The Five Rules for Successful Stock Investing

Recently I read a book named The Five Rules for Successful Stock Investing which was written by Morningstar's Director of Stock Analysis, Pat Dorsey; it covering a wide range of stock research and investment strategies. This comprehensive guide can helping any serious investors on their right track to pick the right stocks, find great companies without paying too much for their investment. I summarized some important topics and investment strategies here:

Five rules recommend by Morningstar:
1. Do your homework
2. Find economic moats
3. Have a margin of safety
4. Hold for the long haul
5. Know when to sell

4 steps to analyze a company's economic moat:
1. Evaluate the firm's historical profitability.
2. If the firm has solid return on capital and consistent profitability, assess the source of the firm's profit.
3. Estimate how long a firm will be able to hold off competitors, which is the company's competitive advantage period.
4. Analyze the industry's competitive structure.

5 ways that an individual firm can build sustainable competitive advantages:
1. Creating real product differentiation through superior technology or features.
2. Creating perceived product differentiation through a trusted brand or reputation.
3. Driving cost down and offering a similar product or service at a lower price.
4. Locking in customer by creating high switching costs.
5. Locking out competitors by creating high barriers to entry of high barriers to success.

The 4 sources of growth:
1. Selling more goods or services
2. Raising prices
3. Selling new goods or services
4. Buying another company

Some Red Flags and Pitfalls to watch out for:
1. Decline cash flow
2. Serial chargers - be wary of firms that take frequent one-time charges and write-downs.
3. Earning growth outstrips sales growth over a long period, this might be a sign of manufactured growth.
4. The CFO or Auditors leave the company.
5.A/R are increasing much faster than sales growth.
6. Gains from investments
7. Overstuffed warehouse - inventories rise faster than sales.
8 Change is bad - for example like depreciation expenses.
9. To Expense or Not to Expenses - costs such as marketing and some kind of development can be treated either way.

5 Steps to calculate a firm's intrinsic value:
Step 1: Forecast free cash flow (FCF) for the next 10 years
Step 2: Discount these FCFs to reflect the present value
Step 3: Calculate the perpetuity value and discount to the present value
Step 4: Calculate total equity value = 10 yrs FCFs + Perpetuity value
Step 5: Calculate per share value = Total Equity Value / Total share outstanding