Stock Picking Strategies of various Gurus

Stock Picking for Noobs

June 11, 2007 20076 12:06 pm | In Finanducation | Comments Off

Who best to learn but from the gurus themselves? Here's a brief list of gurus and their strategies:

1. Benjamin Graham – Value Investing Guru

Strategy: Buy shares at price well below company's intrinsic value!

Indicators:

• P/E < 15 for average earnings over last 3 fiscal years (or current P/E whichever is higher)
• No financial/technology stocks
• Annual Revenue > $340 million
• Liquidity: Current Assets/Current Liabilites > 2
• Industrial companies: Long-term debt < Net current assets
• EPS increases > 30% over 10-year period, must not be negative within last 5 years.
• (Price-to-book ratio)*(P/E) < 22

Source: NASDAQ, Kiplinger, Forbes

2. Peter Lynch – P/E Growth Guru

Strategy: Divide attractive stocks into different categories.

Indicators:

a. Fast Growers:

• Little debt, Debt to Equity Ratio < =1
• Annual EPS Growth Rate = 20 to 30
• Current P/E < = 1.75*Annual EPS Growth

b. Slow Growers:

• High dividend payouts
• Sales > $1 billion
• Low yield-adjusted PEG ratio
• Reasonable debt-to-equity ratio

c. Stalwarts:

• Moderate earnings growth
• Potential for 30-50% stock price gains over 2 year period if bought at attractive prices
• Positive earnings
• Debt-to-Equity ratio < 0.33
• Sales rates increasing inline with, or ahead of inventories
• Low yield-adjusted PEG ratio

Source: NASDAQ, MSN Money, AAII Journal

3. Martin Zweig – Conservative Growth Investor

Strategy: To be fully invested in the market when the indications are positive and to sell stocks when indications become negative.

Indicators:

• Quarterly earnings positive and growing faster than:

• –1 year ago
• –last 3 quarters
• –last 3 years

• Sales growing as fast or faster than earnings
• P/E > 5; BUT P/E < 3*Market P/E or 43, whichever is lower
• No high level of debt, below-average for industry

Source: NASDAQ,MartinZweig.org

4. Brothers David and Tom Gardner of Motley Fool – Small-Cap Growth Investor

Strategy: Search for stocks of small, fast-growing companies with solid fundamentals.

Indicators:

• Health profit margins
• Little debt
• Ample cash flow
• Respectable R&D budgets
• Tight inventory congtrols

Source: NASDAQ

5. Kenneth Fisher – Price-to-Sales Investor

Strategy: The lower a company's stock price is relative to its sales, the more attractive its stock is.

Indicators:

• Strong balance sheet with little debt
• Low Price-to-sales ratios

Source: NASDAQ

6. David Dreman – Contrarian

Strategy: Search for deep-discount value stocks.

Indicators:

• Good earnings growth
• Low P/E
• Low P/B Ratio
• Low Price-to-Cashflow Ratio

Source: NASDAQ, Investopedia

7. James P. O'Shaughnessy – Growth/Value Investor

Strategy: 2 investment strategies: "Cornerstone Growth" and "Cornerstone Value"

Indicators:

a. Cornerstone Growth

• Market value > $150 million
• Price-to-sales ratio < 1.5
• Persistent earnings growth, among market's best performers over prior 12 months

b. Cornerstone Value

• Market cap > $1 billion
• Revenue > 50% greater than mean of market's 12 month sales
• Cashflow per share > average publicly-traded company
• Yield Factor: Company which has highest dividend yield from 50 shortlisted using above criteria.

Source: NASDAQ, Forbes

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Reviewing the rise in KLCI from March 09 to now

The market turned in March 09.  Those who continued to hold their stocks during the downturn would have seen substantial rebound in the prices of their stocks.  Remarkably many good stocks have risen above their previous highs.

The initial rise in the prices of these stocks was due to the steep bargain offered by the knocked-down prices created during the severe downturn.  Soon this steep bargain was eroded and most of the stocks were trading close to their fair price.  The market has the tendency to over-react on the downside and the upside.  As was mentioned before, this has something to do with the inexact science of finding the intrinsic value of a particular stock.  Moreover, there are many participants in the market who felt this is not important, driven mainly in their "trade" or "investing" by studying the sentiment driving the buying and selling of a particular stock.

What can we recollect from March 09 to now in KLSE?  The initial price rise from March 09 was broad base.  Almost all counters went up.  Few were laggards.  Soon the initial rise flattened.  The blue chips however continued to performed well.  The index linked counters continued their steady rise over the last few months, probably supported by huge institutional investors initially.  The financial counters moved steadily and swiftly, followed by others blue chips and KLCI component stocks.  The other stocks did not move much, though there were much excitement in some individual stocks like Mamee, Daibochi, HaiO and others. 

As usual, the retail investors were slow to enter the market missing the steepest part of the market rise.  It should be of interest to know the percentage of previous retail investors who are now permanently out of the stock market following the calamity in the market in 2008.  But the market is always a huge magnet.  When the market rises, new players (and also suckers) are attracted in.  The market has paused on a few occasions over the last 9 months.  The correction was not painful, the worst was a 6 percentage dip in the index over a brief period so far. 

As to whether the market price presently reflects the fundamentals, there are as many who argue either ways.  Is the market undervalued at present price?  Is the market overvalued at present price levels?  Is the market reflecting the fundamentals of the economy?  Is the market price ahead of the economy, not supported by the underlying fundamentals?  One way to get out of this confusion is to realise that in investing, you are investing into stocks and not into the market.  Therefore, for those stock pickers, the importance is in understanding the business of the company, the quality of its management and being able to place a value on the price of the business of this company. 

Since the start of market trading this new year, the market has risen upwards extremely fast indeed.  Many would have seen significant gains in their portfolio.  Many stocks have reached their 52 weeks high and there are also many that reach their all time high prices.  The prices of various stocks climbed not by mini-steps but by giant steps. Interestingly, a piece of good news can push up a stock price by a large amount. The present play is in the glove counters. This sector has proven to be resilient and growing.  Can one truly believe that the business fundamentals of a stock has increased 2 or 3 folds over this short period as would have to be accounted for by such rising prices in the stock?  As with all things too good to be true, be prepared now for when the music stops.  This is particularly most relevant for those who are late or recent comers to this wonderful bull party in the stock market.

Among my favourite stock picking matrix:  Search for those companies with 5 or 10 years consistent records of :

• high ROE of  >15% and
• generating large FCF (FCF/Sales >5%, high FCF/TOCE of >10%) 

This matrix has turned up many big winners with long sustainable economic moats for long term investing consistently.  Keep track of these companies and buy them when they are offered at fair or bargain prices. 

At bargain prices,

• the EYs (EPS/Price) and DYs are at the higher of their usual historical ranges,.and
• the FCF/EV yields  are attractive multiples of the risk free interest rates offered by fixed deposits.

[where,
FCF = Free Cash Flow = Cash Flow from Operation - Cash Flow from Investing = (CFO - CFI)
TOCE = Total Capital Employed = (Equity + LT Debt)
EV = Enterprise Value = (Market Cap + ST Debt + LTL Debt - Cash)]


http://www.investopedia.com/articles/stocks/05/cashcow.asp