Know your circle of competence. Look for public companies that are in your area of expertise. More importantly, you should know what you do not know.
Build some search screens and save them. A separate post will describe the screens that can be built.
Select a few companies and add alerts to them if the price falls by a certain percentage.
Understand the way the market is pricing these companies. Are there any anomalies in the price?
See if you can analyze a stock and come up with a floor for the price. How do we know what the absolute low a stock can go? Some hints are the cash available in the business, a discounted P/E of similar companies, discounted value of the assets (book value per share). This way, you know the risk associated. But be prepared that there will always be surprises regarding the price of a stock. Sometimes, the market may get depressed about the prospects and price a stock illogically (even at bankruptcy levels). This is where you get bottom bargains. But the volatility will be high with these stocks, so if you cannot stomach the ride, stay clear.
Stocks are not ticker symbols that go up and down but are part of whole businesses. This is the most important principle to understand. When you are purchasing a stock, you are actually becoming a part owner of a company.
Learn how to understand financial statements (Income statement, Balance sheet and Cash flow statement).
Look for companies that do not have huge debt (leverage).
The company should have earnings to start with. Weed out all the companies that have not earned anything.
If there is a dividend payout from the company, that is much better. But look for the payout ratio, which is the percentage of earnings that are paid out as dividends. If it’s more than 50%, the dividend may not be sustainable. Stay clear of companies that borrow to pay dividends.
Find out if the prospects of the industry in the long run look brighter or dimmer. Due to disruptive technologies, it is very difficult to analyze how the business will fare in 10 years, but at least, you can evaluate the chances in the next 3 to 5 years.
The cash flow should always be positive. If the company is burning cash, very soon, it will have to borrow to stay afloat or close shop.
The management should be honest and shareholder friendly. Especially look for capital allocation capabilities. How are they handling the retained earnings?
If the company is buying back its shares, then it is an indication that the management thinks its stock is undervalued or another way to look is that they do not have any more ideas to deploy their capital. Personally, I have seen shareholder value destroyed because companies squander capital when the shares are high and not actually buy when the market falls. Be wary of buybacks.
