9 Criteria Stock Selection

3/27/12
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9 STEPS TO VALUE INVESTING TUTORIAL
Daily Market Analysis
Our Objective:
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To achieve a target annual return of 15%- 25% on our investments
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Investing 101
The key to building a successful portfolio is to:

1. Identify very good businesses
2. Buy them at a good price (huge discount)
Candle Stick Studies
3. Wait for the market to realize its true value or over-value it
Market Watching
What is a VERY GOOD business? It is one that:
Minimum Risk Entries
1. Has exceptionally good long-term economics
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2. Has a durable competitive advantage (economic moat) that protects it from any competition.
3. We can predict with strong confidence that over the long term, earnings, shareholder value & prices
will grow.
4. Can recover and prosper in the event of any major recession or bad news.
Buffett s Investment Philosophy: Investing from a Business Perspective
When you buy the stock of a company, you are buying to become a part-owner of the company.
If the company earns $3 per share in 2004 (EPS) and you own 500 shares => You have earned $3 x 500
= $15,000
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The Price You Pay Determines Your Initial Rate of Return

You buy OSIM stock at $0.89
Earnings per share is $0.071
Earnings per share growth rate 31.14%
Your initial rate of return is $0.071 / $0.89 = 8%
Would you rather put your money in FD at 2% per year
OR invest in OSIM that returns 8% per year, with a growth rate of 31%?
9 STEPS TO VALUE INVESTING
The first 7 criteria are used to determine if the stock you are investing in is a GREAT BUSINESS that will
grow in value over time.
The 8th and 9th criteria are used to determine if the price is right and if it is the BEST TIME to buy the
stock.
IS IT A VERY GOOD BUSINESS?
Criteria #1:
History of Consistently Increasing Sales, Earnings and Cash Flow
* Note that earnings, net income and profits are used interchangeably, while Sales & Revenue are used
interchangeably
The first indication of a good business is one that has at least a 5-10 year history of CONSISTENTLY
INCREASING SALES, EARNINGS, & CASH FLOW, especially during tough times.
If a companys past earnings show consistency, then future earnings will be more predictable to
forecast with confidence.
For example, look at General Motors Corp and Johnson & Johnsons Earnings (in green) and price
chart (in black). General Motors past earnings are too erratic to predict with certainty. However,
JNJs earnings can be forecasted with a lot more confidence.
Chart 2: Stock Price & Earnings Chart
Screen Capture From www.corporateinformation.com
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While earnings can be creatively manipulated by accountants, cash flow & sales cannot be manipulated.
SALES REVENUE & CASH FLOW FROM OPERATIONS should also increase at same rate as
EARNINGS.
Where To Find This Information?
Go to Morningstar.com => Enter Quote => Financial Statements
To look at the companys Sales Revenue and Net Income, look under 10-yr
Income.
Table 3: Income Statement from Morningstar.com
Screen Capture From www.morningstar.com
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To look at the companys Cash flow from operations, look under 10-Yr Cash Flow.
Table 4: Statement of Cash Flows From Morningstar.com
Screen Capture From www.morningstar.com
Since Sales Revenue, Net Income and Cash Flow from Operations have been
increasing consistently over 10-years, Criteria 1 PASS.
Criteria #2:
Sustainable Competitive Advantage
For the company to continue to increase earnings growth, it must possess a sustainable competitive
advantage (wide economic moat) that protects it from any potential competition.
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What Creates a Sustainable Competitive Advantage?

1. A Strong Brand E.g. Coke, Nike, Hersheys, Budweiser
2. Huge Market Share. E.g Wal-Mart, GE, VISA, ExxonMobil
3. High Customer Switching Costs. E.g. Adobe, Stryker.
4. Patents, Copyrights, Government Approvals or Licenses E.g. Pharmaceutical companies, SPH
5. The Network Effect. E.g. EBay, Google
Note: A competitive advantage created by a HOT new technology isn t sustainable because it is only
a matter of time when the technology is made obsolete by a better one.
Examples of Companies with Sustainable Competitive Advantage (Wide Economic Moats)
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Examples of Companies with Narrow Economic Moats
Where Do I Find This Information?

