We’ve all been there, you pick up a book on investing in property, stocks, your health etc and after reading the last word on the last page you realize they’ve told you nothing!
Mine was September 2015 when I was going over my share portfolio and wanted to crystallize my methodology but realized I still didn’t know that “one thing” about investing. And so I finally relented and decided to go and look for The Intelligent Investor. I had had enough and decided that if this fails then there was no truth in the world and I would rely on luck to make it in life, atleast the investing life. Not a nice position to be in.
Fast forward almost four years later and I have a website and could be saying nothing. So here’s my “secret” how to.
When I buy a share I look at four things that reduce the probability of me picking a bad share. Note that a share is a part ownership of an underlying company.
That’s it. That’s the secret. And to be even kinder I’ll expand just so that it doesn’t seem “too good to be true.
The less debt a company has, the less likely it is to fail. If you don’t owe anyone anything you don’t have to go to work. So if a company of mine has little to no debt I don’t have to worry about them feeling pressure to cheat or do business by taking shortcuts. They don’t owe anyone so when they open their doors they’re trying to make money not survive.
To evaluate this I look at the statement of financial position in the financial statements (more on this later) and I take out my desktop calculator. A phone calculator is just as good.
Current assets/current liabilities should be atleast 2. Higher than two I celebrate, lower than two I run like the wind.
Current assets/Long term liabilities should be atleast 1. Higher than 1 I celebrate, lower than 1 I run like the wind.
Both ratios must be met otherwise I take my money and don’t look back!
I want a company that is making profits. Whether profits are increasing or decreasing doesn’t immediately matter to me, as long as the company is making a profit. The reason the direction doesn’t matter year on year is because a company starts from scratch each year. So if the profit is less than last year, that is realistic. You don’t always beat your previous highs. Yes I would like my companies to be able to, but I have seen many managers forge numbers just to look appealing to investors. So I take fluctuations.
So look at the last 5 years earnings per share (eps) on the statement of profit and loss and all 5 years must be positive.
Cash is king, and money in the bank doesn’t lie. As an investor the company can look as big and glamorous as it wants in the media, but if my bank account doesn’t show it then I’m wasting my time. Dividends also help to make sure that the profits the company is reporting are actual cash and not just accounting nerds dribbling me.
For this again I will look at the financial statements or even news announcements. Whatever the Earnings is, I like companies that pay as close to 33% as possible as a dividend. 33% is a thumbsuck but a realistic number I expect from a company that has little to no debt.
Higher is better and lower needs to be explained.
The only thing you can control on an investment as the investor is the price you pay. Period.
The more you pay for a good investment the more likely you are to not make a profit on that investment. The less money you pay for a good investment the more likely you are to make a profit.
It is very important to realize that the stock market glorifies companies who’s share price is going up and demonizes one’s going down. And that’s for a very good reason, it’s a reflection of the company. But remember that a good company at a bad price is a bad investment. So accept you’ve missed out and work harder to identify companies before the price rises so that it rises with you.
This one is the trickiest calculation but still doable on you phone or pocket calculator.
- Take your 5 years of earnings per share and work out a 5 year average. Ie (yr1 + yr2 + yr3 + yr4 + yr5) dividend by 5. This is our E (more later)
- Google the share price of your company and note it. This is our P (more later)
- if the answer is below 11 then good. If the answer is above 11 then write it down and check every time your company is mentioned in the news or you’re considering it again.
Why 11? 100%/11years equals an expected return of 9,09%. This is important because a risk free investment in a 10 year government bond (R186) averages 9%. Your investment must atleast be expected to beat this rate for you to know you are paying a good price. 11 years instead of 10 because year 11 is the profit, year 10 is break even.
Now on Financial Statements before I close. Where does one get these scary documents??
Go on any company website that you want to invest in.
Go to the tab Investor Relations
Either you should see the financial statements or they will be inside the Annual Report.
I really cannot break down my how to any further than I have above. Many of these points have got libraries written about them and can be discussed until the cows come home. I’m happy to do that with you any day. The important thing to realize is that no matter how much theory you have on the topic, failure to decide or invest puts you in the same position as someone that’s never picked up a book, or read the article!