How to be a DIY Equity Investor - The Minimum Considerations

It's been sometime since we updated this blog, having been distracted by something beautiful. We have learnt a lot about ourselves these few years ,made some terrible investments but life goes on. We can't turn back time but the only thing within our control now is to learn from our mistakes and not ever make the same ones again. For this article, we thought of sharing our opinions and proposing a systematic way in which one should pick their stocks and when to buy and sell equities in general. This should actually be the minimum we think one should do. The steps have actually been written in bits and pieces throughout this blog. The steps shown below is not too time consuming. we feel...In addition to the below, one can go always go one step further to do graphs to see trends such as whether the sales or cash flow is increasing along the years if they think the amount they are investing is worth the time. Pls feel free to critique or suggests improvements for one should always be humble in this world and to learn and upgrade oneself. The objective is to keep things simple. Simplicity is beautiful.

Before reading further, read this first.
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Step 1: Look at the Yield curves as a forward looking indicator to decide when to underweight or overweight on equities. (Read our blog post here)

Start selling (especially cyclical stocks): flattening yield curve

Start buying: steep and rising yield curve. Buying should increase in intensity when VIX indicator is high.

Rationale: We believe in timing business/economy cycles. Such cycles are a fact and nearly everything goes down in a downturn, even defensive stocks. But we would wish to state that we think there is no point in trying to predict exactly when the top or bottom is.

Link Tools: We have included the links on the right of this blog for the US yield curves and VIX indicator charts.

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Step 2: Select companies which generate positive free cash flow consistently from the cash flow statement for the past 4-5 years. This is one of the most important steps. This step is for filtering out stocks that don't generate free cash flow and ignoring these.

Rationale: In investing, no one can be 100% certain in anything, but one thing for sure is that companies which have flopped are those that have not been able to generate free cash flow. See below for facts. Anyway, whats good about having a business that does not generate cold hard cash? Net Profit shown on Income statements is really unreliable, subjected to depreciation expense, management manipulation, and does not take into account recoverable sales from accounts receivables.

Ferrochina (above)

Jurong Technologies Industrial (above)

Link Tools: http://www.reuters.com/

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Step 3: From Step 2, select companies that have their current assets greater than their current liabilities. Even safer is to select companies whose cash balances or fixed deposits is greater than their current liabilities. ( Read this blog post for an example here). This step is for filtering out stocks that do not have current assets greater than current liabilities and ignoring these.

Rationale: This is just to ensure that the company can survive during the bad times where banks are not as generous in their loans or will charge high rates for loans. An alarm bell should ring in one's head if the company is taking on bonds or loans that have a high interest rate. See herefor example.

Link Tools: www.sgx.com. Click on the company ticker. Click announcements and take their latest financial statements and look at the balance sheets.

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Step 4: Compile a list of the companies which satisfies Step 3 AND Step 4 . This is the watchlist. Find ratio of Price /Free Cash Flow. (P/FCF) . The FCF we use is an average of the Free Cash Flow for the past 4-5 years so as to smooth out any one offs. This step is for comparison between the different companies filtered out up till here.

Rationale: The lower it is, the more value it is relative to the other companies as one is paying lesser $$ for a unit of free cash ( or cash that the company is free to use) that the company has. It also allows comparison between different kinds of companies, such as between service and manufacturing companies. We don't subscribe to P/Book ratio as it penalises service companies by showing them generally having a large p/Book value compared to capital intensive companies. Similarly, we don't subscribe to P/Earning ratio as it generally penalises capital intensive companies due to their higher depreciation expense. All companies, no matter what their capital structure is, have to generate cash and P/FCF can allow a comparison.

We will be posting up an example of a spreadsheet we did sometime later comparing some companies.

Link Tools: http://www.reuters.com/ . Take the following data: Diluted weighted average shares, Cash from Operations, Capital expenditure to calculate the FCF per share.

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Step 5: For the list of stocks filtered till here, find the intrinsic value by using Benjamin Grahams funny formula ( See blog post here). Find also the intrinsic value using DCF for dividends. (See blog post here). This step is just to get a fluffy feel, awareness and some insights.

Rationale: Actually, we don't know the logic of Benjamin Grahams formula, but since he has proved himself and have also taught Warren Buffet before. No harm using it. Actually if one is to see the intrinsic value calculated by us, its not too ridiculous when one compares with the current market price of the stocks. DCF is quite fluffy in the sense that dividends are not constant. But the purpose of this step is to gain some insights and to get a number as a value. This is because comparisons between different companies using P/FCF simply tells one which company is more value than the others but does not tell one whether it is cheap or expensive to buy. Another good thing about doing this step is to shake off the anchoring bia-ness ( See blog post here). Anyway, it acts as an assurance if one buys a company that is trading below both the value churned out by DCF and Benjamins Grahams formula to prevent one from being too emotional, right?

