Finding Great Value Stocks Amidst the Chaos, Part II

Source: From Profit From the Panic

(Summary) 

A. Go to the company’s website and download their annual report and understand their business thoroughly.

Step #1: History of Consistent Earnings & Cash Flow Growth

Step #2: A Sustainable Competitive Advantage (Economic Moat)

Step #3: Conservative Debt

Step #4: High Return on Equity (ROE)

 ROE should be above 12-15%

Step #5: High Free Cash Flow

Free Cash Flow = Cash Flow from Operation – Capital Expenditure

 Free Cash Flow/Sales Revenue (x100%) > 5% is considered a GREAT investment.

Step #6: Management is Holding/Buying Stocks

 Go to www.SGX.com >> ‘listed company-general announcements’ >> ‘Notice of Interest/Change in Interest’ or

 www.ShareInvestor.com (paid site) >> ‘Insider Trades’

 To see if the directors and the company itself is buying or selling their shares. If they are buying, it could be a good sign.

Step #7: Stock Price is SAFELY Below Intrinsic Value

 Recommended only to buy when stock price is AT LEAST 25% below intrinsic value.

(A) Projecting Operational Cash Flow for the Next 10 Years (CF Proj)

Tips: Average earnings growth rate of most listed companies is 15%.

(B) Calculating a Discount Factor (DF)

(C) Discounting All Future Cash Flows to Present Value (DV: Discounted Value)

- The intrinsic value of the whole company would be the sum of all the future ‘Discounted Cash Flow’ for the next 10 years = Add up all the Discounted Values (PV of 10yr Cash Flow)

- To find the intrinsic value of one stock = total worth of company (PV of 10yr Cash Flow)/total no. of shares, then compare with the current stock price.

eg. intrinsic value of a stock = $10, current stock price = $5. This means the stock is 50% undervalue. (surpasses the 25% recommended mark.)

Last Step #8:

 Finally, it is always safest to wait for the stock price to reverse into an uptrend and break above its 20-day or 50-day moving average before making an entry.

Start Building a Watchlist of Great Stocks

1. Identify companies that you are familiar with and companies whose product we use, eg. zip companies, fans companies, light bulb companies, rubber companies (tyres for vehicles), etc.

Tips: Avoid choosing companies that you are not familiar with. For instance, Warren Buffett do not invest in technology companies (eg. Microsoft) because he simply do not understand how the business works. Think simple, think great!

Ask yourself what products you use daily? Or what products do people use daily? More examples would me SMRT (trains and buses), staple food such as rice, water, spices, etc.

2. All great investors build a watchlist of great companies that keep an eye on. They prepare when the time is right to buy

Creating a Balanced & Diversified Portfolio

Tips: Never put more than 20% of your money into one stock.

Build a stock portfolio from various sectors and industries such as technology, real estate, oil & gas, consumer goods, financial, etc.

What Every Portfolio Should Have

 

 Include inflationary driven stocks and defensive stocks. Buy stocks that will benefit from the inflation and higher oil prices.

 Inflationary driven stocks: eg. property stocks, REITS (real estate investment trusts), commodity stocks. For instance, oil ETFs like the United States Oil Fund (AMEX: USO)

 Defensive stocks are stocks that people buy during economic crisis. These stock prices tend to be more stable or even move up when the overall market is bearish.

 Defensive Stocks: eg. Food, oil, utilities, defense and tobacco. SMRT, Singapore Press Holdings (SPH), MacDonalds’, PepsiCo, Kraft, Lockheed Martin, etc.

Tips: People smoke more in bad times. (Ethically, i strictly do not advocate smoking or investing in related companies. What are the things people do when the times are bad? Entertainment? De-stressing activities? Hobbies? Turn to religion? Sharing some ideas that may spur the economy.)