Many famous investors, including Warren Buffett, suggest that you need to think about stocks as a source of entering into part-ownership in a business. Of course, you actually are!
So, next time when you think of buying a stock, you should ask the following questions from yourself:
- Is it a business you want to have 100% ownership in?
- If the share price falls by 50% the next day, do you have the conviction to purchase more?
- Are you OK owning this company if the stock market is closed — one day?
- Would you feel proud if one day, your children work in the company?
- Would you feel comfortable owning it as compared to other businesses out there?
Although the stock market is not doing well lately, this presents opportunity to scoop up shares in undervalued company to earn profits. This method is famously known as Value Investing. Investors that adopt a long term buy and hold perspective like Warren Buffett have the best chance of profiting during downturns.
What exactly do you look out for?
When finding good stocks, one should think of this as if he/she is an owner in the business because they really are. The followings are some traits to look out for a good business to invest in:
- Such companies are able to generate positive strong cash flow from operations. Over time, a company should have pricing power to price their products and/or services above their competitors. They are able to do so because of a stronger branding power and stronger customer satisfaction. We would caution against companies who borrow money in order to pay dividends. Ideally, the source of dividends should come from operations.
- These companies are fast-growers and market leader in their respective industry. For example, we look for a healthy Return on Equity of above 15% or more. This is a signal that their products were well-received and one should look further into the pipeline of products/ services that is offered by the company to expand the revenue base.
- For turnaround companies, ideally, you would want to find out whether the companies have cash to buffer against tough times. Ideally, we love to see companies with net cash after considering its debt position.
- The management or founder should own at least 20% of the outstanding shares to demonstrate their ‘skin in the game’. We also look into their pay structure. We love companies where the management derived most of their pay from performances. There are some companies where management is on a fixed pay. Regardless of the performance, the management is still paid the same. There is no economic incentive to improve the business.
If you want to learn more about investment techniques, please join us for our Value Growth Workshop where we will share with you more of our insights.