• Is ABC Bhd a good stock to invest in?
• Which sectors or industries should I invest in for future growth?
These are two commonly asked questions.
Firstly, newcomers to the investing world are encouraged to make decisions independently, as decision-making is vital to becoming a savvier investor.
Secondly, don’t choose stocks based on their industry or sector. Rather, be company-focused – study a stock in detail and place less emphasis on macroeconomics.
Most importantly, these questions reflect an absence of a proper investment framework by aspiring investors. Such a framework is crucial as it provides structure to your stock portfolio.
To answer the first question, it is best to put ABC Bhd to the test under an investment framework that should consist of the following elements:
1. Business model
The objective of investing should be to earn recurring and growing dividends from stocks that, in turn, earn consistent income from a large pool of customers.
To reduce working capital and for greater flexibility, opt for stocks that derive cash sales over credit for their goods and services.
2. Finance
If a stock’s business model is solid, it should deliver consistent growth in sales and profits. The company should bring in a positive cash flow from operations in the long run.
Analysing a company’s performance over 10 years is a good test of its consistency. Look out for key indicators such as financial results, strong balance sheets, and ample cash at its disposal.
3. Growth
Find out whether a company is geared for growth in the future. This can be done by looking at official sources such as annual and quarterly reports, investors’ presentations, and announcements via a company’s website.
4. Valuation
Remember: good investments = good stocks + good valuation.
Once you have a pool of good stocks to choose from using the first three points above, use valuation ratios – P/E ratio, P/B ratio and dividend yield – to ensure you do not overpay for them.
Not infallible
“What if I still incur losses despite having a framework?”
Remember, an investment framework is about efficient capital allocation to meet your investment objectives by building a portfolio according to your criteria. It is meant to reduce investment mistakes while boosting returns, but it is not infallible.
Always reassess your framework to see which of the elements you should work on to strengthen your portfolio. Learn from your shortcomings and make adjustments so that over time, you reduce risk and enhance returns as you gain more experience.
This article first appeared in KCLau.com.
Ian Tai is a financial content writer, dividend investor, and author of over 450 articles on finance featured in KCLau.com in Malaysia, and ‘Fifth Person’, ‘Value Invest Asia’ and ‘Small Cap Asia’ in Singapore. He is a regular host and presenter of a weekly financial webinar in KCLau.com.