Last week I looked back at both the good and bad of my stock buys. Now it's time to try to formulate some simple rules to be applied from my past experiences.
These rules, like any of sort of rules, are made to be broken. They will always be a work-in-progress.
I guess what I'm saying is, these aren't really rules at all. Maybe just guidelines, or philosophies, or hypotheses.
Whatever. Let's get started.
1) Fundamentals matter. Everything starts with the fundamentals (duh). These are easy enough to find on the web using Yahoo Finance's "Key Statistics" pages. The ones I really pay attention to (followed by what I'm looking for) are:
Market Cap (min)
Forward P/E (min)
PEG Ratio (min)
Profit Margin (max)
Operating Margin (max)
Return On Assets (max)
Return On Equity (max, and greater than Return On Assets)
Total Cash (max)
Total Debt (min)
Levered Free Cash Flow (max)
% Held By Insiders (max)
% Short of Float (max)
Forward Annual Dividend Yield (max)
These values should be compared vs. competitors and vs. the market in general.
Now, you can't find a stock that has all of these things, but you can find stocks that have most of these things, in your favor. Sometimes it's good to own stocks that are average across the board, but exceptional in one category (such as a large dividend yield). In any case, you'll certainly want to think twice about buying stocks that are unfavorable in any more than a few of these categories.
2) Don't fight the market. Or, "Don't try to call the bottom." If you have your eye on a stock that is well off of its high, be aware that it could very well be further off from its high in the future - especially if its fundamentals aren't the best.
Please note I am not saying "don't buy distressed stocks". Fallen stocks often represent the best opportunities the market has to offer. I can see two ways around this: either let the market carve out the bottom for you before you decide to buy (i.e. the chart has a nice "bounce" established already); or just buy the stock, and be prepared to DCA your position, or bail out altogether, if the stock falls further.
3) Understand, and disprove, the bear case. Bears aren't stupid; they can't be because, by definition, they make up roughly half the market at any given time. But just because they aren't stupid doesn't mean that they aren't wrong at any given time. When you find that the reasons keeping a stock down in the short-term aren't likely to hold up in the long-term, you have a catalyst for that stock to outperform the market.
4) Find a compelling bull case. Beyond the fundamentals, I want my stocks to tell a great story, such as "Google is going to be the first trillion dollar market cap company", or "Baidu is the next Google", or "Under Armour is the next Nike". It's up to you to find the evidence for which such bold proclamations are going to become true, and when you do find that evidence, it becomes a lot easier to own the stock through thick and thin. (For the record, I do own GOOG, BIDU, and UA.)
Tomorrow I'll look at the sell side.
