Tuesday, May 23, 2017

How I Research and Select My Stocks

I've been getting increasing number of queries from readers on emails on how I research and select my stocks. I have to admit that it's extremely difficult to organize your thoughts in that split second and reply to readers in a single email. It's been so natural for me to think about it in real time because I have done it so many times myself unconsciously but to put words into perspectives can be a real challenge.

I'm going to try and do that in this article and hope I am able to articulate well on my thoughts. Once I do that, I'm going to pin the article up in one of my pages so I can refer to at any time and refine the process when it is necessary to do so. New readers can also refer to that if you want to know how I select stocks.




The first and foremost disclosure that I have to make is that I am not the traditional value investor like Warren Buffet and Charlie Munger that many people adore and follow. Neither am I using the traditional value investing methodology that many people went to courses and get their learning from.

I have my own unique style that fits my profile and character.

To me, everyone in my eyes are a value investor by default. If you are winning, then technically you are getting some sort of value out there. So you are value investing. I'm really not too concerned about the term.

Okay, so let's get started.

My first screening is usually through undergoing a series of news, articles or stories about the underlying nature of the company. This is just done leisurely through reading your favorite newspaper, talking to your supplier or networking through your peers who come from specific industry. It usually comes as a natural to me and I get lots of variation inputs and understanding about the company itself. No hassle and hustling about this first step.

Once I get interested in a particular industry or company because of its competitive edge or moats, this is where I get my hands dirty by going through their last 4 quarterly financial statements and also at least reading their last 3 annual reports. I chose the last 4 quarterly statements because it is important to see the seasonality of the business and if there is a one-off to take note. If I'm still interested to go on at this point, I would then take an hour or two and compile the company's last financial metrics for the last 10 years, preferably covering a year or two before the big crash in 2008 when most company's earnings are showing a trough. This is where you get the idea of how the company is performing during a crisis mode. It is very important on this step. You can refer to what I did for my Kingsmen example for instance.

The second part of the research would focus on the peer comparison.

Generally, I tried to pick as many as I would like to but it is often difficult to find a similar peers in the same industry in a small market like Singapore. Hence, the closest I can find is to go regional with countries such as Hong kong, Thailand or Indonesia as the next destination.

From here, this is where I tried comparing some important operating and financial metrics like the gross profit margins, enterprise value to EBITDA or EBIT, free cash flow yield, cash turnover ratio, working capital efficiency, return on equity (roe), etc etc. If I'm still excited and awake at this point, I tried to dig deeper by going into the Dupont analysis of the roe, one of my personal favorite metrics to look out for. For those who are not familiar with the dupont roe, you can refer to my fellow blogger, LP who consistently bully the bear out of the blue with teaching materials articles like this.

If you have access to Capital IQ or paid access elsewhere like Morning Star premium, you can easily get all the metrics at one simple click to go. If not, you'd have to dig deeper on finding these metrics. They are all nothing but a function of mathematical formula which you can get those numbers from the financial statements, if you know what you are doing.

I've been wanting to incorporate a higher level of thinking at this point by finding out the company's business divisions or segments return on invested capital (roic) for each acquisitions or investment that they've made but I've been very lazy to do this since I became a father. This step is not as evident as much of the steps I've written above and you'd have to really browse through the devils to get the details. But I believe this is where you separate the great from the good.

The third part of the research would focus on the historical comparison on valuation.

After compiling the past 10 year data on step 1, this is where you start looking at trough and peak valuation to see the trend. For instance, if I'm looking at Micro-Mechanics (vested) trough and peak valuation, you'd find that they tend to trade at the range of 4x to 13x earnings multiple. It is not as simple as saying that 4x multiple is cheap and 13x multiple is expensive. The question to ask is what warrants them to trade at 13x earnings at this point. Does that mean growth in future can substantiate and justify this sort of current valuations? Or the market has priced in too much optimism at this point in time expecting future growth to materialize?

Since I have all the data available from step 1, I can easily plug the numbers to simulate certain growth and multiple scenarios into the financial model and see where it takes me from there. You can find how I did it here for example.

The fourth step of the research would focus on getting a step ahead of the analyst.

As most people know, analyst tend to cover companies in their research report after companies have reported their earnings or when there are catalysts that they are expecting to materialize.

The key is to get a step ahead of what the analyst thinks and will write on their report which will impact the share price once it has gone public. You may not believe it but if you generally buy only after the analyst has cover in their report, most of the meat would have probably been gone. It does not mean necessarily you will lose money, but everyone is already on the boat so you will have less margin of safety or meats to play for.

