Aimlock on The Dream Stock 🎯

In this lesson, we sketch out the ideal stock we’re hunting for. It’s simple enough, and it’ll be our northstar as we progress through the these stock-picking lessons. First however, you’ll learn the cornerstone method for valuing stocks with multiples, and three value investing tactics that are very successful. One concerns bankrupt business stocks, another dividends, and the final has to do with exceptional businesses whose stocks are compound machines. Sounds juicy! Let’s get started!


Multiples Are Dead Simple.

Multiples help you value companies. When you divide one business metric by another, you’ve got a multiple, otherwise known as a ratio. The flagship multiple is the P/E. That’s price over earnings, and its supposed to indicate value for money.

Price/EarningsCorresponding Yearly Return
1100%
250%
425%
812.5%
166.25%
323.13%
641.51%

You can think of the P/E multiple as however many dollars of stock price you need to buy to make $1.

The P/E is utterly useless as an investing metric because companies can so easily manipulate their net income, which you don’t get by the way. It’s also a lazy shortcut which doesn’t tell you the story of a stock. Feel free to engineer multiples you think would be useful when comparing one company to another, other frequently used multiples being the price/sales, price/free cash flow, and debt/equity. You’ll learn about those in the next lesson.


The Twist 🌀

If a businesses is out there on the stock market for very low PE ratio, it’s probably down at that low PE for a reason. Investors feel negatively towards the company. They feel pessimistic or uncertain about how much money the business could make in the future for them. As a result, the stock price and multiple has found an equilibrium where investors will agree to become owners because the return just about compensates them for the risks they see. That explains stock prices in a nutshell.


So, What About My Favourite Hot Stocks? 🔥

I don’t know what’s hot to you but everything the hosts on CNBC talk about all day is exactly not what we should be thinking about. Emerging industries and stocks that are in fashion end up too expensive to offer a decent return. It’s very difficult to outperform an index as a value investor by investing in these companies because they’re so noisy and heavily followed by competing investors. An investment would be more of a momentum move than a value investing move, because your betting on greater fools theory.

That’s not to say these businesses are suddenly shoddy businesses because they’re expensive. They’re awesome businesses, the best in the world! But fame is our problem. Everyone already knows about these stocks so there’s very little edge left for us in investing. The multiples are too high. I think I showed you that with Amazon.


Value Investing Fishing Holes 🎣

Aside from multiples, there are other signals in stocks and businesses that can make them interesting prospects. All of these are sound.

Deep Value
The first tactic value investors use to find opportunities out there that align with their principles, is to look at firms going into bankruptcy. The stock of these firms can get absolutely hammered. If the price goes so low that you can buy the business for less than what its assets are worth (at flash sale prices), then you can’t lose. This is a brilliant strategy but it’s been out the bag for some time. To catch these opportunities you have to be quick, which is why I use an automatic filter that alerts me when something looks good somewhere. Click on the image below to refer a couple of friends and win all three of you a special guide in making money from these deep value bankruptcy opportunities!

Dividends
Some companies are labelled Dividend Champions because they have really good track records for always paying their dividend. This is the list of these companies, and if you need the income from dividends then you can focus your investing skills on those companies.
Franchises
If a company has really strong competitive advantages, it’s able to protect really good profits. If a business can protect really good profits, then it can be a compounding machine to store your money. If you find a franchise stock, you can hold it long term and it will do you the best return as well.

The Perfect Franchise Stock 😍


 

Chris Morrissey

Chris started in financial advisory, assembling client portfolios with pension companies and investment banks. Following that, he worked at an agricultural commodities trader in London and now various "fintech" start-ups. He's also studying business full-time at Lancaster University. Feel bewildered by the stock market? Chris will help you get things under control.

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