How do you go about picking a value stock to buy at a good price and ready to appreciate?
There are altogether 8 criteria to help you pick for these value stocks.
To define what makes a good value stock, a basic understanding of accounting and ability to read a company’s financial and income statements, balance sheets and statement of cash flow.
These reports will tell you everything you want to know!
1. History of Consistently Increasing Sales, Earning and Cash Flow
The relationship between Sales, Earning and Cash Flow overlaps.
A consistent increase in sales and earnings would, therefore, show that there are demand and a strong position of the company in the market. This will affect the prices of the company’s value stocks, which in turn, will affect the liquidity of the company to run its business.
A good cash flow supports the business operations. If the company is running out of cash and cannot support the operation, it will soon collapse.
2. Sustainable Competitive Advantage
What are the advantages of having a sustainable competitive advantage?
Sustainable competitive advantage should be paid attention to when new competitors enter and seize the market share, the company is still able to overcome and remain in the market.
It can come from:
- A strong brand (e.g. Coca-cola, Nike)
- Patents and trade secrets (e.g. pharmaceutical companies like Pfizer and Merck)
- Gigantic economic of scale (e.g. Walmart, Amazon.com)
- Market leadership that competitors will find very difficult to overtake in the next decade (e.g. General Electric, Visa, eBay, Google)
- High switching costs that lock in customers (e.g. Adobe, Microsoft)
- Being a monopoly in an industry (e.g. Singapore Press Holding is a monopoly in the Singapore media industry)
- Gross Profit Margins (GP) and Net Profit Margins (NP) that is higher compared to the closest competitors.
3. Future Growth Drivers
The company that you invest in should be selling a product catered to the population growth market, rising employment rates, and wages. The demographic trends of the market should also be in the company’s favour. That way, we can see the potential growth in the business.
Growth drivers can be seen from:
- Development of new product lines
- Upcoming product innovations
- A new application of patents
- Expansion in capacity (e.g. building bigger factory)
- Opening new markets and building more outlets
4. Conservative Debt
It is important to ensure that the amount of money borrowed by the company is conservative and can be easily paid back within 3-4 years. The rule of thumb is that long-term debt should be less than 3 times the current net income (after tax).
5. Return-of-Equity (ROE) Must Be Consistently above Average
Return-of-Equity (ROE) shows how much profit a company is generating with the money shared holder invested. A company’s value stock that has an ROE of 12% is considered a fair investment. If the ROE is more than 15% consistently, is considered a great investment.
6. Management is Holding or Buying the Company Stock
Who else would know the company’s value better than the people who are running it?
When the company management is collectively buying a large amount of company stock, means they have the confidence to get a good deal at the current price.
It’s a good indication that this is a good time and a good rate to chip in the stock, making it a great investment for your value stock portfolio.
7. Stock is Undervalued: Share Price < Intrinsic Value
No matter how great a business is, you never want to overpay for it. It is only a great investment if you can purchase this great company at a price that is below its true value (known as “intrinsic value”). Otherwise, your value stock might turn out to be worthless.
8. Stock Price is On Uptrend
When the stock is on the uptrend, it means that people are getting more and more optimistic about the stock and the probability is that the stock is going to move higher in the short term.
The best time to buy would be when the stock makes a dip on its uptrend.
Now that you know the ingredients to selects a great stock to invest, do you how to spot market up trends and downtrends accurately so that you can enter with confidence and exit with a maximum profit every time in the stock market?