Stock picking metrics: how ROCE and compounding build wealth

0:00Welcome to the How You Build a Seven Figure Portfolio programme. I'm excited that you have joined and enrolled and that you've made the decision to invest in yourself and take your investments to the next level. We're going to do that here as succinctly and as information dense as possible. I'm not going to assume any knowledge though, so I will explain concepts that to some of you might seem obvious but to others it might be new. That's always the way I run programmes, I assume nothing. However, if you have questions you have the community to ask me directly through the Discord, and of course there are also comment sections below each of these, so use them. The more interactive that you make this, the more questions you ask, the more you'll get out of this.

0:51Now this first lesson here, what is it about? What's the secret behind the seven figure portfolio? How do we get there? Well, to start with I must say this is not financial advice. Me and my chief financial analyst here, here she is, Tula, are going to give you the tools and the knowledge to make decisions yourself. So just because I'm buying a stock it doesn't mean it's necessarily right for you, and the same applies to absolutely anybody else who gives thoughts, advice, recommendations anywhere in the world. You have to always understand, is it right for me? And you will be able to do that by the end of this programme.

1:31So the first part here is really let's look at what an investment portfolio is really all about. So this first lesson here is a little bit of an introduction and also setting out our goals so we are all on the same page and we all know what we are here for. So what is an investment portfolio? Well, it's made up of a lot of things. It's basically made up of a bunch of assets.

2:01Most of you will think of stocks. You might think of bonds. But there are plenty of others and we will go through quite a lot of this. Cash is an asset, not my favourite asset in the world but it is an asset nevertheless. We have cryptos which are becoming more and more important. We have, I'm going to write gold here but you could also write precious metals. There are REITs which is essentially real estate but in a kind of a fund way, and we will look into that as well. You could also add physical real estate to this, though that would typically not be held in a portfolio the way that we envisage it when it's online, digital, in some sort of app or another. So those would kind of be the core assets here. We're going to look at which of these make the most sense for you and why they make sense for you and how that actually changes over time.

3:11So how do you hold your investments? Well, you probably have a bank account. In fact I'm pretty sure you have a bank account, otherwise you wouldn't be here. You might have various investing accounts with one or more platform. You probably, if you have worked somewhere in the world, have a retirement account, and you may or may not be able to decide what's in that. You might also have something like a 401k, which is the American essentially retirement account, pension plan, where the employer contributes as well. Again this is fairly common in most parts of the world. There are some others but these are kind of the core ones here.

4:01Now the big mistake most people make with a lot of these investments is that they wake up one day and they go, okay I'm going to invest something here, throw some money at something. That might be their retirement account or their portfolio, and then they leave it and they come back to it 10 years later and they go, oh, that didn't do all that much, did it? We are therefore going to look at life stages and your plans and your goals and your targets and how we can make, for your specific need, the best portfolio that will give you the best returns for your targets. It's not the same for everybody, it just isn't. It depends on age, situation, income, and very much what your goals are and what you're going to need to spend money on. So personalisation is what this is all about.

4:57So the whole thing is really truly personal to you and it will change. Change is a huge part here. So we are going to become our own portfolio managers here, and that means we don't need to wake up every morning and trade a thousand stocks and spend the rest of our life worrying about every little move, absolutely not. But we should probably sit down at least monthly or quarterly and review what is going on against our targets. Now for that we're going to need to have some targets first, which we get to in module 2.

5:33In module 1 here we are firstly going to run through a few core concepts that are absolutely essential. Inflation, compound interest, and living with volatility and how much of that you can live with. So those are the building blocks. We will then take into your personal goal and target building, and then we implement them.

6:01Now the whole thing here is broken up into small little bite-sized pieces so you can listen to them when you're on the move, when you are travelling or going to work, or whenever you have 10 or 20 or 30 minutes. If you have an iPhone there is a Teachable app so you can listen and access the course through that. If you use Android or a computer just log into the website and you can do it that way. I will let you know when there is stuff you would need to look at on screen. Some people find it very helpful to look at notes. There will be notes, there is also a handbook where all the notes go, so you could either print that off or just refer to it. I'll share that with you and we'll keep updating that as the programme develops.

6:51As more and more people ask questions we'll add the FAQs to that and so on. So it's a living, breathing being, this programme, and you have lifetime access to it. So it'll get better and better and more comprehensive over time, or greater and greater I should say. So do come back to it even once you've run through it and check on the FAQs. Take advantage of it, and as you each month or each quarter do the management of your eventual portfolio, share it, ask questions and help each other and reach out, and therefore you will learn a lot more. So take advantage of the community here. If you are not on the Discord, which is where our chat group lives, and the Discord is confusing to you, send me an email and ask me how to get on there. I'll help you to get on there. Once you've signed up it's actually very easy to use, but I appreciate everybody has a different level of technology phobia, so don't be shy. I'm here for you throughout this entire journey.

7:54In this lecture we're looking at inflation, and we're going to look at two types of inflation and how we beat them and why beating them is the most important thing to start with. If we don't, we are basically sliding down backwards the mountain that we were trying to climb, if that is a useful metaphor here.

8:17So let me show you a couple of bits of data here which is important to understand. This is the United States inflation rate. If you don't live in the United States it's still pretty similar, pretty much no matter where you are in the developed world at least. And this is the last 25 years and you can see it basically moves around the 2 percentage point, and it has done so for the last 20 years. In fact it's actually become less over time, inflation has generally speaking declined.

8:55Now as I'm recording this we have this great big spike here in inflation, so people are starting to get worried about it. But that's not really the thing to worry about, because whether your milk or bread or fuel goes up by 2% or 6% a year, that's almost neither here nor there, because the problem of real inflation that affects your wealth is much much greater. A lot of things that you are buying day to day have actually gotten cheaper thanks to Amazon, international trade and cheaper manufacturing and so on.

9:29So this inflation metric that the government gives you, this is the core price index, is to start with manipulated, because it's statistics. And I studied econometrics and statistics and I can tell you that you can basically get a statistic to show you whatever you want. And governments have done that, so they keep massaging this basket of goods to tell everybody that inflation really isn't all that high anyway. So I'm not worried about this 2, 6% or whatever it might be inflation.

10:02But let me show you something that is a little bit more concerning. So this is the US money supply, all money basically, and what you can see is that the speed at which the US government is printing money has increased. Look at that, the scale here, we're going up faster. And then I'm recording this a year after Covid and this is of course a big factor here. So what's happened? Well, what's happened is that about 40% of all US dollars in circulation were created in the past one year.

10:44And what has that done? Well, it's created lots of free money, lots of cheap money. And what does cheap money seek, what does all money seek? Money seeks returns, and these returns are to be found in the most profitable asset classes, which generally speaking have been stocks and real estate and to some extent crypto. So the real inflation rate in terms of asset inflation is far far greater than

11:15The 2% plus that the government would like us to believe there is. So you might think, okay, I have $10,000 here, if I don't invest it this year, in theory yes I lose 2%. No you don't, you lose a great deal more than that. And let me show you why.

