How to Successfully Approach Long-Term Investing In Individual Stocks By Value Investing

Note: This article has been copied, and amended, from the bottom of the financial section of this website, so that it can be more easily accessible to the general reader. If it seems too lengthy, or complex, there is a valid reason for it, given at the bottom of this article.

For information on how to invest in high-quality stocks for long-term goals, read below.

You can realistically potentially get 10 - 15% returns on average, annually, using this method, over the long run.

A Common Problem

Are you interested in investing in stocks, but don’t know which companies are going to be around in the next ten years?

Do you want to save and grow money for a long-term goal, such as retirement, or your child’s college education?

Have you heard of the different styles of investing, but don’t know which is best for you?

Time and Energy

The truth is, many people don’t have the time, or energy, to research individual company’s stocks or industries, to see which companies might be best to put their money in. So they watch different business and finance shows, where “experts” are touting which stocks to buy or sell now, for various reasons. Or, they listen to stock “tips” from friends, or in social gatherings.

If you don’t feel like you can spend enough time each week to do your own stock research, you may be better off investing in index funds or balanced funds, and that is not an insult. Finding the right stocks at the right price, takes time and mental effort. I list a link below to a video on how investing in an index fund is recommended for most investors who are uncomfortable buying individual stocks.

There are different types of investing out there, such as investing in growth, day trading (with technical analysis), and value investing (with fundamental analysis). Today I am going to teach you about the only kind of stock investing I am well familiar with, and that is value investing. 

Before you read any further, watch this video for an easy to understand and practical explanation of value investing, and why it works best:

THESE STOCKS are performing the BEST in the Long Run

Based on the Fundamentals

The reason I believe in value investing, is that it is based on fundamental analysis, and, of course, this website is based on the fundamentals.

Now, if you’ve heard about value investing, you’ve probably heard of the most famous investor of all-time, and one of the world’s wealthiest people, Warren Buffett. 

He runs the company Berkshire Hathaway, which has averaged annual returns of over 20% since 1965. This is nearly twice as good a return as the general stock market. 

What’s funny is that, even though he talks about his investing strategy publicly, most people tend to follow different ones, or claim that other strategies are doing better at the time. 

The reason the way he invests is so successful, though, is that he invests for the long-term, while the market fluctuates over the short-term, making it look like he may not be doing as well currently.

You Can, Too

I have read and followed value investing and stocks for a couple of decades, and what I have found is that it works, even for a common investor. Today, I am going to tell you how to do it yourself, and get better returns, with less worry.

The whole idea behind value investing, is to value a company based on an estimate of how much money will be returned to the investor, over the life of the company, or over a given set period of time. To do this requires fundamental analysis of the company’s financial statements. 

Now, there are different types of ratios that can help determine the right price for a company, such as P/E ratios, Price/Book ratios, and Price/Sales ratios, among others. While these can be useful, the main number that Buffett claims to use to determine the “intrinsic value” of a business comes from the Discounted Cash Flow method.  

The Ultimate Method

In this method, the company’s future cash flows are discounted back to the present using a “risk-free” interest–rate. This is to compare it a similar investment such as the treasury bond, which is considered “risk-free” because the government has a very low chance of going out of business. In this way, the company’s annual cash flows can be considered similar to a bond, and the coupons it pays.

So, why is this important? This valuation method takes actual dollar figures into account, as opposed to speculating whether a firm will grow quickly, or make some discovery to prop up the stock price. However, it often takes patience to make a return on your money, since it requires the value of the company to go up over the long-term. This is probably the main reason most people invest in other ways.

So, while this is the most essential calculation, we first need to make sure that this company is strong enough financially to be around, and fight off competitors for the next several years or the rest of its lifetime. To do this requires some prep work.

If you know that you do not have the time to spend researching companies, or that you do not have the temperament to handle stock price fluctuations in the market, don’t worry. Buffett has an alternative for you to still come out ahead by investing in stocks. He recommends putting your money in an index fund (such as the S&P 500 stock index) periodically, by “dollar-cost averaging.”To learn more about this method, click on this link:

Warren Buffett: How You Should Invest in 2023

Ok, so if you have time to spend, you’re prepared mentally to do research, and you’re ready to wait for months, maybe years, to get the optimal return on your money. I am going to take you step by step through how to value invest using fundamental analysis.

