How to Pick Winning Stocks

The following 5 simple investment rules will enable you to make between 15% to 30% annual returns.

Invest in Companies with Great Management
Invest in Companies with a Competitive Edge
Invest in Companies with a Superior and Consistent Business Operations
Determine a Stocks Intrinsic Value
Buy with a Margin of Safety

Rule 1 - Great Management

When you buy a stock you are essentially entrusting your money with the company's management to provide you a decent return on your investment. This is the soft side of investing which you can assess by reading annual reports, listening to quarterly and annual conference calls, as well reading various new releases. You should look for the following 6 management traits:

Strategic Growth Plan
Excess cash is being returned to shareholders via dividends or share buybacks
Honest and upfront with shareholders
Willingness to make short term sacrifices for long term value
Management ideally has significant ownership in the business
Not excessively paid and diluting shares for personal gain

Rule 2 - Competitive Edge

Look for companies that provide a service or product that is desired or needed, has no close substitute and is not regulated.

You should also look at the following financial metrics as proof that the company currently has a competitive edge:

Higher ROIC, ROE and ROA than its competitors
Higher profit margin compared to its competitors

Rule 3 - Superior and Consistent Business Operations

Limit your stock selections to companies that have the following traits:

Simple and understandable business model
Consistent operating history which enables you to forecast the future value of the company with a relatively high degree of accuracy.
High ROE >15%
Low Debt < 25%

Rule 4 - Determine a Stocks Intrinsic Value

Their are 4 steps in calculating the DCF intrinsic value of a stock.

Step 1 - Calculate Present Value of the Next 10 Years of FCF
Step 2 - Calculate Present Residual Value
Step 3 - Calculate the Total Value of Common Equity
Step 4 - Common Equity Value divided by # of outstanding shares

The Stock Valuation Model will automate the mechanics of calculating the Intrinsic Value of a Stock enabling you to spend more time annualizing your forecasted value drivers and the management of the company. The following link is a more detailed explanation of the mechanics behind each of the DCF steps mentioned above as well as a PE Valuation explanation

How to Value Stocks

You should also be on the lookout for the warning signs during your valuation process. You should monitor Accounts Receivable, Inventory and Operating Cash Flow growth rates and make certain that their growth rate is tracking about the same or better than the Revenue Growth.

Rule 5 - Buy with a Margin of Safety

You can master all the previous traits and still have subpar investment returns if you don't patiently wait to allocate capital until the stock price reflects a price that will enable you to make your minimum required rate of return.

Instead of worrying about the future direction of the market, you should spend your time creating a list of qualified companies and adding them to your watch list. Once the stock price hits your conservatively calculated required rate of return, you will purchase it. Once the stock price starts to approach its intrinsic value, you will start selling it. This takes the emotions out of the investment process.

You will find that it is rare that you will have a large number of buying opportunities but when they make themselves available you need to be prepared to purchase them. This is usually when the rest of the market is running for the doors. So by following the simple 5 step stock selection process and waiting for the right time you make your move you will be buying low and selling high.

The secret to making market betting returns is to keep your estimates conservative, invest in great management, invest in great companies and be patient for the right time to buy and sell.