Friday, August 10, 2007

How I Select Securities

I am for the most part a value investor and as such invest primarily based on fundamentals. Some of the main metrics that I use are:

-P/E
-Forward P/E
-Price/Book
-Dividend growth rate
-ROI
-ROE
-Average EPS growth
-debt levels
-revenue growth

I am not going to provide specific numbers for each of the above metrics as it varies from industry to industry. However, one number that I generally view as being important is the forward P/E and I will rarely invest in a company with 1yr forward P/E of over 18 and a 2 year forward P/E of over 15. Due to that fact I generally do not invest in the technology sector (regardless of how great a company’s technology is I’m not going to pay over 18X next years earnings for it). From my experience, growth companies and those with a high P/E will often get caught with “multiple compression” when either the economy stalls or they fail to meet expectations.

I also look at qualitative factors such as:
-barriers to entry
-competitive advantage
-long term prospects of the industry (ie- I wouldn’t invest in a Cassette tape manufacturer that was trading dirt cheap---unless of course they had some valuable underlying assets such as real estate that weren’t factored into the price)
-management (do not focus on it though)
-cyclicality of the industry
-the fit of the stock in my portfolio

I usually don’t set target prices but in almost all cases I use limit orders when both buying and selling.

5 comments:

G said...

One of two ways to make money in market is to buy undervalued stocks. It seems you have a better understanding of valuation. So far mine have been pure guesses. I find it extremely hard to analyze intrinsic value of anything. I think there is a factor of entrepreneurship involved here.

Other method is to index the portfolio - the one I might end up using.

moneygardener said...

Good post.

I use a simlar method. One thing I really like is long-term consistency of EPS growth. I think that is the one factor that makes me feel the best about a company.

Nabloid.com said...

I'm surprised you don't use any cash flow indicators... cash flow can sometimes be the most reliable as it isn't subject to as many 'creative' accounting trickery.

Middle Class Millionaire said...

nabloid,

I do sometime use cash flow but usually when looking at resource companies.

kojak said...

I love dividend stocks but I noticed the yield was absent? with banks especially, wouldn't this be an indicator of a stock being on sale?