Value Stock Investing – Quality Is Essential

In Value Stock Investing, Quality is Job One
Exactly how much financial bloodshed is needed before we realize that there’s no safe and easy shortcut to investment success? When do we learn that most of our mistakes involve greed, fear, or unrealistic expectations about what we own? Eventually, successful investors start to allocate assets in a target directed manner by adopting a realistic Investment Strategy… a continuing security selection and monitoring procedure that is guided by realistic expectations, selection rules, and management rules of thumb. If your considering trying a strategy for annually to see if it works, you’re due for another smack up alongside the head! Viable Investment Schemes transcend cycles, not years, and viable Equity Investment Plans consider three disciplined activities, the first of which is Selection. Most familiar strategies ignore one of the others.

How should an investor determine what stocks to buy, and when to purchase them? Will Rogers summed it up: “Only buy stocks that go up. If they aren’t going to go up, don’t buy them”. Many have misread this tongue-in-cheek observation and joined the “Buy (anything) High” club. I’ve found that the “Buy Value Stocks Low (er)” approach works better. A Google search produces a selection of criteria that help to recognize Value Stocks, the standards being low Price to Book Value, low P/E ratios, and other "fundamentals". But you would be surprised how the definitions can vary, and how few include the term “;Quality” In the late 90′s, it was rumored that a familiar Value Fund Manager was asked why he wasn’t buying dot-coms, IPOs, etc. When he stated that they did not qualify as Value Stocks, he was told to change his definition… or else.

Just how do we make a confidence building Stock Selection Universe? Simply operating on blind faith with one of the commonplace definitions can be too simplistic, particularly since nearly all of the numbers originate from the subject firms. Also, a few of the figures could be challenging to buy rapidly, and it is necessary not to get over-involved in endless research. Here are five filters you can utilize to develop a selection universe of higher quality companies, and you can obtain all of the data inexpensively from the same source:

1. An S & P Rating of B+ or Better. Standard & Poor’s is a major financial data provider to the investment community, and its “Earnings and Dividend Rankings for Common Stocks” combine many fundamental and qualitative reasons into a letter ranking that speaks only to the financial viability of the rated businesses. Potential market performance (a guessing game anyway) is not a consideration. B+ and above ratings are believed Investment Grade. Anything rated lower adds an element of unnecessary speculation to your portfolio. A staff of thousands does your research for you.

2. A History of Profitability. Although it should seem obvious, buying stock in a company that has a history of profitable operations is less risky than acquiring shares in an unproven, or start-up entity. Profitable operations adapt more readily to modifications in markets, economies, and business growth opportunities. They are more inclined to produce profit opportunities for you speedily.

3. A History of Regular Dividend Payments. The payment of regular dividends, and periodic increases in rate paid, are sure signs of economic viability. Firms will go to extreme lengths, and endure great hardships, before electing either to cut or to omit a dividend. There’s no requirement to center on the size of the dividend itself; Equities ought not to be purchased as income producers. A further benefit of using dividend payment as one of your selection criteria is the clear indication of financial strain that a cut communicates.

4. A Reasonable Price Range. You will discover that most Investment Grade stocks are priced above $10 per share and that only a few trade at levels above $100. If you’ve a seven-figure portfolio, price may not matter from a diversification viewpoint, but in smaller portfolios, a round lot of a $50 stock might be too much to risk in one position. A bizarrely high price may be the result of an oddly high degree of sector or company specific speculation while an inordinately low price may be a good warning signal. With no real structural size limitations, I feel familiar with a range between $10 and $90 per share… but I would avoid most issues at the higher level.

5. A NYSE Listed Security. I’m not sure that the listing requirements for the NYSE are still more restrictive than elsewhere, but it is useful to be able to center on one set of statistics as most of the info you need regularly is reported by Exchange (Market Stats, Issue Breadth, and New Highs vs. New Lows).

Your Selection Universe will become the spine of your Equity Investment Program, so there is no room for creative adjustments to the rules and guidelines you’ve established… no matter how strongly you feel about recent news or rumor. Now you can center on operating procedures that will serve you branch out properly by position size, industry, etc., and on guidelines that will serve you identify which stocks should be watched closely for purchase when the amount is right. Keeping in mind that you want to sell each Equity Position at a target profit ASAP, you’ll want to establish right buying (and selling) rules. For instance, I never consider buying a standard until it has fallen at least 20% from its highest level of an earlier period 52 weeks, so I include those that are close or at this price level on a "Daily Watch List". Then, I select those that I would be prepared to include to equity portfolios if they fall a bit more during the trading day. Your actual "Buy List" changes every day in both symbol and limit price.

You will need to use consistent and disciplined judgment to your final selection process, but you may be confidant that you are choosing from a select group of higher quality, well-established companies, with a proven track record of profitability and owner awareness. Additionally, as these businesses gyrate above and below your purchase price (as they absolutely will), you can be more confident that it is just the nature of the stock market and not an imminent financial catastrophe… and that should help you are sleeping nights.

By the way, never say no to a profit when the upward movement equals 10%, and you’ll be able to do it again, and again, and again.

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