I was a licensed stockbroker from 2001 to 2007, managed private money for almost a decade, and while I continue to publish my thoughts on hundreds of stocks each year, the majority of my time is spent helping business leaders drive profit and progress. Business ownership remains the most lucrative way to build wealth – just ask Warren Buffett, Jeff Bezos, or Elon Musk – and owning publicly traded stocks is the best way to do it without taking excessive risk.

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Below, I’ve outlined a step-by-step system to better investing based on more than 40,000 hours of work in business and the financial markets. Maybe it will help you make better decisions, beat the market, and compound your money faster.

From 2002 to 2018, I published real-time trade alerts to a select group of individual and professional investors. Performance varied based on individual trading. Stocks bought on publication date and sold at year end documented cumulative gains in excess of 6,000%. Gains on my best ideas based upon the initial purchase on publication date and held until 2018 or acquisition. In 2018, I stopped publishing my real-time alerts newsletter. These are the results.

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When it comes to business, everything is either an investment or a deliverable. Some investments can be placed as “expenses” or “liabilities” for accounting purposes, but when it comes to capital allocation, profits or losses is all that matter.

Over the years, I’ve turned the strategies and best practices top money managers use to earn billions into models for better investing. Two factors almost always stand out: (i) Companies that grow their book value also see stock prices increase; and (ii) Assets that provide the fastest capital payback tend to be the best investments.

The following methodology has been refined through more than 40,000 hours of success analyzing and forecasting the world’s leading investments, and now forms the backbone for the majority of my business and investment decisions.

01. What is the current yield?
02. What is the future potential?
03. What is the margin of risk?

Payback Theory

Let’s say you live in a town with two bakeries for sale at $1 million each. Both offer similar products with almost exactly the same type of customer, and asset structure – one earns $100,000, the other $150,000. Which one do you buy? The one that has the highest yield, which in this case is the second bakery. In fact, if these numbers held up, bakery number two would pay you back in less than 7 years, a full 3 years ahead of the first one.

Earnings Yield

To know whether an asset is worth buying, you’d have to know the profit it generates compared to the price you’re paying. For example, if you buy a house for $500,000 and lease it for $2,500 a month, the annual yield before expenses is 6%. For publicly traded stocks, this yield is based on net income versus market value.

Shareholder Equity

Shareholder equity is the difference between total assets and total liabilities – also known as book value. Companies that translate retained earnings to equity growth become more valuable. It is worth noting that legendary investor Warren Buffett has used book value to benchmark the value of his conglomerate Berkshire Hathaway for over 40 years.

Book value is a historic number, providing no information about the future prospects of a business, apart from demonstrating consistency. However, if every dollar in retained earnings can generate at least the same in market value, then the company has added value to shareholders. That’s why return on equity is such an important ratio to top value investors.

Even though Apple and Amazon are valued differently by the market, investors cannot overlook the ability of both companies to grow book value. No matter what strategy you follow, being able to find stocks attached to companies that can do this will virtually guarantee you make money in the market.

Value Analysis

Analyzing both book value and earnings per share, investors can estimate the future value of almost any stock. Companies that have built brand power and strong competitive advantages tend to last longer. However, for an investment to meet a baseline for growth of 15% annually, certain traits still need to line up. Here is a list of my core tenets…

• Consistent Growth in Sales
• Consistent Growth in Earnings
• Consistent Growth in Book Value
• Debt to Income Ratio < 5x
• Return on Equity Average > 10%
• Operating Costs to Income < 75%
• CapEx to Income < 75%
• Gross Profit Margins > 25%

Investment Risk

Even the best investors on the planet lose money on certain assets, regardless of how intelligent or risk averse. Don’t make the mistake of trying to be perfect. The best way to limit risk in the stock market is to invest in businesses that are going to withstand the test of time. These are typically profitable and growing and bought at the lowest price multiple possible. Then diversify into as many of these stocks as you can find, and plan on holding them for the long-term.

If you’re not outperforming the S&P 500 Index over a 5 or 10 year period, you should place the majority of your assets into an Index Fund, and speculating on trades with far less capital. Again, there’s nothing wrong with trying to find the next Facebook or Priceline before they turn profitable, but while you do it, make sure you’re building wealth with the market too.

