Brainteaser

• In this picture, the small rectangle is of dimension 6 x 12. What is a radius of the circle?

Brainteaser

• Sqrt[(x-6)+(x-12)]= 30

or 6, but that is rejected

x

x - 6

x - 12

Intro to Investing and TradingSeptember 9, 2014

What is investing?

Find a seller, selling at a low price

• Who will sell you cliff bars at a low price?– Bulk seller– Seller of non-economic

reasons

• Say, you buy Cliff Bars at $1 per bar…

Find (or wait) for a buyer

• Sell for market price of $2

• Say, you manage to sell 10 bars a day, every day. What is your profit for the year?

The business

• You now have a business, with $3,650 a year of profits

• I come up to you to offer to buy this business from you, how much do you sell it for?

The approach

• DCF– 3650 a year

discounted back at 10% gives me $36,500.

• Multiples– 3650 of earnings, at

a 10x PE gives me $36,500

What do think my offer actually is?

• Can you sustain your profits?– Can a friend compete with

you for market share easily?

• Can you grow your business?– Is it easy to apply this

business to another product, say coffee?

• Given the nature of the business, should I offer a little or a lot?

Is your business really worth that much?

Good business bad business

• Investing in businesses is about finding out the fundamental economics of the business

• Which is a better business, Dell or Microsoft?

• What about Apple vs. NYSE?

The key point

• If you are willing to sell me your Cliff Bar business for $10,000– I can use the business to generate cash OR– I can sell the business to someone else for

higher

• Businesses are worth a multiple of their cash flows in the future!

What about new businesses?

• Not all business produce cash, we price businesses based on what we think they can produce, rather than what they are producing

• The problem is that we are so bad at guessing, we tend to overvalue growing businesses, and undervalue terminal ones

Everything has a price

What other things can you invest in?

• Assets that can act like a business (Real Estate)

Trading

• You are always both a buyer and seller

I’m willing to buy from anyone at $1.2 and sell to anyone at $1.7

Trading

• Always willing to buy or sell from someone

• Hedging another’s position• Scenario: – Your bank has been hired to sell an airline’s

stock, and thus current has 20% of the airline stock

– As the trader, you are told to reduce the risk of that position without selling the stock

– You go to the market and buy oil

Trading

• You profit from the “spread” (1.7 - 1.2 = 0.5)

• The spread you offer can increase or decrease

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Trading

• What if you really don’t want to buy from the market?

• Most traders are not allowed to take views

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What can you trade?

• If you can think it, Wall St. will sell it to you

• Stock, bonds, interest rates, commodities, rice, wheat, orange juice, hogs, and frozen pork bellies

What investing and trading is not

• It is not gambling or taking guessing.

• It is not chart driven

What investing and trading is

• Facts and data driven– Unfortunately, the market does not care what

you think or what your opinion is

• Clinical avoidance of institutional bias– you own shares in a company and the stock tanks

20% for no good reason, you panic and worry, what do you do?

– A company’s shares has been surging up for the past 14 months, your broker tells you the stock is hot and will keep going up due to its momentum, what do you do?

What does it look like in the major league?

• Diligence– Rule of thumb: Read everything with the name

of the company on it– Speak to everyone in the know– Judgment call on the quality of the business– What is the market missing that you aren’t?