Where the Experts Agree
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Look for strong income statements and balance sheets
A high profit margin means the company keeps more what it earns.
You would rather own a company that has a lot of cash on hand than a company that has a little.
Don’t invest in companies with a lot of debt, don’t go into debt yourself.
Look for insider stock ownership and company buybacks
Look for a management team that communicates honestly and makes all decisions in the best interest of shareholders.
Look at the present value of future free cash flow, PE and price-to-book ratios, and earnings acceleration.
Conduct thorough research
Buy at a price below the company’s potential
A value investor looks at a company’s assets, how much it's sold, its profit margins, and other factors before determining whether the price is more or less than the company is worth. A growth investor looks at earnings per share, the acceleration of deceleration of those earnings, analyst expectations, and positive surprises.
Look at future free cash flow!
The company must have accelerating earnings, a small supply of stock and high demand, a leading industry position, and moderate institutional sponsorship.
Keep or Buy more of what's working.
Watch things like the company’s profit margins, its return on equity, and honest communication with shareholders. Do not look at daily or weekly stock price fluctuations because they’re took fickle.
An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business.
Take advantage of Price Dips
If you bout a company because of its outstanding new products, high profit margins, and accelerating growth rate and the company still boasts those attributes, there's no reason to sell. In fact, there's every reason to buy more- regardless of price.
Time helps wonderful businesses but destroys mediocre ones.
The business valuation is simply the stock’s book value and its earnings. The Book value is determined by dividing all the company’s assets by the number of stock shares outstanding. In other words, it’s the amount you could get if you liquidated the company- sold everything the company owns, like the delivery trucks, fax machines, and conference tables.
The Market Valuation is what the stock trades for.
You’d much rather buy stocks at prices lower than their business valuations, of course, because they’re on sale.
Buy stocks at prices near their business valuations. That means you’d like price/book ratios to be around 1 and your would also like P/E ratios low, preferably below 15.
Margin of Safety: difference between business and market valuation.
A stock with a big margin of safety is trading at such a cheap price in the market that even if your calculations are a little off or something terribly happens at the company, the investment is likely to do well. A stock with a small margin of safety is trading so close to its business valuation that if your calculations are wrong or something terrible happens at the company, the investment is likely to decline from where you bought, causing a loss.
Buy stock for no more than 2/3 of its book value (A stock's price/book ratio should be no more than .66).
You can thoroughly understand only so many companies. Therefore, Fisher recommended a focused portfolio. He rarely placed more than 10 companies in a portfolio and even at that most of the money was usually concentrated in three or four stocks. A few superior companies are better than a slew of mediocre ones.
Know a company’s profit margin
Look for positive cash flow and a healthy cash reserve so the company can meet obligations without borrowing
Lowest-cost producers have an edge in all phases of the economy. Combined with a high-profit margin, low cost production is Fisher’s version of Graham margin of safety.
Day trading is worthless
Buy quality companies rather than speculating about the direction of a stock price. Good companies are still good companies when times are bad. If you buy a good company and the price of its stock drops, that doesn’t signal anything more than a chance to pick up additional shares at a discount.
Time helps wonderful businesses but destroys mediocre ones.
Look at ROE instead of just plain earnings. It's just as important to know what a company does with what it earns as it is to know what it earns.
A company’s net profit margin is determined by dividing the money left over after paying all its expenses by the amount of money it had before paying expenses. So, if a company makes $1 million and pays $900,000 in expenses, its net profit margin is 10%.
Determine the value of a company by projecting its future cash flows and discounting them back to the present with the rate of long-term US government bonds.
Compare the value to the price and determine the margin of safety. In other words, if the stock is selling for just under what the company is worth, there is a small margin of safety and he doesn’t buy. If it sells for well under the company’s worth, there is a large margin of safety and he buys.
If you research thirty companies and find two that are clearly better than the rest, why place your money in the top 5 or 10? For diversification, you might say. But diversifying across mediocre companies is riskier than focusing on good ones.