11:32Even if you ignore this massive money printing spike here in recent times, when we look at this chart here, what is this chart? This chart is the S&P 500, so it's an ETF, a fund you can invest in that tracks the largest 500 companies listed in the United States. So it's the S&P 500 ETF, it's called SPY, one of the most commonly traded ETFs. And this is a 20-year time period here, but this applies to pretty much any 20-year time period. We start in 2001 and yes the market goes down a bit, it has a sideways motion, we get 2008, we get a crash here, but none of those matter because over the time period the S&P 500 has gone up 236%.

12:30Now this is 20 years, but it doesn't take a genius to work out that, ignoring compounding here for a moment, that's 10% plus a year. So what does that mean? It means that if you held cash throughout this period, so you have some cash here and you don't invest it throughout this entire period, if you wanted to buy the same stocks now that you could have bought 20 years ago, so just say the index of those 500 top companies, it would cost you 236% more. So what's happened to your money? Well it's worth a great deal less, and it's worth a great deal less more than the official inflation rate because you lost at least 10% a year.

13:20So this is why holding large amounts of cash is just horrible, and we are therefore going to look for alternatives. Now depending on your targets and your situation and your income levels and your age and all those things, you may need to hold onto some cash. It also depends on your mental wellbeing. Some people don't sleep at night unless they have a certain amount of cash tucked under the mattress, and that's all well and good and we're going to go through that. And I'm not going to try and convince you to not do that because our sanity here is more important than a little bit of extra return.

14:00But what I wanted to show here is, without going into the money printing which exacerbates this situation significantly, you are losing at least 10% a year by not being invested, and that's quite a lot. Do that for 10 years and you see where I'm going with this.

14:18And what's the solution? This lovely little chart here has got two lines on it. It has in blue money supply, so this is money, it's called M2 if you're an economist, it's basically all the cash out there. And then we have in black the stock market, I think it's just the S&P 500. And you can see that the black line, the S&P 500, tracks the money line rather well.

14:54So what we've established so far is that stocks are pretty good at offsetting asset inflation, and if you don't participate in this you are just losing that 10% plus a year. And if you do participate in this you are at least doing as well as you can to offset the inflationary destruction of your wealth, because that's exactly what that is.

15:24So what I want to get across here really is that there are two types of inflation. There is the official CPI inflation data that you see in the news, it's 2%, 5%, whatever it might be. That number is pretty irrelevant because it only affects the basket of household goods that you spend things on and it doesn't go up all that much, so I wouldn't lose sleepless nights over that.

15:45What I would lose sleepless nights over is asset inflation. You've seen property prices have gone up tremendously over the last 10 years, 20 years, 50 years, whatever time period you can remember. They always do, same with stocks. And that is the real inflation. So think about it, if you had $100,000 10 years ago you could buy whatever the house next door. Now that's not possible because that house is now worth $300,000 or $500,000 or something like that.

16:18That is asset inflation, and that just means if you kept that $100,000 in cash you would now only be able to buy a third or a fifth of that house. Whereas if you would put it into an asset, whether it was that house or really or stocks, your wealth would have gone up in line with the asset inflation. So one of the key key things is simply wealth preservation, and asset inflation does exactly the opposite.

16:47So don't mean to freak you out here at all, we will address this and there are solutions for this that are low risk and higher return. But we need to basically outperform asset inflation to really become wealthy, and that's the goal here, that's the target here. So that's a quick roundup on inflation. If you have any questions or thoughts about that, put them down below in the comments or ask them on the Discord.

17:12In this lecture we talk about compounding. You might know what compounding is, you might say I've read a book on this, I've watched some videos on this, I've heard you Felix rant on about this, so why are you repeating it? If there is one thing you can never repeat often enough it's compound interest. It is the secret sauce to pretty much every fortune out there.

17:37And what I'd like you to do is go on my website and at the top here there is a menu called free resources, and then you scroll down and you'll find calculate your future wealth. You click on that and then it opens for you a completely free compounding calculator. I'd like this to become your best friend. I'd like for you to put in some numbers here, not just ones but really go for it, spend an hour with this and go through different interest rates, which is essentially the return you're getting from your investments. Look at different amounts you can invest and look at longer and longer and longer time periods, and you will be amazed.

18:23I think what I've done is I have my target for this, I've printed it out, it's on my wall. In fact I have two, I have a baseline target and I have a bullish target. Both have 9-figure portfolios as the goal, and it doesn't take that much to achieve your goals with this. Now we will get more into goal setting, but before we do it's important to understand what you can achieve if you put your mind to it and if you are a little bit more disciplined about investing.

18:59So I've taken a screenshot here of two calculations. This is 20 years, so this is 240 months, and you might say Felix, 20 years, I don't know what I'll be doing in 20 years. Well I hope by the end of this you will know what you'll be doing in 20 years because it's so exciting. Actually the longer the time period the more exciting this gets.

19:20So what have we done here? I'm saying you're investing $700 a month and you're getting an 11% return. Now I'm hoping that we'll do more than 11%, but for me that's a bit of a baseline. You could also run it with 8 or with 15 or with 18 or whatever you like. And my particular portfolio, I'm recording this, for the last 10 years or so my portfolio has done 18% per annum. That's pre-compounding, compound that and it becomes 40% plus, which is incredible. Now I don't rely on that kind of performance because of course that isn't my true genius that's doing that, because a lot of that is just the market overall. It's a time period where markets have done very very well.

20:03Now 3 numbers here and then I'll show you some pretty pictures. You have invested over the 20-year time period $168,000 US or whatever your currency of choice. That has earned you interest, and I use the term interest very loosely, it's basically return. So it could be capital or it could be dividends or whatever. I personally prefer capital because I don't pay capital gains tax, whereas on dividend payments there typically is some sort of withholding tax.

20:38But that again depends on your tax situation and we'll talk about that a little bit more down the road. But it is something to bear in mind when you are choosing stocks and financial products, how is this going to get taxed, how are the gains here going to get taxed. But let's not get too sidetracked here. So what's happened? You put in $168,000, you got $434,000 for free, and that's given you $605,000. That's not bad, right? So if you think that you only invested out of the $605,000, $168,000, that's a pretty good setup for doing something fairly boring.

21:18So why is this not really boring? Well when you look at this chart, this is what happens to this portfolio over the 20-year time period. And you can see there are two parts to it. There is the red part down here, and each of these bars down here is the same size. What does that mean? Well because you are investing $8,400 per annum each year, $700 times 12, $8,400. So that's not changing.

21:51I haven't allowed for wage increases of yours or your business increases, so in an ideal world you would start to increase that amount. And again we can look into more detailed calculations with that later, but we're going to want to keep it simple here. So if you can invest $700 now, or $100 or whatever the amount is for you, you would think that in 20 years it would be easier for you to achieve that. Otherwise you're doing something really quite horrific on the income earning front.

22:23What's the bit that keeps going up? That's the green part. The green part is basically return, and that's your compounding returns because they're getting bigger. So that little portfolio, that little bit of money you're investing every year, in the first year it only does a little bit, the second year it does a little bit more, and then we jump for 10 years and already your investment is maybe about a third of what's actually in there. Then towards the end of it you can see it's basically all free money.

