The art of stock picking


“The common measuring standard for differentiating the valuations would be to look at their price to earnings multiple.”

Art is defined by Webster’s Dictionary as a “skill acquired by experience, study or observation.”

This definition to my mind aptly describes what it takes to be a smart investor in the stock market contrary to how the uninformed would typically liken the market to as nothing more than a casino. Like an artwork, the appreciation of its beauty would vary from individual to individual. So, as a caveat to my readers: the following commentary is strictly my own approach based on my experiences and biases and is far from an investment advisory on what stocks to pick. And surely, like all investors, I have had my own share of hits and misses.

We need to study the companies listed in the PSE which number almost 300. These companies are categorized into seven sectors: Financials; Industrial; Holding Firms; Property; Services; Mining and Oil; Small, Medium and Emerging. To simplify life however, I tend to just focus on the PSEi which is a stock market index comprised of about 30 companies. These companies in the PSEi consist of the largest in market capitalization or value and most actively traded names in our country. I find comfort in investing in shares with high liquidity because it assures me that when I need to buy or unload shares, there would be ready sellers and buyers so prices will not gyrate that wildly. We need to realize that what may seem to be a great posted market price could simply be due to the limited availability of the shares thus bumping up unrealistically the market price. Conversely, it could also suggest that when you need to unload, demand could also be limited, putting downward pressure on the price. The level of the public float or the shares held by the non-strategic investors such as the controlling shareholders would be a good indicator of the liquidity of a stock. In fact, the PSE currently requires a minimum of 15 percent free float for a company to be eligible to be included in the PSEi. Furthermore, to be eligible for inclusion in the PSEi, the shares of the company must be among the top 25 percent in trading volume in nine out of 12 months of the year and are in the top 30 percent bracket in market capitalization. Simply put, a key consideration in stock picking is to select shares that have the highest market values, are widely held by the public and are actively and regularly traded in the market.

How do you choose which shares to buy?
I look primarily at the fundamentals of the company which are essentially the history and prospects of the company’s profitability guided by reputable majority shareholders and proven professional management. My bias is for companies operating in an industry that is stable and whose growth prospects are sound. Personally, I tend to favor banks particularly the top tiered banks that regularly declare cash and/or stock dividends. The simple argument I would put forward especially for those ultra conservative investors is that if you can trust a bank with your deposits and only earn low interest rates, why not be a part owner instead of the bank that makes money on your deposits and hopefully share in the fruits as a shareholder, i.e. regular cash dividends and capital appreciation?
With our burgeoning population, companies that are in the consumer and retail business would also be in my list of preferred companies. As the economy expands, so will the buying power of consumers grow, auguring well for these companies catering to the consumption needs of our population. And then there are the housing needs of the people particularly those who are in the low to mid-income levels that grow in proportion to the population growth. The real estate companies catering to this segment that have a solid track record in making good on its promise to complete its real estate development projects on time would take my vote. An added bonus in my checklist would be diversified real estate firms that also have regular rental income from commercial developments. I would also include in my portfolio a small position in utility companies with steady cash dividends such as those in telecommunication and power which are good long term hedge bets that would be assured of survival in good times and in bad. Finally, I would have at least one diversified conglomerate holding company in my list that would provide a broad coverage of the economy.

Price earnings multiples (PE Ratio)
Listed companies in the different industries would have varying market valuations. The common measuring standard for differentiating the valuations would be to look at their price to earnings multiple or PE ratio which in simple terms is the market valuation of the company’s earnings. Currently the whole stock market is trading approximately at a PE ratio of 18x. That means investors on the average are prepared to pay P18 for every peso earned by the listed companies on the average. This is a convenient and simplistic way to compare one company to another or to the market in general. Investing in a company that has a lower PE ratio could suggest that it is cheaper relative to another company with a higher PE ratio. Note however that we also need to factor in the growth prospects of each company that could account for a higher PE ratio. Unfortunately, projected earnings are usually not readily available since the PSE is fairly strict about disclosing information to the public that can be deemed to be speculative in nature and an earnings forecast would be in that category.

The occasional exceptions
As an exception to my fundamentalist approach, on a few occasions, and only for a very modest portion of my equity portfolio, I also keep an eye on companies that may have potentially a surge in market valuations in the near term because of different reasons such as being a rumored takeover target or a planned stock rights offering or an IPO in the works. In such scenarios, one would have to be as nimble as Jayson Castro streaming down the court for a fastbreak after a steal! Timing would be essential however. Go in, set your target price levels and get out as soon as you reach it. Don’t be greedy. And if your read was wrong, cut your losses. Until next week folks. One big fight!
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