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How to choose stocks?

Sunday, October 17, 2010

I received this email from a reader recently:

Hi AK,

just want to understand better with respect to the various stocks. I  understand how say a TRUST / REITS works..and noticed that the price does not fluctuate much- but in return there is steady dividends that is tied to the NAV.

How then does one determine the NAV of say a stock that is tied to a business like manufacturing, services etc etc? and also the PE ratio?

Say for e.g memstart which focuses on membranes for water treatment.  I do think that this is one sector  besides solar/ green energy that would have a strong demand in the future given the scarcity of natural resources in the  future. How does one decide whether this is a good stock to invest in. Are there  questions that one should ask if we're investing for long term vs short term?

It's good to get a FAQ on how to choose stocks for long term and  short term, and not just purely on TA or FA.

Cheers
D

My reply:

Hi D,

A FAQ on how could we value different companies in different sectors would be a gold mine.  Unfortunately, I do not have the expertise to do this.  I think we would probably have to assemble 10 to 20 different bloggers who are experts in their own stocks of interest. ;-)

Different sectors are valued differently. So, some companies could have PEs of 30 and is considered cheap compared to other companies in a different sector with PEs of less than 10.  So, comparing against peers in the same sector is something I do often.

If you are asking questions about NAV and PE, you are doing fundamental analysis (FA) and likely to care more about values (i.e. you are a value investor). These numbers are easily obtained in a company's financial report (quarterly) or annual report. NAV is usually found towards the end of the reports.

I believe that the idea of long term investment is actually flawed and made into a legend by stories of how Warren Buffet kept adding to his investment in Coca Cola, for example.  If Coca Cola's fundamentals should take a turn for the worse one day, I am sure Warren Buffet might sell out. Stay nimble because circumstances are very fluid.  They could and often change from time to time.

If you really like the idea of long term investment, you would need the kind of foresight that Warren Buffet has.  Take note that even he makes mistakes. You want to look for companies with big "moats" (strong competitive advantages which are hard to replicate). To this end, there are many books available about how Warren Buffet picks winning stocks for the long term. :)

Best wishes,
AK

Related post:
Looking for value.

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