In Value Stock Investing, Quality is Job One
Steve Selenut
About Author :
Steve Selengut has been a successful professional in portfolio management since 1979.
He maintain two websites : sancoservices and
valuestockbuylistprogram.
He has has authored two books : "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and
"A Millionaire's Secret Investment Strategy".
How much financial bloodshed is necessary before we realize that there is no safe and easy shortcut to investment success?
When do we learn that most of our mistakes involve greed, fear, or unrealistic expectations about what we own?
Eventually, successful investors begin to allocate assets in a goal directed manner by adopting a realistic Investment Strategy...
an ongoing security selection and monitoring process that is guided by realistic expectations, selection rules, and management
guidelines.
If you are thinking of trying a strategy for a year to see if it works, you're due for another smack up alongside the head!
Viable Investment Strategies transcend cycles, not years, and viable Equity Investment Strategies consider three disciplined
activities, the first of which is Selection.
Most familiar strategies ignore one of the others. How should an investor determine
what stocks to buy, and when to buy them? Will Rogers summed it up: "Only buy stocks that go up. If they aren't going to go up,
don't buy them." Many have misread this tongue-in-cheek observation and joined the "Buy (anything) High" club.
I've found that the "Buy Value Stocks Low (er)" approach works better. A Google search produces a variety of criteria that help to
identify Value Stocks, the standards being low Price to Book Value, low P/E ratios, and other "fundamentals". But you would be
surprised how the definitions can vary, and how few include the word "Quality".
In the late 90's, it was rumored that a well-known
Value Fund Manager was asked why he wasn't buying dot-coms, IPOs, etc. When he said that they didn't qualify as Value Stocks,
he was told to change his definition... or else. How do we create a confidence building Stock Selection Universe? Simply operating
on blind faith with one of the common definitions may be too simplistic, particularly since many of the numbers originate from the
subject companies. Also, some of the figures may be difficult to obtain quickly, and it is essential not to get bogged down in
endless research. Here are five filters you can use to come up with a selection universe of higher quality companies, and you
can obtain all of the data inexpensively from the same source:
1. An S & P Rating of B+ or Better. Standard & Poor's is a major
financial data provider to the investment community, and its "Earnings and Dividend Rankings for Common Stocks" combine many
fundamental and qualitative factors into a letter ranking that speaks only to the financial viability of the rated companies.
Potential market performance (a guessing game anyway) is not a consideration. B+ and above ratings are considered Investment
Grade. Anything rated lower adds an element of unnecessary speculation to your portfolio. A staff of thousands does your research
for you.
2. A History of Profitability. Although it should seem obvious, buying stock in a company that has a history of profitable
operations is less risky than acquiring shares in an unproven, or start-up entity. Profitable operations adapt more readily to changes
in markets, economies, and business growth opportunities. They are more likely to produce profit opportunities for you quickly.
3. A History of Regular Dividend Payments. The payment of regular dividends, and periodic increases in rate paid, are sure signs of
economic viability. Companies will go to great lengths, and endure great hardships, before electing either to cut or to omit a dividend.
There is no need to focus on the size of the dividend itself; Equities should not be purchased as income producers. A further benefit of
using dividend payment as one of your selection criteria is the clear indication of financial stress that a cut communicates.
4. A Reasonable Price Range. You will find that most Investment Grade stocks are priced above $10 per share and that only a
few trade at levels above $100. If you have a seven-figure portfolio, price may not matter from a diversification standpoint,
but in smaller portfolios, a round lot of a $50 stock may be too much to risk in one position.
An unusually high price may be
caused by an unusually high degree of sector or company specific speculation while an inordinately low price may be a good
warning signal. With no real structural size limitations, I feel comfortable with a range between $10 and $90 per share...
but I would avoid most issues at the higher level. 5. A NYSE Listed Security. I'm not sure that the listing requirements for the
NYSE are still more restrictive than elsewhere, but it is helpful to be able to focus on just one set of statistics since most of the
information you need regularly is reported by Exchange (Market Stats, Issue Breadth, and New Highs vs. New Lows).
Your Selection Universe will become the backbone of your Equity Investment Program, so there is no room for creative
adjustments to the rules and guidelines you've established... no matter how strongly you feel about recent news or rumor.
Now you can focus on operating procedures that will help you diversify properly by position size, industry, etc., and on
guidelines that will help you identify which stocks should be watched closely for purchase when the price is right.
Keeping in mind that you want to sell each Equity Position at a target profit ASAP, you'll want to establish appropriate buying
(and selling) rules. For example, I never consider buying a stock until it has fallen at least 20% from its highest level of the
past 52 weeks, so I include those that are close or at this price level on a "Daily Watch List". Then, I select those that I would be
willing to add to equity portfolios if they fall a bit more during the trading day. Your actual "Buy List" changes every day in both
symbol and limit price. You will need to apply consistent and disciplined judgment to your final selection process,
but you can be confidant that you are choosing from a select group of higher quality, well-established companies, with a proven
track record of profitability and owner awareness. Additionally, as these companies gyrate above and below your purchase
price (as they absolutely will), you can be more confident that it is merely the nature of the stock market and not an imminent
financial disaster... and that should help you sleep nights. By the way, never say no to a profit when the upward movement
equals 10%, and you'll be able to do it again, and again, and again.
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