Value Investing 101

A friend of mine asked how value investors make their picks. Here’s my approach to evaluating stocks. The key concept is buying an amazing asset at a great price.

1. First, they look at the earnings per share over a minimum of a ten year period and see what the rate of return is.
- They typically only look at rate of returns of 10% or higher because the S&P500 typically provides annual returns of 10%. (Note that Vanguard is projecting the S&P500 is projected to return 7% over the next ten years)
- If a company had even 1 year of negative EPS, they are excluded from the list
- If a company had major declines in EPS even if they werent negative, they are excluded from the list

2. Look at the stock price

3. Look at the book value

4. Calculate the PB Ratio. If the PB ratio is close to 1, that means the stock price is close to the book value which means you can buy the stock at a low price. If the stock price is 2x or higher than the book value, you probably won’t be able to buy it at a good price.

5. If the company doesn’t have a high debt to income ratio, has strong leadership, is in an industry that has long term viability, doesn’t have high R and D costs, and has a strong competitive advantage, then purchase the stock.

There are about 3,600 stocks in the US. Most of them are releasing their 10-Ks in February / March. Now is the time to make your picks. The recession is coming soon and when it hits, you'll be able to buy amazing stocks at a great price.

Happy hunting!