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Index
Cover
Series Page
Title Page
Copyright
Dedication
Preface
Acknowledgments
Rawley Thomas
Bill Mahoney
Section One: The LCRT Investment Process
Chapter 1: Introducing Our Investment Process
Key Takeaways
Chapter 2: A Better Way to Invest in Stocks
Put the Focus in the Right Place: On a Company's Fundamental Value
We Bring You an Improved Methodology
Basing Decisions on Under- and Overvaluation by the Market
The Key: Recognizing the Inflection Points
Looking at Our Model
Key Takeaways
Chapter 3: Advantages of Economic, Cash-Based Modeling
Key Takeaway
Chapter 4: Analyzing Mental Models
Key Takeaways
Chapter 5: The Value Creation Process
Cost of Capital and Company Return on Capital
The Importance of Adjusting for Inflation
Where We Are Going
Key Takeaways
Chapter 6: The Corporate Perspective
The Focus for Both Constituencies: Value Creation
Earnings Are the Wrong Measure
Executive Compensation
Creating an Information Advantage
Key Takeaways
Section Two: A Brief History of Investing and Modeling
Chapter 7: Relevant Market History of Investing
Start with Concepts of Risk and Uncertainty
Migrate toward Value and Market Inefficiency
Enter Modern Portfolio Theory
An Emphasis on Earnings, Plus
Leading to Multifactor Modeling
Finding the Right Factors
Dissecting a Multifactor Model
Key Takeaways
Chapter 8: Interpreting Market History
Market is Dealing with Price Change, Not Price Level
Bringing History Up to Now
Back to Earnings: Why They Still Prevail
Key Takeaways
Section Three: Brief Discussions of Various Investing Methods
Chapter 9: Do Stocks Have Intrinsic Value?
Basing Investment Decision on Intrinsic Value
Value Assets on Economic Basis
Estimating Intrinsic Value through a DCF Model
Key Takeaways
Chapter 10: The Pros and Cons of Various Methods and Models
Why Price Level Matters
Why Use Analysts' Traditional Cash Flow Forecasts. Why Not.
Why Use Dividends to Value Stocks. Why Not.
Why Use the Simplest Model, EBITDA. Why Not.
Why Use Earnings. Why Not.
Why Use Price Level from Regression Analysis. Why Not.
Why Use Net Free Cash Flow. Why Not.
Why Use Residual Income or EVA.® Why Not.
Why Use Cash Flow ROI, CFROI,® Economic Cash Margin, or Cash Economic Return. Why Not.
Chapter 11: Suppose You Love Your Current DCF Model
Dividend Discount Models
EVA® or Residual Income Models
CFROI® or Cash Economic Return Models
Regression Models of Price Level
Multifactor Models
Section Four: Explaining LCRT's Conceptual Framework in Detail
Chapter 12: Our Approach
Differences between Intrinsic Value and Market Value Approaches
Explaining Value
Attacking the Old Ways
Modeling on Economic Fundamentals, Not Accounting Mumbo-Jumbo
The Intricacies of the Price Formation Process
The Foundation is Intrinsic Value
We're Fighting Standard Practices, but We Can Win
Key Takeaways
Chapter 13: Focusing on Price Formation
Be Proactive, Not Reactive
Building a Price Formation Process
Oh-Oh: We're Preaching Again
Key Takeaways
Chapter 14: Our Automated DCF Model—The Better Model
Four Primary Measurement Principles to Evaluate a Model
Key Takeaways
Chapter 15: Getting to Know Our LCRT Model
Adjustments to Improve DCF Modeling
Economic Output and Life of Each Asset
Capitalize Cash Flows
Understanding Abnormal Accruals
Cash Flows Fade: Down and Up
Looking at the Discount Rate
Summarizing the Model of Choice
The Next Generation Will Be Even Better
Key Takeaways
Chapter 16: Digging Deeper into the LCRT Model
Exponential Fading of both Cash Economic Return and Growth Rate
Certainty-Equivalent Value and the Use of the Area under a Curve
Dealing with Debt Leverage
Looking at the Discount Rate Again
Inflation Adjustments Revisited
Importance of Accuracy
Calculating Bounded Rationality (Rawley Ranges6)
Market Sentiment and Micro and Macro Economic Drivers
