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Value Investment and Mindset

How to pick good stocks as a value investor?

Key Points to Cover

The ways to choose a good stock as a value investor
Discuss several indicators used by Warren Buffet when evaluating a company.
Valuation techniques to find the intrinsic value of a company

All Steps

🟠Step 1: Understand the overall business.

How does an investor research a company’s information?

The very first step in picking up a good stock is to understand the overall business.
Before investing in a company, we should know what company/business is doing or what product/services they are offering. How the business earns money, the vision of the company, etc.

It is similar to how, before being a couple, you got to know your partner.

For businesses we complete the checklist as follows:

✅Business Overview

✅Products & Services

✅Financial Summary

✅Business Vision & Strategy

Therefore, before investing in a company, you sure want to know about it.

It is the absolute easiest step when you need to find the information just by searching on the internet and reading it.

Example: Amazon e-commerce by Jeff Bezos

Amazon is not just e-commerce it is a technology company now, it has other businesses in the tech industry.

Understanding a business is a process of discovery.

“The more you know the company, the better decision you will make.”

Also, make sure you search the annual report of the company as well.

🟠Step 2: Analyze the Economic MOAT

In today's business world, competition is unavoidable in order for a company to survive or stand out in front of the competition. It is essential for a company to have a competitive advantage within its own industry and competitive advantage is called the economic MOAT.

What is an economic moat?

Economic Moat is the term named and conceptualized by Warren Buffet. It is a distinct advantage a company has over its competitors, which allows it to protect its market share and profitability.

In other words: a company with an economic moat has a certain competitive advantage over its own industry.

(Just as a moat surrounding a castle during ancient times to act as a line of defense for the castle.)

There are 5 types of economic moats:

Cost Advantage
Size Advantage
Switching Cost
Intangible Assets
Network Effect.

We will discuss all of them one by one later in this series, you can check out the content “5 Types of Economic MOAT for Business.”

🟠Step 3: Evaluate the Risk

In our daily lives, we always encounter risks. Everything we do or do not do actually has its own risk.

Similarly, the company/business has its own risks. There is no so-called risk free thing in reality.

If someone is asking you to invest in something totally risk-free, that’s a scam.

Before investing in a company, we have to evaluate the risks. With risk evaluation, we will assess the possibility that an adverse event might negatively impact a business and therefore make a wiser decision.

Company Risk ➡️ Risk Evaluation ➡️ Wiser Decision

There are 4 main risks for a company:

Regulatory Risks
Inflation Risks
Innovation and Technology Risks
Key-Person Risks

We will discuss all of them one by one later in this series, you can check it out at “What are the Four Main Risks for Your Company.”

🟠Step 4: Evaluate the Financial Statement

Income Statement
Balance Sheet
Cash Flow Statement

We will be discussing the Analysis part of these financial statements later in the series. Let’s get familiar with these statements.

🔶Income Statement:

It tells us how much money the company earns during a set period of time.

The company’s accountant traditionally generates an income statement for shareholders every 3 months during the fiscal year and for the whole fiscal year.

** The fiscal year is a one-year period that companies and the government use for financial reporting and budgeting.

Through the company's income statement, we can determine the company's margins, its return inquiry, and, most importantly, the consistency and direction of its earnings.

All the matrix elements are necessary in determining whether the company is benefiting from a durable competitive advantage.

🔶Balance Sheet

It tells us how much money the company has in the bank and how much money it owes.

A company can create a balance sheet for any given day of the year, which will show what it

owns and its net worth that particular day.

Companies generate a balance sheet for shareholders to see at the end of each 3 month period of time, called a quarter, and at the end of the accounting year, or fiscal year.

It determines the amount of assets and debts the company has as an indicator of the presence of a durable competitive advantage.

🔶Cash Flow statement

It tracks the cash that flows in and out of the business

It is good to determine how much money the company is spending on capital improvements. It also tracks bond and stock sales and re-purchases.

A company issues a cash-flow statement along with other financial statements.

We will dig deeper into the analysis of these statements further in the series. Feel free to check out “How to Analyze Financial Statements.”

🟠Step 5: Understanding the management Team

Management is part of business, which is a key element. It is a difficult job to evaluate management because there are too many intangible aspects that we might not be able to discover.

There are four main aspects that we need to emphasize when evaluating the management

Background and Experiences
Length and Tenure
Shares and Buyback
Business Strategy

Background and Experiences: To understand a person, the first thing is to understand his/her background. Just Google it and find out the history of managing teams and founders.

Length of Tenure: How long have the CEO and top level management been serving the company? (Strong companies have great records of management retention.) company rarely changes the management has high management retention (Stays at least 3–5 years)

But if management retention is low, it means top-level executives are incapable of leading the company, or the business itself has a problem.

Share Buyback: If insiders buy shares in their own company, it means they know something we, as normal people, don’t. Also, find out how long management has held the share.

The goal of the management is to maximize the return for us.

Business Strategy: As shareholders, we have to monitor the management to see if they are going in the correct direction with a strong business strategy. Always ask yourself what kinds of goals or vision the management has set out for the company.

Does the company have a clear mission statement for what they are doing?

The company's annual report retrieves all the information.

🟠Step 6: Evaluate the intrinsic value

Intrinsic value is a measure of what an asset is worth. It means how much a company is actually worth in terms of stock.

Stock Price > Intrinsic Value (Overvalue)

Stock Price = Intrinsic Value (Fair Value)

Stock Price < Intrinsic Value (Undervalue)

Example: If an expensive shirt costs Rs. 300/- you probably won’t buy it, but if there is a 50% sale and the price is Rs. 150/- you will surely buy it.

The same is true for investing; therefore, you want to buy stock that is of fair value or undervalued.

Also, the risk of buying a stock that is overvalued is higher because you are paying a premium for it.

So how do we know if the stock is overvalued or not?

There are different valuation methods/approaches in the market for knowing the stock valuation. One of them is Discounted Cash Flow (DCF Approach)

In the upcoming content of these series, we will also be discussing “Different Valuation Methods/Approaches”

#valueinvestor #goodstocks #stocks #stockmarket #investment #financialadvice #goodinvestor

Last Updated: Aug 28, 2024

Tags: #goodstocks #stocks #stockmarket #financialadvice #valueinvestor #investment #goodinvestor Category: Finance & Investment Learning Lifestyle