How to screen companies for investing?

by Manshu on November 11, 2013

in Uncategorized

PP left the following comment on my investment cycle post:

PP November 8, 2013 at 5:43 pm [edit]

Hi Manshu,

Good post. Could you do a post on how you go about screening / evaluating companies (and deciding if its share price is under or over valued), and recommend steps that one should follow while doing it themselves?

Thanks!

My screening technique is very simple and inspired by Peter Lynch’s One Up On Wall Street where he talks about using the power of your common knowledge, and investing in companies you deal with every day.

Following these techniques has been profitable and fun for me. I believe it’s important for this to be fun because if you’re not a professional, you won’t be able to practice these techniques if they aren’t fun.

Who makes this great product?

I watched “Thor: Dark World” in 3D yesterday, and enjoyed it quite a bit. I have seen the last Thor movie as well, but at that time I didn’t notice  Thor is a Marvel character. Before the movie, they played trailers of other upcoming movies with Marvel characters, and I made a mental note to look at Marvel to see if it may be a good buy.

Two other companies that caught my eye were IMAX, and I have bought and sold IMAX at a profit in the past, and RealD, which is the company that makes the 3D glasses for these movies. I have screened RealD earlier and avoided it because of the competition they face, and also the emphasis on re-use of 3D glasses.

Earlier in the day I spent a long time in the snaking queues of Banana Republic, and window shopped a Prada store because I can’t afford anything there. Both these companies seem to be excellent stock picks, and just keeping an eye out for popular products is a great way to screen companies.

You also read about trends like 3D printing and drones, and it is a good idea to see if there are any good companies operating in those areas. When I first learned about 3D printing, I thought it was a very new field, and it would be difficult to find any profitable companies operating in this area but then I discovered 3D Systems which has also been a very profitable stock for me.

Another way to screen companies is to see what enterprise software you use, and if there are any good companies operating in that field.

I was a regular reader of Business India and Business World, and they feature a lot of good companies that you can analyze further. I remember reading a glowing review of Jain Irrigation Systems in Business India many years ago and thinking about buying the stock — I never did, and the stock was a multi-bagger in the years to follow.

Reading about investments from others is also a good way to identify stocks. You can do this easier than ever before by using Twitter, and following people who are interested in investments.

Good ideas are all around you when you are actively seeking them.

Is it listed? 

That’s the question I ask myself often. Yesterday I learned that Marvel is owned by Disney, and both Banana Republic and Prada are private companies that you can’t invest in.

That will be the case with a lot of companies but you have to go through them to find the ones that are listed and could be potential buys. If it is listed then you can go to the “Investor Relations” section on their website and read more about the company, if not, you move to the next idea.

Currently, I own seven stocks and one ETF. I’m a customer of six out of the seven companies, the only one that I don’t knowingly use the products of is Huntsman Corporation, which I bought a couple of years ago because it had a dividend yield of 4%, and steady financials. This stock is over 100% of my purchase price today, and I felt like this would be a good buy when I chanced upon it.

You obviously make mistakes in this process as well, and one good example is Primo Water that I sold at a 50% loss sometime last year. This is a company that sells water, and they ran into financial troubles last year.

Evaluating a company

Not every company that makes a good product will be a profitable company, and not every profitable company will result in a profitable stock. HLL and Infosys are good examples of these. These two stocks were the darlings of investors some years ago, but after a while they lost their favor with investors and were never able to give the returns they once did. They are still good companies that own great brands, and provide great service, but due to other factors they haven’t been great stocks for the past few years.

This is an important thing to understand because it is not very intuitive. My own understanding of this concept became very clear in running OneMint. OneMint is a good product that has benefited a lot of people, but at the same time it has a non existent business model and if it were a stock I wouldn’t invest in it. Just providing value to people is not enough, there has to be a good business model and a way to monetize that value or else the business will never be profitable.

Even if a business is profitable, you have to look at its valuation to see if that justifies the current price, and leaves room for growth.I’m going to do a follow up post on this sometime this week, and share some of my ideas on how to measure this.

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