Stocks Criteria Suppose to be On Your Watchlist
I have adopted value investing principles in building my stock portfolio for years.
I find value investing to be suitable as it emphasizes on investing in good businesses when their stock prices are undervalued and hold onto them for the long-term.
There is no prediction, guessing or chart monitoring to do on a daily basis, which I find it to be very liberating.
The principles of value investing are simple, effective and highly replicable. Millions of investors across the globe who studied the art of value investing had built themselves massive wealth with 6, 7, 8 or even 9-figure stock portfolios today, starting with less capital.
So, I would say that, if I may turn back time to when I was in my 20s, I would start as a value investor.
If I need to rebuild my portfolio all over again, the first thing I will do is build a watch list of stocks that would fulfill the following criteria below:
Criteria #1: Economic Moat
There are many stocks listed on stock exchanges like Bursa Malaysia. But few of these stocks are businesses that are scalable and possess strong economic moats.
Now, you may ask: “What’s an economic moat?”. Here’s an example. What comes to your mind when you first think of smartphones?
Personally, I would think Apple despite the existence of other smartphone brands in the world.
Interestingly, a customer is willing to pay RM 5-7k for the latest iPhone despite knowing that they can easily find other smartphones that function better at substantially lower prices at RM 1-3k.
Today, many are willing to BNPL and service monthly credit card installments for years to own the latest iPhones. Once we become an Apple user, we’re included into its ecosystem and would rarely switch out.
Such brand loyalty or “stickiness” is a type of economic moat and this translates to greater profit margin and eventually, stock valuation to Apple as compared to its peers.
Therefore, the first thing that I look for is the economic moat of the stock’s business. This is because the money lies in its moats.
Criteria #2: ROE >15%
Typically, businesses that have strong economic moats would deliver strong financial results.
These include delivery of consistent growth in revenue, earnings and operating cash flows in the long-term.
In addition to these financial figures, I’ll measure a stock’s return on equity (ROE) as I prefer businesses that are efficient in using capital to earn profits.
For instance, let’s say we have two stocks: A Bhd and B Bhd. Both earn RM 100 million in net profits per annum.
But, here is their difference: A Bhd uses RM 1 billion in shareholders’ equity to make its RM 100 million in yearly profits. Whereas, B Bhd uses RM 500 million in shareholders’ equity to earn the same amount of profits.
A Bhd’s ROE is 10% a year while B Bhd’s ROE is 20% a year. Thus, for me personally, I would prefer to invest in B Bhd as the company is more capital efficient.
Criteria #3: Low Debt Levels
Of course, there are businesses that use debt heavily to expand their operations to grow their income and ROE.
As one who is conservative, I’m looking to own businesses that are stable, profitable, and resilient in both economic booms and busts.
Hence, I would choose stocks that have strong balance sheets with lots of cash and low debt.
To do this, I assess their debt levels based on the companies’ ability to generate operating cash flows on a consistent basis.
Let's imagine two companies: C Bhd and D Bhd. C Bhd is burdened with RM 200 million in debt but struggles to generate positive operating cash flows.
On the other hand, D Bhd owes a hefty RM 1 billion but comfortably brings in RM 500 million in operating cash flows annually.
Based on these figures, D Bhd could pay off its entire debt within two years of its operating cash flows, which is a desirable scenario.
In contrast, despite C Bhd's lower debt, its inability to produce positive operating cash flows makes it financially unhealthy and unattractive to me as an investor.
Another crucial aspect I consider is the financing cost relative to the company's operating profit.
Businesses that incur relatively low-interest charges—let's say less than 10% of their operating profit—are much safer during a crisis.
As the saying goes, we'll see who's swimming naked when the tide goes out.
Therefore, I prefer stocks that can easily pay off all their debts with their operating cash flow and have low financing costs compared to their profits.
Criteria #4: Skin in the Game
Personally, I am drawn to stocks where the directors are substantial shareholders of their own companies.
It's akin to dining in a restaurant where the chefs enjoy their own cooking.
Consider Warren Buffett, for example. As the Chairman of Berkshire Hathaway Inc., what do you think his primary source of wealth is? Is it his $100k annual salary?
Or is it his significant shareholdings in Berkshire Hathaway? The answer is clear—it's his shareholdings. This ties his personal wealth closely to the company's performance, incentivizing him to not only grow the business but also to steer it through tough economic times, like during COVID-19.
Now, imagine a CEO who resigns at the first sign of trouble. That's not the kind of leadership I want to invest in.
That's why I prefer stocks where the leadership has “skin in the game.” Their fortunes and interests are more likely to align with those of minority shareholders like myself.
Criteria #5: Aspire to Grow
I admire businesses where leadership is committed to innovation and future growth.
One of the best examples is Jeff Bezos, the founder of Amazon. Consider this: Amazon started as an online bookstore.
Today, it owns a diversified and valuable portfolio of businesses, with the majority of its profits coming from AWS, its cloud computing service.
How did Amazon become one of the most valuable companies in the world? The answer lies in its relentless drive for innovation and long-term vision.
If Amazon had remained just an online bookstore, I doubt it would have achieved the high valuation it enjoys today from the investment community.
Conclusion
So, if a stock fulfills all the 5 criterias above, I would put it into my watch list. Then, I’ll keep track of its business performance and calculate its valuation ratios like P/E Ratio.
If the stock is undervalued, I would consider investing in it. Otherwise, I’ll retain it in my watchlist and wait for a time when it becomes more reasonably valued in the future.
So, what if you’re a newbie today? Would it be okay to invest in other stocks that do not fit the 5 criteria above?
My personal take is that if you plan to buy stocks in the stock market without having your sets of criteria of what you’re looking for in a stock, you’re just merely speculating.
That is risky. It would be more profitable in this case to consider ASB as an investment vehicle, especially if you are a Bumi.
This is because you could earn annual dividends from it and avoid having exposure which includes market volatility, currency risks, and many other factors that could drive the markets.
However, if you enjoy picking stocks like I do, you may use the above 5 criteria as a reference to find stocks that are fundamentally solid and include them into your own watch list.
