The FALCON Method

A Proven System for Building Passive Income and

Wealth Through Stock Investing

David Solyomi

Copyright © 2017 by David Solyomi. All Rights Reserved.

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Disclaimer
Limit of Liability and Disclaimer of Warranty: While the publisher and
author have used their best efforts in preparing this book, they make no
representations or warranties with respect to the accuracy or completeness
of the contents of this book and specifically disclaim any implied
merchantability or fitness for a particular purpose. The advice and strategies
contained herein may not be suitable for your situation. You should consult
with a professional where appropriate. Neither the publisher nor author
shall be liable for any loss of profit or any other commercial damages,
including but not limited to special, incidental, consequential, or other
damages.
Table of Contents
Preface
The True Story Behind the FALCON Method
Why Stocks? (For The Long Run)
The Black Box
The Goal of the FALCON Method
Outlining the Process of the FALCON Method
A Select Group of Top-Quality Companies
Double-Dip Benefit: Buy Them on the Cheap!
Threshold Criteria: Should You Open Your Wallet at All?
Rank the Survivors
Final Round: Enter the Human
How Can the FALCON Method Help You?
The Price: How Much Can You Save?
How to Use the Newsletter Wisely
Recap: Dissecting the “Black Box Model”
About the Author
Endnotes
Why This Book?
If you are like me, you have probably run across several trading and
investment approaches that promised to make you rich but failed to live up
to those expectations. But within just a few pages, you’ll realize that this
book and the FALCON Method it describes are completely different and
can truly set you on the path to becoming a successful long-term investor
regardless of your current experience level. After years of learning from
hundreds of investment books and my own mistakes, I find myself wishing
I’d had the chance to read such a concise summary of all the important
aspects of investing wisely before I had set sail into money management.
No matter how you ended up here, this book will show you:
Why you absolutely must invest in stocks if you are aiming to
build wealth and a predictable passive income stream.
How you should reduce the universe of stocks from tens of
thousands of possibilities to a few hundred candidates that have
the characteristics that are proven to drive superior performance.
How to tell which of these top-quality stocks are available on the
cheap, thus offering a turbo-boost to your returns (AKA the
double-dip benefit).
What absolute threshold criteria you should set before putting
your money into any investment.
How to rank the stocks that seem to have it all: both top quality
and attractive valuation.
What other aspects to examine before committing your capital to
a promising investment candidate.
And last but not least: how to make the most of an investment
approach—the FALCON Method—that gives you a list of the
best stocks every month. Knowing the names of the Top10 stocks
is not everything, believe me!
Successful investing requires structured decision-making based on a
well-built process—and this is exactly what you will learn in this book.
In fact, you can get a glimpse of the FALCON Method flowchart after the
Foreword and see for yourself what steps it utilizes to achieve superior
performance. (In the following chapters, you will get to know all of them
one by one.)
I want to emphasize that I am the type of guy who is most definitely putting
his money where his mouth is, so I am managing my own investments
based on the approach covered in this book, following the exact same
process. In fact, I have built the FALCON Method from scratch—it took
years of gradual improvements and fine-tuning to reach the standard you
are about to learn here. As a wonderful side effect, I achieved financial
freedom along the way at the age of just 33, proving that this process really
works!
You can get to know my personal story in detail in the About the Author
chapter, which was confined to the end of the book. At this point, suffice it
to say that I’ve established and sold some companies, so I gathered plenty
of experience as both a corporate insider and an outside investor. I
completely agree with Warren Buffett that being a businessman does help
one to become a better investor and vice versa.
After surrendering all my executive roles, I became a full-time investor. I
wrote a best-selling book on dividend investing in Hungary, where I
live, and shared my knowledge in both personal and online training formats
while also taking up speaking engagements at financial conferences. I enjoy
what I am doing—investing is my passion and this will show through on the
following pages, where I have spiced up the useful content with a little bit
of humor to make your learning adventure fun and easy.
Don’t fear—investment doesn’t have to be daunting. You will surely be
able to grasp and use what I am about to share with you because I
packaged it into a simple and easy-to-digest format. I’m not the kind of
person who uses jargon just to showcase his financial education. And
because I’m already living off passive income, I am not even writing this
book with a definite financial motivation or in search of sales—instead, I
wrote it to help you start along the same path that made achieving my
childhood dreams possible. You don’t even need to become a full-time
investor like me—a few hours per month should be more than enough
to profit immensely from what you will learn here.
Let me walk you through all you should know to get outstanding results as
a long-term investor, using 100% honesty and a little bit of humor so that
we both enjoy the journey. And before we move on, as an extra guarantee
for your time invested, I am offering you my personal help when you start
out as an investor. Now you have plenty of reasons to read on!
Preface
What Makes a Good Company and a Good Investment?
The value of an investment is determined by the amount of cash it can pay
you, the timing and probability of these payments, and the prevailing risk-
free interest rate. If this sounds complex, it’s not, really: let me show you
how sensible investing can be simple and rewarding at the same time.
History shows us that stocks provide the best returns in the long run. Since
stocks are not lottery tickets but rather represent ownership stakes in real
companies, there are just two questions a successful investor must be able
to answer:
What makes a good company?
A firm that produces more cash than it consumes and only needs to retain a
fraction of this surplus cash to maintain the standard of its operations and its
competitiveness can be a promising candidate for investment. The key is
having this “no-strings-attached cash,” which can either serve as the source
of further growth or can be returned to the owners.
To understand the importance of this “no-strings-attached cash,” think about
a company that needs to invest all the cash it makes just to stay competitive
and be able to make the exact same amount of cash the next year—which,
of course, needs to be retained again just for the sake of survival. As an
owner of this company, your chances of receiving cash back from your
investment are very slim; this alone renders such a company an unattractive
target for investment.
The essence of a company’s operations can be grasped by following the
“no-strings-attached cash” it generates and the return it makes on the capital
employed. The company’s management must be capable of achieving a rate
of return on the company’s invested capital that is superior to what you
could get as a private investor. Otherwise, why keep your money in the
firm? This both sounds simple and is fairly straightforward to gauge, too.
So a good company produces tons of surplus cash and earns high rates of
return on its invested capital. It’s a great thing if the corporate operations
look splendid, but all that glitters is not gold. Making loads of cash is just
one part of the story—what the management does with this money is
equally important.
This is where capital allocation skills come into play. You want to be the
owner of a company that not only makes a huge amount of the attractive
“no-strings-attached cash” category, but uses it wisely as well…and treats
its shareholders fairly, too. Otherwise, it would be like printing cash in one
room just to burn it in another.

What makes a good investment?

As we’ve seen, a good company excels in the operations and capital
allocation dimensions. But these alone will not make it a good investment,
since the company will give you subpar returns if you overpay for the
shares. This is where the third key dimension, valuation, comes into play.
You need to buy stocks of quality companies when they are available on the
cheap—that’s the recipe for stock market success and wealth building. As
obvious as it sounds, this has been proven to work for centuries, as we will
soon see.

You either have a process or you are just gambling.

“When somebody calls, I can usually tell within two or three minutes
whether a deal is likely to happen or not. There are just half a dozen
filters, and it either makes through the filters or not.”
—Warren Buffett in a Bloomberg video interview, 2016
Identifying the quality stocks that are on sale can be easy if you have a
well-built process to help you. It is like having a machine with an input slot
and an output slot: 300 stocks go in and the 10 best come out. This is
exactly what the FALCON Method is doing, relying on the principles of
value investing, common sense, and quantitative discipline.
You can get a grasp of the underlying process by studying the flowchart in
the following chapter. However, to gain a really good understanding, you
should read the entire book. By the end, you will have become a better
investor. Then you have a choice: I can help you implement what you have
learned or you can continue your journey alone. No matter which route you
choose, you will benefit immensely from learning the all-round investment
approach of the FALCON Method.
Flowchart of the FALCON Method
The True Story Behind the FALCON
Method
Let me prepare you for the honesty you will encounter in this book with a
short story. Any marketing guy would advise against admitting the true
origin of the system’s name, but I will go with my gut and share the real
behind-the-scenes story.
Tons of fake origin stories could be fabricated, listing similarities between
the falcon and a good investor. Here are a few, just for pure entertainment:
 Nothing can hide from the eyes of the falcon. Wikipedia says: “As is
the case with many birds of prey, falcons have exceptional powers of
vision; the visual acuity of one species has been measured at 2.6
times that of a normal human.” How profitable could it be if an
investor noticed opportunities that others miss, while objectively
scanning the field of targets from the distance without any emotional
biases? But come on, this has nothing to do with the origin of the
name, however convincing it may sound!
 Falcons never hesitate; whenever they see a delicious bite, they go for
it. And fast! “Peregrine falcons have been recorded diving at speeds
of 200 miles per hour (320 km/h), making them the fastest-moving
creatures on Earth.” This was from Wikipedia again, as I hardly
know anything about falcons myself. Once again, this was absolutely
not the reason for picking the name FALCON Method.
 Falcons have exceptional hunting skills… Well, instead of elaborating
on this obvious parallelism, I feel it is time for my confession.
In 2016, I had a meeting with a person who was, in fact, a marketing guy.
He offered me his opinion about how I could reach a wider audience with
my best-selling Hungarian book on dividend investing and its related online
courses. At one point, he just stared at me and out of the blue, said: “You
should write your book and create your courses in English, but as there are
thousands of books on dividend investing on Amazon, you need a brand to
stand out from the crowd. I would call it the FALCON Method or
something like that.”
Well, my family name means “falcon” if translated to English, but I
honestly do not know how this idea came to him. As ridiculous as it
sounded, I simply ignored his comment. I created a short video course in
English, but of course didn’t brand it the “FALCON Method.” While that
course was available on popular e-learning platforms, I registered the
domain of my name (davidsolyomi.com) and started experimenting with
building a WordPress site without any specific purpose. I named one of the
menus “The FALCON Method” and created a dropdown menu with two
options: “FREE videos” and “FULL video training.” (This was the biggest
achievement of my site-building career.)
As I gained hundreds of students on the e-learning platforms and my
dividend investing course became a bestseller, strange emails started to flow
in. It seemed that after watching my videos, people were Googling my
name and found that the site was “under construction,” to put it mildly.
They started to contact me, asking questions about where the FALCON
Method mentioned on the site was available because they most definitely
wanted to purchase it.
I had a good laugh when reading the first such email. The second one made
me think a little bit, while the third one almost made me admit that the
marketing guy might be a true genius. (I would never, ever tell him that, so
I hope he is not reading this!) And as these emails continued, I strongly felt
that I should not hold the falcon captive any longer: I should let it fly if the
demand was that high.
This is the true reason for choosing the name FALCON Method for the
most all-round investment approach I am aware of and that you are about to
learn in the following pages. I hope you’ll enjoy this same kind of honesty
and a bit of humor throughout the book, because I believe it’ll make our
journey together more useful and fun.
Why Stocks? (For The Long Run)
“Investing is forgoing consumption now in order to have the ability to
consume more at a later date.”
—Warren Buffett, 2011
Before getting into the details of stock selection and showing you how my
system works, I want you to be 100% convinced that stocks are the absolute
best asset class to invest in if you are aiming to build wealth and generate
reliable income in the long term.
Having experienced violent swings in the stock market myself, I am sure
that understanding the investment concept you are about to employ and
being totally committed to following it is crucial; it will serve as the basis
of outstanding results. Without this part, you are likely to give up executing
the strategy at the worst possible moment, doing serious harm to your
financial future. So, let’s lay down those basics as quickly and effectively as
possible.
Warren Buffett, one of the world’s most successful investors, draws up three
major investment categories in his 2011 Letter to Shareholders:
“Investment possibilities are both many and varied. There are three major
categories, however, and it’s important to understand the characteristics of
each.
1. Investments that are denominated in a given currency include money-
market funds, bonds, mortgages, bank deposits, and other instruments.
Most of these currency-based investments are thought of as ‘safe.’ In truth,
they are among the most dangerous of assets. Over the past century, these
instruments have destroyed the purchasing power of investors in many
countries, even as the holders continued to receive timely payments of
interest and principal. This ugly result, moreover, will forever recur.
Governments determine the ultimate value of money, and systemic forces
will sometimes cause them to gravitate to policies that produce inflation.
Current rates, however, do not come close to offsetting the purchasing-
power risk that investors assume. Right now, bonds should come with a
warning label. Today, a wry comment that Wall Streeter Shelby Cullom
Davis made long ago seems apt: ‘Bonds promoted as offering risk-free
returns are now priced to deliver return-free risk.’”
To sum up, the first category of fixed-income type investments gives you
just what it advertises: a fixed income component. The problem is, nobody
knows what that future sum (interests and the return of your principal) will
be worth at the time you’re entitled to get it. By investing in fixed-income
products, you are basically speculating on the future rate of inflation, and
such macroeconomic speculation seldom turns out to be successful[1]. With
some investments in this first category, you can spare yourself the agony of
price fluctuations (AKA volatility), although in return for the tranquility,
you will slowly but surely lose your purchasing power[2]. Assuming this is
not your goal, let’s move on!
“2.The second major category of investments involves assets that will never
produce anything, but that are purchased in the buyer’s hope that someone
else—who also knows that the assets will be forever unproductive—will pay
more for them in the future.
Owners are not inspired by what the asset itself can produce—it will remain
lifeless forever—but rather by the belief that others will desire it even more
avidly in the future.”
This second category is all about speculation and has nothing to do with
investing. Buffett brings up the example of gold, which never produces
anything, so anyone purchasing it is basically hoping that someday fear will
motivate a larger group of people to buy gold, thus driving up its price. If
you are buying unproductive assets, you are waiting for a bigger fool to
come along and pay more for them than you did—and if that person fails to
show up, you are the one left holding the bag. Speculation is not something
you should build your financial future on.
Assuming you agree, let’s see what Warren Buffett advocates! His
reasoning is crystal clear, as usual.
“3. My own preference—and you knew this was coming—is our third
category: investment in productive assets, whether businesses, farms, or
real estate. Ideally, these assets should have the ability in inflationary times
to deliver output that will retain its purchasing-power value while requiring
a minimum of new capital investment.
Whether the currency a century from now is based on gold, seashells, shark
teeth, or a piece of paper (as today), people will be willing to exchange a
couple of minutes of their daily labor for a Coca-Cola
Our country’s businesses will continue to efficiently deliver goods and
services wanted by our citizens. Metaphorically, these commercial “cows”
will live for centuries and give ever greater quantities of “milk” to boot.
Their value will be determined not by the medium of exchange but rather by
their capacity to deliver milk.
I believe that over any extended period of time, this category of investing
will prove to be the runaway winner among the three we’ve examined. More
important, it will be by far the safest.”
What shall I add? Buffett is right: investing in productive assets like buying
partial ownership stakes in quality companies in the form of shares is the
“runaway winner” in the long run. Before I call on Professor Jeremy Siegel
from Wharton to back up Buffett’s statements with some data, I feel I need
to clear up the meaning of the last sentence in the above quotation. By
calling them “the safest,” Warren Buffett means that the assets within this
third category have the greatest probability of preserving and growing your
purchasing power. Risk is the probability of permanent capital loss and
has nothing to do with the price fluctuations of various investments.
This is where most people go wrong: they chase bonds because of their
illusory safety (low volatility) while avoiding stocks because their prices
fluctuate. That’s the opposite of what you should be doing, though!
Let’s see why you shouldn’t fear stocks and why you absolutely must invest
in them if you are gunning for the best financial future possible.
“How many millionaires do you know who have become wealthy by
investing in savings accounts?”
—Robert G. Allen
Professor Siegel’s widely referenced book, Stocks for the Long Run,
contains an invaluable set of data to draw conclusions from. In the fifth
edition, he examined asset returns from 1802 to 2012 and compiled the
chart below to showcase his findings.