Buffet discourages the common practice among investors of selling their top performers. If a stock runs up 100%, many sell it and take the profits. But Buffett believes in managing his portfolio the same way he manages his business. How would you react if a division of your business consistently showed a profit? You wouldn’t sell it off. You would probably invest more in it.
An investor should ordinarily hold a small piece of an outstanding business with the same tenacity that an owner would exhibit if he owned all of that business
Examine businesses, not stock prices, and buy at bargain prices.
Buy thriving companies at discounts.
Ignore the stock market because its fickle. Never speculate about the direction of prices. Look instead at individual companies and what makes them superb.
Buy stock in a company with the same scrutiny you’d exercise when buying the business itself.
Determine bargain prices by comparing a company’s value to its stock price. Buy when the stock is considerably lower than the company’s value.
Focus your portfolio on a few good companies. Concentrating on good stocks is safer than diversifying across the mediocre ones.
Just as a business puts more money into its most successful ventures, you should invest more money in your stocks that are performing well.
Do your research, do it's well, and disregard the opinions of others.
As a consumer, you’re conducting research all the time. You know what products you're buying and probably have a pretty good idea of what your neighbors are buying. Is there a trend afoot? Possibly, and you might see it long before Wall Street does.
Invest where you already spend most of your time.
Look where you work, pay attention to what you buy, and observe the buying habits of those around you.
Once you know the size of your company's, Lynch says to divide them into 6 categories; slow growers, stalwarts, cyclical, fast growers, turnarounds, and asset plays.
Slow Growers: large, old companies that used to be small, your companies- expect them to barely outpace inflation but to pay a good dividend.
Stalwarts: large, old companies, but they’re still growing strong. I.e. Coca Cola
Cyclicals: companies whose fortune rise and fall along with the economy. Airlines and steel companies are cyclical.
Fast Growers: small, young companies that grow at 20% or more a year. This is the land of ten baggers to 200-baggers.
Turnarounds: good companies that have been beaten down.
Asset Plays: companies with something valuable that wall street missed.
Get yourself a double-whammy by purchasing a company that has a niche and a product that people need to keep buying.’
Protect against trouble by investing in companies with a lot of cash and little debt. If a company has accumulated cash, you can subtract the per share amount from the stock's selling price to see the bargain you’re getting. The stock sold for $38 but the company had $16.30 per share in cash. The $16.30 bonus changed everything. It meant buying the auto company not for $38/share, the stock price, at the time, but for $21.70 a share.
Pay attention to the stock price relative to the company’s value. You’ve read a lot on this already so I won't rehash it except to point out that every one of the master investors in this section offers the same advice: don’t pay too much for a stock. Check the P/E ratio and other measures of value.
A company’s PE ratio should equal its earnings growth rate. If the PE of Coca-Cola is 15, you’d expect the company to be growing at about 15% a year. But if the PE is less than the growth rate, you may have found yourself a bargain.
You want company insiders buying stock and you want the company itself buying back shares.
EXAMPLE: Coca-Cola is selling at the low end of its PE range. The stock hasn’t gone anywhere for 2 years. The company has improved itself in several ways. It sold half its interest in Columbia Pictures to the public. Diet drinks have sped up the growth rate dramatically. Last year the Japanese drank 36% more cokes than they did the year before, and the Spanish upped their consumption by 26%. That’s phenomenal progress. Foreign sales are excellent in general. Through a separate stock offering, Coca-Cola enterprises, the company has bought out many of its independent regional distributors. Now the company has better control over distribution and domestic sales. Because of these factor, Coca-Cola may do better than people think.
Look ahead at a stock's value
For instance, if a stock’s PE ratio has averaged 20 for the last 10 years but it's now 15, it's historically cheap.
Value funds tend to have almost all their money in low PE, low price-to-book or cash flow, and growth funds have the opposite.