The following is for investors with a basic understanding of the financial markets and that have experience making their own trades.

01. Stock Screen
02. Value Analysis
03. Stock Selection
04. Portfolio Management
05. Accelerated Strategies

The goal is to narrow down a list of ideas to analyze. You can always skip this step and opt for news announcements or pick brands that you already know. For the purpose of this guide, we’re using the screener at Finviz, but please use this criteria with any screener you want.

Basic Screen

• P/E Ratio < 15
• Forward P/E < 15
• EPS Growth > 0% (5yr)
• Sales Growth > 0% (5yr)
• Gross Margin > 25%
• Return on Equity > 10%
• Average Volume > 100k

View the Results

Valuation is not an exact science, which is why even the best investors lose money on trades, and different stocks garner different metrics based on industry, business model, growth rates, trader perception, etc. With that said, the upward trend in financial performance is always a correlation to stock price appreciation. The goal is to find companies that have these characteristics and buy them when the stock price falls below a specific threshold, which will be covered in the next section. I typically use Morningstar for financial data.

• Consistent Growth in Sales
• Consistent Growth in Earnings
• Consistent Growth in Book Value
• Debt to Income Ratio < 5x
• Return on Equity Average > 10%
• Operating Costs to Income < 75%
• CapEx to Income < 75%
• Gross Profit Margins > 25%

*split adjusted
USD in Million except per share data

Investing is an accretive endeavor. Over time, you should have a working knowledge of many stocks. Companies that have a positive value analysis (from above) may not be worth an investment the first time you analyze them. The most important tenet in stock selection is to do it based on the facts and not emotion. On the Finviz Screener you can sort the columns. I tend to sort by industry or P/E ratio and then select the companies that I do not already know pretty well and look deeper when the stock has been down or flat in the last year.  In fact, that’s the only time I ever look at the chart.

Buying Criteria

• Positive Value Analysis
• Trading near 52wk low
• Priced for 100% Growth

Long-term stock price appreciation is ALWAYS tied to financial growth. Estimating a company’s future earnings, book value, and cash flow provides a baseline to use when any multiplier is applied. Multiples are not static numbers, fluctuating with market volatility, industry trends, and company specific dynamics.

Microsoft (MSFT) 

Microsoft traded with a 10x earnings multiple in 2008, trailing the S&P 500 average; however, by summer 2018, it’s P/E ratio was 27.50. In the same time, the company’s market capitalization increased from $172 billion to over $757 billion. The 340% rise was attributed to both financial performance and multiple expansion.

Future Estimates

Don’t chase multiple expansion as it relates more to macro events that are out of the control of most individual organizations. Focus on financial performance and understand that stocks are priced based on future expectations as much as past results, and it’s the future financial results that investors must focus on.

1. Historical Growth Rates
2. Future Earnings Estimates
3. Future Book Value Estimates
4. Future Market Value Estimates

Again, market value is priced against a multiple of the company’s financial attributes. While growing the top line is necessary to survive, that growth doesn’t always translate into real value creation, which is why earnings, cash flow, and book value estimates are the important distinctions to estimating future market value. One way to do this is taking the Current Value multiplied by the Historic Growth rate discounted by 5% or 6% to yield a conservative estimate of future value, then multiple that number by its historic multiplier average to get a future value estimate.

Once you have some numbers to work with, it’s time to start asking questions like the following. Will the company be around in 20 years? How long can the company continue this growth? Can it realize even half of its current growth rates? Will its products or services be relevant in 5 or 10 years? If not, could the company pivot? From these you can start to form a mental construct for every future analysis.

Baseline Potential

For the time and risk you take on finding stocks and managing money, I believe that you should only buy into stocks that can product, at a minimum, 15% annualized returns from the investment. That equates 100% over a 5 year period and 300% over a 10 year period. Otherwise, buying an index fund, if you have the capital, rental units in a major city would yield better returns than inflation.

To that note, stocks are typically the most liquid investment vehicle, and at anytime can be sold for a profit or loss. Investing for the long-term is different than holding an individual stock for the long-term. Remember that every company’s value eventually levels out, at least for a period of time, and if you get too romantic about it, you may miss other opportunities.

