As an investor with a long term perspective it is important that I investigate the fundamentals of the business before buying its shares.
The goal is of course to mitigate risk and generate wealth in the long term.
When I first started out in my investing journey I would use a value investing approach and would look into the financial statements of the company to determine how well the business was actually performing.
Before investing into any company, these following three statements are critically important to analyse.
1. The Income Statement
2. The Balance Sheet
3. The Cash Flow Statement
By digging deeper and analysing these statements you get a more holistic view of the company’s financial position because essentially at the end of the day you want to minimise your downside risk while maximising upside potential in your investment.
Ideally when I identify a potential company I am interested in, I look at these financial statements and analyse some preferred key metrics before buying the share.
Preferably for starters I want a good quality company with low or manageable debt levels, growing margins and above average profitability.
By looking at some key metrics I am able to determine an intrinsic value of the company to determine whether the stock is cheap or not. Essentially as investors we want to buy shares at bargain prices but also ideally we want to identify quality companies. The following financial ratios are ones I use to forecast future growth and performance of a company. I think they offer terrific insights into the financial health of a company & the prospects for a rise in its share price.
- Dividends and Retained profits
- Book Value per share
- Price Earnings
- Dividend Yield
- Return on Capital Employed (ROCE)
- Free Cash Flow
- Free Cash Flow Yield
- Free Cash Flow Dividend Pay-out ratio
- Free Cash Flow/Total Assets
- Net Working Capital
- Accrual Ratio
- Return on Invested Capital (ROIC)
- Return on Equity
- Enterprise Value
- EV / EBIDTA
The standout and personal favorite key metric for me is the ROE (Return on Equity). It’s a wonderful profitability metric that indicates every Rand of profit generated by each Rand of shareholder’s equity. ROE offers insights into a company’s management utilising profitability, efficiency & leverage.
When searching for a company to invest in you want to ensure the company is generating sufficient cash for its operations and able to utilize its capital expenditure and working capital properly. Determining the company’s Free cash flow is an important way to value an entire company.
Beside Fundamental analysis I also incorporate a technical analysis style approach that aids me in predicting possible trends with buy and sell targets.
This approach has worked well for me over the years and has given me some sort of an edge. This combination of investing styles has helped me buy growth stocks when they seemed undervalued thus reducing the risk by only investing at a time when the current price is much lower than their true value.
This difference in true value and its current purchase price is called the margin of safety. In a nutshell, I find companies that are undervalued and under-priced.
When the Covid pandemic hit in March 2020 global markets were very volatile and we witnessed a huge sell off.
During that time, I was able to find many opportunities in almost every sector in the market.
There were companies that were undervalued and profitable and yet produced good earning results despite the pandemic. By utilising some of the key metrics mentioned above I was able to buy some wonderful companies that are generating substantial returns.
To view my current portfolio, click the link below
Happy investing