Asked on 20 Mar 2019
I would suggest reading up on the annual reports itself, instead of relying solely on 3rd-party analyst reports (especially the sell-side ones) to get to the source of your information.
Just re-reading The Intelligent Investor by Benjamin Graham - where he looks at Value criterias. Some stipulated below:
Quality rating of B and above - look at S&P's rating system and look at S&P Earnings and Dividend Rating of B and above. The range is from A+ to D.
Positive EPS growth in the last 5 years with no earnings deficits.
Current Ratio (CA/CL) of 1.50
Total Debt to Current Asset Ratio of < 1.10 - Always look for companies with low levels of debt.
EPS ratios of < 9.0 - this is what allows you to look for companies trading at a bargain.
P/B of < 1.20. Book value gives a good sense of a company's underlying value. If the stock is trading at close to, or even below book value, that makes it a stock worth analysing further.
Hello! Benjamin Graham, the former mentor of Warren Buffet, had actually outlined 7 tips, I'll just briefly outline them here, and also add my thoughts in. Hope it helps!
Credit Ratings: Sticking to companies that have credit ratings of B+ or better using the S&P rating system. This method can help you to do some of the grunt work so you don't need to analyse the credit strength of the company so rigorously.
Debt/Current Asset Ratio: Graham reccomends investing in a company with a ratio less than 1.10. Having this ratio low helps to ensure that the company has sufficient liquidity to pay off its debts, which makes the company less risky. It also helps to meausre the level of debt a company posseses so that it has enough free cashflow that flows to investors.
Current Ratio: This is simply current assets divided by current liabilities. Graham reccomends looking at a ratio higher than 1.50. This ratio is important because it measures whether the company can pay off its short term liabilities.
EPS Growth: Graham advises to look for stocks with positive EPS growth over 5 years.
P/E Ratio: Graham thinks that we should look for companies with a P/E ratio for less than 9. The reason for this is that the lower the P/E Ratio, the higher the chance the stock may be undervalued. But I would add that you should compare this to other companies. If other companies P/E Ratio are around the same, then the stock may not be undervalued after all, and the converse may be true also.
P/B Ratio: Graham suggests looking at a P/B ratio of less than 1.2. P/B ratio measures how much the market values the share compared to its underlying book value. Like the P/E ratio, this is a gauge of whether the stock is undervalued which should be compared against different companies.
Dividends: Finally, Graham advises to invest in companies that pay dividends. Dividends add to the value of a share! Also, they help to give you a source of passive income in the mean time. The downside is that not all companies pay dividends, and their dividend policy may change over time.
Hi there! Value investing requires mastering your own emotions and being confident in your analysis of the company you're investing in. For most people new to value investing, I would strongly encourage reading Warren Buffett's 1977 letter published 40 years ago, which is still 100% relevant today (link: http://www.berkshirehathaway.com/letters/1977.html)
He suggests investing in businesses where (and I am quoting verbatim here):
(1) one that we can understand,
(2) with favorable long-term prospects,
(3) operated by honest and competent people, and
(4) available at a very attractive price.
Let's go through these criteria one by one, with a (simplified) example/analysis of a real (and complex) company: APPLE INC (NASDAQ: AAPL).
(1) one that we can understand
Do you understand the business of Apple? Where do they make money from? Is it mainly desktops? or Laptops? or iPhones? or watches? Do they also make money from services (music, app store etc)? Do you understand each of these individual products and services well? Or is it too difficult to understand?
(2) with favorable long-term prospects,
Many call this the Moat. Just like the water surrounding a castle prevents intruders from taking down the castle, when evaluating a company, it's important to understand what makes this company special, and likely to thrive (not just survive) for the next decade? Will Samsung be able to beat iPhone with their Galaxy series? Will Microsoft be able to beat iPad with their Surface tablets? Will Windows become so much better than MacOS? Will Spotify beat Apple Music? Will they continue to dominate America? Are they able to conquer Europe and China?
