How to be a better investor? Part 3

The value investor looks for stocks with strong fundamentals – including earnings, dividends, book value, and cash flow – that are selling at a bargain price, given their quality. The value investor seeks companies that seem to be incorrectly valued (undervalued) by the market and therefore have the potential to increase in share price when the market corrects its error in valuation. Here is a breakdown of some of the numbers value investors use as rough guides for picking stocks. Keep in mind that these are guidelines, not hard-and-fast rules:

  1. Share price should be no more than two-thirds of intrinsic worth.
  2. Look at companies with P/E ratios at the lowest 10% of all equity securities.
  3. PEG should be less than one.
  4. Stock price should be no more than tangible book value.
  5. There should be no more debt than equity (i.e. D/E ratio < 1).
  6. Current assets should be two times current liabilities.
  7. Dividend yield should be at least two-thirds of the long-term AAA bond yield.
  8. Earnings growth should be at least 7% per annum compounded over the last 10 years.

Things To Look For in companies earnings:

  • Look for companies with a consistent growth in earnings.
  • Look for companies whose annual earnings in the last three years have significantly outpaced the market.
  • A company whose earnings are growing faster than its competitors should also have a stock whose price should grow faster too.
  • Well managed companies generally take a significant share of their earnings and reinvest them back into their business to fuel the company’s growth.

Things To Look For in companies EPS:

  • How does the current EPS compare to the stocks historical performance?
  • How does it compare to professional analyst expectations?
  • Look for a company whose earnings “beat” analyst expectations.
  • Are the profits from routine operations or are they from a one-time occurrence, such as sales of a division or assets? You should look for profits from routine operations.
  • Look for a company whose EPS in the latest quarter is higher, preferably much higher than the same quarter a year ago.

Things To Look For in companies ROE: ROE Explains how efficiently the company uses its money. Technically, it is the company’s net profit after taxes, divided by its book value.

  • Return on equity that grows year after year.
  • Look for a company with a Return On Equity of 15% or higher. The higher the better.
  • If the ROE is up and down, or just plain down, the company might have a problem with debt or profit margins.

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