Approach to investing:
Over the last 10 years, I have matured from a speculative investor into a conservative, detailed and portfolio focused investor. In advance of making an investment in a company, I cover the five core areas outlined below.
1. Does the firm have a story that I can understand and believe in?
In order to be a successful investor you must have confidence in your conclusion to stay the course when times get turbulent. Having a clear understanding of what the company does, the market it operates in and developing a logical investment thesis based on that research is vital to being confident in your decision to invest.
2. Is the firm in a financially secure position?
An observably great product or service does not necessarily make for a smart investment. To gain confidence in a firm’s financial stability I look through 5 to 10 years of annual financial performance.
- Income Statements
- Balance Sheets
- Cash Flow Statements
*I pay particular attention to cash flows, growth rates, margins, debt and abnormal items (restructuring, lawsuits, etc.).
Remember the adage, past performance is not indicative of future results. However, historical data is an invaluable tool for forecasting financial results. If a comprehensive annual financial analysis checks out favorably then I move on to review the past several quarters of financial performance and a few earnings calls.
*During earnings calls, I assess whether the management of the company in question has a narrative that is both positive and consistent. Listening to the calls can provide insight on management’s goals and personalities, which in turn influence the goals and culture of the entire firm.
3. How is the stock priced in the market?
If the firm’s story and financial stability are promising, I then move onto a relative valuation of the firm in question. This involves comparing the firm to both its respective industry and the entire market. Relative premiums or discounts will be observed at this phase of analysis and it is paramount to understand and interpret the rationale behind whichever result is seen.
+The firm may have a differentiator or advantage compared to peers (a moat) that will enable the firm to prosper comparatively. Strong moats can be a reason for a stock to have a premium compared to peers and or the market.
–Alternatively, discounts to peers may occur due to perceived relative shortcoming(s). For example, a firm may be less efficient than another firm, or have taken on a lot of debt to acquire a business that the market has deemed sub-optimal.
In this stage, with variances relative to the industry, I look at various financial ratios as key indicators to find value; tending to favor P/E ratios (trailing 12M and forward), EV/EBITDA, P/B, P/S, CF/NI, coverage ratios and growth comparisons.
4. Additional Checks:
- I analyze technical indicators to make sure there are no glaring red flags in the price or volume charts. While I typically do not make investments based on technical analysis alone, I understand that many investors do. An investor should be aware of those patterns to potentially avoid entering a fundamentally sound stock that is in a bad technical trading pattern.
- Another factor I take into account is the VIX (CBOE Volatility Index); this index is derived from strike prices and spreads seen in short-term options on the S&P 500. The VIX is nicknamed the “Fear Index”. In my experience, it has been unwise to sell when the index is high because that is when fear is gauged to be high and many tend to sell when fear is high.
5. Portfolio Perspective:
Any potential investments should be analyzed with respect to spreading risk across industries, asset classes and geographies. All investment options have these characteristics and each have different risk and reward profiles.
In closing, by covering these five core areas I hope to stay confident in my investments and stay the course, which should lead to long-term success.