Last update: 2019-10-02

Stock valuation 101

Most financial analysts tend to recommend investing in index funds or ETFs for a new investor, or anyone wanting a set-and-forget strategy to get decent returns. I agree with this, however personally I still decided to go the route of picking individual stocks. There are 3 reasons for that:

  • Index funds charge management fees, usually between 0.05% and 1.00%, yet a lot of their holdings are public for all to see, so it's simple to compare your choice to their portfolio for reassurance.
  • Picking individual stocks means you get to decide how your portfolio is going to be balanced. For example maybe you're bullish on REITs but don't want exposure to oil stocks.
  • If you're willing to take the time to research and learn about the market, then it's far more interesting to build your own portfolio rather than let someone else do it for you.

Here I'll show you what I use to pick my own stocks. Note that I'm not a financial advisor and you should do your own research before investing.

Understanding the company

The first criteria is to understand the company. This is the number one thing Warren Buffet always says, which is that he doesn't invest in a company that he doesn't understand. That means going to their website, looking at how diversified their product line is, where they make their earnings, the barrier to entry, etc. For example, a company that sells phones, tablets, computers and has a cloud service, along with a brand known world wide, is an established player that isn't likely to be going anywhere. On the other hand, a company whose sole income source is operating a single mine in the arctic may be subject to climate change, the mine drying out, etc.

Undervalued stock

While it's best not to time the market, trying to pick an undervalued stock is a good idea. Finding the right value can be very tricky. You can look at the P/E versus other companies in the same sector, or check some analysis sites. One site I like is Simply Wall St, which provides useful charts like this:

Good financial health

Regardless of stock price, the company must have good financials. You can easily look at a company's financials on the Yahoo! Finance site for both balance sheet:

..and income statement:

If a company has more debts than assets, or if they are losing money every year and have never been profitable, then that's not the sign of a stable long term pick.

Dividend history

The dividend payment is important for my portfolio because I use a DGI strategy. Basically I only invest in companies that pay a decent dividend each year, and have a history of maintaining or growing this amount. Of course you want to avoid companies that have a yield too high, because they aren't likely to be able to maintain these payments. Something around 3%-6% is the sweet spot.

There are of course many other criteria you can use to pick stocks, such as insider trading, past performance, growth potential and so on. But the items I listed so far are the most important ones for me, needed for me to buy into a specific position.

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