DK Equities Research

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Investment Terminology

Independent stock research
	Primary research far removed from Wall Street. No investment banking activities, just pithy and timely progress reports/updates for institutions seeking a different opinion from a research boutique (DK Equities Research) led by a seasoned chartered financial analyst (CFA).

Franchise stocks
	Stocks (businesses) endowed with earmarks of sustainable differentiation. Such stocks bestow on shareholders above average “all-weather” earnings power, implying reduced risk and greater upside potential assuming price-sensitive purchase. DK Equities Research features such shares.

Sustainable differentiation
	Determined by factors such as lowest unit cost structure, pricing power, leading market share, top-notch distribution assets, first-rate brand equity, large client lists, material patent portfolio, etc. DK Equities Research features stocks possessing sustainable differentiation characteristics.

Asset-light
	The best businesses tend to be "asset light" or non-capital intensive. "Hot dog stand" economics usually trumps traditional airline, steel, and even semiconductor economics. DK Equities Research features a strong representation of such shares.

Return on Investment (ROI)
	This is largely determined by how much one needs to invest in the first place (please see enterprise value below) yet so frequently “forgotten” by investors to their own detriment! Invest $10 to earn $1, that's a good 10% return; invest $100 to earn $1, that's a bad 1% return with typically poor return on capital -- much less return of capital -- odds. Return on investment is measured in normalized net income terms checked for earnings quality (accounting conservatism and free cash flow). Footnote: the same logic obviously applies to stocks and P/Es, which if inverted (E/P) result in an ROI equivalent. DK Equities Research employs such analysis.

High ROI
	Tends to dovetail with asset-light businesses and free cash flow. It means good or at least benign management can pay us out a good chunk of our earnings -- or buy in stock to shrink the base and thus leverage EPS -- instead of plowing income and then some (such as taking on debt or issuing more shares) into excessive capital outlays or empire building. DK Equities Research seeks out high ROI vehicles.

Free cash flow
	Equates to value creation and is determined by taking cash flow from operations less capital spending and dividends paid. Free cash flow (FCF) is a surrogate/reality check for earnings and is closely related to Warren Buffett's "look through earnings" concept. FCF helps determine earnings quality and "cash equivalent" earnings even as it limits dilution risk thanks to the associated availability of internally generated financing. FCF helps slice through so-called “accrual accounting” and generally disregards external interest-bearing financing to “tell” shareholders whether their company had more cash in the till a year later. DK Equities Research typically features shares generating material free cash flow.

Sustainable free cash flow
	When bought at the right price, suggests good "what can be eaten" returns over time relative to bond yields; it also reins-in one bane of investors, dilution risk. DK Equities Research actively seeks out shares that have sustainable free cash flow earmarks.

Investors' "pilot checklist"
	Sustainable and material differentiation and attributes (as in free cash flow and high ROI) coupled with price sensitivity are key investment considerations for DK Equities Research as concerns its research universe.

Bottom-up style
	Stock selection, as practiced by DK Equities Research, which originates at the company level instead of at the macroeconomic level (top-down). Why bottom-up stock selection? Because difficult-to-call business cycles will come and go; key is whether we’ve chosen the right partner at the right price for the "hilly trip" ahead that will allow us good odds of realizing favorable long-term growth in our investment.

Stable share count
	This means shareholders’ pro rata income doesn't get diluted so DK Equities Research clients can share “their stake” with the party of their choice instead of management having yet “another party” at shareholders' expense. Worthy of mention: free cash flow is a key determinant in achieving stable-to-declining share counts over time.

Taking cue
	Investors should take their cue not foremost from near-term stock price fluctuations concerning existing positions, but from how earnings and associated free cash flow are evolving over time, a discipline practiced by DK Equities Research on behalf of its clients.

Value creation
	Free cash flow relative to invested assets and/or an increase in the market value of a given firm's "investment activity" (cap ex, brand marketing, distinguishable R&D) on behalf of shareholders. This is how DK Equities Research defines value creation for its clients.

Intrinsic worth
	Estimate of "fair value" for franchise stocks derived by making NPV calculations and adjusting them for net debt balances as well as projected share base dilution. Noteworthy: such estimates, as calculated by DK Equities Research so as to calibrate buy/hold/sell codings for its clients, can only be made with companies featuring earmarks of sustainable differentiation, i.e., franchise stocks.

NPV
	NPV for franchise stocks is obtained by DK Equities Research by discounting projected free cash flow-supported earnings to current value using risk-adjusted interest rates (usually 30-year treasury yields plus 500 BPs of risk premium).

