emotional meltdown, you are going to become very rich. You don’t have to be real smart. You
just have to be calm and rational. Can you keep your head when the Big Guys—the mutual fund
managers who control more than 85% of the money in the stock market—are freaking out? Of
course you can. And if you’re not sure, read on. One of the main themes of this book is to show
you exactly how to stay calm when everyone else is freaking out. You do that, my friend, and
you are going to get very rich. For certain.
Pre-order Payback Time Now at
Amazon.

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