22:57So this situation, $700 a month over 20 years, what do we get? Well we get $437,000 return. So this green area here is $437,000. That's basically money that money has earned, you didn't earn that. Now the red stuff is deposits, so that's what you earned, that's what you put in. So this looks pretty good, right? It basically means you put in about a quarter and your money generated the other three quarters, so that's the magic of compounding.

23:41Now let's run through one more example here to illustrate this. So what have I done here? Same amount of money, same interest, but I've added 10 years. You're thinking, Felix, in 30 years, good God, that's a really long time. Well let me get you excited on this. Why? Because you have over 30 years saved essentially and invested $252,000, and how much did you get back for that? $1.7 million in returns, taking you to pretty much $2 million. That's starting to look a little bit more sexy, isn't it?

24:25So this is what the chart looks like. Still every single year down here you are investing your $8,400. You're not increasing that, which I would say is unrealistic. I think we would very much hope that your income would go up over a 30 year time period. And the green stuff is for free, just comes and lands in your lap.

24:48So what does the chart at the end of that 30 years look like? Well, you've invested, what was the number that we said at the beginning, you invested $252,000. So this here is $252,000, and then you got for free $1.7 million, and those two together create $1.96 million, just shy of $2 million. So you have now taken your $252,000 and how much have you grown that by? $1,963 divided by 252, that is 7.8 times increase. So you have generated a 7.8 times increase of your money over that time period.

25:50And let's do it also for the number up here so we can see the comparison. And you can start to see that was $168,000, that's what we invested here. So here up here the deposits were $168,000, and we ended up with, let me just see what the total was, $685,000. So this came out at $685,000. So your deposits turned into that. So 685 divided by 168 is 4 times. So this here is a 4x of your money.

26:46Why then does it become 7.8x? How does that happen? I've done the same thing, I've saved the same amount of money, I've invested the same thing, my returns were the same, my returns were 11%, I kept investing $700 each month. This is compounding. The longer you do it the bigger the number gets. Your multiplier gets bigger and bigger and bigger. Why is that? Because when you have $1 million in your portfolio and you get 11%, you get $110,000 for free, right? If you have $100,000 you get $11,000 at 11% for free each year. When it becomes $10 million you get $1.1 million for free. So the acceleration gets faster and faster.

27:36And let me show you another example. Say you are wonderfully young and you're going to work for say 40 years, right? And then it becomes $6 million, right? And you invested $336,000. You're approaching 20x here. And this continues, this of course also gets faster the more money you put in and the higher your return, which is why we're going to focus a lot on those two in this programme.

28:05But what is important is that you grasp this concept, that there is free money out there as long as you are a consistent investor into things that don't destroy your capital. So capital preservation and investing in stocks that actually generate more wealth for you as a shareholder is the key thing here. And I use the word stocks, I should say assets, because there are also other asset classes we're going to look at here. But this is the slow and steady, which is the basis of all investing wealth.

28:44Now you say, well what about growth stocks, what about crypto, what about this and that, I can do 100x in a week. Well yes, we're going to look at those and I'm not saying you should exclude those, but this here is the fundamental. This here is the basis of how you can build wealth reliably over a time period that seems relatively long. But just imagine retiring with $10 million, $20 million, $100 million. Very nice place to be, right? You no longer have to worry about stuff. And also knowing that you are on that journey and knowing where you are on that journey and what you need to do will motivate you, it will focus you. And it means you actually end up putting more money into the market and you'll buy better things and you hold them for longer, the good ones, and you will make greater returns than the ones we're envisaging here.

29:32So this is compounding. It's not about getting dividend stocks and reinvesting that money. That is not really what it's all about. It's anything that generates returns and that's reinvested compounds. So there we go, this is the magic of compounding, my favourite subject, always.

29:58In this lesson we're going to cover how to pick really great stocks, as simple as that, which are in my view the backbone of every portfolio. So what are we going to do? Well, I've got an opinion on the screen, the how to pick great stocks Google spreadsheet. The link's below, you might want to open that at the same time so you can follow along more easily, or you might want to print bits off or scribble on them or whatever you wish. You can, when you edit these, you click on file, make a copy, and then you've got your own copy and then you can edit that one to your heart's content.

30:32This is my core portfolio. That means most of my money is in these stocks in this proportion. The only one missing from this that I've added lately is Amazon, but it's not a top 10 item so far so it doesn't make a huge difference here. And we will look through some of the key criteria that I've got open over here, but before we do that we're going to go back a step and we're going to look a little bit more at what the difference is between a good portfolio and an index fund.

31:11So let me take a little full screen snapshot of this so I can scribble all over this and make a mess of the thing. Right. Now I've recorded here the performance of my portfolio since March 2013, no particular reason for that date, it was just the date I had data up to. And it's gone up absolutely marvellously, 376%. The S&P 500 in the same time, it's gone up 159%, which is also pretty amazing.

31:40And the return per year, therefore this is about 8 years, is 47% for me and 19.8% for the S&P. I mean I would generally be very happy with 19.8%, so I'm not bashing the S&P 500 here at all, that's still a tremendous return. Now if we work at that backwards and take the compounding out of it, then the annual growth rate of the S&P is actually 6% and my portfolio was 18%. And there's no reason why my portfolio is going to continue doing 18%. I think 10 to 12 is more likely in the long run, but who knows, more people pour more money into the market.

32:22So you can see already very, very clearly the compound and not compound difference. So you can see that compounding really makes an enormous difference. It turns 6% into 19.8% over a here 8 year period or so.

32:48Now what does this actually mean? If you had invested in this time period, and I appreciate we're looking backwards here, but it's important to understand. Say if for 20 years you invest $1,000 a month and you increase every year by 5% for inflation the amount you put in, so in year 2 you're putting in $1,050 and in year 3 it's $1,000, whatever that is, $1,125 or something. So you're increasing that by 5% each year to make up for the loss of inflation, and hopefully your earnings are going up by 5% each year. If they're not, seriously drop me an email, we'll have a chat about that, because I think there are things you can do to make sure your income does go up by at least 5% a year because it's important for investments and your future and not wasting time moving sideways.

33:38So for both portfolios you've invested over that 20 year time period $396,900. You turned that into $693,000. So 693 divided by 396, that's 1.75x. For my portfolio it's a little bit more dramatic, that is about 7.5x. So you can see the enormous difference that a bit of a change in growth rate per year makes to the outcome, because it just compounds, it just gets bigger and bigger and balloons.

34:37So that's the key takeaway here, is that the return you make really, really matters. Because 20%, most people would say brilliant. 47%, yeah, staggering. That's about double, right? I mean, what is that, 47 divided by 19, that's about 2.4, right? 2.4x is the difference in an annual return. But 7.5 divided by 1.75 is 4.3. So from there to here is 4.3x. So basically doubling your return percentage return per year quadruples your actual monetary output at the end of it, say a 20 year period. If you did this for longer it'd get bigger, if you did it for shorter it would be smaller.

35:30For 30 years the difference even gets bigger and bigger, just because the now $2.95 million portfolio will grow next year then by another 18%, right? So that's $3 million, that's near $500,000, $450,000 or so for free just lumping on top of that. So the smaller portfolio with the smaller returns will never ever catch up. It's impossible. So that's why returns really matter and picking good stocks really really matters.