Read and thoroughly understand the companys business model by entering the ticker symbol (e.g.
JNJ) into:
1) finance.google.com (Go to Summary),
2) Morningstar.com ( Go to Company Profile and Analyst Research)
3) Moneycentral.com (Guided Research -> Stock Research Wizard).
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3) Moneycentral.com (Guided Research -> Stock Research Wizard).
From understanding the business model, you can distinguish if the company has a Competitive
Advantage or is Price Competitive.
Morningstar.coms Analyst Research (Premium Paid Service) does the classification for you.
JNJs huge market share, strong consumer brands (e.g. Tylenol, Johnsons Baby Shampoo,
Neutrogena etc ) and pharmaceutical patents give it a sustainable competitive advantage (wide
economic moat) Criteria 2 PASS.
Criteria #3:
Future Growth Drivers
Although the company has a strong track record of consistent revenue and earnings growth, are there
any strong goals and strategies that management has announced that will continue to drive growth into
the future? Are there any new market opportunities that will allow the company to keep selling more
products and services?
Development of new product lines
Upcoming product innovations
New application of patents
Expansion in capacity
Opening new markets
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Building more outlets

Huge untapped market potential
To read about the companys future growth plans, you can go to:
a. Companys website and go to Investor Relations (Find the Link from Finance.Google.com)
b. Companys Annual Report under CEO Message or Future Growth Plans
(Google Search)
c. Morningstar.com => Analyst Research => See Growth and Bulls Say (Premium
membership)
Criteria #4:
Conservative Debt
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The next criterion is that the company should have a conservative debt policy. The rule of thumb is that
long-term debt should be less than 3 X Current Net Earnings (After Tax)
Long Term Debt < 3X Current Net Earnings (After Tax)
Note: While having conservative debt is useful for generating growth while k eeping ROE high, too much
debt can lead to bank ruptcy during a prolonged recession or calamity.
Go to Morningstar.com
-> Enter Ticker Symbol -> Financial Statements
-> 10-Yr Income (to check Net Income)
-> 10-Yr Balance Sheet (to check Long-Term Debt)
Since JNJs long-term debt ($2.014 billion) is much lower than its Net Income ($11.053 billion) in
2006, CRITERIA 4 PASS
Criteria #5:
Return of Equity (ROE) & Return on Assets (ROA) Must be Consistent & High. ROE > 12-15% &
ROA > 7%
A company that shows a high & consistent ROE indicates that:
a. The company has a sustainable competitive advantage.
b. Your investment in the form of shareholders equity will grow at a high annual rate of compounding
that will lead to a high share price in the future.
Generally, a company that has ROE of 5-10 years:
ROE > 15% => Great Investment
ROE > 12% => Good investment
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ROE = 12% => Fair investment (most global business average this)
ROE < 12% => Unattractive investment
Danger: Some price competitive companies show high ROE as they purposely shrink their equity base
through large dividend payouts or share repurchasing. To solve this problem, Return on Assets (ROA)
should be consistent and > 6-7% as well.
How To Find This Information
Go to Morningstar.com
-> Enter Ticker Symbol
-> Go to Key Ratios
Since JNJs ROE is > 12% and ROA > 7%, Criteria 5 PASS
Criteria #6:
Low Capital Expenditure (CAPEX) Required to Maintain Current Operations
There is no use in a company generating high earnings if a substantial amount goes to replacing plant &
equipment in order to maintain current operations and competitive advantage. This is normally so for
PRICE COMPETITIVE businesses and businesses involved in MANUFACTURING.
Why? Because the earnings cannot be paid out as dividends, be retained to be re-invested in growth
projects or to re-purchase shares.
How To Find This Information

