Looking For Value Stocks?
First let me start by telling you why I am qualified to provide insight into equities research. I hold a B.A. in Economics and an M.B.A. in Finance, and have worked for one of the top two Investment Banks in the world in their Hedge Fund group for 5 years. I have done extensive independent research in the U.S. and European equities markets and feel confident in my approach to value investing.
Rule number 1: Know the company you would like to invest in. This sounds like a simple request, however, it’s one that causes investors to stumble over and over and over. The simplicity of this statement is what causes such a perplexing reaction. Why would anybody invest capital with a company they don’t know anything about? People do it every day. I promise you. So in short, do your best to understand the niche within which you would like to invest, understand the products, and what makes the industry tick. Once you understand the products you will have a better opportunity to understand the greater economic factors that affect the share prices of stocks within that sector or industry. If you know who Benjamin Graham is, then you know that he espouses this model in his book, The Intelligent Investor.
Rule number 2: Look for an equity investment with a strong earnings per share ratio. What this tells you is that the share price is trading at a discount given the amount of revenue generate per share. These types of stocks are generally in a depressed state for one reason or another, but if they have a strong Return on Equity value (talked about next), they will likely bounce back in the coming years.
Rule Number 3: Look for signals of strength from the financial ratios. You should look for businesses that show either a strong return on equity or a strong earnings yield. You usually will not find both. Here’s why. Businesses generate cash, the good ones generate a whole lot of it. This cash doesn’t do anything for them in a Money Market account, so it must be deployed in order to have it “work” for the business. A growing company, with a strong return on equity, generally a few percentage points above the risk free rate will reinvest that capital into the business, with the expectation that through operations the cash will earn, on average, the amount of the average Return on Equity figure. A high earnings yield on the other hand signals that a company has reached its pinnacle and is no longer in a growth mode. Corporations in this position are generally very well established, with large cash stores, and are willing to pay shareholders a Quarterly, Semi-Annual or Annual dividend as a bonus for continuing to hold their shares. This provides incentive for shareholders not only to stay, but to come into a particular equity, with the expectation of future dividends down the road. Your investment horizon will determine which direction you should go. Longer term, aim for the high Return on Equity option, and shorter term, look for the high earnings yield option.
So what did we learn? Bet on companies that you know and know well. Look for strong Earnings Per Share ratios, combined with strong Return on Equity and/or Dividend Yield. If you can examine and narrow your search by these factors you will greatly increase your chances of beating the major market indices.