how to generate stock ideas

7/25/2019 How to Generate Stock Ideas

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How to Generate Stock Ideas24 Nov 2013 08:55 pm | Vishal Khandelwal

In an interview with Warren Buffett in 1993, Adam Smith, author of Supermoney, asked how the

small investor can find good investment ideas

Warren Buffett:I!d tell him to do e"actly what I did #$%oddyears ago, which is to learn a&out every company in the

'nited States that has pu&licly traded securities, and that &ank

of knowledge will do him or her terrific good over time

Adam Smith:But there are (),$$$ pu&lic companies

Warren Buffett:Well, start with the A!s

*very&ody knows that Warren Buffett gets his investment

ideas largely from annual reports

+f course, now he has &ecome so influential that companies

call him to share their own ideas But, fifty years ago, Buffett was not the go%to guy if youwanted to sell your company or raise capital for your failing &ank

e was a small investor who was clawing his way up the investing street &y reading whatever

annual report came his way, and then finding his investment ideas that workedwonders in the

su&se-uent years

.ou are pro&a&ly at the same stage Buffett was fifty years ago But there!s a &ig advantage you

have over the early day Buffett

/hat advantage is 0 technology

With annual reports now availa&le at the press of a few &uttons on company we&sites and BS*2,

you can look through hundreds of companies in lesser time than it took Buffett to access tencompanies

.ou may ask, But how do I select companies whose annual reports I should read45

Well, one -uick suggestion is what Buffett told Adam Smith 0 6start with the A!s5

I would simplify this for you6

1 /ake, for instance, the BS*%($$ listof companies

( 7emove all companies that you know5 are outside your circle of competence 8on!tworry if you remove lot of companies6&ecause the sie of the circle is not important,

knowing its &oundary is2
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3 :or companies that remain, start reading annual reports of companies whose names start

with A, then B, and so on

If you find this difficult to implement and it is2, here are a few other ways you can create a listof companies you would like to do a deeper research on to generate stock ideas6

7emem&er, good ideas rarely come from6

/;, newspaper analysis and &reaking news

Brokers and research analysts

:riends, colleagues, and people you meet at social gatherings

6so you may rather do your own homework than relying on free tips, however enticing they

may sound

Screening Your Way to Stock-dom!While I am not anymore a &ig fan of using readymade screeners to generate stock ideas 0

&ecause you tend to su&stitute thinking with a lot of data 0 simple screeners still help me in doingthe initial groundwork

Also, while there are a few paid and e"pensive2 screeners availa&le in the market 0 like Ace

*-uity, ine 0 I find a few free screeners to &e very effective when it comes to

the value I can derive from using them

ere are three steps you can use while using three free screeners I use to do a &asic analysis on

companies6

Step : se a Goog"e Screener

;isit this ?oogle :inance Stock Screener pageand select India5 from the drop down list ofcountries, and then BS* or @S* from the stock e"change list

7emove all entries like arket =ap5,


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'atest .e/t0$uity ,atio &>ess than 1"

'atest )arket 1apita"i2ation &At least 7s (D &illion 7s (D$ crore2 to e"clude

e"tremely small companies

'atest %0$ ratio &Between D" and (D"

3o"ume & At least 1$$ shares traded daily

ere is how the screening and its output look like6

Note:Another good screener that a triesmen has directed me to is !rom "inancial #imes $"#%&'it( )creener* +t has greater n'mer o! criteria than ,oogle-s screener. 't does not displa(

the res'lts in +N/* o' m'st however tr( it o't !or s're*

Step 4: 5rom the "ist of companies you get6 e7c"ude those outside your circ"e of competence

&&usinesses you know5 you don!t understand like I would e"clude commodity &usinesses likemetals and mining, or oil E gas &usinesses2

Step 8: G"ance at the "ast #09 years financia" performance on sites "ike Screenerororningstar+>ook for trends inF

Sa"es growth &=heck for rising and sta&le growth

(et margin &Sta&le rising margin Be wary of margins that are falling

,eturn on euity &Sta&le or rising Be wary of falling 7+*

.0$ &@il or small de&t is fine Be wary of companies where 8* G 1"

515 change &orningstar gives the free cash flow calculation, which instantly tells you

if the company is generating cash or &urning it >ook for &usinesses that have generatedpositive :=: over the past few years

Apart from the ratios given, calculate ones like 515 yie"d0 :=: per Share divided (

Stock


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companies that you get from Step 1 and Step ( a&ove, a far &etter way is to pick up the annual

reports of the resultant companies and then read them one &y one

After having used readymade screens for the past few years, I have realied that you should notuse num&ers prepared &y others, &ut rather generate them yourself /his way you get into the

ha&it of actually reading annual reports and also get to learn what num&ers you need to focus on

ere are two videos that will tell you what you must focus on in an annual report6

If you can!t see the videos a&ove, see here 0 ;ideo 1H ;ideo (

'ltimately, as you would realie, ust a few num&ers facts varia&les will help you understandwhat drives a given &usiness

I have seen analysts and investors trying to get perfect in their analysis &y accumulating as many

data points as possi&le

But then, my e"perience suggests that trying to increase your confidence &y gathering

information that is supposedly unknown to most others really only makes you more comforta&lewith your investment decisions, not &etter at them, and is generally an unproductive use of your

limited time

/hus, I would suggest that after you arrive at your list of companies using any or a com&ination

of methods suggested a&ove, use a >ess is ore =hecklist5 while reading the annual reports ofthe companies in your list

se the ;'ess is )ore< 1heck"ist7ather than o&sessing with the &ewildering fusion of news and noise, concentrate on a few keyelements in stock selection, ie, what are the D%1$ most important things you should know a&out

any &usiness you are a&out to invest in4

+f course, if I knew the e"act answer I would have retired long agoJ

*ven if I could know all the facts a&out an investment, I would not necessarily profit /his is notto say that fundamental analysis is not useful It certainly is

But information generally follows the well%known K$($ ruleF the first K$C of the availa&le

information is gathered in the first ($C of the time spent

So if I were to list down eight -uestions that, I &elieve, would help me do an K$C analysis of a

&usiness, they would &e6

1 Is the /usiness simp"e to understand and run==omple" &usinesses often face

comple"ities difficult for its managers to get over2
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( Has the company grown its sa"es and $%S consistent"y o*er the past #-9 years=

=onsistency is more important than speed of growth2

3 Wi"" the company /e around and profita/"y /etter in 9 years= Suggests continuityin demand for the company!s productsservices2

# How has the company performed on Buffetts earnings retention test=Suggests how

a company has used retained earnings in the past 0 a very important -uestion to answer2

D .oes the company ha*e a sustaina/"e competiti*e moat=

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