Portfolio Building Part 3
Portfolio Building Part 3
This is the third part of Portfolio Building. We’ve already covered Risk Profile, Risk/Return Curve, Position Sizing, Number of Stocks and Portfolio’s Volatility. In today’s article, we’ll talk about How to Screen for Stocks and How to Research them.
How to Screen
The screening process or how to come up with stocks to research can arise from multiple ways. My personal favorite is social platforms like Twitter/Commonstock. Once you detect which accounts post about the type of stocks you are interested in, these accounts will continually bring you new stocks to the table. For instance, for dividend seekers:
@DividendGrowth , @SteveWagsInvest.
For Growth Investors:
@puru_saxena , @StockMarketNerd
For mid/large caps with growth potential:
@InvesQuotes
There are accounts that cover almost every niche in investing, you just have to look for the ones that post quality. Having a well-built following base on Twitter will make the screening/discovering process much smoother.
On the other hand, actual screening can be done through filters on finance platforms. My personal favorite is Koyfin. For example:
Results:
I used few inputs just for the point to be made, but ROE/ROA/Cash/Debt and multiple more financial metrics can be used for filtering through the stock market and arriving to the particular companies you are looking for.
How to Research
To expand on this subject, I’ll base my writing in the authors often mentioned and will add Benjamin Graham criteria for Stock Selection for the Defensive Investor.
Firstly, you’ll most likely want to buy the best company possible, so the question answers itself when looking for the contact points among the best performing stocks of the past. Among the qualities that top investors/authors have focused on and given relevance are:
Competitive Advantage: As explained in article 7, a long-durable competitive advantage allows a company to sustain its market position, keeping competitors away and allowing them to compound capital and returns for a long time.
Qualitatively, they can be found here:
Financially, it’s often seen in profitability metrics when comparing the company to competitors. The company with a MOAT tends to have higher than average margins and Return on Equity, Return on Assets and Return on Invested Capital. For more info, check the book ‘Warren Buffet and the Interpretation of Financial Statements”.
Management: Here are 4 factors most investors look at.
If the company’s founder led, here’s why:
If management owns a decent amount of the business stock. A higher percentage of ownership signals confidence in future appreciation by management and, it is a fact that when people have their money at play, they tend to make better decisions. At the same time, it doesn’t matter if a company has excellent fundamentals if management is extremely bad.
Capital allocation skills. The key to long-term compounding is the capability to reinvest earnings at higher than average rates or use them in highly efficient manners, in order to create the most value possible.
Culture. They are the ones who inevitably create the company’s culture.
Thesis: A company’s thesis shall include what’s the business about, what industry is it in, why should it continue to operate in the future and its future growth opportunity. This mental exercise gets rid of easy-to-detect trash.
If a company is mission/purpose driven.
Financials. Margins and returns on capital show the business inherent quality, it’s not about growing but on converting growth into profit. Cash and Debt can make an investor infer if the company may be in a financially fragile position. Free cash flow shows the company’s natural profitability, and so on.
History. The company’s historical performance, both as a business and in the market, reflect the actual average capability of the business and avoids biased/short time frames of non-natural metrics.
Risks. It’s important to contemplate the risks a company is subject to since they are threats to their long-term compounding.
Where to find them
The SEC is the entity that regulates public companies in the US, these companies have to report their activity and several documents. To find them, you type in Google “X investor relations.” If the SEC filings appear there, great. If not, you go to the Investor Relations page and somewhere on there, they should be.
Once in there, the Annual Report (10-k filing) includes Business Overview, Risks, Comments, Legal, Discussion and results, Trends, and more. Financials can be seen there or in Quarterly Reports. Historical ones can be seen in any Finance webpage, like Koyfin.
Insider Ownership can be found in another SEC filing, the DEF 14A:
It usually has 100+ pages but you just press “Control F” and type “Ownership” or “Beneficial Ownership.”
Other information can be usually found easily with google.
Personal Commentary.
This is by no means a manual, just a recompilation of what many investors/authors look for when analyzing a company. Many more variables could be included since the approach to research is as personal as it gets. And, when doing so, always keep in mind this Graham quote:
"Companies that outperform will have lots of things in common, but unless that factor 'causes' the out-performance, it's useless"