With around 10,000 stocks to choose from when making investment decisions, you need to have a way of narrowing down the universe to a manageable number to perform more detailed research on. I’ve discussed my investment process a bunch in past posts, and I’m always looking for ways to make my routine more efficient. I basically use Value Line, screeners, 13-F’s, and other blogs for ideas on specific investments. I then put all my potential stock ideas onto a couple different watchlists to keep track of them. Then I do more detailed research one stock at a time, which basically involves reading the annual report and a few articles to get a better understanding of the business model.
But I’m a big fan of simplicity and process flows here at BHI. Joel Greenblatt said to not get bogged down too much when looking at the details. Instead, understand the big picture, and put the majority of your emphasis on just two key metrics:
- Return on Capital (which measures how good a business is)
- Earnings Yield (EBIT/EV: which measures how cheap a business is)
Using just a couple key metrics allows you to quickly sift through the universe and focus your efforts on the best potential investments. That’s the idea behind using the Magic Formula screen.
I just read this article by another favorite writer of mine, David Merkel, over at the Aleph Blog. In his recent post, he answers a question that basically asked:
What’s the best way to determine in five minutes if a stock is worth further analysis?
David listed the following things to review first:
- Look at price to expected earnings. Look at past earnings.
- Look at indebtedness and goodwill. Ask: is this a stable industry? Does the goodwill represent anything valuable, some barrier against competition?
- Compare cash flow from operations versus earnings. An excess is usually better.
- Look at price-to-book for financials and price-to-sales for utilities and industrials — lower is better.
- Ask yourself if this is an industry with increasing, stable, or decreasing pricing power.
- Look at whether the share count is rising or falling. Falling is better.
- Does it pay a dividend? Yes is better.
Check out the full article for more details. I thought those were good points…
Have a great weekend!