My share buying criteria are slowly taking shape, based on extensive back testing as reported in “What has worked in investing” by Tweedy, Browne Company LLC, plus some testing of my own using DigitalLook’s Market Stars system and my reading of Ben Graham.
I’m a simple chap so I like simple rules. I start by sorting the FTSE all share plus the FTSE Fledgling indices by price/book. I select those in the bottom 10%. Then I sort those by market cap and select the smallest 10%. Then I exclude those with a dividend yield less than 1%. Finally I sort by price/book again. Basically this gives me small cheap shares that are still paying a dividend. Generally I don’t like to buy shares with price/book over 0.5.
That’s the quantitative part, then I have a qualitative part.
I look at the historic share price. Is it reasonable to expect the price to double at least, in order to get back to a price/book of 1 (fair value) with the current book value? If the stock is at p/b of 0.5 at a share price of £1 but has only traded around £1.50 for the last 10 years then it’s less likely to get up to the £2 required to reach fair value. Compare that to an equivalent share that was at £2.50 until some recent quarterly losses and it seems more reasonable that the share will return to those levels if the management can fix whatever the problem is.
Then I look at the recent news for the company. If the news is all about how the company is about to go bust or is issuing rights or is looking for a buyer, then I’m not interested. I want companies that are trading reasonably well. Perhaps the share price is low due to the general negative economic environment (which will become more positive in time). Or perhaps the company has made some losses or weak profits for the last year or so which can also be turned around in time.
I also like the company to have enough current assets to pay of their current liabilities and preferably enough to pay off all their liabilities, although this is more rare. I don’t want a company that is too loaded with debt when losses are being made otherwise the lenders may have more influence than shareholders.
Once a company has jumped those fences then I’ll pick it if I don’t already own too many similar companies in similar industries.
That’s it, and good luck to all who sail in her.