36:04Fees really matter. Management fees and every other brokerage fee, transfer fee and everything else, because every percentage point or every fraction of a percentage point gets magnified over time very very substantially. So that's really the point I want to get across here before we dig into the actual method.

36:25Now I'm going to run you through here about a dozen metrics, so this is going to be a little bit school-like I'm afraid. What I would suggest you do is you print off this particular page or just take some notes on the site, because it's quite a bit to let it sink in. It is of course all on here so you can go over it again, you can replay this video too. Now what do we look for?

36:54The first thing we look for is, and again I'm going to take a screenshot of this because I like screenshots. Okay, have to save this and then we're gonna have to insert this into a Microsoft Whiteboard. Microsoft in their infinite wisdom, great stock but software sometimes a bit of a challenge, created a new system where we can no longer copy and paste. So I'm just going to have to load this app here and put it in here so you can see it properly. There we go, so that's the metric, these are the criteria.

37:38What's the first criteria? The first criteria is, is the business profitable? That's the first thing I look for. I don't like black pens, I think they're gloomy. The first thing we look at is 3 metrics for profitability and how efficiently the business is run.

37:57Gross margin is the first one, and what does gross margin actually mean? It basically tells you what the core efficiency is of the company. And if you have a really high gross margin of say 60, 70, 80%, if there is some sort of shock, supply chain or some other shock, and their costs go up, they can absorb it. If their gross margin is 5%, they can't.

38:21Operating margin is similar but different. Operating margin basically tells you profitability after all operational costs. So it's really a cost control measure, so it tells you a lot about management's ability to keep costs in check. So it's kind of the next step onwards from the gross margin.

38:45Now my absolute favourite, my absolute one metric, if there was only one metric I was allowed to look at for stocks it would be ROCE. If I was completely blind otherwise I'd look at ROCE. What is it? Return on capital employed. And the important part about ROCE is capital means all equity, so this is all the money that you shareholders put in, and it's also all debt, so all the money that all bondholders put in or all other lending they might have from banks.

39:24So you take all of the profits and basically divided by all of the capital, the debt and the equity. It's, I think most people would agree with that, the single best measure of management effectiveness, of how well this company is run. The way I would look at that, and then there's the comparison I always give, imagine you buy a house. Say the house is $100,000, you put in $50,000 cash and $50,000 mortgage debt.

39:55Look at, say this house is Microsoft. Microsoft has a ROCE of something like 47% or something like that. Let me see if I've got it on here on the chart. By memory I think it's about 47%. Okay, sorry, 30%, right, by at least this metric here. I think it might have gone up a little bit. 30%. So what does that mean? If you are the Microsoft house, so let me draw a little house. So this is the house, this house is called Microsoft, and the house costs $100,000.

40:39Okay, now the house is paid for in half. So it's paid for in cash and debt in equal proportions. So we've got $50,000 in cash in here and we've got $50,000 in debt in the house. Now the Microsoft house gets in year one rent after all deductions of $30,000. And that is a ROCE of 30%. Why? Because it's 30,000 divided by 100.

41:49Now most property investors would tell you that actually the return on investment, the return on your money, is greater because they only look at the cash they put in. So they would say it's 30,000 divided by 50, which is 60%. So that's what most people look at, but it's a bit of a misleading figure because you forget about the debt. At some point the debt has to be paid, and you can mess with those numbers.

42:22So the return on equity number which a lot of people look at, which is essentially that, so return on equity would be this here divided by that. So return on equity, which a lot of people look at, is basically $30,000 income over $50,000 which is the cash. And that metric would give you a higher number, that would then give you 60%. 60% ROE, everyone jumps up and down and goes oh my God what a brilliant business.

43:03But the ROCE number I think is the more honest number because it takes into account the debt and it therefore tells you there is some debt here. So that's why this is generally speaking the most accepted number. And as I say it is just easier to manipulate. If you are interested in more about this I have a really long in-depth article on this which is probably 20,000 words, if you really want to dig deeper into the difference between ROE and ROCE. You don't have to understand it, you just have to know that ROCE is the better metric that is much much harder to manipulate.

43:40So what's next? What's next is number 2, is it generating cash? Is the company generating cash? Now we're looking here at metrics for profitable companies. If we're looking at growth stocks we have an additional set of metrics that we look at which we will do just after this. But this is still the basis of it, and you will also see that analysing profitable stocks is much much easier because you have a lot more data. Growth stocks, very little data, a lot more about the stuff that's up in the air. But we'll look at that in a second.

44:18So 2 things I look for for cash. I look at cash conversion, and again this is a metric, all of these metrics you can look at in Google. You type in ROCE or cash conversion and then the stock, you will find it on Google. It's completely free, which is the marvel of investing nowadays. So it's the ability to convert profits into cash, and you might think if you're profitable you're creating cash. Sadly not the case, it really depends on how efficient the business is run. So super super important.

44:48A great business has a cash conversion of zero days or near zero days or even negative. So Microsoft for example has a negative cash conversion rate because it's subscription. They get paid before they deliver the service to you, right? You pay them at the beginning of the year for 365 days of using Office or whatever else you buy from them. So it's measured in days.

45:12Second is free cash flow margin. So I care less about, most people say oh it's got free cash flow of $1 billion or $5 billion. It's like, what does that mean? Because you don't know how big the business is at this point, right? So I look at the cash flow margin which I think is a much much more efficient way of looking at that number. So that basically tells you what portion of sales end up as cash. It's very easy to understand. You got $1 million in sales, you've got $300,000 left in cash, that's a 30% free cash flow margin. So it tells you very very clearly how good the business is at turning revenue, sales, into cash, which is important. Otherwise, businesses without cash eventually go and die. At least they're more risky.

46:11So talking about dying, is it financially stable? I look at 2 metrics here, one leverage and one interest cover. Leverage basically tells you how much debt they have compared to equity, so it tells you about how volatile their returns are. If it's an established business and they've got very good returns, they'll typically have very stable and relatively modest leverage.

46:39Now there are some industries like financial services and so on where leverage is quite a good thing, debt is very cheap, so you'll find a little bit higher debt. So we get to that also in a moment. It's always important to compare like for like, so compare companies against each other that are in the same sector.

46:59Interest cover basically tells you, you want this to be high, it tells you how many times over with their present financial situation can they pay their interest for. So if they can't pay their interest they go bankrupt, right, they go to insolvency. If they can pay their interest 3 times it's like okay, what if next year isn't so good, it might be difficult. If the interest cover is 75 times or something, you kind of think okay, even if the world comes to an end they can probably still pay their interest cover. So again the

47:31Higher the number the better for that one.

47:35Now valuation, and I will talk again a little bit more about that in a moment. I care relatively little about PE numbers. Most people look at a stock and they go, what's the PE, is it cheap? And I'll show you why that isn't very important, why it doesn't really matter. However it's still part of the process, it's just a very small part of the process. And a PE ratio is a very short-term valuation snapshot.

48:03Therefore I also look at forward PE. Forward PE tells you, I usually look 2 years forward, how does the PE change if I buy the stock today? What will my PE be in 2 years? And PE is just price over earnings, so it's basically the valuation, the market cap of the company over their profits. So I like to look at those two together and I'll show you some examples to see the trend.