Link Tools: http://www.sgx.com/

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Step 6 : Compare the average net profits % ( around 4-5 years average) and average gross profit % ( around 4-5 years average). This is just to get a general feel for the company.

Rationale: This is to see how much margin the company has to play with to fight price wars, commodity increases..e.t.c.

Link Tools: http://www.reuters.com/

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Step 7: Compare the dividends yield and dividends consistency. Generally, a higher, increasing and consistent yield is better. This step is just for comparison and gaining some insights.

Rationale: Need we say more. A higher dividend yield allows one to get back some money as one holds the stocks.Its like a "productive" asset as one waits for capital appreciation. And we don't really agree about the theory that says the more dividends a company gives out, the lower its capital appreciation will be. It makes sense actually in THEORY as the money saved can be used to fund projects to increase earnings which in turn increase the share price. But we feel its always better to get back some money earlier. Doesn't one spend money more recklessly if one has lots of it? We think one will spend more prudently and wisely if the money they have is more tight or just enough. This applies to management.

Link Tools: http://www.sgx.com/

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Step 8: Check Management Quality. Check board of directors. There is no criteria for this and its up to one to judge, just to gain some insights. Look for webcasts interviews by management.

Rationale: Need we say more. We like to see directors who are also directors of other companies and we like to see at least one female on the board. Also, directors who have different skills sets like law, accountancy, engineering...e.t.c. Also companies who have CEOs who are also not the Chairman. This makes sense as the purpose of the board of directors is to watch over the management to safeguard shareholders. If the CEO and chairman is the same, then whats the purpose? Also look at the integrity of the management and their past history which could affect share prices. For example why is Golden Agri so much below its NTA. See here for possible reason.

Link Tools : Company website lah..

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Step 9: Check shareholding statistics. There is no criteria, just to gain some insights

Rationale: Is the management putting their money where their mouth is? Our preference is for management to hold some shares but not too much. More than 50% and we think its too much. We think this is a safeguard as if the share market plummets again after we buy and the majority shareholder decides to delist it by buying the shares at a low price, our money is gone.

Link Tools: Company website or financial reports

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Step 10: Check the growth rate of outstanding shares through the years. This is just to gain some insights.

Rationale: Actually we dislike companies whose outstanding shares grow too much too fast. We don't like employee stock incentives and management share options. All this just means that our proportionate ownership of the business is lesser and that the company has to make more money to justify the increase in oustanding shares and to make sure that our proportion of the money the company makes does not decrease too. Again, we don't agree that giving out such shares will motivate workers much. This is from experience and also talking to people on the ground. Its too theoretical.

Link Tools: http://www.reuters.com/

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Step 11: Check for management buying and selling the shares and at what cost. Check for share buybacks and at what cost. This is just to gain some insights and feeling shiok that we bought lower than the managers or company.

Rationale: Generally companies or management buy back shares if they think their company is undervalued or its a better to invest in their own company than to use the cash to do anything else. Share buybacks increases one's proportionate ownership of the company also.

Link Tools: http://www.sgx.com/

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Step 12: Sit back, relax and think about the business model of the company. Does it have an economic moat? Who are its competitors? How many suppliers it has? Is it highly regulated? Is it highly exposed to commodity prices as their input?Talk to your friends working in the company ( not insider trading lah...as in ask them about the industry trends, how stingy is the company in doling out bonus to staff, generally, the more stingy the company is to the staff, its better for the shareholders...sound sick but hey, its always about the shareholders)

Rationale: This is to determine the factors affecting their revenue and expenses.

Link Tools: Your own brain, google and porter's 5 forces.

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Step 13: Use of technical indicators just to get a general feel of when to enter. What we use is ADX, RSI, Volume and Bollinger Bands . We are not traders, but just trying to get a little better deal.

Rationale: If more people use it, the more likely it is true right, like a self fulfillig prophecy. Actually, these are not dependable for the SGX market due to the low volume and the ease for manipulators to play around. More dependable for US markets with their high volumes of trade. But as long as it gives us a 0.0001% better chance of buying it at a o.o1 cent cheaper price, why not? since it so easily to use. But we are not too bothered anyway even if it tells us wrongly, cos we are not traders but some cheapskates who are trying to just get that slightly cheaper deal.

Link Tools: Any respectable brokerage house should have it. DBSVOnline's free charting is pretty decent due to the ability to choose the colours for the chart lines.

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One can always go further my following what this blogger who calls herself Dancerene did. See here . ( In addition, always read the footnotes !)
Important: The objective of the articles in this blog is to set you thinking about the company before you invest your hard-earned money. Do not invest solely based on this article. Unlike House or Instituitional Analysts who have to maintain relations with corporations due to investment banking relations, generating commissions,e.t.c, SGDividends say things as it is, factually. Unlike Analyst who have to be "uptight" and "cheem", we make it simplified and cheapskate. -The Vigilante Investor, SGDividends Team