1. There is no established pattern between GDP growth, S&P500 EPS growth, Inflation and bull/range-bound markets.  

2. Nominal growth excludes inflation. Real growth includes inflation

3. Corporate earnings do not grow at a faster pace than GDP

4. 1981 - 2006 average profit margin for corporate America was 8.8% <- not sure how true that is since the following graph shows a different result

5. Something else Vitaly claims does not correlate is interest rates and bull markets. He claims that interest rates going up or down do not trigger bull or sideways markets which I would argue is not correct. Almost every US recession was triggered just before or right after the FED started lowering interest rates as seen on the "Historical FED Interest Rage" graph.

6. Everybody has some sort of a bias, you just need to discover it. CEOs with billions of network worth into real estate blind to housing bubble, hedge fund managers with portfolios full of tech stocks blind to absurdly high P/E ratios, even ones parents who prefer to use their holiday allowance for a nice trip away in stead of to spending time with their grand daughter at home. Just be sceptical ...

   • We are more inclined to believe a person with more authority(the company's CEO) in stead of someone with a lower rank(car salesman).

7. Poor quality management is a slave of short term Wall Street expectations. Great management focuses on investments that will bring the most value to its shareholders.

8. Less indebted companies are more attractive targets for acquisition as the acquirer (even when pays a premium on top of the price of the company) can leverage its balance sheet which will in turn somewhat pay for the acquisition - borrow money against the company at a lower interest rate due to the higher credit rating of acquired company.

9. Companies with recurring revenues grow a a lot easier compared to companies whose revenues come from long lasting products. Take Ford and Spotify. People buy cars with lifespan of decades. Spotify subscribers pay for subscriptions with a lifespan of ~30 days and then renew it. If Ford wants to up revenues by 10% they need to find 110% more customers since people who bought a car from them last year are not going to buy a car from them this year. If Spotify would like to increase their sales by 10% they need for find 10% more customers since their recurring revenue will stick for next year.

10. Regardless weather you are using 1-year, 3-year, 5-year or 10-year trailing P/E averages, markets always revert back to the median ratio over the long run. The average P/E ration of the S&P 500 over the last 100+ years is ~15. We are currently at 29.6 as of July 2024

11. Buying at lower P/Es leads to higher returns - no surprise there

12. In bear markets most stock returns are from dividends

13. Dividend payout % indicates in what marked we live currently. Average over the last 120 years is 58%. Currently the S&P 500 dividend payout is near all time lows at ~37% which suggests we are in a bull market 

14. Average 20th century US GDP growth 3.5% so earnings are lower. US inflation for the 20th century also averaged ~3%

15. Treasury bills (short term bonds) and bonds 100% do not outperform stocks in bull markets and struggle to keep up with stocks in rangebound markets. Key is to pick the right asset and allocate your capital according to current market conditions.

16. Strong brands do not always equal pricing power. Especially in the retail business. Competition is fierce and customers will sometimes prefer cheaper products of similar quality.

17. "Indigestion is more lethal than starvation" - David Packerd, founder of HP, on mergers and acquisitions

    • Joint ventures should be considered first before diving into the deep and potentially deadly waters of M&A

18. With some companies FCF is rather volatile so what is a better way of looking at it is by average the operating cash flow over a set period of time and then subtract the average CAPEX of the same period of time.

    • Depreciation is a good proxy for CAPEX

      1. High-growth companies have CAPEX exceed depreciation

      2. Approaching maturity companies have CAPEX nearing depreciation

      3. Mature companies have higher depreciation and lower CAPEX

19. Over the 100 years

    • Average GDP growth 3.5%

    • Average inflation 3%

    • Average earnings growth - 5%

    • Average dividend yield - 4%

    • Average P/E - 15

Margin of Safety Model

Margin of Safety model is a way to cushion ourselves if our assumptions( aka inputs) are a bit off target or if the irrational(according to us) market kills the price of our stock for no obvious(again, according to us) reason.

Vitaliy offered a formula here but I do not find it very useful at all.

Required Margin of Safety = ( Required Annual Rate of Return - Expected EPS Growth - Dividend Growth ) x Years to Fair Value

Required Annual Rate of Return can be anything you deem reasonable under the current market conditions. 15% 30%

Putting the concept of QVG (Quality, Value, Growth) together

• Quality - balance sheet, earnings visibility, management, moat

• Growth - dividend and earnings growth

• Valuation - acceptable price with a built-in margin of safety

Not one of those is more important than the others. 

One out of three is not enough as the company becomes too risky. 

Two out of two is also not enough even though risk is significantly reduced.

• Growth and Quality but no Valuation - enter the religious stocks whose investors ignore all rational thinking and take a leap of faith which inflates the price of companies with consistent and appealing past performance (COKE, GE, Wal-Mart, Kodak, Xerox). Those high quality companies with built-in growth perspective can also be significantly overvalued when they hold a position in the Temple of Religious Stocks with a single rating - Buy. It is not a matter of if they will revert back to average market valuations but when.

• Quality and Valuation but no Growth - Vitaliy argues that this is only acceptable if the Margin of Safety is high enough (aka expected Annual Rate of Return is higher). Also, it is important to look out for and analyse possible catalysts that could boost the stock price.

• Valuation and Growth but no Quality - The most dangerous of all three. If a company's rate of invested capital is higher that the return on it then its like buying a money burning machine. Sometimes, this issue can be fixed by increasing scale of operations but this can me a slippery and unpredictable slope. Vitaliy argues that companies with no quality can offset the risk of low quality associated with them by lowering interest-bearing dept and increasing the cash position on their balance sheet.

Risk

Risk can be defined in a number of different ways. Warren Buffet would say that risk is permanent loss of capital. Others would compared to volatility or a stock price declining beyond our expectations. I would say that risk is the statistical chance of events turning out to be worse than our initial predictions.

Randomness can also be compared to risk. Vitaliy brings up a very interesting and important point. Randomness is not absolute and to one person it can bring on more risk and to another it can bring less risk. "The effect of randomness decreases with the knowledge we obtain and not in a linear fashion." I find this incredibly insightful. As we have more knowledge in a certain area our awareness all the possible outcomes of an event grows exponentially. For example, if you would put me in an operating theatre and asked me to perform open heart surgery on a patient chances of complications are much greater compared to when the surgery is carried out by an experienced surgeon.

Hindsight

"The ability to understand the nature of an event after it happened."

It brings a number of dangers we need to be aware of:

1. It makes us think that there was a single reason an event occured. We do not pay attention to the bigger picture and omit the part randomness played in bringing the event to fruition. 

2. It kills most peoples' sense of curiosity. Curiosity as to what would have happened if prior events have taken a different route.

Diversification

Because randomness plays a an important but hidden role in everyone investing game it is important to come to terms with the fact that sometimes, even though your analysis is immaculate, your predictions based on solid data and your margin of safety bigger than very conservative your investment will get decimated by randomness. This is why diversification proves to somewhat cure the negative effects of randomness.