These are real returns, reflecting the effect of inflation and showing how
your future purchasing power could vary based on the investment asset you
pick. Stocks are way off the chart, while hoarding cash is the worst possible
thing you can do.(Note that investing $1 in the stock market multiplied your
purchasing power by almost 705,000 between 1802 and 2012, while the
second best asset only had a multiple of 1,778. A huge gap indeed!)
“By a continuing process of inflation, governments can confiscate,
secretly and unobserved, an important part of the wealth of their
citizens.
The process engages all the hidden forces of economic law on the side
of destruction, and does it in a manner which not one man in a million
is able to diagnose.”
 —John Maynard Keynes
Are you serious about building wealth? Stocks are the vehicle you need to
use, as centuries of data and the insights from the most reputable and
accomplished investors in the world show. Accepting this fact is the first
crucial step toward success.
Now let’s move on and clear up the mystery that surrounds stocks and the
stock market!
The Black Box
“Stocks aren’t lottery tickets. There’s a company attached to every
share.”
—Peter Lynch
There is nothing special or hard to understand about stocks. A stock simply
represents an ownership stake in a company. If you buy a share of Coca-
Cola, you become an owner of that company and are entitled to your share
of profits. It is as simple as that—although the financial industry doesn’t
want you to get the picture and have the courage to invest on your own, so
they deliberately try to overcomplicate things and use jargon most people
don’t understand. After all, they have to make money somehow, even if
they provide a shocking disservice by not being able to invest better than
you could, despite still offering their “help” at a really hefty price[3].
At this point, you must be convinced that you should invest in stocks. You
know that with stocks, you are basically investing in the underlying
companies. Now it’s time to take a look at how a company operates and
how it can generate and use cash, since understanding this will be the key to
your financial future. (Don’t be afraid! The solution I draw up with the
FALCON Method will free you from analyzing all the factors one by one,
but I still feel you should have a look at them once to get a better
understanding of how everything works under the hood.)
I came across a very illustrative description of how a company operates in
David van Knapp’s book Sensible Stock Investing[4], so I will use his model
to highlight all the points that are good to know. The following picture will
simplify things:
First of all, when thinking about a company financially, consider it to be a
black box. You must accept that because you’re an outsider, you have
absolutely no chance to know with any certainty what is happening inside
that black box. The good news is that you do not actually need this
knowledge to create a reliable and growing passive income and achieve
outstanding total returns from your investments. Since a company is all
about value creation, meaning that it must generate more money than the
amount that went in, you will be perfectly fine focusing on the money pipes
connected to the black box. Let’s see what input pipes can carry money into
the box!
The input pipes are:
Revenues: The money the company receives from customers of
its products and services.
Borrowed money: The firm can get a bank loan or issue bonds to
finance its operations. The key will be how the management puts
 this borrowed money to use and what return it can squeeze out of
it.(Hint: it should be way above the interest paid.)
Equity sale: The company can issue new shares, thus diluting its
existing shareholders’ stakes. It is extremely important to have a
look at this input pipe, because many companies are funding
their dividend payments from this source—which is not
desirable, to put it mildly. (Too many dividend investors don’t
pay attention to this and can fall prey to unfair practices
employed by a company’s management.)
“Other companies sell newly issued shares to Peter in order to pay
dividends to Paul. Beware of dividends that can be paid out only if
someone promises to replace the capital distributed.”
—Warren Buffett, 1981
The output pipes are the following:
Ongoing expenses: These are about financing the company’s
day-to-day operations. This pipe typically includes salaries,
office supplies, marketing and advertising costs, etc.
Capital expenditures: This is money spent on things that have a
useful life of more than one year, like computers, machinery,
buildings, etc.
Acquisitions of other companies: One form of growth can be the
purchase of other companies.
Payments on debts: The money that the “borrowed money”
income pipe brought into the black box does not come for free.
This output pipe shows how much the company pays out to
service its debt.
Taxes: This is pretty self-explanatory. All companies have to pay
their fair share to the government.
Profits: Intelligent investors keep close tabs on not only the level
of profits a company makes but also the way it uses the surplus
cash it generates[5]. The dimension of capital allocation is just as
important as profit generation.
“We, as well as many other businesses, are likely to retain earnings
over the next decade that will equal, or even exceed, the capital we
 presently employ. Some companies will turn these retained dollars into
fifty-cent pieces, others into two-dollar bills.
“This ‘what-will-they-do-with-the-money’ factor must always be
evaluated along with the ‘what-do-we-have-now’ calculation in order
for us, or anybody, to arrive at a sensible estimate of a company’s
intrinsic value.”
—Warren Buffett, 2010
Paying attention to Buffett’s words, investors should focus on what a
company’s profits are used for. In the FALCON Method, we surely will!
But to get you ready to tackle this key component, let’s have a look at the
three possible uses of profits: the sub-pipes of the “Profits” pipe!
Dividends: The company can pay part of its profits to its
shareholders. (Hint: You will love the money flowing
through this pipe!)
Share buyback: When a company spends a certain part
of its surplus cash to purchase its (hopefully
undervalued) shares on the open market, it can decrease
the total number of shares that represent the underlying
company. As a result of the decreasing share count, the
earnings per share figure grows. To paraphrase the title
of a bestselling book: there are at least “50 shades” of
buybacks, so we will pay attention to this pipe along
with share issuances in order to help us identify value
creation and destruction.
Retained earnings: Through this pipe, the company
recycles money back into itself for growth and
expansion, so this becomes the fourth input pipe. Again,
the key here will be how efficiently the management can
employ this capital.
This is all you need to know to understand how to pick the right companies
to invest in—and this was the toughest part of the book, I promise! You will
not need to learn this model by heart, but it is useful to read it through so
that you can gain a better understanding of why the FALCON Method is
built the way it is. You may notice that the investment process I outline
below really takes all the important variables into account and is much
more than an oversimplified dividend investing model, of which you can
find dozens, if not hundreds, on the market…most of them with serious
flaws. (So serious, in fact, that after reading just these few brief pages,
you’ll be able to uncover some of them!)
To summarize: As an outsider, you should accept that the inner processes of
a company will be hidden from you. Treat the company as a black box and
focus on the input and output pipes that are attached to it! After all,
corporate operations are about value creation: generating more money than
the company uses in the process. You can grasp this perfectly by turning
your attention to the pipes transferring the money. Don’t take your eyes off
the ball… I mean, money, and you will be fine!
It’s somewhat sad to say, but even if this was your first reading about how a
company operates, you already have a more nuanced understanding of the
issue than most investors do.
One more thing before we move on: rest assured that you will not need
to analyze these pipes that I have detailed one by one! The steps of the
FALCON Method cover all the critical parts.
Now that you’ve learned the basics here, the rest of this book will be so
logical and self-explanatory that you won’t understand why you aren’t
already practicing the ideas I outline!
So let’s see what purposes the FALCON Method serves, and set our goals
properly before we get into the step-by-step process of implementation!
The Goal of the FALCON Method
It’s all about buy and hold! This is not the classic
quant model
“All the real money in investment will have to be made—as most of it
has been in the past—not out of buying and selling but out of owning
and holding securities, receiving interests and dividends therein, and
benefiting from their long-term increases in value.”
—Benjamin Graham
The FALCON Method is meant to assist you in constructing a “buy and
hold” stock portfolio. This is a far more important distinction than you may
think. The classic and popular quant models are back-tested with the
assumption that you are ranking stocks based on some quantitative criteria
and then buying the best of them (the ones that ranked highest). You are
supposed to hold these picks for 12 months, then sell them and repeat the
process: do the ranking again and simply buy the stocks that rank highest at
that time[6]. Quant investing means 100% mechanical investing.
Although there are some quantitative factors that are proven to explain
outperformance, there are serious problems with the practical application of
the classic quant approach.
First of all, most of these rankings produce a list of stocks featuring totally
unknown companies that are very hard, if not impossible, for most investors
to buy from a psychological perspective. (Would you commit your capital
—your hard-earned cash—to something you’d never heard about? Most of
us feel quite uncomfortable with this.)
The annual rebalancing of the portfolio is another issue. Back-tests seldom,
if ever, factor in the transaction costs and tax effects of changing all the
stocks in your portfolio every year. Plus, this practice doesn’t come
naturally for most investors. Still, if you sign up for the convincing
promises of a quant model, you should follow its implementation to the
letter, however bad it feels. (Otherwise, you may base your expectations on
data that are not relevant for your modified investment process.)
 “A portfolio is like a bar of soap: the more you handle it, the smaller it
gets.”
—Unknown
The most important shortcoming, however, is that no quant model performs
exceptionally well every single year, so you will have to deal with bad
results along the way, all while not being totally comfortable with the
background of your stock selection. (Whichever quant strategy you choose,
I bet you won’t feel good about the “black box background” of the ranking
process and the list of stocks it makes you purchase.) Understanding the
logic of the strategy you are implementing and completely trusting the
approach you’re using are crucial to your future success, since you will
have to stay the course in tough times as well as good.
“[Investing in quant models is] hard for people to do, for two main
reasons. First, the companies that show up on the screens can be scary
and not doing so well, so people find them difficult to buy. Second,
there can be one-, two- or three-year periods when a strategy doesn't
work. Most people aren't capable of sticking it out through that.”
—Joel Greenblatt
Long story short: when investing, you will probably quickly give up using
the classic quant models for psychological reasons, while you will be
capable of sticking with the buy and hold approach of the FALCON
Method. That’s because you’ll understand the process, and the stocks it
suggests are mostly household names. It is easier psychologically to hold
stocks in reputable, well-known companies that are putting more and more
money into your pocket in the form of dividends than it is to buy stocks in
unknown small companies and then change all of them when the year ends.
Active stock trading—buying and selling stocks often—is also a field that
makes only a small proportion of adventurers rich. The reasons are
numerous: psychological factors, transaction costs, and taxes, just to name a
few.
Buy and hold is the way to go, and gives the best results for most investors.
More than just dividends
The FALCON Method does not employ a pure income-focused strategy.
There is much more to stock investing than the current dividend yield!
Although our process embraces a wider scale of factors than most dividend
investors do, we still get the predictable and growing passive income
component by investing in companies that have been paying stable or
increasing dividends for decades.
“Do you know the only thing that gives me pleasure? It’s to see my
dividends coming in.”
—John D. Rockefeller
Besides focusing on dividends as an important part of our total return, the
FALCON Method picks the list of stocks that are both producing the
passive income we love and are available at bargain prices (that is, they are
valued lower than their average historical valuation level). When the natural
process of mean reversion comes into play and the valuation multiple
expands, our total return gets a huge extra boost. (I will explain this in more
detail later, illustrating the point with examples.)
In the end, by understanding that a stock’s current dividend yield is only a
part of the total return equation, you get much more than just a reliable and
growing passive income. And you get more than just dividends, since you
will be investing in a more sensible way than 95% of the people out there
trying their luck with stocks.
By the end of this book, you will see that on the one hand, dividends are a
very important factor in determining your total return, while on the other
hand, stable and growing dividends are the symptom of a wonderful
corporate operation and by no means the cause of it. Anyway, we are
more than happy if such a symptom serves as a telltale sign for us to
identify top-quality companies that have been generating more and more
surplus cash for decades and rewarding their shareholders fairly along the
way.
Without a system, you are just gambling
“The rational man—like the Loch Ness monster—is sighted often, but
photographed rarely.”
—David Dreman
Most mistakes in investing come from psychological biases. Just imagine
what irrational decision makers we must be when a whole new field of
science called behavioral finance is flourishing these days! None of us can
escape the biases we are born with—this is why we need to tackle those
mental hangups in the best possible way, getting past them so we can make
smarter choices.
I believe in structured decision-making and the consistent application of a
logically built, proven system. This way, you can tilt the odds of success in
your favor before your ego comes into play. Going by your instincts or
investing without a system is all about dumb luck and can promise no
consistent results. Focus on what you can control (the process) and the
results will take care of themselves!
Do you happen to know why so few professional investors manage to
beat the S&P 500 index in the long run? Because the index is totally
emotion-free; it just consistently executes a very simple strategy (like
investing in the 500 largest companies) without overthinking or
changing its style, whereas most investors are not capable of staying
the course and sticking with their chosen strategy in the long run.
James O’Shaughnessy points this out in his wonderful book What
Works on Wall Street.
The FALCON Method is built to limit psychological errors and emotional
decision making. It’s based on a well-structured process that only leaves
room for subjectivity in the later phases, when it is already too late to make
any costly mistakes, since basically all stocks that survive the filtering
process until that last round provide significantly above-average investment
opportunities. Although my ego may feed on the belief that I can add extra
value by carrying out some qualitative analysis at this last stage, this is hard
to test (lucky me!),so I would rather overweight the proven factors of
outperformance that are to be detailed on the following pages.
In summary: The FALCON Method is a structured stock selection process
that helps to construct a buy and hold portfolio with a focus on both income
and total return. The model is about 90% quantitative and 10% qualitative.
Putting all these into practice
"In theory, there is no difference between theory and practice. In
practice, there is."
—Yogi Berra
Anybody can fill pages with empty sentences about how to invest wisely
and what you need to know to succeed. The difference is in how these lines
are implemented after the talking is done.
1. First and foremost, because buy and hold is the best possible
investment approach you can practice, we need to focus on a
select group of stocks that are suitable for this strategy. These are
reputable companies that have been making increasing profits
and paying growing dividends for decades. Such pre-filtering of
the whole stock universe is absolutely necessary to help you stay
the course in the long run.
2. The FALCON Method will never “sell” you the so-called “deep
value trash” stocks that are cheap if evaluated on certain metrics
but otherwise represent terrible companies. Such a quantitative
approach can be rewarding for a small minority of people who
are psychologically prepared to practice it—but when taking
taxes and transaction costs into account, I am not sure that such
strategies could significantly outperform the quality-focused buy
and hold approach in the long run.
3. I advocate a SWAN (Sleep Well At Night) style of investing,
since you only live once, and if your investments keep you up at
night, you have basically ruined your life. This is too high a price
for any return! If you were able to calculate some totally
subjective indicator of returns that also took your feelings into
account, I’m pretty sure that the investment approach you’re
learning here would rank highest.
4. Since you need to stay the course through thick and thin,
dividends play an important part in our model. It is always easier
to hold onto (and maybe even buy more of)the stocks of well-
known companies that are paying you growing dividends, even
when the stock market collapses, than to commit yourself to
 some microcap[7] garbage that’s been spit out by a semi-reliable
stock screener.
5. The power of understanding how the FALCON Method works
cannot be overemphasized. You should never blindly follow
anyone who advertises himself as an extraordinary investor,
because this is a sure path to huge losses. I’m not the type of
guy who will hard-sell you anything, be it a single stock pick or
my investment newsletter. I believe in passing on valuable
knowledge so that people can have an insight into what I am
doing and why. This way, you can learn and prosper at the same
time, while becoming a much better investor than you may be
today.
6. Strong long-term performance always stems from staying the
course. Remember the eye-opening example of the S&P 500
index? Consistency pays dividends! All of the previous points
are there to help you stay the course and tilt the odds in your
favor.
If you are dedicated to long-term wealth building and the thoughts above
are resonating with your core values, then it’s worth reading on and getting
to know the components of the FALCON Method.
Outlining the Process of the FALCON
Method
“Investing money is the process of committing resources in a strategic
way to accomplish a specific objective.”
—Alan Gotthardt
Next, you will learn about the components of the FALCON Method, but it’s
a good idea to take a look at the full picture before zooming in on its
components one by one. So here’s a brief summary:
1. Determine the group of stocks that are suitable for selection.
(Hint: we will be very picky, and for good reasons!)
2. Which stocks on our list are available on the cheap side of their
historical valuation levels? (I promised examples of an extra
return boost; this is the section where you will find it.)
3. Which of the qualifying stocks fulfill our threshold criteria for
capital allocation? If these absolute levels are not met, it is
simply not worth investing our money. Hold cash in the rare
instances when nothing appears appetizing!
4. Rank the stocks that survived the first three steps! The FALCON
Method employs a multifactor quantitative ranking that results in
a list of the “crème de la crème.”
5. Use a qualitative analysis to eliminate the stocks on the shortlist
that I would not be comfortable investing in based on the
synthesized knowledge derived from reading hundreds of
investment books over the years. (Again: it is almost impossible
to prove that this phase adds value to the process, but at least it
makes me more comfortable investing in the final list of stocks.
The power of this personal feeling is not to be underestimated,
since a good investor has to stay the course in the periods of
panic as well as plenty, and feeling comfortable with the stocks
in your portfolio surely helps with that.)
By applying these steps, the FALCON Method gives you a list of the Top10
stocks that offer the best relative opportunities in the current market
environment. Beyond this, I also highlight my Top Pick for the month: the
stock I myself would go for at the moment.
A later chapter will explain how the FALCON Method can help you and
what the newsletter contains, but for now, we’ll focus on how you can use
these principles yourself. Let’s zoom in on the steps of the process I
highlighted above to deepen your understanding along with your belief in
this approach.
A Select Group of Top-Quality Companies

