How do I select a stock?

I analyse stocks in two perspectives:
(A) Business Perspective 
(B) Financial Perspective

(A) Business Perspective

1. What business the company is doing?
I will not buy the stock if I don’t like their business, regardless how good the rating given by the analysts or how frequent the recommendation from my friends. I will never analyse the company in detail or pay attention to the related news if I don’t have any interest in the business or the industry the company in.

2. Does the company has certain core competency and sustainable competitive advantage to have a wide economic moat?
I don’t invest in those companies which business model is to compete in cost and without any product differentiation. These kinds of companies face fierce competition in the industry with low entry barriers and very unlikely to be sustainable in the long run. So, why bother to waste time to analyse and monitor these companies whether they will survive eventually? Furthermore, these companies are very unlikely to have consistent and nice profit margin year over year. Some examples are EMS companies (Electronics Manufacturing Services), low end plastic injection company.
 Companies with niche technology or solution (e.g. Intel – every computer need microprocessor, Microsoft – every computer needs operating system), reputable global brand name (e.g. SIA – airline), niche environmental solution provider (e.g. Hyflux – water treatment), monopoly business (e.g. SPH – media, SGX – Stock Exchange), companies that backed by Temasek Holding (e.g. Chartered Semiconductor), companies that forms the pillar of Singapore’s economy (Banks & Finance, Property), are the stocks under my monitoring portfolio.

(B) Financial Perspective
1. Does the company have consistent growth in Sales Revenue, Net Income & Cash Flow?
I read the company financial statement to check whether the company has minimum 10% annual growth in Sales revenue, net income and cash flow. I also check whether the company has minimum 10% net profit margin year over year as this number give me a rough idea whether the company has certain competitive advantage in their business. Operating Cash Flow is also another key thing to check because I want to make sure the company is generating positive cash flow from their operation due to business expansion year over year. Although some companies are making money in certain years but not necessary they are making money from their core business. Creative Technology is losing its competitive advantage and its business has shrunk significantly. However Creative Technology still reported profit a few quarters ago but when I deep dived to analyze Creative P&L Statement & Cash Flow statement, I found out that Creative Technology made profit by selling its headquarter building & won $100M patent lawsuit from Apple MP3. I have to watch out for any abnormality in one time profit reporting or  one time write off as this will distort the financial statement and mislead me in the analysis.

2. Does the company have lots of debt or lots of cash? Does the company liquid enough to pay off its short term liabilities obligation?
I look for the company with low debts or have lots of cash, Current Ratio (Current Asset / Current Liabilities) > 1, Long Term Debt < 3 x Net Income.

3. How efficient is the company?
I use ROA & ROE to judge the efficiency of the company.
ROA (Return On Asset) measures how the company uses its asset to generate profit.
ROE (Return on Equity) measures how the company uses the money from shareholder to generate profit.
My criteria for ROA is > 10% and ROE > 15%.

Besides analysing the stocks from Business & Financial Perspectives, I also pay attention to whether any insiders (Chairman, CEO, COO, CFO, Board of Directors) are buying or selling the stocks. Insiders know the company inside out as they are managing the company daily. They have the most updated company information, financial status and future business plan compare to other peoples. I have to be very cautious if the insiders start selling the stocks in a massive way although the stock is still meeting all the criteria. It is better to avoid the stock than buying blindly base on the selection criteria.

How do I invest in stocks?

Gone of the old day (as newbie) when I just invest base on what other people said (friends, collegues, newspapers and even BANKS!). I’ve even lost money after listening to Bank’s “RECOMMENDATION” investing in mutual funds and currency. I also had a chance to learn from a new friend who previously was a remisier, the dark side of the stock market. “Someone” is just out there to make money from the retail investors like most of us. Those were really painful lessons as I threw away my hard earn money to make someone rich. 

Fortunately, I took action to better equipped myself to continue to play in this investment game. I consider myself a better investor now with the knowledge I acquired from the investment workshop.

There are 3 parts of homeworks I do before putting my money in particular stocks:

  1. Identify and select a good stock / company with a good business.
  2. Value the stock price to see whether it is undervalue.
  3. Plan my entry point and exit point. Do technical analysis to determine the right time to buy and sell.

I will share these 3 parts in detail in the subsequent posts.