BITE-SIZED GUIDE. Buying Great Stocks Extra Cheap with Value Investing
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1 BITE-SIZED GUIDE Buying Great Stocks Extra Cheap with Value Investing
2 General Advice Warning: The ideas and information contained in this publication are for general information only. They do not take into consideration your personal circumstances or objectives. Please considering if these ideas are appropriate for your needs before taking any action. We suggest you seek advice from a financial professional if necessary. Disclaimer: We have prepared this publication to the best of our knowledge and consider it accurate. Please do you own research or inquiries before acting on any of the ideas or information contained. Performance: Past performance is not a reliable indicator of future results. Any published performance figures are hypothetical as they are based on prices at the time the idea was released, and may not accurately depict slippage or transaction costs. 2
3 In this guide you will learn how to buy great stock extra cheap with Value investing. Value Investing is the art of purchasing the shares of top quality businesses with excellent financials, great prospects and strong cash flow, when they become cheap on the stock market. Value investing has proven to be a timeless strategy and is used by some of the world s most successful investors. 3
4 Value Investing in a Nutshell Value investing is buying stocks when the share price trades below the valuation of the business. For example, if company X has 1000 shares worth $50 each, it would be worth $50,000 on the stock exchange. If you then calculated that the business was worth $60,000, you could consider buying the stock in the hope that the share price will rise to reflect the true value of the business. Sounds simple, but why would a stock end up trading for less than its worth? 1. The stock market can be irrational! People and institutions are making decisions to buy or sell a stock on many factors other than value. They could be buying the stock because it is part of an index, because it has formed a pattern on a chart or because of a general market sell off. This is generally where the opportunity lies for us to acquire a great stock for less than its worth. 2. It can be difficult to determine the true value of a business. There are plenty of different ways to determine the value of a business. What might represent true value by one measure might not on another. Our favourite metric for determining value is return on equity. But there are many other factors to consider, such as how much debt the company has or if they have a sustainable competitive advantage. 3. There is something we don t know. We cannot always be sure if something about the business that is causing the stock price to be decline. This could be due to an accounting irregularity, a problem with a product, or a variety of other things. We need to be vigilant in keeping our eyes peeled for this type of information. Just as importantly we need to have money management rules in place so that if this does happen to one of the stocks we are investing in, then it does not harm us too much. 4
5 Focus on Value Not on Price When we are investing we want to remove our focus from the price of the stock itself and look to understand the true value of the business. The stock market becomes a place for us to go shopping for businesses that we want to buy when they are on sale. Be Patient Determining the value of the business is the easy part of value investing. What is more difficult is the waiting. If you have done the research and found a great stock, but it is not yet on sale it can be tempting to jump in too early. We also need to be comfortable not buying a stock that we have put the time into researching if we find something we don t like. We must be disciplined and patient and only buy businesses that tick all the boxes and at the right price. Finding a Value Stock to Buy There are six things we like to consider when searching for the most extraordinary value stocks. If you are a value investor already, they make look familiar to you, as they are based on Warren Buffett s philosophies. Warren Buffett is the world s most famous value investor Our 6 keys to value investing are: } Great profits } A sustainably high return on equity } A sustainable competitive advantage } Top quality management } A strong cash flow } An absence of debt. 5
6 Great Profits. If a business is increasing its profits and there is no reason to suspect this will change then it should have good long term prospects. We also want to consider if the business is sustaining its growth with or without additional capital being invested. Great businesses have growing profits without the need to add more investor money. A Sustainably High Return on Equity. If a business is able to make strong returns on the money invested in it then it could be said to have a high return on equity. Think of it like a bank account. If you put your money in a bank account and earn 20 %, then that would be a good thing. If you earn only 2 %, than that would not be so great. Businesses are the same the higher the return, the better. Furthermore, if the business is able to make profits, reinvest them, and still retain a high return on its equity, then it becomes very desirable for us to buy. A Sustainable Competitive Advantage. Companies need to maintain their high return on equity moving forward. This can be a little more tricky for us to determine. Some companies have few barriers to entry and are open to intense competition. If we are to invest in a business we want to safeguard against competitors coming in and undercutting market share. Areas of Competitive advantage. Management Culture Brand Systems and Processes Information Technology Size and Scale Pricing Power Government Regulation or Policy Location or Access to Natural Resources Customer Inertia High Switching Costs We want to stay away from companies that are one-trick ponies. One good product or offering does not make a great company. By contrast, a great company would have the ability to continue to create great products with high margins. 6
7 Top Quality Management. We want a quality management team in place that treats shareholders like owners. There are some signs that indicate when this isn t happening. Watch out for: } Companies that are engaging in acquisitions and mergers } Companies with management that enrich themselves at the expense of the shareholders } Companies that attract outside CEOs at high salaries } Companies that look to expand outside of their core competencies } Me too companies that look to imitate their more successful peers. If businesses are engaging in any of the above practices, we should stay away from investing in them. A Strong Cash Flow. When we purchase a business, we require it to have a strong cash flow. Paper profits just don t cut it in the real world. While it might seem easy to determine if a business is generating cash, accounting vagaries can make it a bit difficult. What is important to understand is that we are looking to figure out if the company is going to end up with a big chunk of physical cash at the end of the year that it can use to grow the business and pay shareholders. When we assess a business, we want the cash flow of the business to be growing. Perhaps it is not always growing in a straight line, but the general trend should be heading upwards. The business should be calculating cash-flow after all tax and interest liabilities are met. 7
8 An Absence of Debt. If the business we are looking to buy has debt, then that is bad. Some people will argue that debt can enhance the returns and for sure, it can. But in the context of value investing, debt is bad, full stop. Debt means the business is riskier to invest in and returns might be inflated. If a company has debt that is declining consistently, then it may imply that the company is still desirable. If debt is growing, it is a sure sign that we want to stay away. The very best companies have no need for debt. They are able to generate all the cash they need to do the things they want. If we can find a company with high return on equity and little or no debt we may have found ourselves a winner. It Will be Worth it! Value investing will take some time to get used to. Some of the concepts are unavoidably mathematical in nature and it s not always simple. Persevere and take the time to learn. It will be worth it! If you would like someone to do all the research to find the very best global value stocks then please feel free to get in touch with us at 8
9 SpoonFed Investor s beautifully simple investment ideas may be just what you re after. Jump online and take a look how we can help you at Get rewarded for referrals! Receive a 10% discount on your subscription for every friend you refer to us who signs up! 10 x friends and your subscription is free! Become a personal investing guru! Join SpoonFed Investor Blog and receive Bite-Sized Guides for free at blog
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