“The research of the past half-century showed that the tried and true
clearly triumphed over the bold and new.”
—Jeremy Siegel
After Prof. Siegel taught the world to love stocks in his book Stocks for the
Long Run, he went on to study which companies provided the best
investment returns. His mission was to identify the underlying factors of
stellar performance so that he could create a recipe for successful stock
selection. He made his latest findings available in another book, The Future
for Investors, which is a fascinating read. Jeremy Siegel is one of a kind
when it comes to his depth of data analysis. Even Warren Buffett speaks
highly of his work, and for good reason!
“Jeremy Siegel’s new facts and ideas should be studied by investors.”
—Warren Buffett
The conclusion of Siegel’s study (backed up by tons of data) is that we
should invest in the stocks of reputable, well-established companies that
have been paying uninterrupted dividends for a long time. Trying to identify
the next Google or simply falling victim to “sexy stock syndrome” is not
the way to build wealth. Boring dividend-payers are the way to go if you
are serious about your financial future. (Don’t believe me? Read Siegel’s
book!)
“The importance of dividends in generating stock returns is not just
historical happenstance. Dividends are the crucial link between
corporate profits and stock values.”
—Jeremy Siegel
Dividends don’t lie; they cannot be cooked or falsified. A company either
has money to pay the dividend or it doesn’t. While earnings and even cash-
flow numbers can be distorted by unfair practices, the dividend stands out
as the single truly reliable item in corporate reports. If a company has been
able to pay growing dividends for decades, it’s a sure sign of its consistent
earnings power. Taking this argument one step further, it is no surprise that
companies with these characteristics tend to outperform. Let’s see some
proof!
The data in this chart comes from S&P Dow Jones Indices LLC[8]. The S&P
500 Dividend Aristocrats index shows an annualized total return of 9.66%
over the 10 years examined, while the S&P 500 index—which serves the
purpose of representing the whole stock market—came in at 6.97%. This is
a very significant outperformance. Investing $10,000 at an annual return of
6.97% gets you $19,616 in 10 years, while investing the same amount with
the 9.66% return takes you to $25,147. (Increasing the timeframe makes the
gap even wider.)
If dividend aristocrats are that good, we clearly need to define what they
are. Let’s see what the S&P has to say about this: “The S&P 500Dividend
Aristocrats measure the performance of S&P 500 companies that have
increased dividends every year for the last 25 consecutive years. The index
treats each constituent as a distinct investment opportunity without regard
to its size by equally weighting each company.”
As an investor, I have some problems with this index. First of all, why
should I limit myself to only invest in stocks that are part of the S&P 500
index? This makes absolutely no sense to me—and fortunately, I am not
alone with this opinion, so you can find ready-made databases of stocks that
have been paying growing dividends for a long time, but are not necessarily
members of the S&P 500.
And this takes us to my second objection: Why is it so crucial that the
company raises the dividend every single year? Corporate operations rarely
follow a straight upward-sloping line, so I don’t really mind if the
management just keeps my dividend intact in difficult periods and goes
back to raising it when the underlying operations offer some room for that.
Wise managers would not sacrifice the overall health of the balance sheet
just to keep an uninterrupted dividend-raising streak; however, they would
do anything they could to continue paying the level of dividend they
already promised, since their shareholders are expecting to receive that
sum.
There may even be situations when investing some extra money in the
future of the firm creates more shareholder value than increasing the
dividend. Having seen corporate operations from the inside as a manager, I
can personally come up with numerous reasons why increasing the dividend
every single year might not always be sensible. As a result, I am perfectly
satisfied with a long dividend history that shows no cuts, but a generally
rising trend. Note that it isn’t necessary to raise the dividend every year to
fulfill my requirements!
Let me show you a hopefully eye-opening example of why I am not
fascinated by annual dividend increases alone. You can see the dividend
trends of Mercury General (MCY) and Boeing (BA) in the following chart.
Notice that Mercury General is a Dividend Champion[9] with 30 straight
years of higher dividends, while Boeing was nowhere near that respected
status at the time of this writing, as it has the practice of keeping its
dividends at the same level for some years before giving its investors a
considerable raise. See the difference for yourself before I draw some
conclusions!

The management of Mercury General surely knows that even minuscule

increases of the dividend can keep their company in the group of
Champions, so they are doing just that[10]! However, recent increases came
in below 1%, hardly a growth rate that makes investors salivate. Boeing, on
the other hand, got kicked out of the dividend databases when it didn’t raise
its dividend for some time—but since then, its shareholders have enjoyed
huge increases, the latest of which was 30%! I prefer to invest in companies
in which the management employs capital wisely; when returns materialize
in the form of increased cash generation, they know it is time to give me a
considerable raise.
Why not buy the Dividend Aristocrats index? It’s simple and it
outperforms!
Before we move on, I want to address this question, since this is one I
get quite frequently. My problem with buying this index (or any index,
for that matter) is that you are buying a basket of stocks. This means
that you are buying the overpriced ones along with the reasonably
priced and really cheap ones. I hate overpaying for something, so I
prefer buying only those quality stocks that are available at good
prices. I’d rather wait for the others until they’re priced well, too.
The Dividend Aristocrats index is full of quality companies—there’s
no question about it! But quality alone is not enough to make a
successful investment; you also need to pay attention to valuation.
The select group of stocks the FALCON Method focuses on includes the
ones that have been paying a dividend for at least 20 years and did not
cut it within this period. We never compromise about a company’s
immaculate dividend history.
“Many investors, especially those with a long-term perspective, prefer
to receive a steadily growing rather than fluctuating level of dividends.
A policy of continually raising the dividend commits management to
meet specific return requirements of its shareholders. For this reason,
we have also examined the 10 highest-yielding stocks among those that
 have not reduced their dividend in the last 15 years. A period of 15
years was chosen because that means the firm must have passed
through at least one recession. Managements that have not cut their
dividend have demonstrated the consistent earning power and strength
of their corporations.”
—Jeremy Siegel
Prof. Siegel found that the group of stocks described above tends to
outperform. Basically, we need a long dividend history so that we can test
how the company’s management behaves when things get tough. Siegel
uses a 15-year timeframe, while the FALCON Method goes for 20 years of
immaculate dividend history. Notice also that the professor simply picked
the highest yielding stocks from his select universe, while the FALCON
Method uses a multi-faceted approach (the components of which are all
proven). It is always good to see some serious data backing up an
investment process, so thanks again to Prof. Siegel: we know that the
FALCON Method is unquestionably on the right track!
Before summarizing this section and proceeding to the next step of the
process, I want to remind you of an important thing most dividend investors
completely miss: a company does not become a good investment target just
because of its long and immaculate dividend record. This dividend record
is simply a telltale sign, a symptom that gives away how wonderful the
underlying company is.
Remember the black box model with all the money pipes? For a company
to be able to pump more and more dividends through that output sub-pipe
over the course of decades, it must have consistent earnings power—a
really strong cash-generating business model. Having a long and
immaculate dividend history is only a symptom of being a cash cow
company where the management not only excels at maximizing operational
efficiency but also caters to the shareholders’ interests and treats them as
partners. A company with such practices is the exact type of investment you
should commit your capital to for the long run.
Now that you know that dividends are not the Eighth Wonder of the world
but rather a decent telltale sign, you are head and shoulders above most
investors out there.
To summarize: The FALCON Method focuses on a select group of stocks
that have been paying dividends for at least 20 years and have not cut the
dividend in this period. Companies qualifying for this list are reputable and
widely known firms, so most investors feel comfortable buying and holding
their stocks. Studies show that stocks with these qualities tend to
outperform the market index and in addition to offering excellent total
return potential, they also provide a reliable and growing passive income.
Note that concentrating on this select group of companies alone is proven to
tilt the odds in our favor—and we have hardly started the process of the
FALCON Method yet!
It is important to understand that defining our “Premium Dividend Club” of
stocks lays the foundation for consistent application of the strategy, as these
shares are psychologically the easiest to hold onto (and even buy) in tough
times. This pre-selection gives you serious extra power to stick with the
strategy of the FALCON Method through thick and thin and enjoy its
superb long-term performance. You may find the theory simple, but practice
will prove that this last part is so important it is worth repeating over and
over—this alone will determine your financial future. No matter the
strategy you pick, you must stay the course and stick to the plan or you’ll
never win. Winners never quit and quitters never win. You have just
received the greatest help possible to join the group of winners.
Double-Dip Benefit: Buy Them on the
Cheap!

