Here are two common questions that I like to address in this write-up:
1. Is ABC Ltd a good stock to invest for the long-term?
2. Which sectors or industries are you investing today for future growth?
First, I do not tell people which stocks they should buy, hold, or sell and I do not have any intentions of doing so in the future. Instead, I would encourage you to make your decisions independently as decision-making is a vital part to become a savvier investor. Note: The investor is more important than the investments.
Second, I do not choose stocks based on their involvement in a specific industry or sector. I am not sector-specific but company-focused. This means, I would be studying a stock in detail and place lower emphasis on macroeconomics, before investing.
Those are my short answers to the two commonly asked questions above.
Hence, as an add-on, I like to address the root cause for the questions above. In my view, I believe they reflect an absence of a proper investment framework by aspiring investors. An investment framework is crucial for it offers a structure to your stock portfolio. Investing without it is likened to trying to beat Real Madrid or Barcelona with our very own ‘kampung football’.
So, if you ask me, ‘How do I know if ABC Ltd is a good stock to invest?’, I will say, ‘I will put ABC Ltd to the test under my investment framework which consists of four key elements as listed below:
Element 1: Business Model
For a start, my objective of investing is to earn recurring and growing dividends. Thus, I prefer stocks that earn recurring income from a huge pool of customers.
I prefer stocks which derive cash sales over credit sales from their products and services, which I hope will remain relevant and in demand over the long-term. I have bolded the key words as follow:
Recurring = Kudos to businesses that generate repetitive sales.
Huge = Reduce concentration risk of a few key customers.
Cash Sales = Reduce working capital. Flexible to invest it or pay me dividends.
Relevant = Something that I would realistically pay for or need in the long run.
Element 2: Finance
If a stock’s business model is solid, it should deliver a consistent growth in sales and profits. The company should bring in positive cash flows from operations in the long run. In general, my test of consistency is based on 10 years. In addition to its financial results, I prefer stocks that have a strong balance sheet and have ample cash at its disposal so that it could choose to invest it or pay dividends to me in the future. The key words include:
Consistent = Remain increasingly profitable in both good and bad times.
Growth = Past track record of growing wealth to shareholders (beat inflation).
Positive = Must have cash flow to invest or to pay me dividends.
10 Years = Test a stock’s resilience in all economic conditions.
Balance Sheet = In great financial position to invest for the future.
Element 3: Growth
Who says dividend investors don’t invest for growth?
I do. This is because I want to earn increasing dividend income. Thus, to do this, I will find out a stock’s initiatives to sustain growth in the future. This is done by:
Latest Annual Report = Chairman/CEO’s statements and Management’s Discussion & Analysis
Latest Quarterly Report = Read the section under ‘Prospects’
Latest Investors’ Presentations = Just download and read.
Announcements = For Bursa stocks, I retrieve their latest at Bursa website.
Announcements = For others, I retrieve their latest at their corporate websites.
So, there is no need for speculation. All it takes is a little initiative to read, study and process the information presented from above.
Element 4: Valuation
Remember the equation below:
Good Investments = Good Stocks + Good Valuation
We have covered ‘Good Stocks’ under the first three elements. So now, if we do have a pool of good stocks to choose from, we then make our selection of what stocks to invest in based on its valuation so that we do not overpay for them, as good as the stocks are. Typically, I use the three valuation ratios as listed below:
P/E Ratio = Below its 10-Year Average
P/B Ratio = Below its 10-Year Average
Dividend Yields = Above its 10-Year Average
If You Don’t Have an Investment Framework
It is time for you to have one, especially when investing in times like this, where the markets are crazily volatile and uncertain. An investment framework is vital, crucial and an anchor for us to build our portfolios in all market conditions.
It is time to put on the thinking cap of Sir Alex Ferguson when he was preparing his team for the next football match. He was purposeful and strategic in placing his starting eleven on the football pitch.
There was no room for ‘Kampung Football’ in the Champions League.
‘But, what if I still incur losses even after having an investment framework?’
Here are my views on this:
First, an investment framework is about efficient capital allocation to meet your investment objectives by building a stock portfolio according to your criterias. It is supposed to reduce investment mistakes while boosting returns. But, just like Sir Alex Ferguson, Manchester United was not immortal under his management as the club occasionally lost some matches.
With an investment framework, I get to reassess my framework to see which of the elements above I should work on to strengthen my stock portfolio. As such, I could learn of my shortcomings and make adjustments to solidify my portfolio and over time, I am able to reduce risk and enhance return from stock investing as I gain more experiences.
But, if I choose to play ‘kampung football’ in the stock market, always asking for stock tips and chasing hot stocks, what will I learn if I make mistakes? Imagine if one is doing this for the next 20-30 years of his life. Will he be a millionaire or is it possible for him to deny himself a chance of passive income and great wealth for a lifetime if he is to build his portfolio steadily over time?
How we choose to invest today will impact how we live tomorrow.
That is it for now. Stay tuned for more.