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Sri Lanka Equity Forum » Stock Market Talk » How to pick winning stocks by analysis not through predictions and gossip news-1

How to pick winning stocks by analysis not through predictions and gossip news-1

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Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
Some say market gonna crash and wait till 2020 Rolling Eyes 
So we heard enough, if you like to invest after 2020 be my guess Very Happy 
Bull market/bare market/yahapalanaya/pohottuwa/Ravi/Mangala and etc, think these are2 different side from a same coin Basketball 

The only thing matters end of the day is which share you pick to invest or trade sunny 

So here is the part 1 of
Identifying Value Stocks Is Methodology And Art-John Navin

I had noticed a certain reverence in the demeanor of the mostly male guests on the Wall Street Week of the 1970s whenever Warren Buffett was mentioned, host Louis Rukeyser included. When the discussion moved to Buffett and the talk moved to “value stocks” you could detect a change of vibe almost as apparent as a change of studio lighting. Such a topic must be approached with the deepest respect is the message I got when I used to watch the show as a teenager working in the videotape room of University of North Carolina Educational Television. It ran on Friday nights just after The Creative Person, a wonderful unintended contrast of two worlds.
That was the context for my first exposure to the value stock universe: it’s that subject that comes right after poets, novelists, musicians and artists and just before the weekend. What I have to say about what I’ve learned about it starts there.
A couple of years after watching Wall Street Week every Friday night, I picked up a copy of the Graham and Dodd book and taught myself as much as I could understand. I got this much: if you studied financials, sometimes you could find stocks worth more than the market price. It reminded me of when I bought 45 rpm records from a wholesale record distributor in Brooklyn for 59 cents and sold them to my Teaneck, New Jersey junior high school friends for 89 cents. Oh, now I see.
It’s the same basic principle: buying what can be identified as cheap and selling it to others at a higher price which, in the case of stocks, means later as in after a period of time. It sounds simple but there’s a lot of work involved to get there. Or, you can skip it and try your hand at growth stock investing, a method much more popular lately. Value stock analysis is a long walk through metrics that were used as long ago as the 20s and 30s – old school, to be sure, but, to me, that’s the beauty of it.
When I started becoming interested as a teenager, I didn’t realize that the market could be divided up into types or categories of stocks. I had the standard outsider’s view that the main thing was the company story and the strength of the brand: GE made good light bulbs, must be a pretty good stock. IBM made big computers, must be a decent investment. Chase Manhattan is a huge bank in New York City, must be the way to go. It didn’t dawn on me for years that digging deep into financials could be telling in a way that wasn’t apparent on the surface.


Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
The Meaning of Value.
Every stock is a value stock of some kind. You could say that there’s “value” even in the riskiest of businesses based on the wackiest of ideas – the value is present in the potential for great reward. Emphasis on “the potential.” The problem is most companies like this eventually go out of business and it’s usually sooner rather than later. A select few garner huge rewards, but that’s rare. Mostly, high risk, unhedged and over time, gets murdered.
But when seasoned investment analysts mention the word “value” as they’re ranting away on CNBC about stocks, they’re referring to something specific and it has to do with less risk, not more. A value stock has value when it meets a certain set of criteria that indicates the current market price is less than its intrinsic worth.
To de-mystify: you can buy it cheap. That is, relative to most other stocks. Sometimes they call it “break-up value” – if you broke it up into pieces and sold everything, you’d get more than the current non-break-up price tag. Sometimes they use the term “undervalued,” but among the Wall Street knowledgeable, that just means value stock.
Value stock, undervalued situation, breakup value, cheap. These are the terms used to describe what you end up with if you analyze companies the way that Benjamin Graham did when he was teaching business classes at Columbia University long ago. Call it whatever you want, add any nuanced details, that’s what’s being discussed.
Along with identifying value, these methods generally keep the investor away from potentially hazardous situations based mostly on expectation. Generally. You won’t be looking for “explosive earnings growth” or “disruptive innovation.” It’s the opposite: value stocks tend to be old, boring and not much fun to tell your friends about.
Here is the mix of metrics you’ll need, for the most part, to clearly identify this kind of value in the stock market, if that’s where you want some of your money to go: price/earnings ratio, book value, earnings growth, debt to equity ratio and dividend payout.

