Recently, I have been very busy with my work. Still trying to get used to the habit of logging in a blog entry but always felt that it was a chorte for myself. One could tell that my last post was about 4months ago. Totally pathetic.
Anyway, here i am trying to jump start this journal again.
Not too long ago, i finished this book by Pat Dorsey, author of "The five rules for successful stock investing" I thought the book was quite well written, supplemented with examples and step by step analysis. Very good book for beginner.
Well, today's post is about finding the choosing the right stock to purchase. I am extracting a chapter that i read from the book to be shared here. Well you see, sometimes, stock selection can be a very tedious affairs. There are so many stocks out there in the market. You can be doing a detailed analysis of every single one of them. However, everyone of us have a full time job and we need to make use of the time efficiently. In short, this entry is on how to narrow your stock selection to a few good ones using the following method.
Broad Picture - You determine the industry that you are interested to look at. Eg biotech, services, manufacturing, commodities. After determining the industry, generate a list of the companies in that industry and measure them according to the metrics below.
1. Company must be generating profits.
Easier said than done. Most often firms that are still in the money losing stage sounds the most exciting for promise of major turn-around. Think again.
2. Consistent CF from operations.
It is possible for the company to report profits even before they generate cash. Company with a persistent negative cash flow eventually will have to seek re-fnancing options and increase the risk for the Shareholders.
3. Return of equity of more than 10 percent
This is a baseline figure but its a good gauge. one thing to note is that firm must practicse adequate leverage to achieve a high ROE. (exception for firms in cyclical industry. But one can try to annualised the annual growth rate to determined if earnings are lumpy)
4. Earnings growth must be consistent.
Lumpy earning growth could mean that the firm faces tough competition and have yet to strengthen its foothold in the industry. This is a issue for concern.
5. How clean is the balance sheet. (Debt to equity ratio and net cash position as strong indicators)
Make sure you understand the debt that the company is taking. Company that is involved in too much complex deriatives should be avoided.
6. Does the firm generate Free Cash Flow.
Yes this should be the case always but in the case of a negative CF and you understand that these are capital expenditures used for expansion then its alright.
7. Has the number of shares increased or decreased over the years.
Increasing shares through placements and rights are anti-stakeholders action and dilute the SH value whereas company that re-purchase its own stocks are generally creating more SH value. But take this with a pinch of salt.
After going through this metrics, you should have narrowed down your selection by a lot. Whats' next?
Examine the 5 year I/S, B/S and C/F statement. Read more about the company industry, their business models, who are the competitors to get a better knowledge of the company that you are looking at.
After which, the most tedious part is to start valuing the company. Using valuation multiples or discounted cash flow valuation to do your work. Establish a rough guideline and establish a reasonable margin of safety and decide for yourself if the company is worth buying.
Anyway, here i am trying to jump start this journal again.
Not too long ago, i finished this book by Pat Dorsey, author of "The five rules for successful stock investing" I thought the book was quite well written, supplemented with examples and step by step analysis. Very good book for beginner.
Well, today's post is about finding the choosing the right stock to purchase. I am extracting a chapter that i read from the book to be shared here. Well you see, sometimes, stock selection can be a very tedious affairs. There are so many stocks out there in the market. You can be doing a detailed analysis of every single one of them. However, everyone of us have a full time job and we need to make use of the time efficiently. In short, this entry is on how to narrow your stock selection to a few good ones using the following method.
Broad Picture - You determine the industry that you are interested to look at. Eg biotech, services, manufacturing, commodities. After determining the industry, generate a list of the companies in that industry and measure them according to the metrics below.
1. Company must be generating profits.
Easier said than done. Most often firms that are still in the money losing stage sounds the most exciting for promise of major turn-around. Think again.
2. Consistent CF from operations.
It is possible for the company to report profits even before they generate cash. Company with a persistent negative cash flow eventually will have to seek re-fnancing options and increase the risk for the Shareholders.
3. Return of equity of more than 10 percent
This is a baseline figure but its a good gauge. one thing to note is that firm must practicse adequate leverage to achieve a high ROE. (exception for firms in cyclical industry. But one can try to annualised the annual growth rate to determined if earnings are lumpy)
4. Earnings growth must be consistent.
Lumpy earning growth could mean that the firm faces tough competition and have yet to strengthen its foothold in the industry. This is a issue for concern.
5. How clean is the balance sheet. (Debt to equity ratio and net cash position as strong indicators)
Make sure you understand the debt that the company is taking. Company that is involved in too much complex deriatives should be avoided.
6. Does the firm generate Free Cash Flow.
Yes this should be the case always but in the case of a negative CF and you understand that these are capital expenditures used for expansion then its alright.
7. Has the number of shares increased or decreased over the years.
Increasing shares through placements and rights are anti-stakeholders action and dilute the SH value whereas company that re-purchase its own stocks are generally creating more SH value. But take this with a pinch of salt.
After going through this metrics, you should have narrowed down your selection by a lot. Whats' next?
Examine the 5 year I/S, B/S and C/F statement. Read more about the company industry, their business models, who are the competitors to get a better knowledge of the company that you are looking at.
After which, the most tedious part is to start valuing the company. Using valuation multiples or discounted cash flow valuation to do your work. Establish a rough guideline and establish a reasonable margin of safety and decide for yourself if the company is worth buying.
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