48:31Are earnings growing consistently? I like a consistent performer. I don't like a Ford that jumps up and down for no particular reason. I want a reliable business. I don't usually want a cyclical business. It also tells you whether the management's any good.

48:48Are earnings per share increasing? So why are we looking at earnings per share here? Well it tells you all about dilution. Are they able to increase their profits more than they're diluting shareholders through stock issues or convertible bond issues? So this metric covers for me not just earnings growth but also dilution and I get it all into one. So I'll show you that one in a second in some examples, so that's a really good one too.

49:24Number 5, this is where the numbers leave us sadly and we need to know a little bit more about the business, understand a bit about the industry and what they're doing. Moats are exactly what it sounds like, it's a great big deep trench that protects the business from the outside world. So it's a unique edge over competitors.

49:49And it can come in many forms. Cost advantage, so that could be you're just better at making something, you've invented something that makes it easier for you to do it. That could also link together with the size advantage. Say if you are Toyota and you buy 50 million, 100 million tyres a year, presumably you pay less per tyre than if you are a new little startup that buys 20,000 tyres. So economies of scale from a purchasing point of view but also from a scale point of view. Again if you have a massive production line and you put out millions of the same product, you're going to be able to make that cheaper than the mum and dad shop who's filling jars on manually. So economies of scale is a big one.

50:36High switching cost, what does that mean? High switching cost means it's expensive for your customers to change to a competitor. So anything with a high setup cost is actually a great moat. Many examples of this. Say you are an elevator company, there are only like 2 in the world and they're great businesses. Generally you put an elevator into a building and you probably make very little money on that, but then you get a service contract to maintain that elevator.

51:12Now if that building now wants to switch to a different elevator, it would cost them an absolute fortune, they'd have to demolish half the building. So the switching cost there is completely prohibitive. That's an extreme example, there are of course a lot of other industries where it's somewhere in between, but that's an important one.

51:33And then the good old ones are patents. You simply have a patent on something that you have for a certain period of time where you have unique access to it. Brand, now with brand think Apple for example. Apple has a very strong brand. If I'm an Apple customer, which I'm actually not strangely enough, you have an iPhone, you have an iPad, you have Apple TV, your Wi-Fi runs on Apple whatever. And for you to go and then buy a Google phone or an Android phone, it's pretty unlikely because it won't really work with your existing setup, your existing systems. So Apple has created through brand power a moat.

52:16And also a lot of people just feel that the Apple brand is so strong and powerful and beautiful and lovely and they identify with it that they wouldn't want to be seen dead with another phone. I'd rather be dead in a ditch than buy a Google phone.

52:31Government licences, more rare, but there are some industries where you just have a licence to do something. You have a licence to be the Wi-Fi provider or the mobile phone network or a mining licence or the water board or whatever it is. So there are those examples.

52:49So that's essentially what my metrics are. Now I then, and you can see that here on the right, score my stocks according to that. And these are the maximum numbers of points I give out for each. So some are more important than others. ROCE for example is actually 20% of my entire decision making here. And a lot of the other stuff is a lot smaller. So that's the way I do that and I will show you that now in a real life example.

53:22So that was the valuation method. Before actually we show you that in a real life example, I want to explain a little bit more about why I ignore PE ratios. Buffett, obviously fantastic investor, but he basically says time is the friend of the good business. And I added to that, which I'm sure I pilfered from somebody, is basically you can buy a good stock at the wrong price, it'll fix it for you, but you can't buy a bad stock at the right price. There's just no right price for that and it'll never give you a good return.

53:53So I'll give you here some examples which I pinched from a presentation of a UK fund called Fundsmith some years ago, which is a great fund which I hold quite a lot of. Let me give you some examples.

54:11So Visa card, if you bought Visa card in 2012, which is my data here, and you would have at the time paid 23 times earnings. So 23 years of profits was the share price and people were saying that's crazily high, why would anybody pay that? If you held that for 8 or 9 years, the earnings would have grown so much that you would now own shares with a PE multiple of 6 times. So it went from 23 to 6. And that's the power of a company with great earnings and with great ROCE.

55:01Now that leads a lot of people to go down this value trap and they say, well I'm just going to look for these value stocks, these Buffett type stocks, Ben Graham metric stocks, all these things that value investors look for. A lot of the value stocks that people thought were value stocks are absolute horrible things. And the problem is that their share price goes up faster than their earnings because everyone thinks it's a value stock and is the sure thing.

55:27So look at IBM for example. You bought IBM in 2015, you would have paid 10 times PE, basically 10 times earnings, and people were saying that's a great deal, that's fantastic, this stock will make you rich son, you can retire off this. Well if you hold that now you would have paid 26 times. So earnings grew more slowly than the share price, the share price went up way faster than earnings. So that stock became more expensive and a worse investment.

56:06Whereas if you bought Visa it was the other way around. And General Electric is the same, Deutsche Bank is a horror for example, Exxon's the same, Shell is the same, there are quite a lot of these.

56:19Now let's look at some of these stocks that value investors were banking on. For example Adobe. Adobe in 2015 was trading at 136 times its earnings and everyone was like that's crazy, the value investors were saying nobody should ever buy that, totally overvalued. If you held it for about 8 years or so, maybe a little bit less, 6, 7 years, you would now hold Adobe stock at only 7 times earnings. So that means the stock price you paid previously is now only 7 times today's earnings because their earnings have gone through the roof and their stock price hasn't gone with it.

57:01So the same could be said for Amazon, it went from minus 593 times earnings to 7 times. Facebook from 71 to 8. Netflix from 550 to 8. And PayPal from 88 to 11. So great stocks, companies with great returns on their capital employed and great returns consistently, in the long run fix you paying very very high prices for shares.

57:27Which is why I'm never particularly bothered about the PE ratio. All I'm bothered about is the underlying business because I know it'll fix it for me over time. So that's a quick summary here of why price earnings are not that important.

57:47We are going to look at a couple of stocks here. So I've done a benchmark on here of some profitable companies, anything from Facebook to Amazon, PayPal, Tesla, Alibaba, and then some not profitable companies, Neo, SoFi, Palantir, Lucid, which are relatively popular as we are recording this. And the data will change a bit over time so depending on when you're watching it, but it doesn't really matter because the theory stays the same.

58:17So to start with you can see that Facebook for example has an 80% gross profit margin, which basically tells you they can absorb some serious shocks. And Nvidia the same, 63. PayPal 48. Amazon 41. Tesla 23, why is Tesla only 23? Because they're manufacturing things, so margins in

58:35Manufacturing is just much, much lower than someone who's just putting out a digital business, a product like Facebook. And return on capital employed for Facebook, again tremendous, 32%. So if you think of that house, that's what they're doing. They're getting $32,000 every single year on all the capital invested in their equity and debt. Cash conversion cycles, again you can see these are for all the white stocks here, all the profitable stocks, pretty low, even negative. So Amazon and Tesla obviously get paid up front before they deliver a product, which is why it's negative. They receive money 33 days before they spend it, so that's pretty brilliant.