Ryan Hudson

Assistant Vice President - Equity Analytics
Assistant Vice President - Equity Analytics


Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
The price/earnings ratio

The p/e is the market price of the stock divided by the amount of its yearly earnings.

A company earns a dollar per share. The stock is trading for 10 dollars a share. What’s the price/earnings ratio? I got 10. That’s low.
A different company is earning 10 cents per share. The stock is also trading for 10 dollars a share. What’s the price/earnings ratio? 100, right? That’s high.
Right away, without thinking about it too much, I can see that the second company is being priced more on expectation than on current results. That’s the most common, likely explanation -- although a few others could be possible. All of the analysts over at the growth stock desk can’t stop talking about how amazing the future earnings are expected to be, why it’s probably the next Amazon or Apple, if you look at it in just the right way, you definitely want to buy at least several thousand shares before next Tuesday’s sales report, what are you waiting for?
But if we’re thinking like a value investor, we already prefer the first company with the much lower price/earnings ratio. The business it’s in puts us to sleep with the stupefying dullness of its operation, but the thing is: we can pay substantially less for more actual earnings, earnings already sitting in the bank, waiting patiently for their turn to become the cheerful part of a dividend check. It’s cheaper, according to this single measure – a simple analysis which obviously requires much further work. We’re just getting started. Context is important.
Nonetheless, this beginning step to examining how much in earnings we’re receiving for the price we’re paying is essential once we take this classic analytical path.
By reducing the number of stocks to analyze using the price/earnings ratio, we are separating the wheat from the chaff. Although a number of other screens are necessary to pinpoint worthwhile value stocks, this first step helps to diminish the taint of “expectations” from potential investment candidates.
It greatly moderates the list and, in general, helps to keep us away from speculative stories based on the imagination. Not always, but for the most part – that’s why looking at a few other metrics is required. As a basic rule, a list of those stocks with p/e’s below the market p/e gets us on the right track to value. Significantly below is even better.


Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics
What’s the “market p/e”?
For most purposes – and our purposes – that’s the price/earnings ratio of all stocks included in the Standard and Poor’s 500. All of their earnings added up and divided by 500.  It’s the generally agreed upon benchmark against which all p/e’s are measured. Some smart analysts with economics degrees adjust somewhat for inflation and cycles, but since we’re looking for significantly lower p/e’s, we don’t need to worry about it.
If you were only looking at small capitalization stocks and ignoring the big ones, then it’s the price/earnings ratio of the Russell 2000 “small cap” index that might more appropriately fit. Since a significant number of small caps have no earnings at all, this one’s tricky.
If you were only considering very big capitalization equities, it might be enough to start with the p/e of the Dow Jones Industrial Average. The drawback is the fact that the DJIA consists of only 30 stocks. They’re all big companies, but is that number enough to begin to make judgements? Context is important but the main thing here is to make sure the stocks you’re looking at are trading at valuation levels lower, much lower if you can find them, than their peers.
When you begin to hunt for price/earnings ratios on the Internet or in financial print media, you may find different kinds of p/e’s listed. Find the one that indicates what the earnings were for the last year – don’t make the mistake of making a case from “estimated earnings for next year.”
“Projected” earnings or “expected” earnings are interesting but mostly irrelevant when you’re analyzing for value stocks. We’re interested in what is not what might be. Skilled analysts with fine investment firms spend a lot of time coming up with figures like “expected earnings” but they’re not looking for the kind of stocks we want. That’s the pursuit of “growth” not value, a much different game with its own set of rules.
Once you start examining the p/e’s of many stocks you’ll begin to notice that certain types of industries fall into the “low p/e” category and certain others fall into the “high p/e” category. For example, right now – in general – many technology stocks and Internet-related stocks will end up on the “high p/e” list of those we want to avoid. Not all, but many. A lot of expectation is built in to those companies and that’s fine if it develops, but we want only established, recorded earnings. Because of their non-tech orientation, lower p/e stocks tend to generate less media coverage.
How much money would you pay to own a company that’s making money?
That’s the question answered, partially, by determining the price-to-earnings ratio of a publicly traded business. The vast multitudes continuously buying and selling stocks put a market price on the amount of earnings.
The poker analogy is to bad opening hands that you must fold because there’s not any point in continuing, the odds of hand value are that bad. In Texas Hold Em poker (see Matt Damon and John Malkovich in the movie Rounders) the worst first two cards you can be dealt are seven and two. Mathematically, this hand really stinks, the correct play is to fold. You might get lucky, but that’s all it would be: luck. If you are dealt a pair of Aces, the odds are good, in fact that’s the best hand possible and the practice is to continue with that combination. These price/earnings metrics help you to decide quickly when to fold and when to continue.  Doyle Brunson is highly likely to be folding high p/e stocks.


