How do you narrow down from a list of 5-6 stocks to 1-2 that you want to invest in?
So I'm currently looking at 4-5 companies (equities) right now, and I'm having trouble narrowing them down to 1-2 that I would invest in. I understand there are a great many factors that go into security analysis (including qualitative elements), and there are many things to look for. However, I am not quite asking this.
Like all investors, we are trying to find which stocks might be undervalued for whatever reason. However, how can I narrow down this list relatively quickly without building DCFs for every single one to see which might be undervalued? Is there a faster way to narrow down the list? Just looking at their operating histories, any one of these companies could be undervalued for different reasons, so it's extremely challenging to eyeball which to research further.
Asking because it is impractical to do a deep dive into each company AND afterwards building out operating models/DCFs to figure this out. How do you guys do it when given several companies in an industry you are interested in, and figure out how to narrow it down to 1-2 potential companies to invest in? (From which now you can dive into and spend days/weeks researching)
Any thoughts?
Catalysts. Strongest or quickest.
Any advice on how to search for these catalysts quickly?
What’s the macro environment, good or bad, why? When will it change, why will it change? This is the easiest type of catalyst because it’s hard for management to fuck it up and flows directly into earnings, with limited canabilization. What’s the micro? Does this company have excess cash reserves, what did management say they’re going to do with it. Are they FCF negative? Why? What’s their credit rating, is there chance of default? What’s their liquidity profile vs commitments look like? How are the debt markets? Buying everything up? If refinancing is a concern, how do you price that in? If it’s not, list a comparable transaction where they got refinancing and why that company is similar to this company. Basically, stock prices are generally based on 2 components. Earnings and P/E. Earnings increases or decreases are the easiest ones to pitch. P/E will depend on a host of other factors that are hard to observe and even harder to predict. Economics, investor sentiment, attractiveness vs other sectors or regions.
Just look for stocks with the general characteristics you look for when doing deeper dives. Maybe you’re a fundamental value investor who could use software to quickly sort companies in an industry by P/E ratios, EV/EBITDA that could quickly give you an idea of what companies you may want to more closely inspect
May I suggest the MSCI style characteristics - value methodology.
They use the simple average of: Book/Price ratio Earnings/Price ratio (forwards looking if you can source it) Dividend ratio
These ratios would need to be normalised relative to an appropriate benchmark before averaging:
(Pf ratio - Benchmark ratio mean)/(Benchmark ratio sd)
Guess this depends on whether it’s for a PA or not.
For my PA it depends on my time horizon. If I have 4-5 names and want to concentrate my positions - perhaps I plan to buy 2 - with a short holding period (say six months) and tolerance for risk I would go with the two that I believe have the best near term catalyst to close the valuation gap. Maybe it’s beta to crude or a commodity or earnings event. Of course making such a call implies that I believe that I have an information advantage that will disappear in the near term. If it’s a longer holding period then I focus less on the near term and more on expected total return and quality of the assets. Also, I don’t invest in areas i don’t have a good understanding of, so as to avoid unnecessary risk.
For a managed portfolio it’s a little different and relies largely on the investment process which ought to have some quantitative metrics. If it’s already narrowed down to a handful of stocks that clear the process (and thus valuation hurdle) then it falls back on relative value, expected catalysts and possibly some technical analysis to avoid a potential blunder on timing. Not exactly something you can shortcut but you don’t necessarily need a DCF for this part. If something screams as expensive vs peers and its own historic metrics then it might need less time to check out and easier to put aside.
Industry knowledge should help narrow it down as well and then you pick up the phone and talk to management and even analysts if needed (and why build a model when you can get a few analyst models that can quickly be audited and enhanced for your sensitivity analysis).
If they are all potentially interesting companies, why wouldn't you just keep it simple and compare the multiples?
Comparing multiples might be a last step. If you are comparing two equities, similar market cap, similar or the same business lines and you are confident in your assumptions and catalysts then the multiples might be that final decision that brings you to buying the cheaper stock (presumably with a better total return).
For some investment processes that might be the first step but for me it’s somewhere in between and closer to the final piece of analysis.
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