Let’s Get Started And Learn How To Find Undervalued Stocks Today!
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Let’s Get Started And Learn How To Find Undervalued Stocks Today!

Hi everyone!

Welcome to Session # 1 – Let’s Get Started And Learn How To Find Undervalued Stocks Today

Today, I’m going to walk you through one of the most significant investment skills that being used by world’s most successful value investors. Before we move on, let’s find out how to first, Identify GREAT business or great company (or great stocks), then, using ONE-OF the method I am using currently, to calculate and decide whether one business or company was underestimated or selling at a fair price.

Before we begin our exciting journey today, please allow me to define briefly on the meaning of undervalued stocks. Under the Efficient-market-hypothesis, one company will be valued by the “market” so efficiently, that the market price always equals to its intrinsic value. However, in an actual situation, a company’s price is determined by the emotion of the market, and the market sometimes acts irrationally against the company’s value. That is how an undervalued stock is defined as the market price of stocks that selling BELOW their intrinsic value.

There are handful methods that are being used by value investors around the world. However, one of the main objectives of this site is to shorten your time in finding the most useful methods in finding an underestimated company. All investors get a company’s financial statements as its essential fundamental analysis tools. Information such as future cash flow, P/E ratio, earning yield, insider purchasing activity and some other data or ratio were being used as a benchmark in valuing a company (before decide to buy in the company when the market offers in great discounted price).

Let’s recall that the investment strategy for value investors…

1. To identify very good businesses

2. To buy them at a good price (a huge discount to its intrinsic value)

3. …and wait for the market to realize its true value or over-value it

Briefly, the first seven criteria (Criteria #1 to Criteria #7) are to help you identify very good businesses. Again, recall that a very good business is one that you are certain will:

1. Increase its Earnings Per Share (EPS) and hence its stock value. When the stock’s value increases, so will its share price, thus earning you a profit when you decide to sell.

2. Be able to recover and prosper from bad news and disasters like wars, recessions, management errors and new competition.

Criteria #8 will help you to determine the real (intrinsic) value of the stock. By buying only when the stock price is much lower than the real value, you are giving yourself the chance to make a good profit when the market finally corrects itself.

Let’s move on to Criteria-To Find Undervalued Stocks…

Criteria #1: History of Consistently Increasing Sales, Earnings and Cash Flow

The first indicator of a good business that will consistently be able to increase its future earnings is its track record. If the company shows a history of consistently increasing sales and earnings over the last five years at least, especially during periods of recession, then there is a high chance it will be able to continue its performance.

Criteria #2: Sustainable Competitive Advantage

Although a company may have been able to increase its earnings in the past, there is no guarantee that it can continue to do so in the future. New competitors could enter and steal market share or cause price drops, forcing the company to experience lower sales and earnings.

Let me give you an example. What allows Nike to sell more and more shoes every year, allowing it to consistently increase its earnings? Why can’t competitors capture all of Nike’s customers by offering a cheaper shoe? Even if you could invent a better shoe called Niko, could you take away all of Nike’s customers?

Highly unlikely. Why?

There are seven (7) characteristics that decide whether a company is having sustainable comopetitive advantage or not.

(Where Do I find this Information? I will COMMIT myself to show later you in great detail for free.)

Criteria #3: Future Growth Drivers

Having a good track record and a strong sustainable competitive advantage will not automatically translate into higher sales and profi ts in the future unless the company has concrete plans that will translate into the sale of substantially more goods and services.

To find out more about a company’s future growth drivers, you can actually find these information from annual report.

Criteria #4: Conservative Debt

It is important to ensure that the amount of money borrowed by the company is conservative and can be easily paid back within three to four years. The rule of thumb is that long-term debt should be less than 3-4 times Current Net Earnings (after tax).

Criteria # 5: Return of Equity (ROE)

Must be Consistent & High at ROE > 15%

Criteria #6: Low Capital Expenditure (CAPEX)

The characteristic of a company with low capital expenditure can be found from the company’s financial statement. Under the “Free Cash Flow/Sales Revenue”. If the free cash flow to sales revenue percentage is greater than 5%. The company is consider as healthy.

Criteria #7: The Management is Honest & Competent at Capital Allocation

This is one of the most important criteria in evaluating a company; however, it is also the most difficult to ascertain. (this topic has been discussed and shared in Phase # 4 – Understand the “People behind a company, and why it is crucially important?”

There are many companies run by CEOs and management teams that do NOT act in the shareholders’ best interests, but in their own best interests. You must understand that CEOs and directors are just employees of the company and may not even be shareholders. One of the indicator is their over-paid salary, bonuses and share options.

Criteria #8: The Stock is Undervalued: Share Price < (smaller than) Intrinsic Value

Before you can know if you are buying at a good price, you must know how to calculate the intrinsic value of a stock. So, how do you measure the value of a company?

Let me explain using an example. Think of this question, ‘What is the most you would pay for a machine that would generate $100 today?’ The answer is $100!

If you paid $100 for a machine and it generates back $100, you would breakeven. So, $100 is the most you would pay. Now, what is the most you would pay for a machine that will generate $100 in one year? Would you pay $100? Of course not. You would definitely pay less than $100, as you would have to wait a year to get your $100 back. So, what is the maximum you would pay today? The answer depends on the risk free interest rate, which is usually measured by 3-month US Treasury Bills. If the risk free rate is 4%, then you would pay a maximum of $96.15 ($100/ (1+ 0.04)) for the machine today. Why? Well, if you were to put that $96.15 in a risk free investment earning 4%, you could get $100 a year later. So, $96.15 is the present value you would place on $100 to be received a year

later. In other words, money received in the future is worth less today. To find out the present value of $100 received in one year, we divide it by 1+0.04 (risk free rate) to get $96.15. This is known as discounting future value to present value.

Now, how much would you pay for a machine that will generate $100 in one year, $100 in the second year, $100 in the third year and so on till the 10th year?

To find the answer, you would have to discount each future payment to its present value.

If you ever need any feedback or support regarding with the investing know-how and brainstorming discussion, I would be more than happy to connect. Simply leave your comments below and make sure you visit my site regularly as I am always updating it with lots of “A-ha” ideas and information that I come across and I guaranteed that you will find interesting.

Stay tune, in the next Page of Session # 2 – Mold your habits

Posted by Mike.

Note:

Please bear with me in few factors that need DEEPER and DETAIL elaboration as well as demostration. There are:-

criteria # 2, criteria # 3, criteria # 7 and criteria # 8. Please accept my sincere apologies because these posts and pages are still under construction.

Reference: Secrets of Self Made Millionaire


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