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.
- 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 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.
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.
- Historical Growth Rates
- Future Earnings Estimates
- Future Book Value Estimates
- 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.
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.