Stock Analysis as a retail investor

Evaluate how the business behind a stock is doing using yfinance library https://github.com/ranaroussi/yfinance

To make a conclusion on whether you should buy a stock, the following 8 questions need to be answered.

As Warren Buffet used to say, it's okay to miss out on great companies with great growth, but it's not okay if you buy a stock without understanding the business behind it. If you don't do the research and don't understand the business, you are just gambling. Great investors like Warren Buffet, Charlie Munger, Peter Lynch, Bill Ackman, and Michael Burry keep emphasizing that you should do your own research on the business behind a stock, listen to opinions that are different from theirs, and form your own opinion. Even the greatest investors like Buffet and Peter Lynch have wrong judgment about their investment, no one can avoid it, but that doesn't mean there is no way we can maximize the chances of picking a stock with great growth. All you need to do is to minimize the risks by doing research and having a diversified investment portfolio. The father of value investing, the author of the Bible in stock market investment, the man who mentored Warren Buffet, Benjamin Graham, explained this concept by saying that in the short-run, the market is a voting machine. In the long-run, the market is a weighing machine.

Over the past 18 years, Bill Ackman has generated a 17.1% annualized return against 10.7% for the S&P 500. Peter Lynch earned 29% a year for 13 Years. How do they achieve this? They both have developed their own framework for stock investing and done their due diligence on the business behind the stocks they are buying. That's also why I'm building this checklist for both you and me to have a better judgment, and make an informed decision. You can check this video Brian Feroldi's Stock Investing Checklist: A Step By Step Guide for a different investment framework, also the playlist Investing Lessons on the same YouTube channel. My favorite YouTube channel on stock investment.

Again, this framework is just my thought process, you should take it with a grain of salt, go read great books on investment, and develop your own. If you don't have time to develop a checklist for yourself, borrow mine or Brian Feroldi's for now. The following books are recommended:

1. The intelligent investor by Ben Graham
2. Warren Buffett and the Interpretation of Financial Statements by Mary Buffet
3. The Little Book That Builds Wealth: The Knockout Formula for Finding Great Investments by Pat Dorsey
4. What is Strategy?: An Illustrated Guide to Michael Porter(Porter's Five Forces) by Joan Magretta
5. 7 Powers: The Foundations of Business Strategy by Hamilton Helmer

Getting your first 100,000 dolloars saved and invested will change your life. The quicker you can hit that milestone, the better. This is the advice coming from the legendary investor and billionaire, Charlie Munger. The reason why Munger is advocating hitting the $100,000 dollars mark as quickly as possible has to do with two very simple and powerful words: compound interest. The words compound interest are two of the most magical words for your wealth-building journey once you truly understand the concept of compound interest, it changes the way you view money. Compound interest is the interest on a deposit or loan calculated based on both the initial principal and the accumulated interest from previous periods. The definition is far from inspiring and doesn't truly do compound interest justice. You can think of compound interest as a snowball rolling down a long hill you do the work of making the first little snowball while you are starting on the top of the hill. You then roll the snowball down the fill with each roll, the snowball is picking up more and more snow, and is getting larger and larger. And at the bottom of the long hill, the snowball is massive compared to the tiny snowball you started out with you did no extra work in making the snowball. You just rolled it down and let time and gravity do the work.

The same concept applies to compound interest and wealth building. Let's say John saved $100,000 at the age of 30, and Mary saved 100,000 at the age of 40, both invested the money in the stock market with an annual gain/interest of 10.72% (the S&P 500 for the years 1991 to 2020, the average stock market return for the last 30 years is 10.72%), and no extra yearly contribution/investment thereafter, how much difference in term of the total value of money do you think John and Mary will have when they both retire at the age of 65? It's not 100,000, not 500,000, it's a whopping $2,255,705.61. That is almost a 2.3 million difference, just because John invested the money 10 years earlier than Mary. Go check this YouTube video Charlie Munger: Why your first $100,000 will CHANGE YOUR LIFE for more information.

John's initial investment of 100,000 after 65-30=35 years of compounding becomes 3.53 million, time is your best friend to build wealth!

Mary's initial investment of 100,000 after 65-40=25 years of compounding becomes 1.28 million.

You can check this yourself on this website https://www.getsmarteraboutmoney.ca/calculators/compound-interest-calculator/

So do your research and start rolling your snowball, and let time do the wealth-building work.

Question 1: How is the growth in the past

Good growth in the past shows the business is doing something right in the market. But if its growth is no better than Exchange-Traded Fund, why would I bother buying the stock?

The stock price in the past is compared to

1. QQQ (the best growth ETF in my opinion) and
2. SCHD (the best dividend ETF in my opinion)

Question 2: Financial health examination.

Below is my checklist for a financial health examination.

1. Growing revenue (preferablly > 10%)
2. Quick ratio (preferablely > 1) and FCF/long-term Debt ratio > 0.25
3. Growing OCF/S ratio, operating margin: OCF stands for cash flow from operating, S is sales, i.e. revenue
4. Positive FCF, or net income: FCF stands for free cash flow
5. Share dilution < 5%

If a company can meet 6 of the above 9 requirements, I think it's financially healthy.

Question 3: Is there a wide moat around the business?

This is the most important step, and unfortunately, it can't be evaluated quantitatively by using numbers in the income statement, balance sheets, and cash flow statement.

7 Powers: The Foundations of Business Strategy by Hamilton Helmer are used to determine how wide the moat is.

Question 4: What are the risks?

This is the second most important step, and unfortunately, it can't be evaluated quantitatively either. Porter's Five Forces What is Strategy?: An Illustrated Guide to Michael Porter is used to evaluate the risks. Porter's Five Forces is a framework for analyzing a company's competitive environment. The Five Forces model is named after Harvard Business School professor, Michael E. Porter.

Question 5: How is the management team?

1. Is the CEO honest, trustworthy, transparent, and open to discussions on issues and risks the company is facing?
2. Skin in the game
3. How do the employees rate the company? (Glassdoor review)
4. A reasonable strategy to widen its moat, increase revenue, explore revenue optionality and improve operating efficiency inside the company

Question 6: Are customers happy about the products/services?

Dollar-based retention rate, customer review websites.

Question 7: How is growth potential in the future?

After you evaluate the strength (financial health and moat) and risks of this business, you can come up with a growth rate for the company in the next 3 years. I'm not comfortable predicting more than revenue growth for more than 3 years, because there is too much uncertainty in 3 years.

1. Revenue growth from the current revenue sources
2. Revenue growth from other optionality

Question 8: Is it undervalued?

Valuation methods typically fall into two main categories:

1. absolute valuation, and
2. relative valuation.

I don't like using absolute valuation because it requires a lot of assumptions, which means you are inviting too much uncertainty in the valuation. Therefore here I'm only using the relative valuation method.

Conclusion: Buy