The FALCON Method aims for the highest possible total return while
pocketing reliable and growing passive income in the form of dividends. To
do this, it’s best to know the building blocks of total return so that we can
maximize our so-called “objective function.”(Don’t fret, I won’t use math
lingo along the way; I’ll stick to simple explanations. After all, English is
not even my mother tongue! Simply put: in order to maximize your total
return, you must know its three parts.)
Let’s see how your total return is made when you invest in stocks:
1. Dividends: Harvesting dividends throughout the investment
timeframe means that money flows into your account regularly,
so this must be a part of your total return. The higher the
dividend you get compared to the capital you invest, the better.
(We’ll get back to the often-misunderstood point of dividend
yield later.)
 2. Growth: Imagine a company that is made up of 100 shares and
makes a profit of $100 in Year1. In this case, the earnings per
share (EPS) is $1[11]. In our example, the stock market attaches a
value to this company that is usually 10 its profits, meaning that
the whole company is worth $1,000 and one share is worth $10.
This valuation multiple of 10 means that investors are willing to
pay 10 years of earnings in advance (assuming there is no
growth) to buy shares of this company.
In a no-growth scenario with an unchanged valuation multiple, the
company’s value would be stuck at $1,000(the constant $100 earnings
multiplied by the constant valuation multiple of 10).Now let’s see
what happens if our company switches to growth mode and manages
to increase its earnings at an annual rate of 10%. In this case, by the
end of the 10th year, the total profit grows to $259, while the earnings
per share figure amounts to $2.59[12]. What is this company worth?
What should its stock price be if the investors continue to value it at
10 earnings? Calculating with this fixed multiple gives us a share
price of $25.90.
A company that more than doubled its earnings (and could pay
growing dividends) should have appreciated along the way.
Wherever earnings and dividends go, the stock price is sure to
follow in the long run. Having run through this simple example, I
hope I have made it obvious that growing corporate income and cash
generation can lift a company’s stock price, thus contributing to your
total return. After all, the capital you invested not only generated
dividends but also appreciated nicely along the way.
3. Valuation: Why settle for the two return-generating engines
outlined above when we can switch on the third one (the turbo-
boost) as well? The stock market is made up of investors who are
human beings with psychological biases, and this means that
stock prices often deviate from the intrinsic value of the
underlying companies they represent.
“Prices fluctuate more than values—so therein lies opportunity.”
—Joel Greenblatt
This means that we can sometimes buy the company in the above
example for less than 10times earnings, so we can get its shares on
the cheap side compared to the valuation level that was widely
accepted historically. I feel this is the right point to bring up another
simple illustration to regain your attention.
In the above example, considering a fixed valuation multiple of 10,
you could make a profit of $25.90 – $10 = $15.90 on one share of the
company. This means a return of 159% on your original
investment[13]. Now imagine that a stock market panic hits in Year1
and frightened investors are flocking to unload their shares for $8
(instead of the “standard” $10).This means that you can make a
purchase at a depressed valuation multiple of 8times earnings, as you
only need to pay 8 years of the current profits instead of 10…if you
dare!
“I will tell you how to become rich. Close the doors. Be fearful when
others are greedy. Be greedy when others are fearful.”
—Warren Buffett
Let’s see what happens if you were no chicken and, after determining
that this company represents good quality and the price seems to be a
bargain, you made the plunge and bought one single share (brave
you!). The company grew its earnings per share to $2.59 within 10
years’ time and the decade-old panic is long forgotten, which means
that rational investors are once again happy to pay 10 earnings for
your share. Seeing that you can sell this stock at $25.90, making a
mighty profit of $17.90—which is a return of 224%—you begin to
start thinking about position sizing; the amount of shares you should
buy in a similar situation next time. (We’ll cover that point in a bit.)
All I want now is for you to notice the huge difference in the
return you could achieve (224% vs. 159%) by simply pulling the
trigger when your target seemed to be available on the cheap side
of historical valuation, meaning cheaper than usual!
Let’s think about it more: just like stock prices can become depressed
in times of panic, they can also become inflated in times of euphoria,
 when investors are more than ready to jump on the extraordinary
opportunity that may be represented by your stock. In such cases, they
are paying way more than the “standard” valuation multiple, thus
boosting your return to such high levels that I’m not even willing to
calculate them[14].
Now just breathe deep, take your time, relax, and think about the logic here.
Imagine that the return-boosting effect of buying a quality company at a
depressed valuation was not discovered by me, but by someone you can
trust even with your eyes closed. In fact, by now you may be familiar with
the name and message I quote below:
“Coca-Cola and Gillette are two of the best companies in the world and
we expect their earnings to grow at hefty rates in the years ahead. Over
time, also, the value of our holdings in these stocks should grow in
rough proportion. Last year, however, the valuations of these two
companies rose far faster than their earnings. In effect, we got a
double-dip benefit, delivered partly by the excellent earnings growth
and even more so by the market's reappraisal of these stocks. We
believe this reappraisal was warranted. But it can't recur annually: we'll
have to settle for a single dip in the future.”
—Warren Buffett in his Letter to Shareholders, 1991
Here’s an illustrative summary of all I detailed above:
Your total return is made up of the dividends you receive (the more, the
better) and the price appreciation of the stock. This price movement is
mainly driven by the changing (and hopefully growing) profit-making
capacity of the company: the more money it can generate, the more it is
worth. However, there is one more component that influences the stock
price and is totally unpredictable: market sentiment (represented by the
valuation multiple). All you can do to put this extra wind in your sails is to
buy quality assets when they seem to be priced cheaper than usual. Time
will take care of the rest, since all storms eventually pass.
Before we move on, notice that there is a connection between the profit-
making ability of the underlying company and the amount of dividends the
stock can pay you. As a dividend is cash transferred to your account, it
cannot be fabricated or falsified. In the long run, a company must generate
enough cash to pay its shareholders or it has to cut its dividend.
This brings us to the point of dividend coverage or dividend safety that the
FALCON Method examines in a later phase. (No dividend investing model
can omit this factor! At least not without serious consequences.)
Now that you understand the forces operating in the background, all I need
to say is that this step of the process is about identifying which stocks on
our list can be bought at below average valuation multiples, meaning
that they may offer us a powerful double-dip benefit.
You can imagine that at times of market euphoria, when investors are
buying all the stocks they can get their hands on, there are many fewer
stocks in our very strictly selected database that fit this criterion of double-
dip potential, whereas during times of panic, there may be tons of them. I
am sure, however, that regardless of the prevailing market conditions, it is
always worth looking at this group of historically undervalued quality
stocks because they undisputedly deserve a place on the list of targets for
our following examinations. (In my experience, true gems can be uncovered
this way.)
To show you that these principles of “historical undervaluation” and
“buying on the cheap side of valuation” are not abstract ideas but a reality,
let’s look at the example of CVS Health (ticker symbol: CVS). For this
purpose, I am utilizing FAST Graphs, which is one of the best tools I am
aware of for illustrating the financial data of companies.
Take a look at the first scenario on the chart below, and then read on for
some short explanations of what you see!

The dark green area shows the amount of profit CVS generates. Quite an
impressive growth in the last 20 years, if you ask me! The orange line
indicates the price level that is calculated with a valuation multiple of 15[15].
For CVS, a multiple of 15 is considered to be the fair valuation in this
model. Without elaborating (as that alone could fill another book), have a
look at the black line, which is the stock price, and see how it tends to
connect to the orange line time and again after deviating from it. Long story
short: if you buy CVS when the black line is above the orange line, you are
paying too much. And that’s just what happened in this first scenario. (The
purchase and sale are marked by the red dots, which are connected by the
red line.)
As you see, the investor represented in this chart made a really questionable
purchase of CVS stock at the end of 1998, paying 55 times earnings for the
shares. (Notice that I said “an investor” and not you, since this is such a
blunder that I don’t want to offend you by presuming you’d make it!)
Paying 55 times earnings, when 15 is considered the fair valuation multiple,
is absolutely ridiculous.
For proof, let’s see the result! By the end of September 2008, the earnings
of CVS grew considerably (as the dark green area shows), but the price
retreated to its fair value line, represented by the multiple of 15. So our
hapless investor profited from the huge growth of the company and the
collection of some decent dividends, yet still fell victim to the meaningful
drop of the valuation multiple (from 55 to 15). As a result of these factors,
his annual total return came in at a mere 2.5%. He invested in a wonderful
company, but overpaid terribly! No excuses here; paying an extra high price
can turn even the best company into a nightmare investment.
“No asset is so good that it can't become a bad investment if bought at
too high a price.”
—Howard Marks
To get over this shocking misstep, let’s turn to our second scenario, where
we manage to buy the same CVS stock at a fair price. (Yes, this is “we,” as
buying such a quality company at fair value is something I happily admit to
doing time and again.)
Simply put: we bought at a valuation multiple of 14.2 and sold at nearly the
same multiple of 14.1, so we could profit from collecting the dividends and
the growth of the underlying company, thus getting an annualized total
return of 15.2%, which is pretty acceptable. The turbo-boost of multiple
expansion was not turned on, but we still made a nice return on our
money[16]. However, the step of the FALCON Method I am outlining here is
all about turning on that extra boost, so let’s see how we could do if we
bought CVS stocks on the cheap!
This chart below encompasses a shorter timeframe, which is why it looks
different at first glance. The selection of timeframes for the three scenarios
is arbitrary, since I needed to pick entry and exit points that would illustrate
the point.
I will let the chart do the talking and just emphasize the main message. By
pouncing on CVS shares when they were available at a bargain valuation of
10 earnings (10.1, to be more exact) and holding onto the shares until the
beginning of 2017 when we unloaded them at a valuation multiple of 14.1,
we made a great annualized return of 20.6%.
“As the saying goes, a stock well bought is half sold.”
—Walter Schloss
Long story short: if you can buy such a terrific company at cheaper than
average prices, it is time to open your wallet. If I were you, I would read
over the three annualized return figures in the above scenarios a few more
times so it gets imprinted in my brain that buying extra-cheap is the recipe
that brings extra profits, while paying an insanely high price can lead to
disaster[17]. (In this first scenario, the enormous growth of the underlying
company saved our anonymous investor, but not everyone gets away that
lucky after overpaying, believe me!)
And here comes your favorite part: let’s summarize things and move on!
Based on these examples, we’ve seen that the FALCON Method is
absolutely doing the right thing when it puts in the extra effort to identify
those top-quality stocks on our strictly selected list that seem to be available
on sale (meaning at lower than usual valuation multiples).
No matter what market conditions prevail, we want to see this special group
of stocks and we most certainly want to perform further analysis on them.
Based on this knowledge, it would be irresponsible to skip this test before
compiling a list of Top10 stocks, yet no one I know of seems to perform it.
As you saw, the current valuation multiple alone is nearly meaningless
—it has to be put in perspective. You need to compare it to the historical
average fair valuation multiple, which can vary from stock to stock, and
you are also advised to take the growth characteristics of the company into
account when making a decision.
Depending on the market sentiment, there may be tons of top-quality
companies on our list that seem to be undervalued, or there may be only a
few of them. The FALCON Method does not automatically exclude all
stocks that are not deeply undervalued, but it most certainly prevents
you from overpaying! Buying at a fair valuation can be acceptable,
though, as long as the underlying company is good.
“It's far better to buy a wonderful company at a fair price than a fair
company at a wonderful price.”
—Warren Buffett
In summary: By looking for the turbo-boost of depressed valuation, the
FALCON Method can uncover true gems when the market presents them. It
would be foolish to pass up such opportunities, so this step provides
tremendous added value. (By the way, falcons are not said to be great at
unearthing anything—even gems—but never mind! I’ve spent more time
learning about investing than about wildlife…or anything else, for that
matter.)
Threshold Criteria: Should You Open
Your Wallet at All?

