Before I begin, I hope everyone is staying safe and taking the proper precautions to protect themselves during this time. Also, my love and prayers go to the families who lost loved ones. I am praying that anyone who is battling with COVID-19, defeats it! We will get through this.
I have been thinking about how I pick stocks and comparing my process to other people. Whew! Let me tell you, I am nowhere as intense as some people. I don’t know if that is a bad or a good thing, but I know it makes sense to me. So let’s dive in!
a. Buy stocks in companies you are familiar with and have an interest in. By picking companies you understand you are more able to comprehend how it makes money, sell their products or service, and who their competitors are. This is your portfolio, it needs to make sense to you! If it doesn’t make sense it won’t make dollas! If you are unsure of the ticker (stock symbol) symbol for your chosen company, ask google.
2. A strong and durable moat
a. Besides moat being a term coined by Warren Buffet, it is a company’s ability to protect its profit and market share from competitors. In a nutshell, a company’s competitive advantage. Companies with strong moats=long term profitability=higher stock prices. Of course companies have ups and downs. Companies with durable moats will weather the storm and still come out on the other side whatever season is passing through at the time.
(Types of Moat)
Brand: A brand moat is where you can count on getting that same thing regardless where you buy it. For example, Coke in Detroit taste like Coke in India
Toll bridge: A toll bridge moat is when this company serve as the “source”. You have to go through this in order to have access. A good example is DTE energy. If the vast majority of people want electricity in Michigan, they pretty much have to go through DTE.
Secrets: A secret moat is when a company patent a product and or have a trade secret way creating something and it cannot be copied, which allow them to stay ahead of the competition. For example, 3M create adhesives products that they later patent. Coca-cola has a trade secret that their recipe cannot be copied.
Economies of Scale: When companies have a huge buying power, which allow them to buy wholesale at a lower cost in results have a lower retail price for it consumers. For example, Walmart “everyday low prices” are due to its huge buying product
Network effects: Network Effects moat is when everyone is it. The value of the product or service increases as the number of users grow. For example, Facebook.
Switching moat: This moat is what I call the “trap” lol not really, but a switching moat is when the switching cost it just too much to switch to some other competitor. For example, if all your computers is built on an Intel chip, it will be hard and costly to switch from Intel to one of their competitors.
a. Is this company making money? Which in the long run will make you money. People measure this in many ways, by return on sales (ROC), return on invested capital (ROIC, Earning Per Share (EPS), and the list goes on. I use net margin. Net margin is the ratio of profits to total revenues. I use it, because a company might show a net profit figure of several hundred million dollars, but if the net margin is only 1 percent or less, then even the slightest increase in operating costs or marketplace competition could plunge the company into the red. A larger net margin means greater margin of financial safety and the company is in a better position for growth and expansion.
4. Debt payback time
a. Most companies have debt so it is not bad thing, but it is a double edge sword. As long as a company have enough cash flow to pay back it debt then debt is just a part of their process in running and growing a business. BUT I do not want to see a company in a boat load of debt or forever in debt or worse, borrowing money to pay back debt. . .LAWD! That is why I look at the debt payback time. Long-term debt divided by free cash flow equals debt payback time. A good rule of thumb is 3 years or less.
Those are the metrics I use when picking stocks. Everyone have their own way. Some people take into account the price of the stock to see if they are purchasing at a reasonable price. My way is certainly not the only way nor does a single metric identify the overall financial and operational health of a company. I am just sharing ways I pick companies to buy stock in and maybe it can help you or not. You can find information by using an online data sources, like Morning Star. You use the URL: http://financials.morningstar.com/ratios/r.html?t=STOCKTICKER®ion=usa&culture=en-US
so if you wanted to see Apple data you would use the URL: http://financials.morningstar.com/ratios/r.html?t=AAPL®ion=usa&culture=en-US and so on with whatever else company you want to review. Follow me on SC @iamsisidevoe and twitter @sisidevoe. Just a little story, So I have been using this checklist against Ford. A couple of people I look up to in the investment world have listed Ford (F) as a hot stock. Besides them having a brand name moat and me being familiar the company, Ford would have not made the cut sadly, as you can see from the screen shots below. Sadly because I already brought 20 shares before using this checklist, so may the stock market Gods still be in my favor.
F net margin:
F debt payback time :
USD in Million. I am using 2019 data. Payback time equals 10 years!