How do Whale pick great stocks?
Picking stocks to invest in long-term is different from picking for trading. The difference is similar to getting married to someone vs. going on a Tinder date.
With long-term investing, you’re essentially committing to hold the shares anywhere from 1 to 5 years. Whereas for trading, you hold the stock anywhere from a few seconds to a few weeks and hope to sell at a higher price for quick profits. Traders don’t care whether the company is financially in dipshit or not; for them, it’s just a fling. It’s worth noting that most traders lose money on the market, while all long-term investors profit.
Here is a checklist by Whale when evaluating a business for long-term investment.
Whale likes to see all three of these indicators consistently growing. For example, when a company has an increasing net income but sales are stagnant, that's a red flag. Because in such cases, the company is either not growing, inefficient, or not generating enough cash flow to support its growth.
A company's projected future growth rate indicates how much it will grow over the next few years. This is determined by many analysts who study its financial performance, and you can find this information on many websites. We want a positive growth rate, possibly double digits, and we also want to see earnings per share increase over the next five years.
Competition ultimately means a constant race to increase quality and reduce the price. Suppose a company has a sustainable competitive advantage against others. In that case, it will likely continue to generate substantial earnings because the company will have the luxury of fully controlling its pricing and profit margins.
Here are some clear signs of a company having a sustainable competitive advantage;
- Having a brand monopoly
When you mention a product, if ninety percent of people think of that brand as the first thing that comes to mind, that's called having a brand monopoly! For example: If you think of coffee chain restaurants, what's the first brand that comes to mind? Most people will say Starbucks. If you think of an online shopping site, most will immediately think of Amazon. Brand monopoly brings these businesses immunity against their competitors.
- Having higher profit margins than the industry average
As mentioned above, competition can significantly impact a company's profit margins. If the company can maintain higher profit margins than the industry average, this is a clear sign of a strong competitive advantage
- Having high barriers to entry
How hard is it for a competitor to do what this company does better and cheaper? The answer will determine the company's level of protection from a competitor.
- Having vast economies of scale
The company can produce goods or services at a lower cost per unit than anyone else because it has a large customer base. The company can also use its size to negotiate better deals with suppliers, reducing costs.
- Having a network effect
A network effect is when a business's products or services become more valuable when more people use them. For example, the value of Facebook increases as more people join it because it becomes a more useful platform for connecting with others.
- Having high switching costs
It means it would be expensive or inconvenient for a customer to switch from one company to another. For example, switching from an Apple to Microsoft or vice versa would be pretty inconvenient for their customers. The higher the switching cost of a product/service, the lower the risks of losing customers to competitors.
ROE (Return on Equity) is how much the company returns per every $1 of your investment. To calculate ROE, you divide a company's net income by its shareholder equity. Whale prefers companies with consistently high ROE, around %11 - %15
An outlier business usually has conservative debt levels. It's essential to ensure the company isn't too much in debt based on its cash and equity position. Here is some more mumbo jumbo that you don't need to memorize;
- Debt to Equity Ratio
(The debt to equity ratio is calculated by dividing a company's total liabilities by its shareholders' equity.) Ideally, this ratio should be less than 1, indicating that the company owes less money than it has.
- Current ratio
(The current ratio is calculated by dividing a company's current assets by its current liabilities.) The ideal current ratio should be more than 1, where the company's assets are more than its liabilities.
- Debt servicing ratio
The debt servicing ratio is the percentage of the income spent on repaying debts. For example, if the debt servicing ratio is 30%, the company has to spend 30% of its income on repaying debts. Whale prefers companies with a debt servicing ratio of less than 30%.