Understanding what constitutes the moat of a company will give you confidence AFTER you invested, ensuring that even when the share price drops, you will not panic-sell.
(3) operated by honest and competent people
The company may be a well protected castle full of treasures, but if the management is not aligned with the best interests of shareholders (you), or the profits are being used for extravagant travel (private jets), then maybe it’s not the best investment to make. You can make your own assessment by reading interviews, watching youtube videos and listening to the quarterly calls. Are they good leaders? Do they come up with actionable strategies or blame others for mistakes? Do they understand the business? One quick tip: The ocean is huge - invest in companies where you will be interested to listen to the senior management. This will ensure that you are kept up to date on the developments. Does Tim Cook (CEO, Apple) know where Apple’s strategic strengths are? Is he spending money frivolously on buying other companies? Is he investing in the right areas? Does he know what he’s talking about?
(4) available at a very attractive price
While you may understand Apple (and may even have queued up overnight for the latest iphones), love the moat, adore the senior management; the current share price of the stock may not make sense. Share prices are dictated by demand and supply of the shares - if there’s a frenzy of people trying to buy Apple stocks, the price goes up. If there’s some bad news, the price goes down (e.g. Antennagate) - and NOT by any scientific/mathematical analysis of the intrinsic value of the company. Just look at the stock price of Apple within a day. The price moves up and down like a roller coaster even though there’s no good (nor bad news) on a daily basis. This should give you an inkling that it’s mostly driven by humans. And this is key. BECAUSE the share price fluctuates without direct relation to the actual business of the company, it gives value investors like us awesome opportunities to buy stocks when they are selling at a discount.
But how do you know when it’s too expensive or selling at a discount? And this is the “science” part. You have to read their annual reports (10-K forms), analyze their balance sheets, income statements, cash flow, do some calculations to determine what’s a “fair” price for the shares (there’s a couple of ways to do this. And no it’s not exact.) As of 26 march 2019, Apple is currently trading around $188.70. After your calculations, perhaps you feel that a fair value is $170. And that’s where this “attractive price” critera comes in. If it’s worth $170 and selling at $188, clearly you shouldn’t buy it (note that $170 already takes in consideration your expectations of the future growth of the company). But what if it’s worth $170 and selling at $170? Maybe you shouldn’t buy it either. Why trade $170 for $170? But if it’s worth $170 and it’s selling at $136? That’s a 20% discount. Even if you got some of your calculations wrong (perhaps you were too optimistic about their future growth rates), that 20% margin-of-safety or buffer should be good enough. But perhaps you are just starting to invest, and not so sure of your calculations. What if it was selling at $102? A 40% discount. Would you be able to stare your brokerage app in the face and click on that BUY button?
Controlling Your Emotions
Yes, i hear you. WHY would a $170 thingey sell for $136? Well... the short answer is: because of EVENTS. A downturn, a scandal, war? One of the emotions that we need to overcome as Value investors is FOMO (Fear-of-Missing-Out). An extreme recent example is Bitcoin - but that’s a story for another day.
As the cliche goes, a journey of a thousand miles begin with a single step. I suggest reading line-by-line Warren Buffett’s 1977 letter, with a notebook in hand, and take notes. I guarantee that it won’t take more than 30 minutes. And if you like it enough, read Warren Buffett’s 1978 letter, and so on. You could read one of the hundreds of books that tells you how to invest in the “warren buffett way”, but frankly, it’s much more useful if you go back to the original text.
Always interested to know how it goes for you! Let me know!
Value investing means that you are purchasing a company under its intrinisic value or having a margin of safety.
What I do is that I use my self-created scorecard - Ultimate Scorecard under Fundamental Scorecard Website (https://www.fundamentalscorecard.com/scorecards/) - as a form of evaluating if a score is to be deem undervalued.
Basically i have about 13 criterias, if a company can score 8 points or above, it means it is undervalued.