- Investment strategies
- Why invest in the stock market?
- Buy and hold or technical analysis? Why you need an investment plan
- Value investing and short selling in volatile markets
- Using technical analysis to support value investing
- Investing in the unexpected
- Franking credits, explained
- What is dividend stripping and is it a sensible strategy?
- Investing in quality IPOs
- How to invest in stocks that benefit from a moving Australian dollar
- Reasons to avoid bonds when interest rates are low
- How value investors use Skaffold
- Quality, growth and value = a winning strategy
- Know your investor type and boost your performance
- Technical + fundamental analysis = better buy and sell decisions
- Fundamental investing
- Value investing and the price earnings ratio
- Intrinsic valuation models and methodology
- Value investments or value traps?
- How to find value stocks in a bull market
- Find value investments in expanding markets
- Why capital raisings struggle to add investment value
- How to value an insurance company
- Top stocks
- 5 qualities of top stocks
- How to find stocks with a competitive advantage
- Why return on equity is the best measure of business performance
- Using cash flow to find value investments
- Finding high quality dividend stocks
- Debt is not always a dirty word
- Why Skaffold share investment software makes sense
- Using economic factors to uncover the best investment options
- How do experts find top stocks to invest in?
- Investing in global stocks
- How to invest in international shares on global stock markets
- Benefits of investing in international shares
Manage your portfolio like a smart value investor
Discover the qualities that will make you a smart value investor and improve your portfolio management.
Once you have committed your hard earned money to a company listed on the stock exchange with the expectation of a financial return over time, you are by definition an investor.
What now separates you, as a smart value investor, from the gambling or speculating variety is the quality of thinking that you bring to your portfolio management going forward. Smart value investors will attempt to minimise the risk associated with holding a listed company while maximising returns, whereas gamblers and individuals trading stocks online are happy to trade off higher levels of risk on the off-chance it might deliver higher-than-average returns.
To cultivate a good value investor mentality you need to recognise that as a shareholder, you are a part owner of a listed business that employs staff, borrows money, generates earnings from engaging in one or more core business activities, and where appropriate pays dividends.
Nobel prize-winning economist William Sharpe believes the golden rule of sensible investing is understanding the business, its performance and future growth prospects. This applies whether it’s your own private business or a company listed on the share market.
It’s unrealistic for everyday investors to have the time to independently acquire the knowledge necessary to intelligently differentiate between top stocks and those with doubtful or deteriorating fundamentals that may be potentially wealth-destroying.
That’s why in 2011 online stock research tool Skaffold launched a no-nonsense, state-of-the-art application to help smart value investors quickly evaluate listed companies across five key criteria.
Five questions smart value investors ask before buying stocks online
When searching for the best stocks to buy, value investors ask these five key questions.
Ask these questions and you’ll quickly eliminate poor quality businesses and focus your attention on only the best stocks to buy.
1. What business is this company in?
Smart value investors will avoid companies operating in sectors offering limited future economic growth or where the business model is unduly exposed to fluctuating economic conditions.
2. Have earnings been rising and are they expected to continue going up?
Avoid companies that have stagnant or declining earnings, and limited ability to generate organic growth or fund future dividends without using debt.
3. Are the companies in your portfolio overexposed to debt to fund core business activities?
Smart investors understand the disastrous impact that mismanaged debt can have on a company’s bottom-line earnings. You can’t lay claim to thinking like an informed investor unless you understand the relative performance of the business, its balance sheet and its intrinsic value over recent years.
For example, Skaffold shows that Flexigroup’s balance sheet has consistently been overexposed to debt.
4. How well have the companies in your portfolio used their equity and how profitable are they?
You also need to be aware of key indicators (or performance ratios) to correctly interpret whether the company has been delivering satisfactory returns. One of the key ratios favoured by Skaffold is return on equity (ROE). As an indicator of business profitability, return on equity compares how many dollars of equity were required to produce the company’s profit.
A smart investor would much prefer to own shares in a company that produces a profit of $25 million from $100 million worth of equity than one delivering $5 million profit on the same amount of equity. The former has a return on equity of 25 per cent while the latter’s return on equity is only 5 per cent. As a smart investor you should also be attracted to businesses that can produce increasingly profitable return on equity without needing to raise additional capital or take on extra debt.
5. Are the companies in your portfolio adequately covering operating expenses with sufficient cash flow?
Companies with a notable gap between cash flow and debt required to generate it will seriously deteriorate their balance sheet. A net-negative cash flow position is unsustainable, especially where debt is involved, and if not corrected will result in falling share prices as investor confidence diminishes.
Buy, sell or hold?
Once you understand the business, its economics and future growth prospects, as a value investor you must determine whether the company you’re attracted to represents value for the price you’re prepared to pay for its shares.
Paying too much for a top-quality company can destroy wealth as fast as investing in those with excessive debt. Sooner or later, the share price will start to converge with the company’s intrinsic value (or the sum total of the company’s worth based on earnings, dividends, equity and debt).
So as a smart investor who understands this, you’re less likely to buy shares in a company for $20 when the underlying value is only worth half that.
Ideally you want to buy good companies when there’s a discount between the share price and its underlying value, and sell when the share price moves well ahead of its intrinsic value without good reason.