Friday, June 15, 2007

my stock selection process

The process used when selecting a stock to consider buying is probably different for everyone. As I've mentioned before, I maintain a watchlist that I have compiled over some time. Every stock must qualify for the list. In order to qualify for the watchlist every stock had to go through my process, which I consider to be fairly stringent. I try to look at most angles, analyzing the stock both quantitatively and qualitatively. Any single factor that fails to meet my criteria will disqualify a stock. I'd like to run through a simplified example of the system that I use to select a stock that might someday be worthy of my investment dollars. My example company here is Walgreen (WAG), which is probably one of most fundamentally sound companies I've ever analyzed, a bit of a no brainer...

Steps

1. The Idea
There needs to be an initial idea to spark my interest. Due to the demographic environment in North America, if I could buy any type of retail or staple stock, I want it to cater toward the baby boomer section of the population. Reason being, that the groundwork for growth should already be laid by increasing demand over time. Shoppers Drug Mart is the premier drug store chain in Canada and was added to my watchlist long ago. I needed another choice in the sector as SC seemed to never trade near my 'buy' price, and might not for years to come. I looked south of the border where I discovered Walgreen Company (WAG) and CVS which are by far the two dominant chains. For several of the reasons below, WAG won out.

2. Earnings Growth
The first thing I always do is look at earnings growth. This can be a dis qualifier right away. Two examples of companies which I have disqualified due to their sporadic earnings growth patterns are Disney (DIS) and Caterpillar (CAT). Earnings growth does not necessarily need to be high, it just needs to be steady, smooth, and consistent, this keeps things simple, conservative, and reliable. In the case of WAG, my eyes almost popped out of my head when I looked at their 10 year EPS history, absolutely phenomenal! For the last 10 years they've grown EPS every year by roughly 15 - 20%, without exception.

3. Debt
The lower the debt/equity ratio the better, some exceptions, but low makes me feel good.
In WAG's case it is 0.00 (makes me feel warm and fuzzy :)).

4. Return on Equity
The higher the better, is the long term trend up or down? This is a good factor when comparing companies across an industry. In WAG's case the current ROE is 18.4%, and has generally been on the rise since 2002. When compared to SC (16.5%) and CVS (15.2%), it stands up well.

5. Industry Specific Factors
In retail, net margins and same store sales growth are very important. I liked what I saw here.

6. Dividends
Do they pay a healthy one? Are they growing them regularly? What's the payout ratio, is it healthy, is it increasing? Any major blips in the pattern, why?
In the case of WAG, it's certainly not my usual dividend stock, but it is important to know that they've raised their small dividend every year since 1987. The raise has averaged about about 20% in recent years. This is more of a growth stock for my portfolio. They build stores with their free cash flow, instead of paying dividends.

7. Other miscellaneous factors
Including P/B, P/S, ROA, sales growth, read company website, read annual report, others opinions of management, past Market Call guest opinions, Jim Cramer's opinion (in this case best of breed), retail investor's opinions, my interaction with company, future of industry, risks to industry, risks to company, etc. Not limited to these, and these are all taken as less important than the 6 above.

DECISION = YES - (ADDED TO WATCHLIST)

8. Valuation
I'll explain how I determine my 'buy' price in a later post, as some readers have asked this question.

4 comments:

FourPillars said...

It's interesting to see exactly what other investors do when looking at stocks.

Mike

Anonymous said...

How long will WAG last as a public company, though, with their current metrics?

And why isn't management taking on debt? Seems to me that they would have an excellent credit rating, good internal cashflow, and thus, management is actually forgoing opportunities to grow earnings and putting the company in jeopardy (from LBO) by being so conservative.

Just my 2 cents....I am a buyer of WAG to supplement long-term holdings of SC.TO, but the lack of debt really suggests that eventually the barbarians will gobble this one up.

telly said...

What site / program do you generally use to screen?

moneygardener (AKA investor99) said...

anon,

Who knows. It certainly does seem like the type of company that would be attractive to P.E. I won't be complaining if that occurs.

telly,

I use several sites. I especially like msn's money site for U.S. stocks.