Value investing starts with low PE stocks, but it shouldn’t be an investor’s only financial metric.
What do Warren Buffett, Ben Graham, Seth Klarman, and Peter Lynch all have in common? Besides being wildly successful investors, they’re all are adherents to value investing, a method where one attempts to buy securities that have a higher intrinsic value than their current price.
One of the most basic forms of value investing is to find stocks with low price-to-earnings (PE) ratios. The PE ratio is a simple ratio that divides the current price per share of a company by the earnings per share over the trailing-12-month period. The logic behind buying low PE stocks is simple: As an investor, you are ultimately entitled to a pro-rata portion of company earnings, so paying the lowest cost, or multiple, for those earnings is preferable than paying a higher multiple. Essentially, your dollar is buying a larger portion of company earnings than it would with a high-multiple stock.
In this post I will present a simple 8 step fundamental analysis template which can be used to analyze if a a stock is investment-worthy or not.
For any stock to merit investment, the most important thing is the financial stability of the business. It is important that a company has manageable debt levels and generates enough operating profits to easily pay interest on its loans and has sufficient cash for day to day operations while delivering decent growth in revenues and profits.
I use the first four ratios described below to assess the financial stability of a company when i consider investing in its stock.
- Long term Debt/Equity Ratio –
Debt/Equity Ratio is a debt ratio used to measure a company’s financial leverage, calculated by dividing a company’s total liabilities by its stockholders’ equity.
Companies (excluding financial institutions) with D/E of less than 1 to be stable and can easily cope with short term downturns as they have higher reserves than what they have borrowed.
D/E= Sum of non current debts/Shareholder Funds.
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Forbes Magazine, Dec. 19, 1994
At the typical stock-fund office, phalanxes of computer screens glow like the control room of a nuclear reactor. The portfolio manager is an intense young MBA. He can recite earnings estimates by rote for each of the 100 stocks in his billion-dollar fund. He’s a high-pressure guy, the atmosphere is electric with excitement, and the phones are always ringing. All this costs money, but the managers have to justify themselves. What are they for if not to trade in and out of stocks?
Yet all this striving does nothing for most fund investors. Although the industry has its good years, over long periods of time the average U.S. stock fund does worse than a market index. No wonder: Typical annual expenses run to 1.3% of assets.
George Mairs, 66, does things differently. Mairs & Power, Inc., founded by Mairs’ father in 1931, has nine employees and runs a total of $300 millon out of the old First National Bank Building in St. Paul, Minn. Nearly all that money is in separate accounts. Mairs & Power Growth Fund has $41 million in assets; a balanced mutual fund, Mairs & Power Income Fund, runs $13 million.
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The original post is by Mastermind, Megabaggers and appears here.
I find it ironic that more research is being done today than at any point in time in the past, yet a lot of value investors are failing to beat the market.
Ironically, the mountain of articles on popular investing websites just aren’t helping. Part of the problem might be due to the “more brains” problem Graham cited years ago. Since everybody on Dalal Street is so smart, all those brains ultimately cancel each other out.
This glut of brain power, investment research, and investors clamouring for bargains does not mean that you can’t beat the market. But, knowing how to pick value stocks is a key requirement, along with having a good strategy and being prepared to do things that most other investors aren’t.
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