Case in point, February 2008, Coca-Cola was valued at roughly $100 billion, which at the time was slightly higher than Apple’s market cap. Fast forward ten years and as of 2018, Apple had a market capitalization over $900 billion, making it more than $725 billion more valuable than Coca-Cola. Moreover, the same stagnant price growth will happen to Apple at some point in the future.

The point is that a great investment one day may not be so great on another, even if the company itself is spectacular.

Remember that most stocks will not move in a straight line upwards or downwards. In fact, some of the best investments will lose as much as 50% before appreciating. Portfolio management is necessary to avoid the risk of total loss. And, owning a portfolio of 20 – 30 stocks provides a level of diversification that is close to most index funds.

Equal Weighting Strategy

Divide your total investment capital into at least 20 positions giving them equal weighting regardless of their size. Then buy and hold each stock for one year; sell the losing positions before the one year mark and sell the winners after the year mark, for tax benefits. For example, if you have $10,000 and plan to invest in 20 new companies this year, each position would involve an investment of $500. Just add a zero for your own asset level.

Warren Buffett Strategy

Warren Buffett loves owning the right stocks forever. With this strategy, choose the stock you want to own, put all your available cash into the stock, add to the position over time, and repeat with a new stock. The idea here is that if you “put all your eggs in one basket,” you are more likely to feel certain about the value of that investment and do your research before making any investment at all. In fact, isn’t this what people do with their biggest asset? Owning a home is the major asset for most people. And, most homeowners do a high level of research for years before buying.

Bifurcation Strategy

This strategy involves splitting your portfolio into two parallel operations working with one another to create the highest rate of growth possible. As a base, use your cash to build a portfolio of stocks that you like. Then use leverage against the stock positions to trade option contracts and arbitrage situations  to maximize your ROI. (see accelerated strategies)

Dollar Cost Averaging

If you’re buying companies that you think are going to be much more valuable long term, you will experience short term pain. Anytime you find that a company can produce above average investment performance based on thorough analysis, you should consider owning it, regardless of whether you already own it at a different price. I can’t tell you how many times I’ve been in a stock at $1x and it dropped to $0.60x only to get back to $3.00x. If it’s down and you believe in its long term prospects, buy more at the lower price using the same amount of capital you initially bought in with.

Leveraging a portfolio’s cash positions to make trade for short-term gains is something that great money managers have always done; however, using leverage presents its own risks. For this guide, we’ll cover some strategies to both protect and accelerate your year over year returns.

Writing Covered Calls

When you write (i.e. sell) a Covered Call Option, you give the right to someone else to take the stock away from you. This is beneficial when you already own a stock and want to make money while waiting for the price to reach a specific level. For example, if you own XYZ at $10 and write a call at $12, you collect a premium from the contract. If the stock is called away at $12, you keep the premium and the $2 profit. If the stock doesn’t reach $12, you still keep the premium. Writing covered calls is a great way to exit positions when the stock price is relatively stable.

Writing Naked Puts

When you write (e.g. sell) a Put Option you provide the right for someone else to give you the stock. This is beneficial if you want to own a specific company’s shares at a specific price, but the stock is not yet trading at that price. For example, if XYZ is trading at $10 and you want to own it at $7.50, you can write a put at $7.50 and collect a premium from the buyer who may be trying to protect his/her position in the stock. Naked put writing is a great way to buy into positions during volatile markets. Writing puts is a great way to get paid to wait for the right price in stocks you want to own.

Risk Arbitrage

Arbitrage arises from corporate activity. During a typical year, there are hundreds of corporate mergers taking place. It’s the nature of the business. In these trades, there is a specific price that is agreed upon by the parties before the buyer conducts due diligence. This price is rarely reached before the deal actually closes, leaving a percentage of profit to the investor. The risk with arbitrage is associated with the deal not closing. So, always keep up to date on events that surround the deals you trade. The rate of return will be different for each situation. For instance, if XYZ Corp. is paying a 25% premium for ABC Inc., and if the two companies are merging in 4 months, you will receive an annualized return of roughly 90% as long as you can put the money back to work in similar deals.