Are they value stocks or growth stocks? It doesn’t matter. They’re stocks bought at bargain prices compared to what their futures hold.
If forced to distill his definition of a bargain stock down to a single measurement, Miller would likely choose a cheap present value of future free cash flow. To him, that factor has it all. It trumps low PE ratios, low price-book-ratios, low everything else. If you can buy future free cash flow at a cheap price, you found yourself a bargain.
One of the most important metrics we focus on is free cash flow- the ability to generate it and what it yields: that is, free cash flow per share divided by the stock price.
On the same amount of free cash flow, a cheap stock has higher yield than an expensive stock. I.e, if Kodak had $3.70 of free cash flow per share but a share price of just $20, its free cash flow yield would have been an even more impressive 19%. That’s just 3.70 divided by 20 to get .19 or 19%. With a share price of $50, Kodak’s free cash flow yield would have been a less attractive 7%.
Ideally, what we want is a company that is a leader in its industry, that has the capability of earning above average returns on capital for the long term, a company that has tremendous long-term economics and those economics are either currently obscured by macroeconomic factors, industry factors, company-specific factors, or just the immaturity of the business.
Since one’s perception of the risk of stocks is a function of how often you look at your portfolio, the more aware you are of what's going on, the more likely you are to do the wrong thing.
Don’t just do something, sit there.
Buy more when the price drops.
Find bargains by comparing a stock's price with its future prospects.
Use the present value of future free cash flow to determine whether a stock is a bargain.
Ideal Value Strategy
Value measures, particularly dividend yield, work best against market-leading large stocks.
Market leading stocks came from the large stocks group, had a market cap greater than average, had more common shares outstanding than average, had cash flows per share greater than average, and had sales that were at least 50% greater than average. That was only 6% of the database. These are your household names like Bank of America, Ford, IBM, Microsoft, and Starbucks.
To create shareholder yield, you add the current dividend yield of the stock to any new buyback activity the company has engaged in over the prior year. If, for example, a company trading at $40 a share is paying an annual dividend of $1, the company would have a dividend yield of 2.5%. If that same company engaged in no stock buybacks over the year, its shareholder yield would equal 2.5%, the same as the dividend yield. If, however, the company had 1,000,000 shares outstanding at the beginning of the year and 900,000 at the end of the year, the company’s buyback yield would be 10%. Adding this to dividend yield of 2.5%, you would get a total shareholder yield of 12.5%. This formula allows us to capture all of a company’s “payments” to shareholders, and it is indifferent as to whether those payments come in the form of cash dividends or buyback activity.
The 50 stocks with the highest shareholder yield from the market leaders group returned 16.49% a year.
Ideal Growth Strategy
A Market cap greater than an inflation-adjusted $200,000,000
A price-to-sales ratio below 1.5
Earnings higher than in the previous year
A 3 month price appreciation greater than average
A 6 month price appreciation greater than average
The highest one year price appreciation
These 50 stocks matching this criterion returned 20.75% a year.
It's worth noting that our best growth strategy includes a low price-to-sales requirement, traditionally a value factor. The best time to buy growth stocks is when they are cheap, not when the investment is clamoring to buy.
Investment Strategy Advice
Heres how you would allocate $10,000 among the 10 stocks according to 5 popular Dow Dividend Strategies
Dow 10: Equal amounts in all 10
Dow High 5: Equal amounts in the top 5
Dow Low 5: Equal amounts in the 5 cheapest stocks
Dow 4: 40% on stocks 2 and 20% on 3,4,5.
Dow 1: Puts all of your money on stock 2.
Dow 4 is historically the best
Keep a personalized list of 20 companies to watch. In order for a new company to get a space in the list, it must be better than one of the current 20.
Search for stocks trading between $5 and $20.
Market Cap= #outstanding shares x current stock price
Daily Dollar Volume= Stock’s average daily trading volume x share price.