What if I told you to buy a stock that costs $100, where the underlying
company has an annual (free) cash flow[18] of $1 per share (1% of the stock
price) and pays a dividend of $0.50 per share (0.5% of the stock price)? To
make things worse, the firm is continuously issuing new shares to further
enrich its managers and finance their empire-building obsession, while still
not producing any more money in spite of the growing company size.
You should say I’m crazy enough to be locked up in a dark room alone, and
surely not allowed to share my views on investing at all!
I’ve just described a major difference between the absolute and relative
aspects of valuation. This needs to be discussed a bit more before we move
on to some very important criteria of stock selection.
For the sake of illustration, imagine that you are a very stubborn and
simple-minded investor who is only interested in the stocks of Dividend
Champions (companies with at least 25 straight years of higher dividends).
So this is the well-defined group of your targets and you simply rank this
group of stocks based on their dividend yield: the higher the better. Again,
this would be foolish, but as simple as this example is, it will help us
highlight something very important.
Think about this approach for a while and you should agree that regardless
of the prevailing market environment, you can always rank your
chosen stocks (the Champions) in the order of the dividend yield they
provide. There will always be a highest-yielding Dividend Champion, a
second highest, and a lowest as well. This is a relative ranking. You can
produce this at any moment in time to see which stocks on your target list
offer the best value (in this case, you only measure value by the dividend
yield)—but notice that this does not mean the best-placed stocks in the
ranking are always worth buying!
In times of market panic, stock prices get hammered and the dividend yield
offered by Champions rises. This is when you can easily go for the “top of
the ranking” companies.
But what happens when the other extreme strikes? At times of euphoria,
stock prices get inflated and dividend yields can drop to irrationally
suppressed levels. Imagine an extreme situation in which you do your
ranking of Champions only to see that even the Top 10 only offer dividend
yields below 1%. These are at the top of your “well-established” stock
picking system, so should you go out and buy them? From the dark room
where you’ve got me locked up, I am yelling as loud as I can: NO!
This is where some absolute criteria should come into play. We need to
define certain thresholds where the failure to step over them absolutely
disqualifies a stock, regardless of its place in the relative ranking. After
all, if an investment opportunity can’t offer decent prospects, you should
keep your wallet shut and wait for better times to allocate your capital.
This step in the FALCON Method is all about defining those threshold
criteria that should be met before any money goes out for investment. There
are three things you should know before we proceed:
 1. The indicators I picked are widely used ones, which have
quantitative proof of being attached to superior stock
performance. On the top of this, they are all reasonable, so it is
easy to understand why they are important.
2. I deliberately define low limits with all the three indicators, since
my experience shows that needing to meet all three low
requirements at the same time usually disqualifies a very large
chunk of stocks on our list, but leaves just enough of them to
continue the analysis. So this is really a very tough combined
filter despite seeming to be a bit lenient on the individual factors.
3. You cannot fix all the limits as absolute values for the rest of
your life; this is why I will not disclose the current levels in this
book. Please understand that the same dividend yield that looks
attractive in a market environment when 10-year U.S. Treasuries
yield below 2% can look ugly when risk-free rates approach
10%, so you should adjust your requirements accordingly. I am
using this extreme example on purpose, just to make you think
about and accept that your absolute criteria cannot be totally
independent of the prevailing market conditions. (Well, unless
you are prepared to wait on the sidelines without investing for
decades, speculating on certain macroeconomic developments,
which is an approach no reputable value investor advocates.)
“We spend essentially no time thinking about macroeconomic factors.
In other words, if someone handed us a prediction by the most revered
intellectual on the planet, with figures for unemployment or interest
rates or whatever it might be for the next two years, we would not pay
any attention to it.”
—Warren Buffett
“I'm always fully invested. It's a great feeling to be caught with your
pants up.”
—Peter Lynch
Now let’s see what the three threshold criteria actually are:
1. Dividend yield: This is calculated by dividing the forward 12-
month dividend (what a stock is expected to pay in the year
 ahead) by the current market price[19]. This is totally intuitive:
you want the highest possible dividend for the capital you invest.
The serious mistake many dividend investors make is chasing yields:
going for the highest yields available and losing sight of all other
important criteria (like the safety of the dividend, for example).
Let me repeat that the FALCON Method aims to provide the best
possible total return (a completely different “objective function” than
maximizing the current yield) while also targeting reliable and
growing dividend income. Strategies that focus on maximizing the
current yield often embarrass investors, since your significant other
who looked attractive before the wedding can show his or her true
colors after the ceremony (in the form of a huge dividend cut) and the
marriage will either turn into a long agony or an extremely expensive
divorce where the other party takes most of what you put into the
relationship.
So on one hand, the FALCON Method does not accept ridiculously
low dividend yields (compared to the prevailing market averages), but
it also will not push this criterion to the limits. The falcon is wise
enough to know that it will have further opportunities to weed out the
surviving stocks in the latter phases of the process.
2. Free cash flow yield: This indicator is just as important as the
dividend yield, although many dividend investors do not really
consider it when allocating their capital. Free cash flow is a
category that Warren Buffett made popular with the Appendix of
his Letters to Shareholders in 1986. (I’m not going into details
here, as Buffett himself does not suggest doing so: “I know that
among our 6,000 shareholders there are those who are thrilled by
my essays on accounting—and I hope that both of you enjoy the
Appendix.” Feel free to check out the 1986 letter online if you
belong to this minority.)
Simply put: free cash flow measures the “no-strings-attached cash”
that the company generates and does not need to spend on capital
expenditures to keep its production capacity and competitive
position[20].Basically, this is the money the company’s management
can freely decide how to allocate without sacrificing the company’s
overall future prospects. Free cash flow is the category that provides
 the basis for shareholder returns like dividend payments and stock
repurchases. Although a company can finance these from its existing
cash hoard or by taking on new debt, these sources only work
temporarily. The true value of a business lies in its free cash flow
generation and not the often distorted (or outright falsified) reported
earnings figures.
“Our acquisition preferences run toward businesses that generate cash,
not those that consume it. However attractive the earnings numbers, we
remain leery of businesses that never seem able to convert such pretty
numbers into no-strings-attached cash.”
—Warren Buffett, 1980
The more dollars of free cash flow you get for your investment, the
better, and this is exactly what the free cash flow yield measures[21].
Hoping that you still have some fading memories of the black box
model with the money pipes, let me remind you that making excess
cash is only one part of the equation. When purchasing shares in a
company, you want to buy the most excess cash generation possible,
and after that, pay close attention to the “what-will-they-do-with-the-
money” factor (AKA capital allocation).
3. Shareholder yield: This filter addresses the dimension of capital
allocation. Before committing my dollars, I want to see what
percentage of my investment is returned to me, the shareholder.
Dividends and share repurchases are both forms of shareholder
return. While the first is self-evident, the second decreases the
number of shares outstanding, thus increasing every remaining
shareholder’s ownership stake in the company (driving share
prices higher).
I like using the shareholder yield as a threshold criterion, as it helps
filter out the firms that finance their dividends by issuing new
shares[22]. (This is the previously mentioned “give Peter’s money to
Paul” practice.)
“At both BPL and Berkshire, we have never invested in companies that
are hell-bent on issuing shares. That behavior is one of the surest
indicators of a promotion-minded management, weak accounting, a
stock that is overpriced, and—all too often—outright dishonesty.”
—Warren Buffett, 2014
For the sake of providing the most value possible here, I want to give
you some additional info on this very powerful indicator. To tell you
the truth, I was not a huge fan of the shareholder yield concept, since I
always thought that its two components (dividends and share
buybacks) are not simply additive. In fact, they are on totally different
levels! On one hand, dividend announcements represent a strong
promise for the future (especially if given by a company with an
immaculate dividend history), while on the other hand, an
announcement on prospective stock buybacks often stays just that—
an announcement—and fails to materialize.
“Share repurchases often occur in a haphazard fashion. It is true that
the price of a stock often responds favorably when management
pledges that it will repurchase shares, but shareholders have a harder
time monitoring whether management, in fact, is fulfilling its pledge.
Various studies have concluded that a large percentage of announced
share repurchases are not completed[23]. Often, management finds other
uses for earnings, and not all of them are in the interest of
shareholders.”
—Jeremy Siegel, The Future for Investors, p. 152
Studies suggest there isn’t much use in focusing on announced
buybacks; in this category, the figures of the past (the TTM [trailing
12 months] buyback numbers) are what really matter because those
are real. Based on this, I had the strange feeling that with one of my
eyes, I was looking in the rearview mirror (the TTM buybacks of the
past), while my other eye was fixated on the windscreen, looking
ahead (at the future dividends). It made no sense to simply add these
two numbers up. I was strong in my resistance until I read dozens of
studies that highlighted the shareholder yield as one of the most
powerful factors behind outperformance[24].
In their book Your Complete Guide to Factor-Based Investing, Andrew
L. Berkin and Larry E. Swedroe elaborate on how investing in the
stocks providing the best shareholder yield has outperformed both the
market and the simple dividend-yield strategy in three out of the past
four decades. The top-performing indicator is a three-component
shareholder yield that includes net-debt paydown in addition to
dividends and buybacks, where the net-debt paydown yield is
measured as the year-over-year difference in the debt load of a firm,
scaled by total market capitalization.
Let me remind you that the FALCON Method does not pursue a
classic quantitative strategy, where you purchase the 20 stocks
providing the highest shareholder yield, hold them for 12 months, and
then repeat the process, selling all your stocks and buying the new
darlings of the quant screener. This is very important to understand, as
there must naturally be huge differences between a buy and hold
strategy and a pure quant approach with high portfolio turnover. In the
FALCON Method, we use the shareholder yield to uncover unfair
practices, such as diluting current owners[25]. We favor companies
with strong shareholder returns, meaning that besides paying a
predictable and growing dividend, they are increasing our ownership
stake by buying back stocks.
Before moving on, I’ll demonstrate the enormous value these three simple
indicators can provide. Let’s look at the data of three companies and draw
some conclusions[26]!

Teva
Dividend Yield – 4.1%
Free Cash Flow Yield – 14.9%
Shareholder Yield – -5.4%[27]
Coca-Cola
Dividend Yield – 3.4%
Free Cash Flow Yield – 3.6%
Shareholder Yield – 4.7%
Target
Dividend Yield – 3.7%
Free Cash Flow Yield – 8.7%
Shareholder Yield – 15.2%

Although Teva has the highest dividend yield and its free cash flow yield
looks great as well, the negative shareholder yield uncovers something I
don’t like: the company issued tons of shares, so it destroyed shareholder
value instead of creating it. Whoever is mesmerized by the dividend yield
fails to grasp the situation here! But the FALCON Method protects us from
such blunders.
Coca-Cola is one of the favorite stocks of dividend investors—and rightly
so. The dividend yield of 3.4% is considered attractive here (it is certainly
above average for Coke), but if you have a look at how much free cash flow
the company is generating for every dollar you invest, something not so
nice dawns on you. Coke basically pays out nearly all of its cash flow in the
form of dividends, which is not desirable. As the shareholder yield is
slightly higher, you can assume that the company takes on some debt to buy
back its stocks. These facts are all good to know before committing your
capital.
Target offers a very competitive dividend yield of 3.7%, and the 8.7% free
cash flow yield shows us that the retailer has much more room to increase
its dividend than Coke because it pays out less than half of the cash it
generates. On top of this, Target seems to be pretty active on the share
repurchase front, as signaled by the 15.2% shareholder yield. Considering
these numbers, Target seems to be the best choice from these three stocks.
This short demonstration highlights where defining the absolute minimum
limits of three well-chosen criteria can take you. The FALCON Method
easily separates the wheat from the chaff so that we only analyze the
companies that are worth our time and effort. Stocks that are part of the
carefully selected “Premium Dividend Club” and also meet these threshold
criteria provide investment opportunities where you get decent value (and
top quality) for your money. Now that we have them on a shortlist, it is time
to rank them to see which are the best candidates for our portfolio!
Rank the Survivors

At this point, we have a group of stocks with at least 20 years of

immaculate dividend history—this alone tilts the odds in our favor. We have
split the members of this “Premium Dividend Club” into two separate
groups: those that are currently available at lower-than-usual valuation
(offering a possible double-dip benefit) and those that are trading at fair or
higher prices.
We will pay very close attention to the ones that are available on the cheap,
as sometimes true gems can be uncovered among them. Nevertheless, we
will not completely omit those members of the other group that are offered
at about fair prices. (The rest of the “Premium Dividend Club” members are
way too expensive, and since we know that quality and value are both
required to make up a good investment opportunity, we won’t compromise
and will disqualify them for now.)
Below is an illustration how we treat stocks based on their current valuation
levels.
Knowing the difference between the absolute and relative aspects of
valuation, we drew up some absolute threshold criteria that any investment
opportunity should meet to earn our capital. We show no mercy and also
disqualify all the stocks in the “Sure” and “Maybe” groups that fail to meet
our threshold criteria.
Now that we are done with all these steps, pretty much any company that is
still standing can be considered a good investment. But we want to see
which the best candidates are, so it is high time to carry out a relative
ranking! (Notice that the FALCON Method does this only when the field of
stocks has been narrowed down to the very best. Relative ranking has its
place in a good investment process, but it shouldn’t come first.)
Because the FALCON Method aims to maximize your total return, it is no
surprise that the factors it uses for the ranking all come from the total return
equation that you’re now familiar with. (As a quick refresher: the total
return is influenced by the dividend yield, the growth, and the change of the
valuation multiple.) As the last component, the multiple, has already been
addressed in our process, let’s turn our focus to the dividend yield and
growth!
These two go hand-in-hand and should never be analyzed separately (a sin
many investors commit).A stock that provides a low dividend yield as a
starter should be able to grow and increase its dividend at a high rate;
otherwise, it cannot become an attractive investment. Would you put your
money into a stock that offers a dividend yield of 2% and an annual growth
of a mere 2%? Hopefully not[28]! For a low yielder like that to get your
attention, it must show enormous growth potential, like 10% or more
annually[29].
On the other hand, a high yielder has already built something of a case for
itself by offering a starting yield of, say, 5%. This is the dividend you are
almost sure to receive, so a less spectacular growth rate could be enough on
top of this to provide a decent total return. (If you are not entirely
comfortable with these last two paragraphs yet, I suggest that you play with
this calculator for a few minutes—the connection between the current yield
and growth rate will become obvious. You can compare an imaginary low
yielder and a high yielder, for example, to illustrate what I have been
explaining.)
In the example below, I used CVS Health (CVS) and AT&T (T), two stocks
offering totally different yield and growth profiles at the moment. Again,
feel free to use the calculator at the link below the chart to create your own
examples!
 Source: https://sugar.mhinvest.com/highcharts/investment.php
Examining the current yield and the dividend growth rate together is not an
innovation at all! And it’s always good when we don’t have to reinvent the
wheel, something falcons aren’t known for excelling at.
Dividend investors often use the so-called “Chowder Rule” to determine
which stocks offer the best starting yield and growth combination. The
Chowder Rule is really simple; it just adds up the stock’s current dividend
yield and its trailing 5-year dividend growth rate to determine if the mix of
value and growth warrants a timely buy. The higher the number, the better.
In practice, this is how most dividend investors use the Chowder Rule:
1. For stocks offering a dividend yield of 3% or higher, the sum of
the dividend yield and the trailing 5-year dividend growth must
be at least 12.
2. If the current dividend yield is less than 3%, the sum of the
dividend yield and the trailing 5-year dividend growth must be at
least 15 (to offset the risk that comes from the higher growth
expectations with low yielders).
3. There is a separate set of rules for utility stocks.
While I like the core concept behind the Chowder Rule, I also have some
problems with applying it without thinking. First and foremost: Why should
we focus on the trailing 5-year dividend growth rate alone? If the growth
rate shows some signs of a recent slowdown, the 5-year rate can mask this
and distort our opinion about the stock. If we can have a look at the
dividend growth rates of different time horizons, then why not go for this
more realistic picture?
For example, the retailer Target (TGT) had a 5-year average dividend
growth rate of 16% as of early 2017, as it used to raise its dividend by
20% for some years. However, the FALCON Method highlights that
the last two raises came in at 7–8%. No company can keep up a growth
rate of 20% forever, and even the management of Target honestly says
that they have reached the payout ratio they are comfortable with (by
intentionally raising the dividend faster than the underlying business
grew for a certain period). So from this point on, the dividend growth
rate will correspond with the earnings growth, which is expected to be
 somewhere in the mid-single-digit range. It would be a huge mistake to
blindly pick the Chowder number, as it fails to grasp the whole picture
I have just outlined. The FALCON Method would never make such a
mistake, and hopefully using it will save you from such costly blunders
too. (Of course, you cannot know the story behind every single stock,
but numbers do tell the story if you pick the factors of your model
wisely!)
Secondly, I understand that low yielders carry additional risk, since in the
dreaded scenario when high growth expectations fail to materialize, these
stocks can turn out to be subpar investments. It is absolutely justified to
demand a higher Chowder number in the group of low yielders, but I would
not arbitrarily split the universe of stocks in two based on a fixed yield level
of 3% that fails to take the prevailing interest rate environment into account.
So I like the underlying mechanics of the Chowder Rule but would never
use it the way its massive follower base typically does. Instead, the
FALCON Method looks at different timeframes for gauging a
company’s dividend growth rates and compiles Chowder-like numbers
based on these growth rates. All these “yield plus growth” types of
indicators (encompassing different timeframes)serve as separate factors that
each receive a weighting, allowing us to carry out a multifactor weighted
ranking process. This means that the FALCON Method takes into account
all the available dividend growth data, beyond the current yield, and
combines them in one powerful indicator we can use to rank the stocks that
are still standing.
How does a weighted multifactor ranking work? A quick example
For the sake of simplicity, imagine we only have stocks A and B in our
universe. Our model uses three factors for ranking these stocks. The
first step is to calculate the value of the factors we use. (A factor can be
the dividend yield, the Chowder number, the price-to-earnings ratio, or
anything that makes sense to you.) Let’s say the results are as
follows[30]:

Factor 1
Stock A – 23.3%
Stock B – 27.3%
Factor 2
Stock A – 34.5%
Stock B – 27.0%
Factor 3
Stock A – 24.6%
Stock B – 25.6%