59:17Leverage free cash flow, it's generally for great stocks positive and nice and juicy. Now Tesla is getting there, they are now at positive here, 5.5%. They are obviously reinvesting massive amounts, which is why it is perhaps not as high as it could be. And then financial leverage, so it tells you how much debt they have over equity. Facebook is almost no debt, PayPal has a bit more, but it's a financial services company, makes sense. And then it tells you here how many years they could pay interest for, so Nvidia 33 times, Amazon 16 times and so on. So you don't really worry about these stocks.

59:58Now let's look at what most people jump to, is PE ratios. Say you bought Nvidia today at 90 times price earnings, seems expensive, right, when you can buy Facebook for 22. But look, if you hold this stock for 2 years and the earnings growth predictions are correct of analysts, which they're not always, but a lot of the time they're also understating earnings, in 2 years' time you would have only paid 36 times today's price over the earnings in 2 years. So you can see if there is a big drop between today's price earnings and forward price earnings, you're onto a very, very fast earning company, a company that's growing their earnings very, very rapidly.

1:00:49So Nvidia is a good example. PayPal, you can see the same thing, it would go from 56 to 37. Amazon from 65 to 47. Tesla from 322 to 65. So massive differences here, and that's what you want to see. You don't really want to see it going in the other direction, although sometimes that can also be based on analysts being particularly pessimistic on a stock.

1:01:12The earnings consistency, this is the metric for it, EPS trend score. Again it's something you can look up. You want a stock to grow their earnings per share every single quarter in a row. If they do it like Tesla with a 100% success rate quarter after quarter, you get 100%. When occasionally you get a miss, right, occasionally something happens, there's a bit of seasonality, they paid something, they invested in something and so on. So generally speaking numbers that are above 70% are pretty good. Alibaba here a bit choppy, I can tell you why, there are some penalties and so on in there.

1:01:53But generally speaking you want that long-term earnings growth rate as high as possible. And you have to think, look, if this company continues to perform at these long-term growth rates, if Facebook generates 18% more profit next year than this year and does it again the year after, wouldn't you think that the stock price be moving in a similar direction? Well I certainly do. So that's why this is a really big metric. Consistency of profits in the long term is a big one.

1:02:30So that all sounds very, I hope it sounds relatively straightforward. They're not that many metrics. I don't think you need much more than this really, other than that you needed to add some moat to it, which is the stuff you have to do a bit of digging on to understand it a bit. Now if you really don't understand the stock, what I would literally type in is the stock name and moat, type it into Google. Somebody will have done some research, somebody will have written an article. Find a couple, ideally some that disagree with each other, and that will open your mind to a lot more thoughts. And that's really what I would do as a basic research there, so you understand a bit more about the industry.

1:03:08Now how do we treat these blue friends down here, the growth stocks? Okay, let's look at gross profit margin. 17% for Nio, okay that's not that far off Tesla. You can see automobile companies, similar kind of margins, or EV companies. SoFi 72%, okay PayPal's got 48, that actually sounds pretty good doesn't it. Suddenly Palantir here 71%, it's essentially a software company. So let's look at Facebook 80%, that's more of a publisher. Lucid 27%, that looks pretty good compared to Tesla 23%.

1:03:45Then let's look at operating margin. Oh, they're all negative. Return on capital employed, they're all negative. Cash conversion, Nio is good, everybody else is horrendous. Leverage free cash flow, two are negative, two are positive. And then let's go over here, forward PE numbers are negative, price earnings ratio is negative, nothing on EPS trend scores, gaps in the data.

1:04:14So this is the challenge with growth stocks, is you have very little data to go on. Really the number one thing you have to go on with growth stocks in terms of data that you can really measure wholeheartedly without emotion is gross profit margin, which is the core efficiency of the business. So you have that, that tells you quite a lot. But you basically don't have anything else, I mean with the exception here of Nio and Palantir, both with positive free cash flow, but most of the other metrics are pretty useless, right. What is an operating income margin of minus 20,000% tell you? It's a meaningless number, it's total gibberish, you might as well delete it.

1:04:56Therefore I've created some additional criteria that we can use to handle growth stocks. But at the same time we should realise that investing in growth stocks is more risky because we lack data, and therefore it's more based on things that are harder to measure. So what I'm saying here is essentially the same valuation model does apply. It is however more challenging and more risky because we lack data.

1:05:33Okay, so what is available to us? We can look at high operating margin, that's really the key one that we always have. We can look at strong revenue growth. Now it has to be strong revenue growth because it's a growth company. Without strong revenue growth this is not a growth company, this is something you shouldn't look at. And my criteria for that is it must beat others in the sector, it must grow substantially faster than established companies, because if it doesn't it's never going to outgrow them, it's never going to reach those heights. So if you're looking at a software company that's growing at 8%, it calls itself a growth company, well Microsoft is doing 20 or whatever it is, so you're never going to catch up. You're going to have to grow at 40, 50, 60, 100% to be able to catch up.

1:06:26Third, low debt, because that tells you there is relatively modest risk here. You want cash, you actually want a cash position to survive a crash. When there is a crash, generally speaking capital markets close. So if you are a startup or a growth company and you haven't got much cash and you need to raise money on the market every year or every other year through issuing shares or bonds or convertible bonds, if the capital markets close for you for a year or two, can you survive? So look at their cash burn rate. Look at how much is their cash flow negative by, and for how many quarters, how many years can they survive.

1:07:16You also want a large target market. Lots of people always talk about total addressable market. And I would normally say the minimum here is 25x, better if it's 50 or even 100x. What do I mean by that? Say your growth company has a billion revenue. If the entire market out there for their service is $10 billion, then they're never going to get 100% of the market share. So say they get 50% of the market share before regulators run them out of the room, that would mean they could grow maximum from 1 to $5 billion, so maximum 5x. Not really what you're looking for. Now if the industry has a $100 billion potential revenue as a demand and you're only at $1 billion, you could quite easily grow 10 times, right. You get 10% market share, that's a feasible thing to do. So think about that.

1:08:19You want a strong clean brand. What do I mean by clean? No scandals, no skeletons, no pollution in the river, no poisoning of puppies or babies, or controversial, overly controversial people in management. No sex scandals, no bribery, nobody with their hands in the till, no insider selling when there shouldn't be. All that sort of stuff that we see in the news quite a bit, you don't want any of that, definitely not, because it affects it. Lots of people will just be like, no, I don't trust them. Because a lot of what you're seeing here is this is not so much about numbers but it's about how we feel about management and what's the perception of the company. So therefore clean brand, super, super important.

1:09:07You want tech leadership. I think every growth company nowadays is pretty much based on tech. You want to be a leader in your tech research. So high R&D spend links into that really. You want them to spend a lot in R&D to build a moat, obviously sensibly on R&D, not just throw it out the window. But that's what you want, you want them to actually create something that gives them down the road a serious moat. There are two other metrics that I like, that is that the CEO and or founder

1:09:45Are heavily invested. CEOs and founders are not always the same people, but they often are. Look at Tesla, look at Square, look at Spotify, MercadoLibre, AMD and many others where CEOs or founders are heavily invested and continue to be heavily invested. So that's again a metric you can look at, which is quite nice.