Enterprise value
	How much a firm costs in the market when combining the value of its publicly traded stock with its net-of-cash debt after capitalizing off-balance sheet liabilities with de facto debt attributes. This is analogous to purchasing a home where the cost isn't determined exclusively by the down payment but also by the size of the mortgage (if any) taken on. Only such “net debt adjusted” valuations are considered by DK Equities Research on behalf of clients.

Value stocks
	Equities selling, on an enterprise value basis, at a discount to estimated intrinsic worth and thus possessing a "margin of safety" for long-term holders. Such stocks are sought out and featured by DK Equities Research on behalf of subscribers.

Value investing
	Value stocks are sought out and featured by DK Equities Research on behalf of clients. Over the past five years ended 2004, the aggregate, equally-weighted DK Equities Research research universe has logged material and consistent (four of five years) S&P 500 Index outperformance, fully preserving and enhancing investors’ capital in the process assuming "like investment." Caveat: underperformance in 2004 "dented" this long-term outperformance a bit (please see "Research" tab for details). Having said that, we believe that the related underperformance is more related to the higher volatility footprint of our 15-stock research universe that we discuss in the "portfolio diversification" section than a trend reversal to the mean in the making. YTD performance in 2005 underpins this claim.

Margin of safety
	When enterprise value is below estimated intrinsic worth. Stocks with a 20% plus margin of safety are sought for initial buy recommendations by DK Equities Research on behalf of clients. Conversely, stocks where the enterprise value is above the estimated intrinsic worth have a negative margin of safety.

Discount to NPV
	Stocks with a margin of safety that hence constitute a buy signal for DK Equities Research on behalf of its clients. This stands in marked contrast to investment strategies such as momentum investing (the more expensive, the better!), sector rotation or other forms of market timing “divorced” from operating fundamentals.

Risk/return conundrum
	Risk and return are not always positively correlated as espoused by modern portfolio management theory. Therein, risk is equated to individual stock volatility, not with long-term loss of capital. Fact is, concerning investors with long-term time horizons, such as clients of DK Equities Research, often the opposite is true! Specifically, companies with franchises do experience share price declines for what frequently prove to be transient reasons. Moreover, the depressive side of “Mr. Market’s” ‘bipolar’ behavior characteristically pushes prices down to compelling enterprise valuation levels relative to estimated intrinsic value. As a result, uniquely positive risk/return profiles may result whereby risk is much reduced even as return prospects are magnified. (Mr. Market is a metaphor created by the intellectual father of value investing and the CFA program, Benjamin Graham.)

Capital preservation
	Please pardon us for mentioning the obvious "Keeping what you’ve got!" Say a stock is up 50%, then down 50%. Your clients will be at only 75% of original investment, and in need of a 33% gain to regain initial capital. And we both know how important capital preservation is to successfully funding pension plans even as preservation reduces investors’ need to reach for speculative returns as an “offset.” All said, capital preservation buttresses long-term portfolio return potential by allowing return compounding -- the "Eighth Wonder of the World" -- to “work,” over time, on the existing capital base (12% on $100 is $12; 12% on $75 is only $9) even as risk is reduced. Call it a virtuous circle! Capital preservation is “dialed in” to DK Equities Research by virtue of its value-based investment style.

Sell signal
	There is a price for everything. This is based on estimated intrinsic value being exceeded on enterprise value terms by a noteworthy margin on a sustained basis. DK Equities Research has, historically, selectively placed franchise shares on sell or “reduce stake,” and expects, driven by price targets being surpassed, to do so in the future. Separately, franchise erosion, such as the declining value of traditional television networks in a channel proliferation cable world, may also constitute a sell trigger.

Price sensitivity
	A golden rule for good long-term investing, much as in any other asset purchase, be it a house or a 100% stake in a business. Directly related to return on investment (ROI) or valuation attractiveness. Actively practiced by DK Equities Research on behalf of clients.

Contrarian investor
	All other things being equal, things tend to be most attractive when they are cheap (however unloved) and least attractive when they are expensive (loved). It is along these lines that contrarian investors place their bets. Contrarian investing, while unlikely to win any short-term popularity contests, is a powerful long-term investment style deployed by DK Equities Research with which to seek and follow favorable risk/return equity profiles on behalf of clients.

Buy/hold/sell recommendations
	DK Equities Research bases such recommendations on operating fundamentals and price, not on "head and shoulders" chart patterns, star gazing, horoscopes, tea leaves, etc. We rate our research universe franchise stocks BUY, HOLD or SELL. New stocks are added with a BUY coding only and trade at a discount (margin of safety concept) of at least 20% to our NPV estimates when brought. If stocks reach our NPV estimates, triggered either by rising share prices or re-assessment of NPVs, they are "downgraded" to HOLD. A HOLD coding implies that a stock's long-term performance should be in line with our estimate of free cash flow-supported EPS growth. Once stocks exceed our NPV estimate by 10% - 20%, we place them on SELL (conversely, sharp price declines in the midst of sustained value creation dynamics will trigger coding upgrades if applicable). Why "tolerate" a certain premium to estimated NPV before moving to a SELL coding? Because while everything has its price, shares regularly exhibit 20% or more annual price volatility. We will wait until our franchise stocks pierce that volatility to the upside before recommending sale of the same. (Addendum: worsening fundamentals/erosion of earmarks of sustainable differentiation can also trigger downgrades.)