Senior Vice President - Equity Analytics
Senior Vice President - Equity Analytics

  1. Book Value.

Book value is what you come up with when you add up everything that counts as “asset” and subtract from that everything that counts as “liability.” Book value per share is that figure divided by the number of shares outstanding.
Typically, in the modern era, stocks trade at greater than their book value, usually much greater. If I were a historian of the future, looking back on this, I’d put “much greater than book value” on my list of measures of decadence. Back in 1934 when Benjamin Graham and David Dodd wrote Security Analysis, many stocks traded at much less than book, a major consequence of the Depression era. Eventually these stocks found buyers as investors began to gain confidence in the economy and noticed the value, but that took time.
“Much greater than book” = careening off the hook, caution. “Much less than book” = might be overdone on the downside, take a look. More or less. From the value perspective.
At the time that I’m writing, not many stocks trade below book value. They exist but it’s not like the 1930s. These days a company that you can buy for less than book is likely to have some serious issues -- sometimes related to a perceived inability to continue earning money, often associated with high levels of debt. When Graham was teaching at Columbia and writing classic investment tomes, you could find dozens and dozens of well-run, exchange-traded businesses available for bargain basement prices. The list of such companies today would be short and you would quickly notice, examining other metrics, how questionable their future prospects looked.
In short, value stocks trading below book value always exist. You may live in an era when they’re tough to find and largely ignored. You may live during a Depression and, if you have any money, have the good fortune to discern the value then present. Either way, since you’re picking up assets for less than they’re worth – and which seem to have otherwise solid businesses – you can sleep knowing that value is eventually recognized and respected. The discipline requires sitting through longer-term fluctuations and remaining confident in a method that identifies the attractiveness and validity of discounted price.
Calculating book value is uncomplicated. First, you come up with shareholder’s equity by subtracting debt (or liabilities) from assets. From that figure, subtract preferred stock amount if preferred stock is on the books. The number that you find on that bottom line is book value. If it’s less than the market price for that stock, that’s interesting.
All of this information is available in the annual report of exchange-traded companies and it’s often in quarterly reports. Better yet, it’s reliably reported by those investment websites who track stock markets: a good one that I’ve used is Financial Visualization at which lists many different balance sheet metrics of almost all listed companies.
What you have to be careful about when analyzing for value: the metric “book value” is subject to more interpretation than you would think. Companies with equipment are required by the standards of accounting to depreciate the cost of machinery, for example, at a reasonable rate. Or it may be the case that real estate on the books is doing the opposite, that is, appreciating.
Most balance sheets reflect decent, honest work but sometimes you will encounter attempts to stretch things. Once you begin to examine these figures you may develop a sense for what smells right and what doesn’t. It’s important to be disciplined with the approach -- it’s also important to keep your eyes open to artistic approaches in some numbers crunching. Using book value as a metric for the selection of stocks requires some skepticism about financial reporting: some legitimate companies have creative ways of determining asset value.
One other thing: book value tends to favor those companies with solid physical assets like railroads or solid patented assets such as pharmaceutical companies. This figure tends to be low for the type of companies that don’t necessarily require either of those: like some Internet-based companies or advertising firms or any publicly traded non-traditional outfit without much need of physical machinery or patents.

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