My Research Process When Buying A Stock

One thing I find is that most novice investors spend not nearly enough time researching a company before buying it, often acting on a gut feeling or because of some article they read in a magazine or website. I cannot understand why people will put thousands of dollars at risk without knowing exactly what they’re getting into. To me, that’s just silly.

Take a look at this post at 20smoney, entitled “Why I’m a Nerd.” Kevin talks about his experience reading the 2009 annual report from Walmart- after he had bought the stock and about 6 months after the report was issued. I applaud anyone who does actually take the time to read through the annual report of a company they own, (or are thinking of owning) however that is only the beginning of the research process.

Let me take you through my stock research process, starting at the beginning.

Screeners

I get my ideas primarily from 3 sources:

1. Other investing blogs

2. Business news

3. Online stock screeners

There are all sorts of value investing blogs out there that are chock full of great ideas. They go to all the work of analyzing the stock for you, meaning research time can be cut somewhat. You still want to verify all the information though.

Just a couple of hours a week of watching the business channels can give me a solid idea or two. Usually, it’s the stocks the guests avoid are the ones I’m interested in. Unless the guest is Benj Gallander from Contra The Heard that is.

And finally, spending some time with a stock screener can yield dozens of decent opportunities in a short time. Usually I set the screener to give me companies that are profitable, have a price/book ratio of under 1, have a market cap of more than 25m and have a share price of under $25. From there, I do a quick analysis on each stock. I take a glance at the income statement and balance sheet, as well as the chart to gauge potential upside. If I like what I see, the stock goes onto a watch list and I start the more detailed part of the analysis.

I am unaware of any good stock screeners for Canadian stocks. The online brokerages have passable ones, but I can’t find one that’s any good. If anyone knows of one, please leave a link in the comments.

Getting To Know The Financials

My first step is to spend some intimate time with the balance sheet. I want to have a decent amount of history, so I tend to use Google Finance because they have 4 full years of financials. I’m mostly looking for trends. Alarm bells can ring because of inventory, (too much compared to other years) accounts receivable (a large number may indicate customers who are delinquent), intangible assets and goodwill. I look at the amount of cash on hand.

Debt is very important to look at as well. How much does the company have? What direction is debt going? At the end of the day, debt is the primary cause of bankruptcy. If a company has lots of it, the investment instantly gets riskier. I tread very lightly around companies with a high debt load and so should you.

Next I move onto the income statement. I’m looking for consistency in earnings and just how often the company writes off bad assets. Seeing a company with lots of recent write offs can be either good or bad, depending on how much more crap they have on their balance sheet.

Annual Reports

I make it a habit of reading the last 3 annual reports. I like to send away for them, then I have hard copies on hand I can take with me wherever I go. I also like hard copies so I can make notes in the margins and so I can draw devil horns and a voice bubble saying “I’m a wiener” on the CEO.

I read the annual reports to verify the financials from earlier research, to get a feel on how good the CEO is at fulfilling promises, as well as a dozen other reasons. There are all sorts of interesting tidbits in a company’s annual report if you just know what to look for.

Seeking Other Investor’s Opinions

About half the time I read through the annual reports and decide against investing, for whatever reason. That happened with Menu Foods earlier this year. Usually I’ll keep the company on the watch list and revisit it every few months or so.

If I choose to move on, the next step is spending some time on Google getting other investor’s opinions. I try to seek both negative opinions and positive ones. I also spend time on Yahoo’s investor message boards, reading what other investors have said about the company. There’s usually a good mix of believers and skeptics there.

Conclusion

I spend approximately 10-15 hours researching each potential position, pulling the trigger usually around half the time. If an investor isn’t spending that much time themselves, I sure wouldn’t be taking their advice.

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