Choose Good Stocks to Buy

Using a value investing approach that finds the best stocks to buy by narrowing the field!

When looking for good stocks to buy using a value investing approach, I am immediately confronted with the multitude of companies listed on the stock market.

I manage the task of how to buy stock by narrowing the field of companies to those that appear to provide the greatest value with the least risk.

If a substantial number of companies can be ruled out for good reasons, it helps to reduce the complexity of the task.

I provide links below to those companies or offerings that I generally rule out for a variety of reasons. By taking these reasons into account, I will be more likely to choose companies that offer better value.


Initial Public Offerings (IPOs)

This is the initial sale of stock by a private company to the public.

IPOs are often issued by smaller, younger companies seeking additional capital to expand, but can also be done by larger privately owned companies looking to go public.

They are also referred to as a 'public offering'.

IPOs can be a risky investment as it is difficult to predict what the stock will do on its first day of trading.

There is often little historical data to go on in order to analyze the company.


Single Resource Companies

These are companies that usually explore and develop metal or oil resources.

Companies that mine or explore for one resource are very dependent on the price that they can sell that resource for, if and when they can market it.

So if you buy into a single resource company, you are taking a bet that the price of that resource will rise. Unless your information sources are better than most, you are in a high risk enterprise.


Capital-Intensive Industries

They are companies that require large amounts of expensive equipment, machinery or planes in order to trade.

Why do I generally avoid them?

Unless the companies continue to inject large amounts of earnings into new equipment, they will lose their competitive edge or those earnings will be lost to shareholders.


Penny Stocks or Small-Cap Stocks

These stocks are usually defined by price. For example. those that sell for less than $5 in the USA or less than $1 in Australia.

Why do I avoid them? Mainly because they tend to exhibit either low liquidity (a low trading volume), or high volatility (the price jumps around a lot) - or both!


Regulated Markets and Price-Competitive Companies

I avoid companies that operate in regulated markets where possible, as they are always at the whim of the regulating authority.

They are in a no-win situation because if they are successful in making a decent profit, the regulator usually doesn't like the idea - and you guessed it, moves to tighten the regulations!.

Price-competitive companies have a different problem. They have to be the cheapest business in their industry and usually don't have an economic moat to protect them.

They always have the opposition chasing their tail.


In Summary

The benefit to me in excluding the above six categories of companies from consideration of good stocks to buy is that the overall risk in choosing to invest in some of the remaining companies will be significantly reduced, without compromising return.

Risk reduction, while maintaining a high return, is the name of the game! The risk of loss is real – it can be minimized but not eliminated.

Check out the green links above if you wish to learn more about high-risk companies to avoid.


Characteristics of Top Companies

Being able to avoid the risky companies is one thing. But how do you go about choosing the hottest investment stock? One way is to think of the opposite of each of those categories in the above list.

Here goes ...

• Companies with a significant financial history
• Multiple-resource companies e.g., BHP Billiton, Rio Tinto etc.
• Companies with minimal capital requirements
• Medium to large companies
• Unregulated companies
• Companies with a strong competitive advantage

This still leaves plenty of companies to choose from so that you can easily find good stocks to buy.


Further Considerations for Top Companies

But there are further important criteria that I look for, some of which I find using a stock market screener to filter the best screener stock.

This criteria includes a return on equity of 15 per cent or more, zero to low debt and at least five years of financial information.

After all that, consideration is given to qualitative aspects of the remaining survivors.

Then I can be reasonably assured that I will end up with good stocks to buy!

The above considerations have been incorporated into an investment template that provides a checklist of those aspects of a company that need to be taken into account when considering a stock purchase.


To Conclude

A value investing approach is all about minimizing risk. By eliminating a range of companies from consideration whose risk characteristics can't be controlled by me, I have made a substantial move in the direction of lower risk.

By then concentrating on high profitability, low debt companies by considering those with high return on equity, I reduce risk further.

And risk is further minimized by only selecting from the remaining good stocks when their stock price is below their (calculated) intrinsic worth.

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