1:10:09Now the last one is a little bit more esoteric. You have to fully understand the business model. Are you able, ask yourself this, are you able to write down 3 reasons why this company is better than their competitors? And actually do that, actually write that down for each growth stock you buy. And don't just go, well, management's brilliant, or love their product, love their car or something. It has to go a little bit deeper than that.

1:10:35You have to really show it to somebody who is not necessarily of the same opinion as you or doesn't know much about it and have them question your 3 reasons. Because we sometimes get caught up in the excitement of something and we're so deep in there that we just have this bias towards our own views. So really come up with 3 factual reasons why this company is better than others. I'm going to add a little "factual" in here because it's not just, I think it's amazing, it's going to the moon. That doesn't quite do the trick for someone who doesn't know anything about it.

1:11:12So seriously show that stuff to somebody. Write these things out, and that's what I do for stocks is I write down why I like them, why I buy them, what the metrics are, what the numbers are. And then it removes that emotional bias. I read about it, I hear about it, it must be great.

1:11:34So I hope what you can therefore see is that investing in traditional profitable companies is much easier, just because you've got all the numbers, you got all of them, all the metrics. And if they're all great, fairly high chance you're onto a winner that's going to perform pretty well for you. I struggle to see how these stocks here with 20, 30% earnings growth every year, how the stock price is not going to go up by at least 30%, or I mean of that growth, so at least 10% plus. Be kind of weird if earnings grow 30% every year and the stock doesn't go up at least 10%. So that's the way I look at that, no guarantee, but that's the way I look at that.

1:12:20Whereas you're looking at all these numbers down here which are mostly negative and fairly useless. Therefore you are more relying on your understanding of the business and all the other things we were just looking at for growth stocks here.

1:12:33So what does that therefore mean in terms of how we put our portfolios together? We are continuously digging deeper into asset allocation. For me, I have the majority of my money in profitable stocks. You can see my core portfolio on here. Doesn't mean you should buy these, doesn't mean that these are the greatest companies in the world, but I pretty much think they are. There are some others that I don't have on. Apple for example isn't on here, Amazon isn't on here yet, although I bought some. And there are some others, but I also don't want to buy every stock there is under the moon.

1:13:09Because look at what's 90% of my portfolio, is 17 stocks. Keeps my life very easy. I only have to basically look at 17 stocks, and even that's a bit much. I only have to listen to those earnings calls and read about those and follow those, and I can forget pretty much everything else. So all the other stuff down here is almost irrelevant at this point, but still in there. It still gives me a little bit of diversification, which is why I do it.

1:13:43If you have taken my master stocks course, you also know my take on why I think these kind of stocks are more like performing like bonds. So that's also why I put more money into this. These numbers here, they update automatically from Google. If it gives you these NA numbers, just hit refresh. Sometimes it's a little Google error and then it fixes that usually. There we go, you see it's all back now.

1:14:08I've also put up here the data for these top 10, top 15 stocks or so, so you can see that as well. Although again Google is your friend, it'll give you everything for free. And I've also put on here automatically the 5-year, 3-year, 1-year and 1-big performance and a little chart, so you can see how they pan out. And mostly they've done really really quite well. I mean the ones with the best data, the ones with the best numbers have performed absolutely staggeringly over the years.

1:14:37There are also a couple in there. Well, Sabre is pretty much the only one that has underperformed, but generally speaking they've all been pretty good. Philip Morris for example, there's an odd one in here. It's only done 8.5% but it's gone up 20% last year. It also pays quite a nice dividend on top, so that wouldn't show up in this number here.

1:14:56So I think this is quite a lot to absorb. So maybe step away for a little bit, have a cup of tea and then run through some of these numbers again, run through the evaluation methods again, make sure that it makes sense to you. And if you have questions, likely you do, go and ask on the Discord community. You can ask me, you can ask the community, we can have a chat about it.

1:15:20And what I would do then is start looking at what you have in your portfolio and start writing down these metrics. Make a spreadsheet or a piece of paper, however you like to do it. And you can then put out these numbers like I've done here, for example for NVIDIA, that's another example. And you can see how I have scored them down here. You don't have to follow my system entirely, you can of course adjust it, but you can see how I've given them scores out of the maximum score here. And then overall I came up with a total.

1:15:51And I like doing it because it takes a lot of the emotion out of it, it takes a lot of the noise from our research out of it, and we just go back down to facts. And then we think about the moat, and then we think about the wider business. But it for me works very very well. It's been a very successful system that a lot of investors I believe follow in one shape or another, not obviously exactly my metrics here, but these are the key things that people who are long-term investing are really looking for.

1:16:25And I think long-term investing is by far the lowest risk and highest return strategy that we can all come up with. So do some homework, check through some of your stocks and your portfolio. Eventually hopefully you'll do all of your portfolio, look at all of the stocks, and you might then also start to see why some are performing better than others.

1:16:48My aim in this lecture is to teach you to love volatility. Sounds strange, right? Why would you love the ups and downs? Does it not imply that you're loving crashes? Yes it does indeed, and I will teach you why. I'm not a masochist, I don't love pain or downside or worry. But when I first started investing, when the market went down 10%, 20% or something, I was really worried about it. I was checking my portfolio every 3 seconds and it worried me, and I was thinking should I sell, like whatever, goes down further.

1:17:23And those are thoughts that most, I would say, novice investors have. And it's a wonderful opportunity and I'll show you why now.

1:17:37What measures volatility? The thing that measures volatility is VIX. VIX measures the S&P 500 volatility of next 30 days, and helpfully it's annualised. I don't know why they do that. I think they do that to just confuse and obfuscate, which is often what the financial industry does.

1:18:23So what does that mean? Well, say you get a VIX number, say VIX is 20. You then got to divide that by 12 months. I mean approximately, we're not too worried about some months having 30, some months having 31 days here. And that then tells you the following. So 20 divided by 12 is 1.67% volatility in next 30 days is expected.

1:19:04This is a very important metric that all traders look at, all financial money managers look at, and certainly options traders live by. But we're not in an options course here, so we don't need to go into it too deeply, but you need to be aware of it.

1:19:22There is also the equivalent for the NASDAQ and it's called VXN. It's basically the same for NASDAQ. And if you are investing largely in stocks that are NASDAQ listed, you're probably better off looking at VXN. If you're buying Microsoft, PayPal, Facebook or Meta or whatever it's called now, Visa, etc., then you're looking more at S&P 500. Most people look at the VIX, very few people actually look at VXN, but it's important to understand the difference because volatility is different in growth stocks. It tends to be a little higher.

1:20:02Now excuse me, why are you going to learn to love this? Very simple. When volatility spikes, and it's the orange chart on here, is volatility, when it spikes people get freaked out, people get worried about it, people sell their assets, people sell their stocks, and therefore they lower prices. Once you've gone through this a few times, or hopefully once you've taken

1:20:31A course where somebody explained it to you quite as eloquently as I am, then you know what's coming. After the spike, after it spikes, it inevitably comes back down. So look at 2008, the massive housing crash in the US. Volatility went up, it went down, and what did the stock market do? Well, it went down and then it went up.

