In a highly competitive investment environment where every investor is striving for better returns, it maybe worthwhile to have a checklist for identifying stocks which can give Reasonable Returns over longer periods of time (Ideally 5+ years). To reduce losses as a result of our stock selection and also get reasonable returns, it is ideal to follow a Contrarian approach (which is buying out of favour stocks and wait for the sector/company to turn around). Some of the items which I have identified in my checklist are as follows
|1||Analyse and Invest in stocks which are in bad news||
This is a core idea for a contrarian approach. When stocks are in bad news, majority of the investors will panic and sell them at prices way below their fair value / book value. They become out of favour (but not necessarily out of business), naturally stock prices will be depressed giving an attractive entry point.
|2||Lookout for Steep Discount to Book value||At such depressed times, some stocks tend to fall way below their tangible book value. Try to analyse tangible book value of such stocks (with plant, land, investments, liquid cash, etc.. on books) and get them at a steep discount to such value. By this way, when the company turns around or atleast the outlook turns around to positive, you can atleast expect markets to prices them well over their book value.|
|3||Wait Patiently||Stocks rarely turnaround immediately after you make a purchase. Wait for the dust to settle, let the management execute their plans and the business cycle to recover. This often takes 2-3 years and once company starts recovering from the bad phase, markets will give thumbs up to their stock prices.|
|4||Low ROE stocks and Low PBV||Analysts and big funds usually chase High ROE stocks at fancy prices. But there is good money to be made with Low ROE stocks bought at substantially lower price to book value (Low PBV). Several years back Paper and Caustic Soda companies posted very low ROE and their stocks were trading at low PBV. But now most of them are trading at a premium to their book values as the cycle turned around.|
|5||Management credibility is most important||Regardless of sectors, a Credible management is the most important aspect of wealth creation. They are the people who identify and execute projects which enhances shareholder wealth. Analyse their behavior by reading past annual reports as to how they have enhanced company's net worth over the years. Managements who pay reasonable dividend more than taking salary, doing buybacks, not diluting equity for ambitions expansion projects nor taking too much debt for their ambitions can be considered as credible managements.|
|6||Develop your Knowledge about the company and Industry you invest in||Try to learn and understand every bit of information possible about the company and the industry they operate in. Company websites, stock exchanges and Stockadda.com provide various information such as Presentations, Annual Reports, Conference call details for you to gather information and knowledge. By this way you will know which event can make or break the fortunes of the company. Also it can help you withstand psychologically to any adverse bad news / events in the short term if you know other than the market participants that such an event may not last long.|
|7||Volatility and Drawdowns are part of investor life.||Stocks can move in either direction in a crazy manner in shorter time frames (less than a year or two). It can even fall 60-70% from your purchase price as witnessed by many investors in small caps in 2018. But one of the ways you can manage such a crash psychologically is to believe in the management and company prospects with the knowledge you have gained, that they will come out of the bad phase and markets will eventually reward them in the long run.|
|8||Dont Sell in a Hurry||Compounding wealth is a very powerful factor in investing. Unless a stock goes to crazy valuation like very high PE of 30-40 or 4-5 times its book value, there is little reason for sell considerations. Long term wealth is created by compounding magic to work its way.|
I hope the above checklist maybe of use to identify, buy, hold and sell an investment. I do share my thoughts at https://twitter.com/khebind , if interested please follow.