Use This “Ultimate Stock Screener” to evaluate a Company’s Financial Strength:

First – Macrotrends.net is your friend. On this website, you will find almost every statistic that you need about the company you are looking to invest in. You are going to do a selective screen, to weed out any company that might have trouble financially:

1.    Go to Macrotrends.net

2.    On the main search bar, type in the stock you are ready to research.

3.    Click on the company’s “Earnings Per Share” on the drop-down menu.

4.    Scroll down the given page and look at the column on the left side with the “Annual EPS”, which shows a dollar amount for earnings per share for each year.

5.    Look for a pattern of whether the earnings are going up steadily each year, or at least over several years. If so, that’s a good sign. If the earnings are unpredictable, or cyclical, you may not be able to count on the stock price changes being predictable, either.

Next:

1.    From the page you are on, scroll up to and select, from the top bar, “Other Ratios.”

2.    Now, from the bar below, select “ROE.” This is short for return on equity, which, basically, means the return on your investment. 

3.    Scroll down to the ROE percentages on the right. Look to see if the percentages are at least 15%, which is the common minimum value investors look for.  If they are for some years, and not for others, then it might be cyclical, or not competitive.

Next:

1.    Go back to the menu bar, and select “Financials.” Check the company’s “Revenue” on the top of the Income Statement, and see if it is going up every year. This is a sign the company is growing. If it stays steady, or is going down, then your returns are likely to drop, as well.

2.    See if there are any “Research and Development” expenses. These can be a drain on the company’s income, especially if they are going up. They are standard in some industries, though.

3.    Check to see if the “Net Income,” is going up annually, also.

4.    Examine the “Shares Outstanding,” and see if they are going down each year on average. This means that the company may be buying back shares, which can increase your returns, just like a dividend can.

Next:

1.    Go to the menu bar, and select “Balance Sheet”

2.    On the Balance Sheet, see if the “Cash on Hand” (on the top line) averages at least 1/4 of the amount of the “Long-Term Debt” (near the middle line) over the years. This is important, as a lot of debt can cause problems if the company goes through any adversity. Ideally, you want to see a high amount of cash on hand, and/or very little to no long-term debt.

3. Check to see if the “Retained Earnings” (near the bottom) are increasing, on average, over time. This means that the company is keeping and, hopefully, reinvesting profits each year, to increase earnings.

Next:

1.    Go to the menu bar, and the “Financials” sheet again.

2.    Click on “Cash Flow Statement”

3.    Look at the middle of the page, and see if the “Cash Flow from Operating Activities” is going up consistently every year or, at least every few years, on average, which would be ideal. Also, it should be higher than the “Net Income”, which is listed at the top of the statement.

Finally:

1.    Go to Google (the regular Google search bar), and type in the company’s ticker symbol, and “intrinsic value”. So if you are looking up Widgets, Inc., and the ticker symbol is WGT, type (ex.) “WGT intrinsic value”

2.    On the search results page it pulls up, click on (ex.) “WGT Intrinsic Value: Projected FCF” on the  Guru Focus page. Since calculating the Discounted Cash Flow Method is complicated, you’re going to let Guru Focus do the estimating for you.

3.    Read the paragraph near the top of the Guru Focus page that says, “As of today, (your company’s ticker symbol’s) Intrinsic Value: . . . 

            Continue reading to where it says “Price-to-Intrinsic-Value-Projected-FCF of today is . . . (numeric value)“

4.    You want the number it gives there to be lower than 1.0, which is fair value. Ideally, you want the number to be 0.5 or lower, which means it is being priced at half of its value or less. This is known as a “margin of safety”, meaning that it is unlikely for the company’s stock price to go much lower, based on its solid financial foundation.

5.    Keep in mind this number is based on future cash flow estimates, so it is actually an estimate of a range of projected cash flows, which is not always totally accurate.

Conclusion

If all of these tests pass these screens, then, in my opinion, you may have found a solid value stock at a good price. Just remember that, if you purchase it, you may have to wait awhile (possibly months, or even many years) to see good returns. That is why value investing is known to be long-term investing. Also, and this is an important point, you need to purchase the stock at a good price, otherwise, you may not see good returns, even if the company meets all of the other screening criteria. 