Look for low daily dollar volume of less than $3M
Companies with High Net Profit Margin in the top 20% of its industry. As a consumer, you love low profit margins because they mean less money out of your pocket. As an investor, you love high profit margins because they mean more money out of customers pockets into company coffers.
Good companies have strong financial statements: high net profit margins, lots of cash, and little or no debt.
Lots of cash and little or no debt
Increasing sales per share.
Increasing cash flow per share
Current Earnings per Share is an overall increase from 5 years ago.
High Dividend Yields
High Return on Equity
Inside Ownership of at least 15%.
EPS of 85 ranked on Investor's business daily
High RPS (relative strength): with small companies especially, strong sales and earnings are essential. The typical requirement is for them to have grown at least 25% over the past year.
Increased Sales and Earnings of at least 10% for large companies and 15% for small.
High projected sales
Timeliness/Safety: A prediction of how well the stock should perform relative to all other stocks in the next 12 months. Safety is a measure of a stock’s volatility as compared to its own long term record. Look for a timeliness of 1 or 2.
S&P STARS/FAIR VALUE: Predicts a stock’s potential over the next 12 months. STARS stands for Stock Appreciation Ranking System, and classifies stocks from 1 to 5, with 5 being the best. Fair Value is a rank of the stock’s recent trading price compared to what S&P considers its fair value. That means stock’s with a Fair value rank of 5 are the most undervalued- bargains- and stocks with a fair value rank of 1 are overvalued- rip-offs. Get stocks that rank 5 with a fair value of 5.
Low PE: The PE ratio of any company that’s fairly priced will equal its growth rate. If the PE of Coke is 15, youd expect the company to be growing at 15% a year. But if the PE ratio is less than the growth rate, you may have found yourself a bargain. A company, say, with a growth rate of 12% a year and a PE ratio of 6 is a very attractive prospect. In general, a PE ratio that’s half the growth rate is very positive, and one that’s twice the growth rate is very negative. The current PE should be at or below the 5 yr avg PE. PE should equal the growth rate.
Price-sales is a more accurate measure of a company’s value because sales cant be manipulated as easily as earnings. The measure helps even growth investors identify companies that are selling below their potential. Divide current stock price by the sales per share. If one of your stocks is selling for $72 per share and is expedcted to report sales per share of $47.65 this year, its PS ratio is 1.51 ($72/47.65). We found that in 1995, Koo Koo Roo had sales of $19.8M, Anheuser-Busch had sales of $10.3B, and Coke had sales of $18B. Each company had shares outstanding of 11.7M, 516M, and 2.5B, respectively. Dividing the sales by the # of shares outstanding gave us a sales per share of $1.69 for Koo Koo Roo, $19.96 for Busch, and $7.20 for Coke. On 29DEC 1995, Koo Koo Roo shares sold for $6.31, Busch for $33.44, and Coke for $37.13. Dividing these share prices by the respective sales show that you would have paid $5.16 for every $1 of Coke, but only $1.68 for every $1 of Bud. By this measure, Busch was the better buy. Look for P/S of less than 1.5
Price to Book: compares a stocks price to how much the stock is worth right now if somebody liquidated the company. It’s the second most common valuation measure following price-earnings. It tells how much you’re paying for the actual assets of the company. Smaller is better. A P/B of 1 means that you’re paying the auction price for a company. A P/B less than 1 means you’re paying less than auction price. Ben Graham recommended investing in companies with a P/B less than .66. Divide common stockholders equity by the number of outstanding shares. Then, divide the stock's current price by its book value.
Current Ratio: current assets divided by current liabilities. Look for high Current Ratios of at least 2 to 1.
Quick Ratio: Divides cash and cash assets by current liabilities. Its stricter than the current ratio when evaluating how prepared a company is to deal with short term crises or opportunities. Look for high quick ratios. Every company on your sheet should have a quick ratio of at least .5. That is, the company should have half as much in cash as the liabilities on its balance sheet. Bigger is better.
Max and Min: the Stock’s projected max gain and its projected min gain. Both expressed as %’s.
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