1:20:56I tried to change colours here, I was a little too premature there. So the blue here is my exaggeration of the stock market. You can see in blue the line is the stock market. So the stock market typically moves in the opposite direction of volatility, and therefore when volatility rises the market tends to fall. The greatest buying opportunities are exactly those moments.

1:21:27Now the human psychology is a funny thing, and when the volatility shoots up and our portfolio goes down to 30% and we've got a little bit of cash, most people end up selling stuff because they're worried it's going to go lower. What I want to show you and what I want you as a homework to do is go find a 90-year stock chart with all the crashes and look what happened. Inevitably it's gone back up.

1:21:57So 2002 was a bit of a crash, right? Look at the stock market, went back up. 2008 was a massive one, well we went back up. We had a few more wobbles in 2015, we're going to ignore those because they all look too small. 2018 we had a little bit of a wobble, then 2020 Covid, more than a wobble. But each time, even though the orange line, the volatility, shot up, the market in blue or now in green as I'm highlighting it went down, we inevitably rallied back above it. And I don't think that's going to change, and therefore when the volatility shoots up I start to buy.

1:22:44Now one more challenge. Most people want to time the bottom of the market. So let's look at the 2018 crash because it was such a beauty, it was a real real crash here. Although now, well I've flattened it now haven't I, but you get the idea.

1:23:08Most people want to only buy from the bottom onwards on the way up. Doesn't matter hugely though, because if you bought stocks say here and then maybe a little bit again here and a little bit again here and a little bit again there, because you're buying every month and that's what we've been discussing, going to get into more of that. You will, as you buy through the trough of this market, yeah you're going to buy things and they might still go down some more, but then at some point you're going to buy things and they're going to start going up.

1:23:43And you know that you have a long-term horizon. You know that you have 5, 10 years plus ahead of you investing. Therefore you just don't care. Now if you know that you need to pay for that great big thing in 3 weeks' time, different story. Don't buy the dip. In fact you need to, well we're going to look at what kind of portfolio would be suitable for that situation later down the line, but not a pure stock portfolio because it's going to give you too much volatility.

1:24:14But essentially any stock chart worth its salt, and I'm going to turn off the VIX here for a moment and all my scribbles, this is the S&P 500 since 1993, which is as far back as this chart goes. And you can see massive volatility, but if you simply keep buying every single month come what may, then your performance would look something like this. Unhelpfully blue line here, like this green line here, because that's what happens because you average things out.

1:24:52So simply by buying continuously and by knowing that the end isn't near, the world isn't going to end and it'll all work out in the end, you are going to get very very good returns. You average it out. The problem is most people buy only up here, stop buying when it falls because they're scared, they miss the rally back up, they buy again on the way up here because everyone's excited in the news. They don't buy in the crash because they're scared of it, they then wait a year for the crash to be over, to be back to where they started, and then they start buying again.

1:25:30So what have they done and what does their portfolio performance look like? Well, it looks basically like that. And what they have done is their cost basis is much much higher and their percentage gains are way way smaller, because they're starting here at a higher point. So they are starting at this point here. I'm going to make that red so it matches the line.

1:26:09Whereas the people who are buying the average come what may and they are able to look beyond the noise and the madness, they make about 230%. The guys who only buy when it's hot, when everyone's excited about the stock market, they make about 100%. So they're missing out on about half of the returns. So don't be the red guy, be the green guy. Sorry, the other way around. Yes, okay.

1:26:48Let me make this really clear. I'm going to change the highlights that are red here as well. So the red strategy is the strategy that 99% of retail investors follow. Buy only the peaks, they never buy the troughs, they never buy in a falling market, and they lose. They lose big time. They lose about at least half of the potential returns, so they will never get the real benefit of the market.

1:27:20And if that's you, then if you cannot re-educate yourself by looking at stock charts and going okay, it's always gone up, it's always gone down and then it goes up again, it goes down and it goes up again. And next time it crashes 10, 20, 30, 40, 50% you shrug your shoulders and go, you know what, it's great. I can buy those marvellous assets I'm invested in at a lower price and I'm doing that. And if I'm buying them and they go down another 10% I just don't care, because I know in a year's time, in 2 years' time, in 3 years' time I will have made a very nice return. I will have lowered the average cost of everything that I'm buying and therefore I'm a winner and I love crashes.

1:28:01So if that's you, if you are able to do that, brilliant. And you're like me and you're going to enjoy every time the market dips, you have a smile on your face that morning. If you are a little bit more of a nervous disposition, and there's nothing wrong with that, just the way some people are wired, nothing wrong with that at all, you may wish to look at automated investing. We'll touch upon that a little bit more as well, which basically means you set up with a trading platform that forcefully invests every week $100 or every month $1,000 or whatever it is. And it just takes it out of your account and just keeps buying a preset number of stocks or an ETF or something like that.

1:28:40And that way it's out of your hands and hopefully you will be able to stop yourself from stopping that automated buying. And you'll go back to this lesson and you'll listen to it on repeat and you look at the charts and you go, it's always been all right, it's always been all right, just don't do anything, don't do anything, don't do anything. So that's a little bit easier than actively buying in a falling market. So those are the two strategies here.

1:29:06I personally genuinely love volatility. I also wanted to show you the QQQ volatility here. So in orange again we've got volatility down here and in blue we've got QQQ. Now QQQ has performed twice as well as the S&P 500 just because we've been living in this tech boom since 2000 or so. And therefore volatility seems almost inconsequential, but there are still these crashes like 2008 in here, it's just that they're so small now nobody sees them.

1:29:38Let me pull up another one here. So this is March 2020, the Covid crash that scared everybody, and then here is 2022. So the crashes were still there but they're inconsequential in the long run. And if you buy when it falls, if you buy when it's lower, it's just better in the long run. It basically gives you an opportunity to make a lot more money than everybody else, because everybody else out there doesn't have the constitution for it.

1:30:07They sell when the market falls, otherwise it wouldn't be falling, right? The market goes down 10%, why does it go down another 10 or 20% after that? Because everyone gets scared and everybody sells. And therefore if you understand that and you do the opposite and you buy and you keep buying into that market, you are picking those things up 20, 30% cheaper than say a month ago. Why wouldn't you buy the same asset 30% cheaper?

1:30:37Say if you really wanted to buy that house next door, your dream home, and it's say $100,000 and you were thinking about it, you're thinking about it, you're just signing the paperwork, and then the housing market crashes and it goes to $60,000. Would you still buy it for $60,000? The seller now came to you and said I'm sorry but I'm only going to take $60,000 for it, I don't want your $100,000. Yes, of course you'd still buy it.

1:31:08So this is the same situation, and really the best thing to do is just look at some of these historical charts. And you can go back, I know I'm going back 20 years here, you can go back 100 years. It's always the same situation, same situation with pretty much every single asset class ever. Therefore love volatility, it's your

1:31:26Friend, it essentially is like walking around with a great big coupon. It's like everything being on sale. That's the way I look at it, so enjoy the sale. And look at some charts, that's my homework for you. Look at some charts going back as long as you can for stocks, for indices. Maybe look at your portfolio and type them all in and then look at the chart going backwards. The app I'm using here is TradingView, but there are plenty of others. Yahoo Finance or anything like that will also do the trick.