Monday Musings - 10

On a recent post of mine on Seeking Alpha, The Re-balancing Act, I was asked a question in the comments section that again raised my awareness to the current state of the retail investor. That question went something like this, "What criteria do you use when screening for stocks to purchase?". I replied with a simple answer about an initial screen that I run to try to find potential value, then quickly added that this is simply a starting place that then leads me to further research about the underlying company.

What really raised my interest in this question though, was that I believe that this is a common thing for people to ask, as they feel they can make gains in the market simply by looking at a few numbers, clicking buy, and waiting until the returns come flowing in. Unfortunately it doesn't quite work that way.  because of this I wanted to layout my normal routine when adding a new position to my portfolio.


A little background first in case you don't know a lot about my investing style. I am a long-term buy and hold, always holding at least a year but most of the time thinking in terms of 5-10 years. When I take a position in a company I am looking for an undervalued company with fundamentals that support a price much higher than the market supports. I also look for dividend yielding companies that I believe will be able to provide me with passive income for many years to come.

So what's my process then? It goes a little bit like this: 

  1. Run a preliminary screen. 
    I usually begin my search by looking for. Companies under a 15 P/E, >3% Dividend Yield, and <60% Payout Ratio. This gives me a good place to start.
  2. Research the Debt.
    From here I tend to look at the amount of debt that the company holds and how that has increased/decreased over the past 3-5 years. Also how does this compare to others in the industry? This knowledge comes in handy when heading to my next step.
  3. Research the Revenue & Income.
    What has the revenue growth looked like the past 10yrs/5yrs/1yr? Where has this revenue come from? How has income changed during those periods?
  4. Cash Flow Analysis.
    For me this reaally entails three things. First, what does the free cash flow look like from year to year? How much does the company retain and what can it re-invest. Second what does the Net Operating Cash flow look like? Is the company increasing its reserves and paying the dividend with its actual operating income, or is it paying from its current reserves/borrowing? Third, what is the operating cash flow divided by sales. This gives me a solid number (%) that shows me historically how the margin of the company is changing. I also compare this to the industry.
  5. Dividend History.
    For me the big one is what is the dividend growth rate the past 10yr/5yr/3yr/1yr? From there I look at the current yield, payout ratio, and buyback history. Can the company sustain raises or the current yield or is it a facade?
  6. Earnings History.
    Really this is simple and just an analysis for red flags in terms of EPS, EBITDA, and total shares. Did the EPS rise purely because share rate is declining?  Is there some fancy backside accounting happening that makes the current quarter look better/worse than it really was? This is purely a hunt for red flags.
  7. Insider Buying.
    Finally I like to look at the ratio of buys to sells that are happening by insiders the past 12/6/3 month periods. I look at this both by number of purchases and total volume of those purchases. Obviously a larger amount of discrepancy each way tends to show what the company's executives think about the current share price.

These 7 things provide insight into how much of a potential risk the company may have in the near/medium term. If a company has a lot of minimal debt, a great sustainable dividend (for at least a few years), but declining revenue, I may take a small chance with them if I think there may be a possibility of turning things around or even a buyout.



After I take all of these thiings into account I try my best at analyzing what a fair price is for the company. That process is much more in depth and use a series of algorithms that I organized into an excel program that spits it out for me automatically. It's nothing  fancy but gives me fair price and buy indicators so that I am not running blind. These obviously are not always in-line with how the market thinks (as I believe Apple, AAPL is overpriced) but it gives me a set of guidelines to work through. 

To get a good look at it in action check out my last post about CVS. In fact I have made many of these public in my D30 analysis section and offer free evaluations of companies by request. The current posts in my D30 are based off annual reports so they are currently out-of-date. I have recently updated my analysis to include quarterly data and will soon be re-doing the reports to be more accurate.

 If you do look at the evaluation please note that these are current evaluations based off of purely balance sheet data, not projections for any future innovation or market share gains. 


As always feel free to leave any comments below.