Now that we have these values, the next question is, what weight
should we assign to these factors? In this case, we opt for equal
weighting, which means that all factors will receive a weighting of
33.3%—thus, the three of them make up 100%. (You could pick any
three numbers, the sum of which equals 100 percent.)
The last step is to do the calculation for the ranking. For “Stock A,” it
is the following: 33.3% x 23.3% + 33.3% x 34.5% + 33.3% x 24.6% =
27.47
For “Stock B”: 33.3% x 27.3% + 33.3% x 27% + 33.3% x 25.6% =
26.63
If you rank these two stocks based on the scores you have just
calculated, “Stock A” comes out slightly ahead.
The weighted multifactor quantitative ranking process works this way,
but can have many more than three underlying factors; it can assign
different weights to all of them and, of course, it needs to calculate the
scores for all the stocks in the universe it examines and then rank them
accordingly. (If not all of your factors can be expressed as percentages,
some additional work is required. Fortunately, the FALCON Method
does all this for you.)
By applying this unbiased quantitative technique and selecting Chowder-
like numbers with different timeframes as the ranking factors, our approach
tackles the mistake of arbitrarily picking the 5-year number and drawing an
incorrect conclusion from that simple figure (like many people do).
On the top of this, I see no reason to determine absolute threshold levels
based on Chowder-like numbers. Instead, the FALCON Method uses them
for the purpose of relative ranking only. It is hard to make a mistake this
way, since all I say is “the higher the Chowder numbers, the better,” and
this statement isn’t easy to dispute if one understands the underlying logic I
have outlined so far.
Notice that our investment approach acknowledges that a lower yielder
must provide higher growth to become an excellent investment, while a
high yielder can offer great returns with lower growth rates. As the
FALCON Method examines the Chowder-like numbers of different
timeframes, it penalizes companies where the growth rate fell recently
or which failed to raise their dividend for some years. (Remember
Mercury General, the company that operated with minuscule raises to
preserve its Champion status? Such gimmicks won’t get it anywhere in the
FALCON Method: without serious dividend growth, it falls to the bottom of
our list, even if it managed to survive until this round[31].)
Remember, this weighted multifactor ranking process is applied to all the
stocks in the “Premium Dividend Club:” both those that offer a potential
double-dip benefit by being available on the cheap and those that are fairly
or more expensively priced. Candidates that don’t meet our absolute
threshold criteria (dividend yield, free cash flow yield, and shareholder
yield) are disqualified regardless of which group they belong to. We make
no compromise here, since their prices are simply too high to offer decent
returns for a sensible investor.
By now we have narrowed down the list of stocks considerably, and for
good reason! The last step of the FALCON Method involves some
qualitative judgment, which means it is labor intensive. Only the most
promising stocks on our list deserve this kind of treatment. This is why
we start with the seemingly undervalued survivors that rank high based on
“yield plus growth” characteristics. (Notice that these are companies with
immaculate dividend histories of at least 20 years. In these cases, the
multiple expansion—or reversion to the mean, to be more exact—can work
in our favor, boosting our return, while the current yield and growth figures
together indicate an excellent total return potential. All three components of
the total return equation are our allies, so it is hard to imagine a better
position than this.)
After stocks with double-dip potential, we also examine the fairly priced
candidates in the last phase of our selection process in order to compile the
best Top10 list possible under the prevailing market conditions. Now let’s
see what this final phase involves and how the FALCON Method puts the
finishing touches on this well-rounded stock selection process!
Final Round: Enter the Human

Until now, the FALCON Method followed quantitative discipline. All its
decisions were numbers-based, totally eliminating psychological biases
from the investment process. Although some subjectivity crept in when
deciding which stocks were “about fairly valued” based on the historical
multiples[32], decisions made at that stage do not have a huge influence on
the final outcome of the model.
But now that we have a ranking of the stocks that seem to be the very best
investment candidates, it’s time to have a look at them from a more
qualitative point of view. This is where human judgment and emotions
come into play, so please notice that the FALCON Method only lets these
forces out when it is almost impossible to screw things up, as only stocks
with great attributes remain standing.
This phase of the process means that the FALCON Method is about 90%
quantitative and 10% qualitative. Closely examining the candidates that
ranked well gives me peace of mind that I have done my job and applied all
the knowledge I’ve accumulated throughout the years. Although this human
element may not provide empirically proven added benefits, it is worth
including for this “peace of mind” effect alone, which can seriously
influence how an investor behaves in the times of panic. Now, instead of
overexplaining this, let’s have a look at some points I am focusing on in this
phase.
Dividend Coverage
It is always worth examining the safety of the dividend. Payout ratios can
tell the story, so I look at the classic dividend-per-share/earnings-per-share
ratio as well as the more meaningful dividend-per-share/free-cash-flow-per-
share ratio. The latter is more important, as dividends can only be paid from
cash and not some fabricated earnings. You may notice that the FALCON
Method has already examined dividend safety indirectly along the way. We
had absolute threshold criteria for both the dividend yield and free cash
flow yield, so in an indirect way, we addressed the relationship of dividends
and free cash flow as well.
I believe the dividend coverage ratios are not suitable for quantitative
ranking purposes because it’s not guaranteed that a company that pays out
40% of its free cash flow is better than one with a 60% ratio. I don’t
determine any strict ceilings for disqualification, either, because companies
can have very different business models that explain their payout ratios—
this is where human judgment comes into play instead of rigid filtering
criteria.
Philip Morris is a fantastic company if you put the ethical concerns
relating to the business aside. Even Warren Buffett agrees with me on
this: “I'll tell you why I like the cigarette business. It costs a penny to
make. Sell it for a dollar. It's addictive. And there's fantastic brand
loyalty.”
The company’s management decided that they would pay out almost
all the free cash flow it generates in the form of dividends, so their
payout ratio is intentionally high. Knowing their business model and
their fantastic dividend history, I wouldn’t disqualify this stock based
on some payout ratio criterion alone. Doing so simply makes no sense.
Do you remember the example of Coca-Cola? This Dividend Champion
met all our absolute threshold criteria and yet still failed to make the grade.
The main reason for sweeping it aside was the deterioration of its dividend
coverage, which resulted from increasing the dividend at a higher rate than
the growth of the underlying business would allow[33]. At the moment, Coke
yields 3.4%, but this is all it can provide because its payout ratios are
overextended[34]. The FALCON Method can identify much better
investment opportunities.
So on the one hand, I try to avoid very high payout ratios, while on the
other hand, I tend to look at the company’s business model in dubious
situations. This step cannot be automated wisely; this is why it is carried out
in this last human-based phase.
Return on Invested Capital (ROIC)
“It will continue to be the objective of management to improve return
on total capitalization (long-term debt plus equity)…”
—Warren Buffett, 1971
When you invest money, you want the best returns possible. If you become
a shareholder in a company, the equity corresponding to your ownership
stake in the company is your money. It is worth paying attention to how
well the management employs the capital at its disposal. If the return
figures are low, you may have the feeling that you could do something
better with your money than leaving it in the company where it will
compound at unsatisfactory rates.
I focus on the ROIC indicator[35], which incorporates the long-term debt part
of the company’s capital in addition to the equity, since that is capital the
management puts to work; thus, it should earn decent returns on it. It goes
without saying that the higher the ROIC, the better.
This part of the process also addresses the indebtedness of the firm. I don’t
believe in absolute leverage criteria like debt-to-equity. Again, companies
can have very different business models and these affect such ratios. High
leverage alone is not a problem until the return on invested capital
considerably exceeds the interest rate on debt. For instance, if management
uses the money it raised from debt to earn an annual return of 15% while
paying an interest rate of 2–3%, it can create huge value for its
shareholders. I surely wouldn’t penalize them for such sensible maneuvers
(as long as they do not take it to extremes).
While the combination of high leverage and low returns can be lethal, this
question is never black or white, so coming up with an answer requires
human judgment. Even quantitative studies reveal that companies that use
very little or no debt can offer subpar returns just like their overleveraged
counterparts[36]. The key is striking some healthy balance.
Notice that if you have the chance to examine the three-component
shareholder yield, which is the one that incorporates net debt paydown
along with dividends and share buybacks, you are examining the debt
question from two different angles. Although the FALCON Method sets no
specific criteria for leverage, it pays close attention to the most important
aspects of the company’s indebtedness.
Is it Cyclical?
“Making a huge bet on a cyclical business, which turns on the price of
a commodity, to me is a reckless way to invest money.”
—Glenn Greenberg
Before I influence you in any way here, please have a quick look at the 20-
year earnings charts of two companies: V.F. Corporation and Chevron.
Even if you know nothing about these firms, it should be obvious that they
have entirely different business characteristics. While V.F. Corporation
benefits from the continuous demand for its powerful brands, including
Timberland, Eastpak, Vans, The North Face, Lee, Wrangler, etc., Chevron is
involved in the much more volatile—yet highly lucrative—oil business.
Chevron’s earnings and cash flow fluctuate wildly, whereas V.F.
Corporation has a much more predictable operation. I will not tell you that a
cyclical business is always a bad choice, but it requires some additional
considerations before investing.
Oddly enough, cyclicals are cheap at the bottom of the cycle, when their
valuation multiples seem to be extra high (because of the earnings
collapse), and they can get pretty expensive at the peak of the cycle, when
multiples look much better as a result of skyrocketing earnings. I have read
quite a bit on this topic and what I learned can be distilled as follows:
Investing in cyclicals is often counterintuitive, so it requires careful
consideration.
Suffice it to say that no quantitative model is able to handle this task, this is
why it is essential to take a close look at the companies near the top of our
ranking and determine which of them are cyclicals that are thus in need of
some extra attention.
What Is My Conservative Estimate of Total
Return?
"It is better to be approximately right than precisely wrong."
—Warren Buffett
Based on dividends, future earnings, and changes in the valuation multiple,
it’s possible to come up with a rough figure of expected annual total return
for any stock. There are two important things to know about this: first, no
matter how hard you try, this can never be anything more than an estimate;
accuracy is not only impossible, but shouldn’t even be aimed for. Second,
being very conservative is the key to successfully apply this step. Investing
is all about margin of safety, as Ben Graham taught!
“Confronted with a challenge to distill the secret of sound investment
into three words, we venture the motto, Margin of Safety.”
—Benjamin Graham
Tweaking the numbers can be both fun and useful if you know what you are
doing, have solid background knowledge in investing, and love what you
are doing. However, things can go wrong if you attach too much importance
to the prevailing stories of the stocks you analyze and persuade yourself not
to buy the top-quality stuff that is currently hated by the majority of
investors. (That’s why it is on sale, after all. The exact time to buy is when
others are fearful, but doing so is easier said than done.)
A second potential mistake stems from taking yourself too seriously and
becoming overconfident in your analytical (or, rather, future-predicting)
abilities. On one hand, I would never leave out the step of conservative total
return evaluation, but on the other hand, I would not over-appreciate the
inputs it can give me. By this, I mean that estimates of total returns are not
exact enough for ranking purposes, although they can help eliminate the
candidates that clearly fall short of our rational expectations. Whichever
data provider or visualization tool you choose, this will be a step where you
need to put your mind to work.
By the time I go through the steps of the FALCON Method, I feel totally
comfortable investing in the stocks that rank best and already have passed
all the quantitative and qualitative criteria. This process looks at companies
from many different angles, encompassing “the black box model with the
money pipes” and leaving no room for the mistake of omission.
As a result, we can compile a list of Top10 stocks that provide the best
investment opportunities at the current moment. Beyond this, as part of the
FALCON Method, I also highlight a “Top Pick,” which is the company that
I myself would pick if I could only invest in one stock.
How Can the FALCON Method Help You?

