In
Value Stock Investing
How much financial bloodshed is necessary before we realize that there is
no safe and easy shortcut to investment success? When do we learn that most
of our mistakes involve greed, fear, or unrealistic expectations about what we
own? Eventually, successful investors begin to allocate assets in a goal
directed manner by adopting a realistic Investment Strategy... an ongoing
security selection and monitoring process that is guided by realistic
expectations, selection rules, and management guidelines. If you are thinking of
trying a strategy for a year to see if it works, you're due for another smack up
alongside the head! Viable Investment Strategies transcend cycles, not years,
and viable Equity Investment Strategies consider three disciplined activities,
the first of which is Selection. Most familiar strategies ignore one of the
others.
How should an investor determine what stocks to buy, and when to buy
them? Will Rogers summed it up: "Only buy stocks that go up. If they
aren't going to go up, don't buy them." Many have misread this
tongue-in-cheek observation and joined the "Buy (anything) High" club.
I've found that the "Buy Value Stocks Low (er)" approach works better.
A Google search produces a variety of criteria that help to identify Value
Stocks, the standards being low Price to Book Value, low P/E ratios, and other
"fundamentals". But you
would be surprised how the definitions can vary, and how few include the word
"Quality". In the late 90's, it was rumored that a well-known Value
Fund Manager was asked why he wasn't buying dot-coms, IPOs, etc. When he said
that they didn't qualify as Value Stocks, he was told to change his
definition... or else.
How do we create a confidence building Stock Selection Universe?
Simply operating on blind faith with one of the common definitions may be too
simplistic, particularly since many of the numbers originate from the subject
companies. Also, some of the figures may be difficult to obtain quickly, and it
is essential not to get bogged down in endless research. Here are five filters
you can use to come up with a selection universe of higher quality companies,
and you can obtain all of the data inexpensively from the same source:
1.
An S & P Rating of B+ or Better. Standard & Poor's is a major
financial data provider to the investment community, and its "Earnings and
Dividend Rankings for Common Stocks" combine many fundamental and
qualitative factors into a letter ranking that speaks only to the financial
viability of the rated companies. Potential market performance (a guessing game
anyway) is not a consideration. B+ and above ratings are considered Investment
Grade. Anything rated lower adds an element of unnecessary speculation to your
portfolio. A staff of thousands does your research for you.
2.
A History of Profitability. Although it should seem obvious, buying
stock in a company that has a history of profitable operations is less risky
than acquiring shares in an unproven, or start-up entity. Profitable operations
adapt more readily to changes in markets, economies, and business growth
opportunities. They are more likely to produce profit opportunities for you
quickly.
3.
A History of Regular Dividend Payments. The payment of regular
dividends, and periodic increases in rate paid, are sure signs of economic
viability. Companies will go to
great lengths, and endure great hardships, before electing either to cut or to
omit a dividend. There is no need to focus on the size of the dividend itself;
Equities should not be purchased as income producers. A further benefit of using
dividend payment as one of your selection criteria is the clear indication of
financial stress that a cut communicates.
4.
A Reasonable Price Range. You will find that most Investment Grade
stocks are priced above $10 per share and that only a few trade at levels above
$100. If you have a seven-figure portfolio, price may not matter from a
diversification standpoint, but in smaller portfolios, a round lot of a $50
stock may be too much to risk in one position. An unusually high price may be
caused by an unusually high degree of sector or company specific speculation
while an inordinately low price may be a good warning signal. With no real
structural size limitations, I feel comfortable with a range between $10 and $90
per share… but I would avoid most issues even at that level.
5.
A NYSE Listed Security. I'm not sure that the listing requirements
for the NYSE are still more restrictive than elsewhere, but it is helpful to be
able to focus on just one set of statistics. Most of the information you need
regularly is reported by Exchange (Market Stats, Issue Breadth, and New Highs
vs. New Lows).
Your Selection Universe will become the backbone of your Equity
Investment Program, so there is no room for creative adjustments to the
rules and guidelines you've established... no matter how strongly you feel about
recent news or rumor. Now you can focus on operating procedures that will help
you diversify properly by position size, industry, etc., and on guidelines that
will help you identify which stocks should be watched closely for purchase when
the price is right. Keeping in mind that you want to sell the Equity Position at
a target profit ASAP, you'll want to establish appropriate buying (and selling)
rules. For example, I never consider buying a stock until it has fallen at least
20% from its highest level of the past 52 weeks, so I include those that are
close or at this price level on a "Daily Watch List". Then, I select
those that I would be willing to add to equity portfolios if they fall a bit
more during the trading day. My actual "Buy List" changes every day in
both symbol and limit price.
You will need to apply consistent and disciplined
judgment to your final selection process, but you can be confidant that you
are choosing from a select group of higher quality, well-established companies,
with a proven track record of profitability and owner awareness. Additionally,
as these companies gyrate above and below your purchase price (as they
absolutely will), you can be more confident that it is merely the nature of the
stock market and not an imminent financial disaster... and that should help you
sleep nights.
By the way, never say no to a profit when the upward
movement equals 10%, and you'll be able to do it again, and again, and again.
An Article By:
Steve Selengut