1.1 How to Select A Good Stock

Introduction

There are many stocks out there in the markets, there is no time for us to read every single stock’s annual report out there in the stock market just to pick a good stock. There where stock’s filter help many investors to filter out unwanted counter.

As a value investor we look into these criteria before look into the financial report of a company:

1. Price to Book Value
2. Dividend Payout History
3. Quick Ratio
4. Operating Cash Flow

Price to Book Value (P/BV)

Price to book value is divides the price per shares of a stock to book value per share. These ratio give investor an idea about how much they are paying for $1 of the net asset of the company. For example if company A has a P/BV of 0.6 these means that by using $0.6 we can buy $1 net asset of company A. If company A close down the next day by selling all their assets and pay all their debt. Each outstanding shares of the company will get $1.4 in cash. ($1 + ($1 - $0.6) = $0.4).

As a value investor, we look into company that have P/BV less than 1. A value investor is looking for company which has low P/BV.

Dividend Payout History

Value investor will hold a stock until the counter is overvalue. These investing style need patient. It might take years to have the stock to reach it actual value. If holding a company for years, the only return from the stock is the dividend income. Hence, we have to look for a company with good dividend payout history. Once a company had pay their shareholder yearly for 10 years continually, the probability of the company paying dividend this year is high. The amount of dividend pay (dividend payout ratio) is also importance when selecting a stock. There are many company out there paying high dividend compared to fixed depository in the bank. Why people willing to place their money in bank with low interest rate and not willing to invest in undervalue stock and receive high income per year.

Value investor will look for company that is paying dividend to shareholder yearly and a company with high dividend payout ratio. If the company fails to pay dividend for one year, we have to be caution about the company.

Quick Ratio

Quick ratio is divided Cash + Short term market investment + Receivables by Current Liability. This ratio indicates how liquidity a company is. If the company required to pays back all their current liabilities today, how well can the company pay them using their current assets?

The company with quick ratio more than 1 means that the company can covers all their current liability with the current asset. Value investor will pick a stock which have high quick ratio and quick ratio more than 1.

Operating Cash Flow

Operating cash flow shows how much cash the company receive from the operation. A company has a positive operating cash flow will able to sustained itself from their operation without required addition cash from outside. On the other hand a company with negative cash flow required external source of cash (loan or from shareholders) to sustain the company operating cost. If the company running on operating cash flow for years it cash will drained out eventually and go bankrupt.

Value investor will look for company with positive cash flow. Once the company have negative cash flow even for a year we have to be caution about investing the company.

Conclusion

A good stock will have this criteria:

1. Price to book value < 1
2. Pay dividend continually for 10 years
3.  Quick ratio > 1
4. Positive Operating Cash Flow 

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