By now, I hope I have been able to show you some aspects of stock
selection you may not have thought about before. And hopefully I was able
to present everything in such an easy-to-understand format that you might
be wondering why you haven’t followed this method so far just based on its
common-sense nature.
At this point, you may feel you have learned something completely useful
here and are ready to start implementing all this stuff on your own. When
you do, you will encounter many obstacles (e.g., expensive or outright bad
data providers of stock info), but you can reach your goal if you are devoted
and never give up. I have gone through this process myself, so I should
sound credible when I warn you in advance: this will cost you thousands of
dollars and many months of your time. If investing is your passion, you
may opt for this first option, although I feel your money and energy could
be much better spent.
The second option is to get the targeted results of this investment process in
a ready-to-use newsletter format every month. The FALCON Method
Newsletter includes the following valuable sections:
An introduction: Here I share my opinion on the market,
highlight some current news and opportunities worth paying
attention to, or simply illustrate an important investment concept
with current examples. By reading this, subscribers to the
FALCON Method Newsletter will become better investors and
decision makers.
The Top10: This is exactly what you think it is—the list of the
10 highest ranked stocks that survived all the method’s filtering
processes and met all our quantitative and qualitative criteria.
Short analyses: For all the companies in the Top10, I share the
most important data and considerations in the form of an easy-to-
understand analysis. This part is meant to help you understand
my thought process, along with the background of the investment
opportunities the FALCON Method has highlighted.
Top pick of the month: When compiling the newsletter and
distilling all the details of the month’s top stocks, the best
opportunity usually stands out from the rest of the pack. I feel it
provides added value if I tell you which company I would invest
in if I could only go with one stock. (If it is a close call between
two candidates, I will let you know my thoughts about why I
picked the winner. This is both educational and useful.)
A complete ranking of all the stocks in the “Premium
Dividend Club”: In this section, you get a list of stocks with at
least 20 years of immaculate dividend history, ranked in the order
of their yield-plus-growth characteristics as described in the
“Rank the Survivors” part above. This list highlights the stocks
that fail to meet the absolute threshold criteria of the FALCON
Method so you can omit them if you wish. You can use this
ranking if you are as obsessed with undervaluation and the
double-dip benefit as I am, since this ranking does not employ
the double-dip filter in order to include all the stocks of the
“Premium Dividend Club”. You can also see the broad business
sector in which the listed companies operate, which can help
balance your portfolio. Some subscribers may find this useful, so
why not provide it?
 When to sell: The FALCON Method is not a trading system, but
a buy and hold approach, so it employs very simple rules for
selling that are not often triggered. In the newsletter, I always
give an alert when one of the stocks that in some previous issue
occupied a place in the Top10 becomes a “sell.”
There are two reasons for selling a stock under the FALCON Method:
the company cut its dividend or its shares have become extremely
overvalued. If neither of these happen, it is better to leave the stock
alone. Our attitude corresponds with the teachings of Ben Graham, as
we know we should forget about our stocks as long as they are doing
their job: growing their earnings and putting more and more
dividends in our pockets. We are very picky when it comes to stock
selection in the first place, but we only focus on the dividend and
valuation criteria afterwards.
“Keep your eyes wide open before marriage, half shut afterwards.”
—Benjamin Franklin
With the FALCON Method Newsletter, you are not buying excitement but
performance. The difference between these two is night and day.
Let me share some eye-opening research results with you. Financial
services giant Fidelity reportedly conducted an internal study, a
performance review of clients’ accounts, to see which accounts did the best.
They found that the best-performing investment accounts were from
investors who were either dead or had completely forgotten that they had
accounts at Fidelity.
Hard ways to become successful indeed, but don’t worry—simply staying
passive can do the trick! The problem is, most people believe that activity is
rewarded, so they think they always have to do something to get top results.
Well, it is good to know that this is not so in the field of investing.
“Our portfolio shows little change: We continue to make more money
when snoring than when active. Inactivity strikes us as intelligent
behavior.”
—Warren Buffett, 1996
Practicing passivity is easier said than done, although it clearly protects us
from taxes, transaction costs, and our psychological biases, all of which are
enormous drags on long-term investment performance. The simple yet
effective selling rules of the FALCON Method keep us on the proven track
of passivity and outperformance.
I want to make something very clear before I even mention the price of the
FALCON Method Newsletter: I am not selling some entertaining “show
business” stuff here, so don’t expect me to come up with 10 brand-new
stock ideas each and every month! I am putting my money where my mouth
is, so I myself invest in the stocks that are ranked best by the FALCON
Method. I am experienced enough to accept that I should always limit my
purchases to the best opportunities Mr. Market provides, no matter how
slowly or quickly he changes the names of the stocks on sale. Although I
have absolutely no control over the market, I have total control over my
own decisions. Following the path I have outlined here, one can build a
diversified portfolio of the best stocks in various sectors. This takes time
and the process is more rewarding than exciting.
“Investing should be like watching paint dry or watching grass grow. If
you want excitement, go to Las Vegas.”
—Paul Samuelson
I have always felt I can use the money I make to buy excitement if I wish,
so why seek excitement in the field of investing, where it is simply too
expensive or overpriced to get? (And a sensible investor does not buy
overpriced stuff.)
The Price: How Much Can You Save?
“Price is what you pay, value is what you get.”
—Warren Buffett
I have spent years reading all the books and newsletters on investment I
could get, as learning everything about this field is my passion. After a
while, the pieces of the jigsaw puzzle started to come together and I found I
could synthesize all the information I learned and thought important. This is
how the FALCON Method was born.
The most eye-opening experience came when I had the chance to speak at a
financial conference in 2016; the audience of about 300 people surrounded
me after the presentation. They acknowledged that they understood and
enjoyed my presentation, and the investment process I drew up seemed
logical, but many of them had the exact same question for me: “I see that
you love what you’re doing and you must be good at it. How can I benefit
from this concept without putting in the same amount of work you did?
Couldn’t you just share the names of the stocks you consider the best
investments?”
That was when I decided that I should write this book describing the
underlying process of the FALCON Method and start a newsletter service
that offers people just what they are asking for: the stocks that stand out
from the crowd and provide the best investment opportunities. My main
motivation was to make this service available to as many people as
possible.
I can tell you honestly that such a comprehensive process as the FALCON
Method requires huge amounts of data, all structured and illustrated in a
certain way so that one can manage the group of hundreds of stocks that
make up the “Premium Dividend Club”. These tools together cost me
$1,318 annually as of January 2017. (And the prices of the underlying
services are trending up.)
Even if you are willing to put in all the work yourself, you may not have a
portfolio size that makes paying more than $1,000 annually for data and
visualization services reasonable. And this is just the money part of the
equation—the value of your time and effort is hard to quantify.
I had a serious decision to make about pricing. I did not want to create an
“elite service” for just a few people who could afford the high standard I am
committed to providing. So instead of looking at my costs and time
invested, I examined the pricing of other investment newsletters, regardless
of their (often subpar) quality. I noticed that typical annual subscription
rates ranged from $79 to $795.At this point, I did a quick survey among
the attendees of my above-mentioned presentation and was amazed to find
that most of them said they would be happy to pay somewhere in the region
of $250–300 per year to receive the monthly picks of the FALCON Method
and my related analyses.
Considering this was after they met me in person and had gained an
impression I couldn’t make with this book (or could I?), I thought I would
make your decision really easy. I set the annual subscription rate of the
FALCON Method Newsletter at $197.
And although it’s already deeply below the real value of the service, this is
still not my final offer, since I want to show you how much I appreciate that
you have read this far. Understanding the background of the FALCON
Method is essential to sticking with it for the long run, and it is the only
way my newsletter can benefit you. In an ideal world, I would only have
subscribers who took the time to study my investment process, so I would
like to thank you for doing just that. As a welcome bonus, your annual
subscription rate is reduced to $97 (or about $8 a month) if you use the
coupon code “READITALL30”. You will be shielded from future price
hikes as well; your rate will stay the same as long as you continue your
subscription without interruption.
As I believe in the old-school way of doing business, I answer all the
subscriber questions I receive. So honestly, a bit of selfishness crept in
when I offered you this low price, since I think it’s better to surround
myself with a group of people who are familiar with what the FALCON
Method is about than with ignorant ones who devote no time to learning
and understanding the basics but want instant wealth instead.
There are situations in the stock market when the price you pay and the
value you get diverge considerably, as Warren Buffett frequently mentions.
Good investors pounce on the opportunities that let them buy great value at
a deep discount. Having read this far, you now realize that the FALCON
Method Newsletter can be the cornerstone of your financial future and is
worth much more than $8 a month. Feel free to use the coupon code below
and enjoy the results of your first value purchase. Welcome on board!
Go to https://thefalconmethod.com/newsletter-30day-special to join now
and instantly receive the latest FALCON Method Newsletter.
(Enter coupon code READITALL30 on the checkout form)
Price: $197 $97 annually
As a special offer for reading this book your plan comes with a risk-free 30-
day trial (instead of the standard 7-day version). You are truly not billed for
30 days, so there is no downside at all to trying the FALCON Method
Newsletter, while there is a serious upside to investing in high-quality
dividend-paying stocks.
How to Use the Newsletter Wisely
Building a high-quality stock portfolio is absolutely not complex. However,
depending on your situation, there may be alternative ways to put the
recommendations of the FALCON Method to good use.
If you are saving and investing regularly, it is a wise strategy to see which
stocks in the Top 10 you have the least dollar amount invested in, then buy
the highest ranked of those stocks. Or you can go for the Top Pick of the
month if you do not own it yet. With this approach, you can build a well-
diversified portfolio of top-quality stocks, all purchased at attractive prices.
(Of course, you also can use the Top10 list as a simple idea generator if you
want to analyze companies on your own.)
If you have a lump sum to invest, I suggest that you divide the money into
24 equal parts and invest it gradually over the next 24 months (putting in
1/24 of the money each month), always purchasing the most attractive
stocks on the Top10 list of the FALCON Method Newsletter. This way, you
can free yourself from the frustration of the Mission: Impossible called
market timing.
“I can't recall ever once having seen the name of a market timer on
Forbes' annual list of the richest people in the world. If it were truly
possible to predict corrections, you'd think somebody would have made
billions by doing it."
—Peter Lynch
You may also have your own criteria, like “the dividend yield must be
above 3%.” In this case, pick the stocks from the Top10 that fulfill your
requirements, and do this every month. But if you notice that none of
today’s best opportunities can jump over your bar, it may be time to think
whether your expectations are still realistic in the prevailing market
environment. (You can always go for high yielders, but if the market is not
in the mood to support your passion, you will have to make a serious
compromise on quality that can easily backfire. The FALCON Method will
show you the best ideas in every kind of market.)
No matter whether you intend to invest regularly or have a lump sum now,
you must make a decision about how many stocks you want to own in your
portfolio. You can read numerous arguments for both diversification and
portfolio concentration. Let me clear up this issue once and for all by
highlighting the two opposite ends of the spectrum. These extreme
examples will help you draw the right conclusion.
If you are a theoretical “know-everything” investor who is 100%
sure which one single stock in the whole universe will provide
the highest return, it would be a dumb move to put any money
into even your second-best idea. In this theoretical case, you
should go for total concentration and put 100% of your money
into that single best stock.
On the other hand, if you are a “know-nothing” investor who
wants to profit from the wealth-building power only stocks can
provide, you should put your eggs in as many baskets as
possible. After all, you know nothing about specific companies,
so how could you pick any of them and expect superior
performance?
Professional investors who analyze companies deeply, read all their filings,
and immerse themselves in industry data are often running concentrated
portfolios, since they spend all their lives studying stocks and closely
following the performances of the underlying businesses. Warren Buffett is
certainly this type of investor, but you will most likely not follow in his
footsteps.
A few years ago, Warren Buffett was speaking to students of the
Columbia University School of Business when he was asked what the
biggest key to success was that he could share with the class. His
answer was surprising, to say the least.
He held up a stack of reports and trade publications he had brought
with him and said, “Read 500 pages like this every day. That’s how
knowledge works. It builds up like compound interest. All of you can
do it, but I guarantee not many of you will do it.”
Chances are you won’t become the next Warren Buffett, and you most
likely should not aim for a highly concentrated portfolio, but you can still
beat the market if you strike a balance between the two extremes. My
suggestion is to go for 20–30 positions and make them approximately
equally weighted. This way, you will reap the rewards of
diversification[37]where you can have a portfolio of top companies from
various sectors, and these stocks will put ever-increasing dividends in your
pocket.
If you start following the recommendations of the FALCON Method
Newsletter, after a few years, you might have more positions than you feel
comfortable with. In this case, I recommend that you sell the stock in your
portfolio that ranks the lowest in the complete ranking and use the proceeds
to buy one of the Top10 stocks in which you own the least dollar amount.
(If you are close to retirement, you may decide to sell the lowest-ranking
stock and buy one of the Top10 stocks instead or, depending on your
situation, you may not even reinvest the proceeds in equities at that stage.)
The process of portfolio building is really easy once you start investing and
get in the swing of it. And don’t forget: if you have questions, I am
always here to help the members of the FALCON family.
Recap: Dissecting the “Black Box Model”
Although the FALCON Method truly encompasses all the money pipes of
corporate operations (as detailed in the “black box” section), some of the
connections between our model’s components and the pipes themselves
may not be obvious at first. This is why I decided to provide a really short
summary of the most important issues below.
A company’s value stems from the “no-strings-attached cash” it can
generate, the so-called free cash flow. The FALCON Method focuses on
firms where this free cash flow has made an immaculate dividend history of
at least 20 years possible. As a first step, our selection of the “Premium
Dividend Club” stocks addresses the crucial role of free cash flow (no
company without consistent earnings power and cash making capacity can
give two decades of stable or increasing dividends to its shareholders).To
make things even more explicit, the FALCON Method also examines the
free cash flow yield as an absolute threshold criterion. What’s the
connection with the money pipes? The free cash flow category itself covers
the following pipes: revenues, ongoing expenses, taxes, and capital
expenditures.
You can see stock transactions on both the input and output sides of the
black box model. As investors, we hate when the company issues stock and
dilutes our ownership stake, but we certainly like it when they buy back
their (undervalued) stock. The shareholder yield component of the
FALCON Method addresses stock issuances and buybacks, so it helps us
uncover the dirty tricks some managers employ to deceive their
shareholders. Related pipes are equity sale and share buyback.
The question of leverage gets tackled by the three component shareholder
yield (which contains the debt paydown) and the examination of the return
on invested capital (ROIC), which must be way above the interest on debt.
Related pipes are borrowed money and payments on debts.
The ROIC also helps us uncover how well the management deploys the
retained earnings. Related pipe: retained earnings.
I’m sure that the “dividends” pipe does not need further explanation, but
you may have noticed that the output pipe called “acquisitions of other
companies” was nowhere to be found above. This particular pipe is not
addressed directly in the FALCON Method because acquisitions are simply
an external growth method, and what we are really interested in is the result
of the transaction (that is, its effect on free cash flow and dividend). In
general, I am not a fan of acquisitions, as they are riskier than reinvesting in
the organic growth of the company, but the top managers behind such
immaculate dividend histories tend to know what they are doing.
It is almost impossible to judge an acquisition in advance, even if you read
all the available information on the announced transaction, so it is much
better to focus on its long-term effects. By keeping a close eye on
dividends, free cash flow, and ROIC, you are basically demanding that
management put the company’s money (that is, your money, since you are a
part-owner) to the best possible use so that the firm’s cash-generating
capacity can increase and your dividends can grow along with it.
For the sake of conciseness, this explanation might be oversimplified at
some points, but this section has one single goal, and that is to remind you
that the FALCON Method examines the companies from various angles
and only gives the green light when all three dimensions (operations,
capital allocation, and valuation) are right. No important detail can hide
from the eyes of the falcon.
Let me emphasize again, however, that the FALCON Method is 90% based
on quantitative factors and certainly does not involve reading all the
corporate filings with their sometimes very revealing footnotes. I leave this
kind of tedious work to Buffett and his handful of followers; instead the
FALCON Method identifies the companies that are operated well, have
consistent earnings power, treat shareholders as partners, pay increasing
dividends, buy back their shares, and have attractive stock valuations. When
all these factors point in the right direction, outperformance is virtually
guaranteed on a portfolio level. (You can run into one or two bad apples,
but the rest of your portfolio will more than compensate for them.)
“So the really big money tends to be made by investors who are right
on qualitative decisions—but, at least in my opinion, the more sure
 money tends to be made on the obvious quantitative decisions.”
—Warren Buffett, 1967
Even Warren Buffett admits that the surest way to make money is to stick
with the obvious quantitative decisions like the FALCON Method does. The
alternative is to become a full-time qualitative investor and devote your life
to this.
“I read and read and read. I probably read five to six hours a day.”
—Warren Buffett
It is one thing to agree with most of Buffett’s investment principles, but it is
a completely different thing to try and copy his style without putting in the
same amount of work he does. Chances are that no matter how much you
read, you will not be able to mimic the Oracle of Omaha and judge the
long-term competitiveness of businesses with such a high confidence that
you can manage a highly concentrated portfolio of stocks based on your
conviction. Instead of that demanding and stressful approach, most of us
should go with the “more sure money” theory and live a meaningful life
alongside investing in a sensible way.
Afterword: The Key to Success You Hold
“If you can't describe what you are doing as a process, you don't know
what you're doing. We should work on our process, not the outcome of
our processes.”
—W. Edwards Deming
The FALCON Method is an all-around investment process that is made up
of proven elements. This, however, does not mean that all the stocks you
purchase based on the newsletter will be big winners from the moment you
press the “buy” button. You need to understand that intelligent investing is
probabilistic and not deterministic, which means that by consistently
executing a strategy that tilts the odds of outperformance in your favor, you
will achieve superior results in the long run…but you will have to accept
the inevitability of errors along the way. Simply put: you will surely have
losers in your portfolio, but the winners will more than compensate for
them.
All you can do is focus on the process and its consistent execution, no
matter how you feel. It is easier said than done, but this is exactly what
sensible investing is about. There are similarities between investing wisely
and playing a poker hand well. Just have a look at the “process versus
outcome” matrix of Russo and Schoemaker before we proceed:

