As I move into a small portfolio of individual stocks, I’ve developed a process for selecting stocks that reflect the values I’m looking for. In short, I’m looking for long-term stock investments in companies that are financially stable and exhibit good customer relations and values. My belief is that any company that has their books in order, a solid business model, and treats their customers well will be in a position to steadily earn money for me over the long haul. Here’s the process I use; I’ll move through the process using my favorite “example,” Whirlpool (WHR).
1. Read a healthy number articles about the company at Google News.
Basically, I’m trying to figure out the company’s story as understood by outsiders. Are the articles generally positive and all on the same wavelength, or are people out there talking about all sorts of different things, good and bad? Generally, if I can’t get an overall sense of what the company’s general business plan is after reading fifteen or twenty articles, I back away from the stock. With Whirlpool, I get the sense after reading several articles that they’re focusing on improving their product quality and it’s beginning to show in the marketplace, as they’ve taken over as top dog in the refrigerator market. They’ve also closed a few plants lately, which I view as relatively neutral news. Overall, no red flags here, so I keep going.
2. Visit the company’s corporate website and read the last few annual reports.
You can find the company’s corporate website via the company report at MSN Money Central. I found the annual reports for the last several years for Whirlpool and they seem to be both positive in direction and realistic when discussing failures. A big way to determine how a company will do over the long run is to see what the management says about inevitable business problems: if they are just tossing out blame, it’s bad; look for clear acceptance of blame and description of better future directions.
3. Test their customer service.
I am a firm believer that companies who have great customer service will benefit over the long run (Land’s End, for example). Thus, I usually give a company’s customer service a try before I invest. If the customer service is inaccessible or personally challenging for me, I’m not going to invest in the company, because customers are going to get a similar bitter taste in their mouths. I called Whirlpool’s customer service line to ask some general questions about one of their products (a KitchenAid mixer that I actually am considering purchasing eventually) and I was treated very well on each of two separate calls. So far, so good for Whirlpool.
4. See if the company is carrying a lot of debt.
Now that we’re confident that the business is facing the public well, now we can start digging into the numbers. The first thing I look at is whether or not the company is carrying a lot of debt as compared to other companies in the same industry. This direct comparison is available at MoneyCentral – the first line in this table directly compares the debt/equity ratio of a company with that of others in its industry. For Whirlpool, the debt/equity ratio is above average, but not scarily so. I’d probably mark this as neutral and keep going.
5. See if the company’s book value per share went up at least 35% in the last three years.
Here, you’re checking to see if the company is investing in itself for future growth. We are looking for consistent investment in the recent past, so we check the long term data at MoneyCentral. For Whirlpool, we take the most recent book value per share ($25.66) and compare it to the one three years before ($10.84) to discover that the company’s book value per share went up 137% over the last three years (I take the most recent book value, subtract the one three years before that, and divide it by the older value). This is a nice positive! We also want to see the average growth over the last three years, so we just divide that growth percentage by three to get a very quick thumbnail for future use: 46%.
6. See if the company’s ROIC (return on investment capital) was ahead of others in the industry in the last five years. So, the company is investing in itself for future growth, but is it still making good money while doing this? Now we take a look at return on investment capital over the last five years, again conveniently provided by MoneyCentral in the sixth row of this table. Here, we see that Whirlpool is returning 8.8% on the capital, while the industry is averaging 7.9%. Above average, enough for a slight positive.
7. See if the stock is overvalued using a quick calculation.
When the dot com stock market bubble was bursting, I read a lot about overvalued stock. The big problem that the bubble had is that people were buying expensive stocks in companies that had very little real indication that they would ever make a lot of money or grow significantly in the future. So, we want a quick thumbnail calculation to make sure that a company’s stock isn’t too expensive given the company’s earnings and potential for growth. We already looked at our calculation for book value per share, but we also want to see the price per earnings ratio, which we can also easily get from MoneyCentral. I take this number and divide it by the annual percentage value I got in step 5. For Whirlpool, the P/E ratio is 12.60 and our percentage value from the earlier step is 46, so dividing the former by the latter gives 0.27 as a result. This is a very normal and healthy number; you should only throw up a red flag if this number is above 1.5, meaning either the stock is very expensive compared to the company’s income and the company isn’t building appropriately to scale for the future. Dot-coms before the bubble burst had absurdly huge numbers here.
8. See what the managment is doing.
Is the company’s management team selling stocks hand over fist? We can find this out with the insider trading tab on MoneyCentral. There are going to be more sells than buys, of course (people buying houses and cars and such), but if all you see are sells, there are some serious problems going on because that means some of the sells are related to people simply switching to other stocks – meaning they no longer believe in the company. Whirlpool is pretty typical here, actually; the majority are sells, but there are a few buys, too.
9. Make sure all of the long term trends are generally healthy.
If you reach step 9, the company is looking stable and reasonably healthy for the future. At this point, I check the overall long-term ratios to see if there are any glaring problems. Lots of negative numbers indicate some severe problems, while numbers that are all positive or mostly positive are fine. It’s even fine if you see a lot of negatives in the five-to-ten year range, but not many in recent years, which means the company is getting healthier (usually a management switch).
10. See what analysts have to say.
Analysts have their own agendas. Only balk if lots of people are strongly negative. Usually, though, if there’s going to be a lot of negativity, you’ll already know. You can find analyst information on a lot of different sites; generally, they’ll be a big mix of opinions. You’re mostly just making sure you didn’t miss anything major. Whirlpool’s recommendations range from strong buys to moderate sells with everything in between, so I feel okay.
If you get through the ten steps and the company’s still okay, it will probably be stable for quite a while and be a consistent earner for you. In essence, this process indicates that there is reasonable value in a reasonably healthy stock, which is exactly what I want for long term investing. For me, Whirlpool is something I would be willing to buy to sit on for the next twenty years.