Warren Buffett’s famous quote about value is: “I would rather buy a wonderful company at a fair price, than a fair company at a wonderful price.” So you may be alright purchasing a stock at fair value (example - intrinsic value: 1.0, on the Guru Focus page), if it has really good financial fundamentals.

Also, there are more and other criteria to screen, but the list above is what I generally look for.

Another important point is that if you cannot understand the business the company is in, you should avoid investing in it. Stick to businesses you understand, or you may have a difficult time valuing the stock, or knowing if and when the company is in trouble. 

An important step is to look up the latest annual report of the company, usually found under the “Investor Relations” section of the company’s website. From this report, you can generally tell if you can understand the business, and the direction it’s heading in. 

Buffett, and other value investors, also usually try to determine if the company has a “moat”, or a durable competitive advantage, so that they can hopefully count on the company continuing to grow over the long-term. This can be in the form of an established brand, patent, network, or low-cost of capital, among other factors. If you are not sure if the company has a moat, usually a business that passes the above criteria has one of some sort.

Before buying any stock, it is generally also good to check the news on the company, so you may want to do a Google search on the company’s news. Also, The Motley Fool and Seeking Alpha are a couple of sites that have good articles on companies, based on their fundamentals, so they may be good resources to check on the company (I usually do) before buying a stock. Just go to their websites and enter the company name or ticker in the search bar at the top of their home pages, and scroll down for the list of articles.

If you have a lot of stocks you want to screen, you may also want to check the intrinsic value first, since, the stock may be priced too expensive to buy, anyway. If it’s priced too high, then just move on to the next stock to screen, or put it on your watch list, and wait for the price to go down. You can easily create a watchlist on Yahoo! Finance.

If you would like to perform the discounted cash flow method yourself, I recommend learning from videos such as this one: 

Discounted Cash Flow - How to Value a Stock Using Discounted Cash Flow (DCF) - DCF Calculation

Note: for financial services stocks, such as banks, you will need to use the net income figures (near the bottom of the income statement), instead of free cash flows, since their accounting is different than regular companies.

There are many more videos on YouTube that you can learn from, as well. Just note that for the discount rate in the calculation, Buffett says he uses the average long-term Treasury Bond rate (around 4%) as the “risk-free” rate, instead of the commonly used WACC (Weighted Average Cost of Capital), which usually is 10-12%. 

But, even he admits that, whatever the rates, he generally uses opportunity cost to determine his investments. In other words, he tries to find the safest investment with the best likely return compared to other opportunities. The “risk-free” rate simply represents the highest return he could get without risk, theoretically.

For a simpler calculator, to estimate your optimal rate of return on a stock, I recommend the following link: https://www.hamishhodder.com/spreadsheet

I also highly recommend all of the spreadsheet above creator’s free Youtube videos regarding investing, as he has simplified, made more easily understandable, and been successful with, all of the important steps required to be successful with the methods used by value investors such as Buffett. They are, by far, the best sources of information on the subject that I have found on Youtube, and the internet.

If you’ve made it this far in this section, you may be wondering, is investing really this difficult and time-consuming?

If you think that this section on value investing is too long or complicated, it’s supposed to be. The reason is: you are looking to buy portions of actual businesses, and to be able to estimate what they are really worth, you have to do your research. Otherwise, you are speculating on their values, which is a common, but not usually successful, practice. So you may need to spend an hour or more each week researching companies you may have an interest in. You do not need to find many companies to invest in to be successful, maybe only a few. You just need to read up on them, to be as confident as possible about their long-term success, as well as their current market value. Then just buy them at your estimated right price, and keep up with their business to make sure they maintain good practices, and stay profitable over the long-term. It’s not too difficult, but it definitely requires patience.

Disclaimer: This article is meant for informational and example purposes only. I am not a financial advisor, and am not promoting the purchase or sale of any kind of securities. Also, I recommend that investing in stocks should be done within the framework of a comprehensive financial plan, with risks taken into account. You may also want to consult with a Certified Financial Planner.

Good luck on your stock research, and I wish you good returns.