I would also usually think about what kind of valuation that is appropriate for the companies. For instance, banks are usually valued based on their Price to Book value while developers are usually valued based on their RNAV. Developers typically have low return on assets since the turnover is much slower hence the rnav of the companies tend to increase much slower. The rnav of the companies usually tend to increase the fastest through revaluation of the properties, which is a non-cash items but since everyone is valuing it via the rnav, it must be important to take note. Similarly for banks who are valued based on the Price to Book value, having a double digit Return on Equity (ROE) means that you are indirectly holding onto a company which gives you double digit percentage"growth" from a valuation perspective. 

The fifth step of the research would focus on the market depth of the company.

This is a newly found damn good information for me which I love it very much since there is a free trial across most brokerage until the 30th Jun.

By this point, I would have known very well the fundamentals of the company that I wanted to be getting and the range of valuations that I would be aiming for. Having the market depth information of the buy and sell gives me that extra edge because I am able to enter at the lowest range I am comfortable to be buying and I am also able to sell at the highest range I am comfortable to be selling.

I have done this successfully in recent months with Sabana, Far East Hospitality Trust (FEHT), Comfortdelgro, Singtel, M1 and Fraser Commercial Trust (FCOT). I've either bought at the lowest of the range or sell at the highest of the range I am comfortable at. 

To illustrate, I recently thought of accumulating more FCOT into my portfolio and found the current range valuation to be decent. When I checked the market depth information, it has a 1.7m buy queue at a share price of $1.33 (you can verify this yourself tomorrow). It is an extremely strong support line with very few volume transacted at that price. So, I went ahead and proceeded to buy at a single bid higher which is at $1.335 and got it. So if I want to buy, I won't queue at 1.34 or 1.325 for instance.

Every little bit of cents matters if you are buying in big bulks especially.

Again, if you want to read more about the guide to market depth, you can refer to LP post here.



Final Thoughts

This is really what I have to share about what I generally did for my research and how I select my stocks.

Okay,  if you are going for a course out there,  you probably get a similar nature of what I have covered here.  It's just more structured and they have designed templates for your easy learning.  But otherwise,  it's effort effort and effort.

This method which I have used has worked miraculously well for me for the past 6 years, returning me an average of about 20% per annum from 2011 till to date.

I know it sounds a lot easier in theory than it is in practice but it is only through many refining of the process that I am able to do this consistently on my own. You definitely need to put in a lot of practice and it is only after many trials and errors you'd be able to know where you are weak at. We have not even talked about the psychological impact to investing.

I am also 101% sure that there are better practices than what I am doing here so it is really never about comparing which method is the best but which method fits an individual investor the best.

I hope this helps most that emails me about my thinking process.

If you are interested to read more about my thoughts, you can refer to my two previous thoughts which I have archived below for your easy reference.



Okay, just by writing this post alone it took me 2 hours. So I guess it's really about how much effort you've got to put in for successful investing. Otherwise, you may want to choose passive investing with little or no stress.






15 comments:

  1. Replies
    1. Thank you Joel. Much appreciated.

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  2. Does your 20% compound rate include the cash input coming from your salary?
    Do we calculate including the salary input to buy the stock?

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    Replies
    1. Hi Shawn

      20% is the xirr rate, which takes into consideration also your capital injection and dividends received

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  3. Enjoyed the informative read! Looking forward to testing it out in the weeks ahead!

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  4. This comment has been removed by the author.

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  5. Thank you for sharing. But I think it helps that your background is in finance. You're one of the most financially educated blogger I know.

    I, too, get some idea of a company from an article that I'd come across, but I'm also being extra careful with the pump and dump (they do this with penny stocks). But you eliminated this with Step 2, 3, 4 and 5. Evaluate, get source from morning star, and evaluate 10-yrs. heheh LOL I wish you would invest in American companies so I can follow your lead, bro!

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  6. Hi Brian,

    I just started out on my first job and I came across your blog about a week ago. I love reading your posts! You are extremely financial savvy and your posts are structured and detailed. Because of you, I've decided to start a blog to pen down my own journey! I foresee I'll be learning a lot from you!

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  7. Hi Brian,
    I realised your Kingsmen checklist and your MM checklist are different. I compiling my own checklist and I would like to learn why you use one over the other for valuation of different company.

    ReplyDelete
  8. Hi Brian,
    I realised your Kingsmen checklist and your MM checklist are different. I compiling my own checklist and I would like to learn why you use one over the other for valuation of different company.

    ReplyDelete
  9. can you share your strategy of your technical analysis of when is a good price to buy and sell.

    ReplyDelete

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