Read and thoroughly understand the companys business model by going to finance.google.com,
morningstar.com (analyst research) and moneycentral.com (stock research wizard) and the company
s website.
From understanding the business model, you should only invest in companies that:
a. Does not require high capital expenditure to maintain efficiency or replace plant and machinery
b. Does not require extensive research to maintain competitive advantage
c. Produces a product that hardly goes obsolete
To find Free Cash Flow/ Sales Revenue,
Go to Morningstar.com => Financial Statement => 10-Yr Income and => 10-Yr Cash Flow.
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Criteria #7:
Management is Holding/Buying the Stock
The next factor to look at is whether the companys own directors are holding, buying or selling their
own shares.
If you find that KEY APPOINTMENT HOLDERS like the CEO, CFO or chairman are selling a LARGE
proportion of their own stock, then it may not be as good an investment as it seems.
Go to Moneycentral.com
-> Investing
-> Enter Ticker Symbol -> Fundamentals -> Insider Trading
-> This will show you if key appointment holders are net buyers/sellers
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-> Also, click on Research -> Stock Rating

-> Go to Ownership details
-> Anything below a C grade fails the criteria
Criteria #8:
The Company is Undervalued: Stock Price Is Below Intrinsic Value
You should only buy a stock if its CURRENT SHARE PRICE is SIGNIFICANTLY BELOW its INTRINSIC
VALUE.
When you buy a stock that is UNDERVALUED, it gives you a high margin of safety.
For example, if a companys stock is worth $50 (i.e. Intrinsic Value) and it is selling for $25 (i.e.
Current Share Price), it will definitely be a great buy.
Why is a Great Business Undervalued?
Great Businesses become undervalued from time to time because the market is irrationally driven by fear
and greed in the short-term.
Stock markets tend to over-react to bad news in the short-term, sending the stocks price way below
its true value.
A value investor who knows the true value of the stock will take advantage of this and buy while the
company is on sale and sell when the investor optimism returns.
The Bad News Must Be Temporary
Always check that the bad news that causes the stock price to decline is a temporary reason and DOES
NOT affect the companys long term growth prospects.
Common reasons for short-term undervaluation are:
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Common reasons for short-term undervaluation are:

a. The stocks sector (e.g. Heath Care) goes out of rotation
b. The overall stock market is declining due to recessionary fears
c. The company misses its quarterly earnings estimates
d. Product or patent failure
e. Accounting or management scandal
Find Out the Reasons For The Stock Price Decline
Go to finance.google.com
-> Check the news for reasons of price decline
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How to Calculate a Company s Intrinsic Value

The Value of a Stock is Equal to the Present Value of All Its Future Cash Flows
To be even more conservative, I calculate the Intrinsic Value of a stock to be the sum of all its future cash
flow for the next 10 years only!
In certain cases (especially Singapore stocks), where it is more tedious to calculate and project CASH
FLOW, I use EARNINGS PER SHARE as a proxy instead.
Using the Intrinsic Value Calculator (Cash Flow)
Key in the Following Values:
-> Name of Stock
-> Stock Symbol
-> Operating Cash Flow (Current)
: Go to Morningstar.com-> Financials -> 10-Yr Cash Flow
-> Cash Flow Growth Rate
: Use EPS Growth Rate as a Proxy
: Moneycentral.com -> Research -> Earnings Estimates -> Earnings Growth Rates
-> No. Of Shares Outstanding
: Go to Morningstar.com-> Financials -> 10-Yr Income
-> Current Year Discount Rate
The Intrinsic Value Per Share is automatically calculated.
Criteria #9:
Stock Breaks Out of Consolidation Or On An Uptrend and must be above the 20 or 50-Day
moving Average
This final criterion will help you time your investment just before the stock makes its upward move.
You would want to know if the stock price is on a DOWNTREND, on an UPTREND or in a
CONSOLIDATION pattern (moving sideways).
Always go with the current and avoid going against the current of investor psychology as much as
possible. Once a trend is establishedwhether it's moving up or downa stock is more likely to stay
in that trend than to reverse.
Stock Price On An Uptrend
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The Best Time to Buy Would be When The Stock Price Dips On An Uptrend
Stock Price In A Consolidation Pattern
The Best Time To Buy Is When The Stock Breaks Out Of the Consolidation Pattern on High Volume
Stock Price on a Downtrend
Avoid Buying Stocks When It Is Still On A Downtrend! Keep It On Your Watch-list Until It Bottoms Out.
Also, ensure that the stock price is ABOVE THE 20-DAY AND/OR 50-DAY MOVING AVERAGE. When
the stock price cuts ABOVE the 20-day and/or 50-day moving average, it signals that the stock will rise
even higher.
The 20-Day Moving Average cutting ABOVE the 50-Day MA is also a signal to buy.
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Go to Optionsxpress.com
-> Look at the 6-month, 1-year, 2-year and 10-year price chart
-> Tools -> Apply Studies -> 20-Day and 50-day MA
From observing JNJs stock price over different periods, you can see that the stock price has
consistently is on a long-term uptrend (from 5-year chart).
Currently, the 6-Month chart shows that JNJ is still on a shorter-term down-trend as is BELOW the 20
and 50-day Moving Averages.
It is NOT the right time to buy. Put JNJ on your watch-list and get ready to buy only when JNJ reverses
into an UPTREND and cuts above the moving averages.
What Do You Do Once You Buy?
Regularly monitor the progress of your stock portfolio by checking:
1) Daily
o US Companies
o www.moneycentral.com => Portfolio/watchlist
o Watchlist of your US online broker
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o Watchlist of your US online broker

