This post complements the other posts I’ve done so far on value investing and how to choose a company. My investing style (or FFN investing methodology) has been modelled after Warren Buffett. I’ve also incorporated into the methodology, my own criteria that I look out for. I look out for stocks with a mix of value investing, dividend play and technical analysis. Below is a summary of my style:
Value investing portion
The company I’m looking at MUST have:
- Earnings and free cash flow growth year-on-year
- Little or no debt
- Considerable amount of cash in hand but not in excess
- Low capital expenditures (CAPEX)
- High ROE above 12% and ROA above 7%
- Predictable business with a wide-moat
- Competent and honest management
- Future growth plans in place
- Lastly, the business must be undervalued
It would be preferable if the stock is under-researched, if not, not researched at all by analysts and investment houses. In this way, the price would be beaten down relative to the value of the business.
Dividend play portion
When I invest, I’m looking at both capital gains and income. So, I look out for a few criteria. They are:
- Dividend yield around 5%
- Dividend payout ratio of 30% to 50%
- Dividends paid out growing year-on-year
At times, it would be hard to find an undervalued company which is giving out consistent dividends. If the company is fundamentally very strong without a proper dividend plan, I would still consider purchasing the company.
Technical Analysis portion
Before buying the business, I look at the technicals to have a better entry. The daily candles should be in an uptrend channel and above the 20DSMA and 50DSMA to prevent me from catching a falling knife. The weekly candles should also be in an uptrend.
SudhanP.com 
Hi FFN,
For me, I usually look for ROE in excess of 20% as a benchmark; just curious how did you arrive at 12% as a benchmark? Also, how do you classify an investment as “under-valued”? Using NAV or PER or some other objective measure?
For dividends, I would say a growig dividend is symptomatic of a company which has excess cash which cannot be reinvested; thus it is paying out part of the cash as dividends. Still, some companies may have a combination of both – some cash retained to grow the business (hence high ROE/ROA) while still having enough to pay out some dividends. I look for the latter types.
You are right to say there are not many undervalued companies with consistent FCF and good yield; but then again we must weigh all factors together and ensure you pay a fair price for a good company, rather than trying for a low price for a mediocre one.
Good luck!
Hi MW,
I got ROE of 12% from Adam Khoo’s book (Secrets of Self-Made Millionaires). He stated that on average, companies have 12% ROE. So, anything above that figure is good for me. I use DCF to get intrinsic value.
High five! I’m just like you. I go for companies that both grow and pay consistent dividends like Thomson Medical. This is the reason why I’m a beliver in growth of retained earnings as well. Since it can be difficult to have all financials and ratios perfectly going for the investor, I demand for a margin-of-safety (MOS) whenever necessary. This was the case for Kingsmen. I demanded a huge MOS for Kingsmen due to the very low FCF for the latest FY. But, this has picked up for latest quarter and I’m happy about that (digression, haha).
I go for companies that have a sustainable and wide moat. Coincidentally, most of the companies I’ve invested in falls under the moat of “branding”. Like Buffett says, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”. The most desirale would be to buy a wonderful company at an undervalued price with a huge MOS though.
Hi FFN,
Haha thanks for the explanation. Personally I don’t really like Adam Khoo as I think he’s just full of salesmanship. But that’s another story…. :P
I think we see eye to eye on choosing good companies; willk continue to visit your blog, keep up the good work!
Btw, maybe you’d like to take a look at Royston’s blog? He is also vested in Kingsmen and I’ve left some comments on his post for Kingsmen’s 1H FY 2010 results.
http://thegameplan81.blogspot.com/
Cheers!
Hi MW,
Ok. May I ask how did u arrive at 20% ROE? Do you think 12% ROE is too low?
I’m also a very frequent visitor to your blog. I visit it almost every day. I’ve learnt a lot from your blog as it’s extremely informative.
Woah, Royston holds Thomson Med too. I will keep up with his blog as well. Thanks for the information, MW!
Hello FFN,
Well 20% was a benchmark I used because it’s generally not easy to achieve; as few companies can consistently hit above 20% (without leverage that is). I think I read it in one of the Buffett books (books written on Warren Buffett); but I cannot recall specifically which title. Personally, I think 20% is a lot tougher and acts as a better “screen” for companies; and I have found companies such as Kingsmen which can consistently earn above 20%.
Thanks for visiting my blog, glad it has helped you with your investing! It’s sort of a diary for me initially but now helps me to collect and collate my thoughts.
Regards,
Musicwhiz
We can know and become aware of someone who is dishonest or not. But how to tell someone who is honest?
Hi MW,
Yes, what you have said is true. It’s hard to achieve 20% ROE consistently without leverage.
Hi createwealth8888,
You have said “We can know and become aware of someone who is dishonest or not.” So, how do you know if someone is being dishonest?