Buying Good Companies when the price is cheap - A summary from 小資女艾蜜莉 video

I came across 小資族,靠理財也能創造大財富 video on i3investor. The video interview a girl (小資女艾蜜莉) who draw a salary less than TWD30k (MYR 3k)  but achieve a net worth of TWD 4 million (MYR 400k) in 6 years by investing in stock market.

She reveal how she pick good stock and time the market in the interview. And, below is some of the points shared on the interview.


How to choose a Good Companies

1. Buy companies with strong histories of profitability
2. Avoid commodities business that need high capex with negative growth of the gross profit margin. (In another words, look for franchises which are able to dig deep economic moats around their castles)
3. Avoid company with small cap; look for big cap with long listing history.
4. Check where is the earning come from? Operating profit or investing profit? We should focus on company that able to generate profit from its core business.
5. Check if company invest in loos making initiative?
6. To exclude company with low quality earning. Check Revenue Growth vs Trade Receivable.
7. To check if a firm able to generate Operating Cash Flow to support it's own cash usage.
8. Avoid high debt company?
9. Prevent company that alway ask cash from owner.
10. Avoid company with insider selling.

 (Some of the points is similiar to Warren Buffet Style)

How to determine if a stock price is expensive or cheap?

1. Based on historical dividend yield
2. Based on historical share price
3. P/E
4. P/B
5. ROE

Caculate the  value for selected good companies by using the average output from (1) - (5). Then, she build a traffic light alike dashboard to monitor the share price vs its value:-

• Red - Expensive
• Yellow - Moderate
• Green - Cheap

From the interview sections, she mentioned that she will monitor around 80 stocks and start to buy when the price is cheap, and start to sell when price is expensive. In one time, she will hold 3-5 stocks to achieve diversifications.

1. DY is a good indicator - we can buy a good comapnies when DY is high and sold it when DY is low. This metric can be used at a company with a dividend payout policy.
2. I don't get the idea why should use this? A share price alone not able to reflect the value. What can we know if the share price hit a 52W high or 52W low?
3. I prefer to use the magic formula to replace the P/E.  
4. We need to bear in mind that not all asset is same quality. And, some company is asset light and market will value it based on its earnign power instead of the book value. Compare with P/B, I think graham net net might be a better candidate for us to hunt for cheap stock with good asset quality.
5. There is some issues and pitfall on ROE, do perform DuPont analysis on the ROE, or alternately I prefer to use ROIC

References:-

• 小資族,靠理財也能創造大財富

 

Question Checklist on Company's Business

 

Question picked from ‘The Warren Buffett Way’ by Robert Hagstrom

Questions on the core business 
1. Is the business simple and understandable?
Never invest in a business you do not understand, for you can’t see the future opportunities and challenges before they arise.  
2. Does the business have a consistent operating history?
Past performance is no guarantee for future success, but it shows if a business can operate under varying business conditions.  
3. Does the business have favourable long term prospects?
‘Sustainable business’ is the key word here. Stay away from companies that operate on trends and fads that can go out-dated in the future. Look for business that can sustain in the long term.
 
Questions on management quality
4. Is management rational?
Now this is a very important part of an investor’s business analysis. The rationality of the management and its ability to deploy cash in a profitable manner is what separates a good business from a bad one.  

5. Is management candid (frank) with its shareholders?
You don’t want to get into a future Enron, right? Look for managers that admit mistakes and take complete responsibility of their actions.

6. Does management resist the institutional imperative?
Institutional imperative is the need for managers to act like their peers, no matter how irrational their actions may seem. Avoid managers who have the tendency to give in to peer pressure.

Questions on financial position  
7. What is the return on equity?
As we will understand later, return on equity is one of the most important metric for evaluating the profitability of companies. Earnings can be manipulated, but return on equity will show how worthy a business is.
8. What are the profit margins?
A company that can convert its sales into profits is a successful business. The key is to keep costs at the minimum, and go for higher profits instead of higher market share. Avoid companies with low margins.


References:-

• There’s A Business Behind Every Stock kcchongnz