The nine simple steps that I share with you in this article have enabled me to beat the stock market averages by a comfortable margin while mitigating the risks associated with investing in stocks. If you’d like to do the same, keep reading.
Finding the best value stocks to buy now is easy, but not simple. Just study the most successful stock investors of all time and do exactly what they do. Easy enough, right? But it’s not as easy as it sounds. I talk to countless investors who have studied the works of Benjamin Graham, William O’Neil, Peter Lynch, Warren Buffett, and other investing legends but fail to beat the market. They spend hours analyzing stocks, studying technical patterns, scouring the internet for news and listening to the talking heads on TV. But they fail to put all the pieces of the puzzle into place.
That’s about to change.
Here are the 9 simple steps for finding the best Stocks.
1. Only invest in stocks selling below their true value. Many studies have proven that stocks with a low price-to-book, price-to-earnings growth or price-to-sales ratio outperform those with higher ratios in the long-term.
2. Invest only in what you know. This one is pretty straight forward. Two of the greatest investors of all time (Warren Buffet and Peter Lynch) advise that you only invest in what you know. This can be a particular company or industry that you an intimate knowledge of.
3: Avoid thinly traded stocks. Thinly traded stocks have larger spreads and take a long time to build a position in or exit if the companies financials become negative. Because of this they rarely garner the institutional support that is needed to push prices higher.
4. Look for a company with a steady long-term record of above-average financial performance. The minimum acceptable history of above average market performance is 5 years but preferably 10 or more. Avoid those companies that only show 1-2 strong years of above-average financial performance.
5. The company has to have a strong competitive advantage that can be maintained because it’s not easily duplicated. The advantage can be due to a strong brand name, a patent, a product that’s hard to duplicate or a similar barrier to entry such as a unique business or distribution model that’s almost impossible to replicate. Financially these companies are characterized by strong cash flows, little need for long-term debt (other than for purchasing other businesses), a consistent upward trend in earnings and long-term price appreciation. Operating margins, net profit margins and return on equity are all above industry averages.
6. Find companies with low Debt Levels. Unless you are a specialist in turnaround situations or have some unique insight, it’s best to avoid companies in financial distress and those with high debt levels compared to industry averages. Companies with higher than normal debt levels carry a higher risk for under-performing financially; mainly due to the higher fixed costs associated with interest expense. The chances of a company performing poorly or going under during an economic downturn because of high debt levels are too significant to justify investing in them unless you are a specialist in this area.
7. The company uses its excess cash flow in ways that benefit shareholders. This includes the repurchase of stock shares, paying additional dividends, acquiring other companies that strengthen its competitive advantage or simply reinvesting the extra cash back into the company.
8. Growth Prospects. This is the step that many investors fail to pay enough attention to. In order for a stock to quickly appreciate in price and maintain that price appreciation, it has to have a catalyst in place to spark growth and garner momentum in the investment community. This can include heavy insider buying or large stock buybacks, upward earnings revisions coupled with earnings surprises, new management or new products to name a few.
9. Discipline. To outperform the market, you often have to possess the confidence to invest when others are most negative and sell when others are mostly positive. You also need the discipline to ignore tips, ignore the news and the conviction not to diversify just because someone who has not learned how to outperform the market has told you that you need to.
It’s exhilarating when you consistently invest in stocks that quickly double in price and have the potential to become “10 baggers” as Peter Lynch would say. If you only invest in stocks that meet the above criteria, you will find those stocks more often than not. If you don’t have the time or discipline to do it on your own, we’d like to suggest becoming a subscriber of the top-rated Worthington StockNewsletter and the Value Investors Association.