o SG Companies
o www.sgx.com => Live prices
o Watchlist of your local broker
If price drops significantly, check news and announcements
US: Check finance.google.com
SG: Check www.sgx.com => general announcements
2) Quarterly Review
US Companies
o Morningstar.com => Financial Statements & analyst research
o Finance.Google.com => Financial Statements
SG Companies
o SGX.com => companys all-in-one info => general announcements and financials
3) Real Time
Activate a Google alert for US and SG stocks
Activate a Listedcompany.com alert for SG stocks
Seven Reasons To Sell A Value Stock
You Should Sell A Value Stock For Profit Only When
1. The stock price drops 20% below your purchase price. A 20% drop is very unlikely if you buy a very
good company that is undervalued.
2. You found you made a mistake when evaluating the company, as it does not meet one of the 9
investment criteria.
3. During your regular evaluation, you notice a negative change in one of the 9 investing criteria, and it
does not seem temporary (e.g. fall in profit margin, earnings per share, ROE etc )
4. Management takes action that is not in shareholders best interests or dilutes their stakes
significantly.
5. You identify a much better investment (higher growth prospects, better price) that will give you a much
higher annual rate of return.
6. When the economy is approaching a bubble and the stocks price is way overvalued.
o Inflation is very high => FED begins to raise interest rates
o S&P 500 PE ratio is above 30.
7. The Stock price reverses into a downtrend
Other than these seven reasons, allow the value of your stock to compound over the medium to long
term.
About The Author
Adam Khoo is an entrepreneur, best-selling author and a self-made millionaire by the age of 26.
Over the last 15 years, he has trained over 245,000 professionals, executives and business owners
to tap their personal power, achieve break through results and excellence in their various fields of
endeavor.
Discover his million dollar secrets and download your FREE "Get Out Of The Rat Race!" report at
Secrets Of Self-Made Millionaires now...
Copyright 2008 Wealth Academy . All rights reserved.

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3/27/12

Home > In e o ' Ed ca ion > In e ing 101

9 STEPS TO VALUE INVESTING TUTORIAL

Daily Market Analysis

To achieve a target annual return of 15%- 25% on our investments

The key to building a successful portfolio is to:

Candle Stick Studies

3. Wait for the market to realize its true value or over-value it

What is a VERY GOOD business? It is one that:

Minimum Risk Entries

1. Has exceptionally good long-term economics

The Price You Pay Determines Your Initial Rate of Return

What Creates a Sustainable Competitive Advantage?

Examples of Companies with Sustainable Competitive Advantage (Wide Economic Moats)

Examples of Companies with Narrow Economic Moats

Where Do I Find This Information?

3) Moneycentral.com (Guided Research -> Stock Research Wizard).

Building more outlets

How To Find This Information

-> Also, click on Research -> Stock Rating

Common reasons for short-term undervaluation are:

How to Calculate a Company s Intrinsic Value

Where Do I Find This Information?

o Watchlist of your US online broker

Copyright 2008 Wealth Academy . All rights reserved.

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