Improving the Model with Your Insights and Analyst Forecasting
Key Takeaways
Chapter 17: Putting Our Valuation Proposition into Perspective
Section Five: How to Make Investment Decisions with ValuFocus
Chapter 18: ValuFocus—The Key Tool for Investing in Stocks
The Components of ValuFocus
The Relative Wealth Chart: Cash Economic Return, Growth, and Stock Performance
Rawley Ranges of Bounded Rationality
EPS and Sales Overrides
Analyzing Hewlett-Packard
Determining the Accuracy of the Value Calculations
Using the Value Chart
Earnings Results Can Be Misleading
The Market Often is Slow to React to Value Improvements by Management
Picking the Right Model Version
Contrasting Hewlett-Packard with Coca-Cola
Neither Coke nor Pepsi
Incorporating Revenue and EPS Forecasts
Basic Purpose: Predict Future Stock Price
Taking Advantage of the Flexibility of ValuFocus
The Importance of Fade Rates to Intrinsic Valuation
Continuing Debate: Determining the Right Discount Rate Created from Long-Term Growth Rates
Key Takeaways
Chapter 19: Managing Your Stock Portfolio
Ways to Weight Stocks in Your Portfolio
Risk and Concentration
Rebalancing Your Portfolio
Key Takeaways
Chapter 20: Advanced Portfolio Concepts
Selecting Stocks
Portfolio Weighting
Achieving Low Risk–High Return Trading around a Core Portfolio
Shorting Stocks Based on Value
Cash Generator
Key Takeaways
Chapter 21: What If You Don't Want to Employ ValuFocus
Chapter 22: Always Going Forward
Key Takeaways
Chapter 23: It Is Time to Get Started
Section Six: Advanced Topics for Practicing Professionals
Chapter 24: Security Analysis and Modeling
Empirically Test Terminal Valuation Model against History
Benefits and Rewards
Analyst Dashboard
Financial Modelers and Ideas for Future Practitioner Research
Key Takeaways
Chapter 25: Wealth Management
Key Takeaway
Chapter 26: Portfolio Construction
New Theory
Begin with Under- and Overvaluation, Then Diversify
Weighting Schemes
Rebalancing Your Portfolio
Benefits of Concentration
Key Takeaway
Section Seven: Advanced Topics for Academics
Chapter 27: Another Tour through Our LCRT Model
Description of the LCRT Model
Constructing the Model
Basic Components of the Model
Dealing with the Many Assumptions
The Best of Both: Explaining Our Fade Process in a Single-Period Method
Fade and Model Accuracy
Starting with a Baseline Model
Importance of Understanding Economic Comparables
The Difference between Net Free Cash Flow versus Cash Economic Return
Comparing Conventional and LCRT Models
Validating the Model: The Proof is in the Comparison
Calculation of Tracking Errors
Focusing on Cash Economic Return
Calculating and Delving into Cash Economic Return
Understanding the Growth Rate
Arriving at the Discount Rate for a Third Time
Summing Up
Key Takeaways
Chapter 28: Incorporating Risk into Our Model
Incorporating Risk and Fade into Our LCRT Model
How Risk Modeling for Stock Selection Has Evolved
Managing Risk in Our LCRT Modeling
Looking at Technical Analysis and Ranges of Bounded Rationality Again
Measuring the Extent of Over- and Undervaluation
Modeling the Dispersion of Stock Price
Applying Risk in Our Model
Key Takeaways
Chapter 29: Producing Lower Fat-Tailed Risk with Higher Returns
Alternatives to Stable Paretian Distributions
Comparison of Traditional Gaussian Measures with Stable Paretian
Key Takeaways
Chapter 30: Comparing Our Model against Three Popular DDMs
Evaluating the Three DDMs
Testing the Models for Robustness and Accuracy
Robustness, Accuracy, Nonbias Enhance Predictability
Removing Bias Caused by a Certain Parameter
Portfolio Results for Three ROPE Model Specifications
Using Our Sophisticated Free Cash Flow Process
Key Takeaways
Chapter 31: Suggestions for Additional Academic Research
Epilogue—Key Takeaways
About the Authors
Rawley Thomas
William F. Mahoney
Index
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