Good Process
Good Outcome – deserved success
Bad Outcome – bad break
Bad Process
Good Outcome – dumb luck
Bad Outcome – poetic justice

You can play a poker hand terribly (like going all-in pre-flop with your off-
suit 7 and 2) and still win it[38]. This is because the outcome of a single hand
is strongly influenced by randomness, or luck if you like. But continue to do
this kind of silly stuff at the poker table and you are sure to go broke. With
a bad process, the odds are against you, and the more you play, the higher
your probability of losing grows. With your first hand, you could have
dumb luck (the combination of a bad process and good outcome), but later
you will face poetic justice (the combination of bad process and a deserved
bad outcome).
The opposite is also true, though, and this makes investing a
psychological rather than an intellectual endeavor: you can excel at the
disciplined execution of a good process that tilts the odds of winning in
your favor (like the FALCON Method), but you will still run into some bad
breaks. Some of your stock selections will not work out, which is like
losing a poker hand with your pair of aces; it can happen, but you must not
let it throw you off the right track. You absolutely must continue to play the
game wisely; stick to your good process and the deserved success will
come.
Why am I throwing this stuff in here instead of just finishing this book and
selling my newsletter? Because I am honest and want to highlight the real
key to your success, which is you. Mark Hulbert has been independently
tracking the performance of several investment newsletters for decades and
notes that most of the time, subscribers to the newsletters achieve subpar
performance compared to the newsletter they follow. The reason is simple:
most subscribers fail to act consistently. (Notice that I am not talking about
the quality of the processes the underlying newsletters employ, but rather
the way the subscribers use the recommendations they get. Even if the
newsletter is a decent one—which is a big “if”—most people fail to reap the
rewards of their subscription.)
No matter how good the FALCON Method is—and I certainly hope you’re
convinced about its quality by now—consistency on your part is essential to
your success.
“The main point is to have the right general principles and the
character to stick to them.”
—Benjamin Graham
I have filled dozens of pages to show you the general principles behind the
FALCON Method. Now it is your turn to make a decision about whether
this approach is something you feel comfortable with. You can only stick
with it through thick and thin if you understand the process and accept it
wholeheartedly. Consistency is vital for a good performance—just
remember the example of why the S&P 500 index is hard to beat!
With the FALCON Method Newsletter, the first key to your success (having
a good process) is firmly in place: all the factors involved point toward
outperformance. The second key (your consistent execution) has gotten a
huge boost by focusing on reputable, quality dividend payers that give you
more and more passive income, no matter how their stock prices might
fluctuate. These are well-known stocks that are easy to buy and hold. The
psychology of investing cannot get much more manageable than this, so I
wholeheartedly hope that the members of the FALCON family will enjoy
great success.
See you on board!
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About the Author

“Being honest may not get you a lot of friends, but it will always get
you the right ones.”
—John Lennon
I was born in Hungary in 1982. My parents got divorced before I turned 10
and this had a huge influence on my life. I stayed with my mother, who was
working as a kindergarten teacher, while my father became one of the most
successful businessmen in our town. I saw two very different financial
realities at a young age and made a decision that determined my path: I
wanted to become financially free as quickly as possible so that I would not
need to put in long hours (like my father, who was always working) to get
the kind of income that let me go to the grocery store and shop with the
feeling that I could afford to buy anything I desire (which we most certainly
could not do on my mother’s salary).
This motivation led me to become an economist and start my career as an
equity analyst at Hungary’s most reputable online financial journal.
Because I wanted to break free, I established and sold my first company by
the age of 24, and more of the same “building and selling” processes
followed afterwards. I benefited immensely from having built companies
from scratch, seeing the black box model in operation. This is an advantage
many investors do not have.
"I am a better investor because I am a businessman, and a better
businessman because I am an investor."
—Warren Buffett
Having been the CEO of companies in different fields (e-commerce, digital
agency, media, etc.), I can honestly tell you that as an outside investor, you
have absolutely no chance to see what is happening inside the black box.
You will never know the tiny details, so it is better to accept this and focus
on the money-carrying input and output pipes connected to the black box—
those are the ones that are really important and are still visible from the
outside. Having lived both sides of the story—the CEO and the investor
roles—I am sure that superior investment results can be achieved by
focusing on the money pipes just as the FALCON Method does.
Since investing is my passion, I surrendered all my executive roles at the
age of 33 (I kept some ownership stake in one of my companies but retired
from its operative management) and became a full-time investor. I have
read hundreds of books along the way and asked the authors and other
reputable investors tons of questions until my investment process began to
crystallize. I wrote a book on dividend investing that became a category
bestseller in Hungary and taught my approach in both personal and online
video formats. I have done all this teaching and writing without a definite
financial motivation (since I was already living off passive income at that
stage). My goal was to get my message to as many people as possible and
help them move in the right direction.
As mentioned before, I got an invitation to speak at a financial conference
in 2016, where people from the audience flocked to me after the
presentation and were so enthusiastic that they kept asking questions for
more than an hour (during our lunch break). The only question I could not
answer back then sounded like this: “Couldn’t you just share with us the list
of stocks you think present the best investment opportunities? Not everyone
would like to put in the same amount of work you did, but this process
really looks well-built and logical, so we would use its results if we could.”
This is how the FALCON Method Newsletter was born. Up until its launch,
I was driving full throttle with my eyes closed, putting in an enormous
effort to teach my way of investing to as many people as possible, but I
failed to realize that most of them only wanted to understand the underlying
thought process; once they were convinced that my approach should work,
they wanted me to manage their money, or at least help them with stock
selection. The newsletter service is as close to this desired solution as
possible, and it is more than affordable to most of the people who trust the
process I have outlined in this book. I wrote all these pages so that you
wouldn’t have to buy a pig in a poke as with most newsletters. Please take
your time, understand how the FALCON Method works, and once you
think that you can consistently follow this investment system in the long
run, I welcome you on board.
In closing, let me share with you a part of a song I used to listen to often
while training for my first Ironman triathlon race. It sums up nicely how I
think about life and goal-setting, and how I managed to achieve everything
I’ve done so far. I wish you all the best and hope to see you in the FALCON
family.

Maybe there’s another path that'll

Get you there a little bit faster
But I’m sticking with the one inside of me
That’s the only way I know
Don’t stop 'til everything’s gone
Straight ahead, never turn round
Don’t back up, don’t back down
Full throttle, wide open
You get tired and you don’t show it
Dig a little deeper when you think you can’t dig no more
That’s the only way I know.
(Lyrics of “The Only Way I Know” by Jason Aldean)
The FALCON Method Newsletter helps you to take advantage of the
systematic mistakes that most humans make, rather than suffer from them.
It gets you to buy top-quality stocks when they are marked down because of
psychological biases. The most important thing is to buy quality on sale and
to do this consistently and systematically, while measuring the results of
your entire investment portfolio and not focusing on only a few of your
individual stocks. You have complete control over the process and the
results will take care of themselves in the long run. By buying a diversified
portfolio based on just the numbers, not emotions, you have taken your first
step toward financial freedom.
Get your special discount on the FALCON Method Newsletter with this
coupon:
READITALL30
Use it here: https://thefalconmethod.com/newsletter-30day-special
Remember, you have a 30-day free trial and you will be shielded from all
future price hikes; your annual subscription fee stays $97 as long as you are
on board.
Endnotes
[1]
If you have doubts, read the story of one of the world’s most renowned economists, John Maynard
Keynes, who was a hopeless speculator and market timer before converting to value investing. (See:
Concentrated Investing by Benello, Van Biema, &Carlisle)
[2]
Again, if you have your doubts, please check out this US inflation calculator that measures the
buying power of the dollar over time using the official US government data:
http://www.usinflationcalculator.com. The US dollar has lost 95% of its purchasing power between
1913 (the creation of the Fed) and 2013 according to U.S. Bureau of Labor Statistics.
[3]
Fred Schwed’s fantastic book Where Are the Customers’ Yachts? is a classic on this topic.
[4]
Chapter C-7, p. 118-120.
[5]
Earnings figures in the company’s Profit and Loss Statement (P&L) are not the same as the
“surplus cash” I am referring to. Profit and cash flow numbers can differ considerably, and by the end
of this book, you will know exactly which figures to focus on.
[6]
In my opinion, the best books on quantitative investing are: What Works on Wall Street by James
O'Shaughnessy, Quantitative Value by Wesley Gray and Tobias E. Carlisle, and The Little Book that
Still Beats the Market by Joel Greenblatt.
[7]
A tiny company.
[8]
You can find it here: http://us.spindices.com/indices/strategy/sp-500-dividend-aristocrats
[9]
A company that has been paying higher and higher dividends for at least 25 consecutive years is
called a Dividend Champion.
[10]
By no means do I want to make you think that Boeing paid more dividends in this period than
Mercury General did. Instead, the example serves to highlight that investing in a “Dividend
Champion” does not automatically mean seeing massively growing dividends.
[11]
$100 divided by 100 shares.
[12]
$259 divided by 100 shares.
[13]
Price return alone, not counting the dividends you could get along the way.
[14]
Okay, I will. If you sell out the same share you bought at 8 times earnings at a multiple of 15
(which is still too conservative to describe a situation of euphoria), then your return skyrockets to
386%.
[15]
The actual earnings per share figure is multiplied by 15 every year.
[16]
Notice that we haven’t sold at the overvalued levels, because I wanted to show you an example of
unchanged multiples. By the way, no one can guarantee that the stock you purchase will ever become
overvalued, so there is no use speculating on that. Buy top quality on the cheap and your job is done!
Time will take care of the rest.
[17]
If, for some reason, you do not find the differences in annual returns meaningful, have a look at
the following calculation of what even a 1 percentage point difference in annual return can mean in
the long run. Investing $1,000 for 20 years at an annual rate of 10% gives you $6,728 by the end of
the period, while this result could grow to $8,062 with a slight increase in the annual rate of return to
11%.
[18]
I will define this free cash flow category in a moment.
[19]
Calculating with a forward annual dividend of $3 and a stock price of $100, the dividend yield is
3% (3/100).
[20]
This is calculated by deducting capital expenditures (called capex) from the operating cash flow.
(A better approach is to split the capital expenditures to maintenance and growth components and
deduct only the maintenance capex that is to keep the company at the same level. Unfortunately, this
is easier said than done, so most investors simply deduct the full capex.)
[21]
The free cash flow yield is calculated in the following way: free cash flow per share / share price.
[22]
The shareholder yield is the sum of the dividend yield and the buyback yield, where the buyback
yield measures how much a company has bought back its shares in the last 12 months over a
company's market capitalization.
[23]
Byron Wien and Frances Lim, “Lessons from Buyback and Dividend Announcements,” October
4, 2004.
[24]
The book What Works on Wall Street by James O'Shaughnessy can provide enough evidence all
on its own.
[25]
The FALCON Method prefers the shareholder yield indicator that includes the net-debt paydown
component, since it is a good way to filter out companies that are financing the major part of their
shareholder returns by taking on debt. If such an indicator is not available, the FALCON Method
provides another criterion to address the issue of debt.
[26]
The data is accurate as of the time of writing (20 January, 2017).
[27]
The two-component version that includes dividends and buybacks.
[28]
The yield on your original investment would still be 2.85% at the end of the 10th year, even if
you reinvested all the dividends you received along the way.
[29]
A 10% growth rate would catapult your yield on cost to 5.55% by the end of the 10th year. I hope
you notice the difference. (And the stock price should have increased along with the dynamic growth
as well.)

[30]The figures I picked for the sake of illustration are Chowder-like numbers, so they are the sum
of the current dividend yield and the dividend growth rate of certain timeframes.
[31]
As of January 2017, Mercury did survive the competition, but in this weighted multifactor ranking
process, it only collected 35.37 points of the possible 100, which means it was ranked 285th of the
325 stocks evaluated.
[32]
Stocks offering a potential double-dip benefit are easy to identify, and so are the ones with extra-
high valuation multiples, but human judgment must be employed with those somewhere in the
middle.
[33]
As of early 2017, Coke’s free cash flow yield and dividend yield were almost equal, which means
that the company pays out nearly all the cash it generates. This illustrates how dividend coverage
came into the picture (indirectly) long before the final phase of the FALCON Method.
[34]
The DPS/FCF ratio was 96% as of January 2017.
[35]
Net Income / (Total Equity + Long-Term Debt)
[36]
This again is pointed out in James O'Shaughnessy’s book What Works on Wall Street.
[37]
In their book Investment Analysis and Portfolio Management, Frank Reilly and Keith Brown
reported that in one set of studies for randomly selected stocks, "…about 90% of the maximum
benefit of diversification was derived from portfolios of 12 to 18 stocks." In other words, if you own
about 12 to 18 stocks, you have obtained more than 90% of the benefits of diversification, assuming
you own an equally weighted portfolio.
[38]
This example refers to a hand of Texas Hold’em Poker, where 7-2 off-suit (meaning the cards are
of different suits) is considered one of the worst starting hands. Even if you do not know the rules of
the game, it is pretty easy to accept that you shouldn’t risk all your money (go all-in) on one of the
worst starting hands you could possibly get.