Patience
	One of the greatest virtues of an investor when married to price sensitivity. Great businesses aren't built overnight; commensurately, investors shouldn't expect instant gratification in the stock market, and should thus be willing and able to commit funds to select stocks for at least a three-to-five year period. Over time and assuming a fair purchase price, Company XYZ’s stock market returns should mirror the same concern's value creation adjusted for potential dilution. The DK Equities Research staff pays homage to such patience even as it remembers that all things have their price.

Value will out
	Over time, value, as created by sustained free cash flow or building asset values, is recognized. At times value recognition can take a year or more in capital markets, presenting investors with an attractive investment and re-investment window within the desired constraints of a well-researched investment idea. DK Equities Research is a proponent of the “value will out” strategy on behalf of its subscribers. Plus, we welcome well-defined additional investment opportunities within our stock research universe for our clients even as we caution clients to also consider adequate portfolio diversification.

Portfolio diversification
	It is indeed valuable advice to NOT put all your eggs in one basket. The other extreme advice sometimes pontificated is that the above is okay as long as you “know” and “watch” that basket. Or, in the words of investor legend Warren Buffett, “diversification is protection against ignorance.” DK Equities Research’s stance is in between, although tilted towards materially less than market conform diversification advice. Specifically, we believe that a portfolio constructed from 10-20 carefully selected franchise stocks in differing industries offers sufficient equity-based investment diversification to clients even as it offers above average return potential. Caveat: quarterly investment results of clients will be more volatile on average than that of the S&P 500 Index, and some investors may not be able to “sleep well” with such a “volatility footprint.” Those investors are counseled to seek capital appreciation potential elsewhere. Meanwhile, DK Equities Research clients are kindly reminded NOT to be unduly concerned with the expected above-S&P 500 volatility of the DK Equities Research franchise stock research portfolio based on our consistent research efforts on the one hand and on “patience” and “value will out” considerations on the other.

Compressed break-outs
	Stocks tend to rocket up mainly within a six-week period each year; since neither you nor the DK Equities Research staff knows “which six weeks,” there is an obvious advantage to staying invested if valuation models suggest it to be appropriate.

Opportunity cost
	The interest rate, adjusted for the dividend yield, that investors forsake by remaining invested in stocks. When investors accept the opportunity cost, de facto they are convinced shares are trading below estimated intrinsic value; moreover, investors are betting that "value will out" market behavior shall ultimately bestow upon them favorable long-term annualized returns. DK Equities Research utilizes these assumptions on behalf of clients.

Low turnover
	DK Equities Research adheres to low turnover rates of franchise stock recommendations -- a buy-and-hold strategy with selective new-buy and sell signals -- as this is truly in keeping with multiple investment assumptions that, in aggregate fashion, suggest favorable long-term investor results and below-average long-term risk (loss of capital).

Long-duration vehicles
	How much a firm costs in the market when combining the value of its publicly traded stock with its net-of-cash debt after capitalizing off-balance sheet liabilities with de facto debt attributes. This is analogous to purchasing a home where the cost isn't determined exclusively by the down payment but also by the size of the mortgage (if any) taken on. Only such “net debt adjusted” valuations are considered by DK Equities Research on behalf of clients.

Itchy trigger fingers
	Participants that buy and sell stocks for the sake of trading excitement. Such behavior usually won't allow for good long-term results (better to buy cheap lottery tickets and take the hit up front!). In a related manner, DK Equities Research will probably lull insomniac traders to sleep, thereby possibly offering one quite redeeming value! On a more serious note: DK Equities Research is clearly aimed at institutional investors, not traders.

Common stock investors
	They are pro-rata business owners, not lottery cardholders. Owners wouldn't buy or sell their businesses based on stock chart patterns, as mentioned elsewhere, other than to look for cheap entry points and attractive sales junctures. Neither does DK Equities Research with its recommendations for its clients.

Parallel interests
	Stocks featuring managements which “build” businesses for the long pull as owner/operators are keenly sought by DK Equities Research on behalf of clients. Such enterprises frequently stand in marked contrast to numerous public companies. The latter category is often "run" by transient, slash-and-burn MBA-types with rubber-stamp boards beholden to management and to maximizing that constituency's monetary interest in place of “building” sustainable long-term value for shareholders.