Sometimes, it can be complicated to identify the right stock to buy among the tens of thousant of potential stocks (55k worldwide). In the meantime, how to maintain a portfolio with a reasonable number of stocks while there are so many opportunities?
To help you improve your own process, I will share mine. This might also help you to understand my decision process.
Step 1: Identifying stocks
You have numerous resources for identifying potential stocks. For example, websites like marketscreener.com provide valuable information. While it is relatively easy to identify large-cap companies, screening for small and mid-cap stocks can be more challenging.
To assist you, I often share potentially appealing stockss. Here are a few examples:
Quality stock screeners for large-cap like these ones in Europe or in the US
Potentially interesting small-cap stocks can be explored here
You can also find industry screeners highlighting the most appealing stocks here
Step 2: Is the stock within my investable universe?
To address this, I have developed a personalized rating system. You can find these scores for each stock in my screeners, such as the one I use to benchmark the sportswear industry.
The scoring system uses 5 different categories. Each category has different metrics, mainly quantitative. Each metric gives a score depending on thresholds I defined, once again to fit my investment style.
Growth. The growth category uses 4 metrics:
Past and future revenue growth
Past and future EPS growth
Quality. The quality category uses 3 metrics: net profit margin, ROE and cash/debt ratio vs the EBITDA.
Valuation. For valuation, I use 3 metrics: PE, FCF yield and PEG.
Shareholder return. This category shows if the company is shareholder oriented. I look at 3 metrics: dividend yield, dividend growth and buybacks/dilution in outstanding shares.
Market. This is the only qualitative metrics. It represents the value of being present in the market and the company’s strength in it. It is a personal appreciation.
Step 3: Does the company have a robust business model?
Understanding a company's business model and identifying the best ones is crucial. Depending on your investment style, you can assess various factors. Here are a few examples:
The company’s competitive advantage / moat. I talk in these two articles about moat and widening moat
The quality of its management team
Percentage of recurring revenue
Market share trends
R&D spending, innovation, patents, pipeline
Customer dependency
SWOT (strengths, weaknesses, opportunities, threats)
These are just a few examples. To help with this analysis, I publish a weekly deep dive on a company, exploring its business model, strengths, weaknesses, outlook, risks, and opportunities. This is a critical step in the investment process. Some examples:
In the US market, deep dives about ServiceNow, ADP or Zoetis
Fast-growing companies like BoneSupport or Mader
Step 4: Is the market appealing?
Identifying and mapping interesting markets is crucial. This process enables you to pinpoint potential competitors while examining factors such as projected CAGR, market share trends, dynamics, and key insights.
To assist with this analysis, I periodically publish industry reports and benchmarks:
Sometimes I publish insights about specific industries like luxury or silver economy
Step 5: Estimating the fair value
The fair value serves as a reference point. While I don’t use it as a definitive investment signal, it provides a useful indication of whether a stock is undervalued or overvalued. Among all the decision-making steps, this is the least critical.
How do I calculate my fair value? I employ three methods to determine my fair price: fair P/E valuation, DCF analysis, and analyst price targets. Then, I take the average of these values. Detailed examples of these calculations can be found in each of my deep dives or in my one pagers.
Step 6: Estimating TSR
To assess the potential of an investment, I estimate the Total Shareholder Return (TSR) over a 10-year horizon. My TSR estimation incorporates six components, calculated on this same timeframe:
Estimated organic revenue growth
Projected growth from acquisitions
Annualized changes in margins
Annualized adjustments in valuation ratios
Expected dividends
Anticipated share buybacks
I describe my method with detailed examples in this article. I set different targets based on whether the company is a growth stock, a defensive stock, or a small-cap company.
Step 7: Evaluating if the stock is better than existing holdings
I consistently seek to enhance my portfolio while maintaining a reasonable number of stocks, typically between 15 to 20 per portfolio. Therefore, when a stock successfully passes the previous steps, it must also outperform any existing holdings to justify an addition to my portfolio.
Step 8: Using technical analysis to identify entry points
I find technical analysis to be more valuable than fair price estimation for pinpointing optimal entry points.
I typically identify three key zones: the initial entry point, followed by two reinforcement points in case of a pullback. If the stock continues to rise, I will consider reinforcement during local pullbacks.
My approach to identifying these zones is straightforward: I look at trendlines, channels, and previous support and resistance levels. I generally use a weekly candlestick chart for these analyses. Here an example of an article where I identify attractive buying zones for major stocks. It is important to conduct this type of analysis regularly, as these zones can change over time.
Conclusion
This 8-step framework enables me to identify promising stocks and maintain a continuously improving portfolio. This ongoing improvement process is essential to ensure I always hold appealing stocks and avoid retaining those with declining fundamentals or diminishing interest.
My articles can assist you at each stage of this investment process, providing deep dives, industry analyses, and resources like screeners and scoring systems. Let’s grow our portfolios together!
Nice learning about your process!