The main keys to investing

Many people think about investing money in an important global economy like the US. This can be carried out with the S&P 500 stock index of over 500 first-class US companies. That doesn’t seem like a lot set alongside the roughly 5,000 stocks traded on the US market. However, these 500 companies take into account around 80% of the full total capitalization of the US stock market.

The Standard & Poor’s 500 is the primary US stock indicator. Its performance influences the GDP of exporting countries and wage growth in addition to many derivatives. The entire world tracks the index daily.

As for the companies (components of the S&P 500 index), everyone knows and uses the services or products of the companies, among those are Microsoft, Mastercard, Google, McDonald’s, Apple, Delta Airlines, Amazon and others. If you spend money on securities of such major US companies, it will be the best investment you can make.

Could it be difficult to construct a profitable stock portfolio all on your own?

Indeed, it will seem something unattainable for a non-professional.  Anyone desiring to start investing needs extra money, understand and read company reports, regularly make appropriate changes in their portfolio, monitor market share prices, and most of all, decide which 500 companies to buy at the start of their journey being an investor. Yes, there are a few issues, but they’re all solvable.

Share price. That is the price tag on a company’s share at a point in time. It can be a minute, an hour, a day, weekly, per month, etc. Stocks are quite a vibrant instrument. The market is unstoppable, and price will be higher or lower tomorrow than it’s today. But how do do you know what price is sufficient to buy, whether it is expensive or not or possibly you must come tomorrow? The answer is straightforward, there are financial models for determining what is called fair value. Each investor, investment company and fund has its, but in the middle of the complex mathematical calculations is usually a DCF model. There are numerous articles explaining DCF models and we won’t get into the calculations and examples. The main goal is to find a currently undervalued company by determining its fair value, which can be later transformed into an amount per share. We make daily calculations and find out the fair prices of aspects of the S&P 500 Index based on annual reports, track changes in the index and update the data.

Investment algorithm.

For the forecasting model to work very well, we need financial data from companies’ annual reports. We process this data manually, without using robots or automated systems. This way, we dive to the companies’ financials completely, read and discuss the report, then feed that data into our forecasting model, which determines the fair price. It is essential to possess at the very least 5-year data and look closely at the dynamics of revenue, net income, operating and free cash flow. Ab muscles decision to possibly buy company comes only after determining the company’s current fair value and value per share. We consider companies with a possible of more than 10% of fair value, but first things first.

Beginning. So, the company’s annual report happens today. The report must be audited and published by the SEC (Securities and Exchange Commission). Centered on section 8 of the report, we make calculations in our model, substitute values, calculate multipliers, and finally determine the fair value. By all criteria, the business is undervalued and right now the share value is significantly less than the calculated values, let’s go deeper to the report.

Revenue. Let’s look at revenue dynamics (it is a significant factor). Revenue has been growing for the last 3-5 years, it will be ideal if it has been increasing year after year for 10 years, but the proportion of such companies is negligible. We give priority to revenue in our calculations—no revenue – you should not include the business in our portfolio. We pay attention to possible fluctuations. Like, throughout the pandemics (COVID-19), many companies from different sectors have suffered financial losses and the revenue decreased. That is someone approach, with regards to the industry. The most effective option: revenue growth + 5-10% during the last 5 years.

Net profit. We consider the net profit figure, and it’s good if it also grows, in practice the web profit is more volatile. In this case the important factor is that company has q profit, rather than a loss, which can be 10-15% of revenue. Of course, a strong decline in profit will be a negative element in the calculations. The most effective option: a profit of 10-15% of revenue during the last 5 years.

Assets and liabilities. We visit the balance sheet and see that the company’s assets increase year after year, liabilities decrease, and capital increases as well. Cash and cash equivalents are increasing.  We pay attention to the company’s overall debt, it should not exceed 45% of assets. On one other hand, for companies from the financial sector, it’s not critical, and some feel comfortable with 60-70% debt. It is focused on someone approach. We consider only short-term and long-term liabilities, credits and loans, leasing liabilities. The most effective option: growth of company assets, total debt < 45% of assets, company capital significantly more than 30%.

Cash flow. We are immediately interested in the operating cash flow (OCF), growing year by year at an interest rate of 10-15%. We look at capital expenditures (CAPEX), it may slightly increase or remain the same. The principal indicator for us will be free cash flow (FCF) calculated as OCF – CAPEX = FCF. The most effective option: growth of cash flow from operations, a slight upsurge in capital expenditures, and most of all, annual growth of free cash flow + 10-15%, which the business can invest in its further development, or for example, on repurchasing of its shares.

Dividend. Aside from everything else, we need to pay attention to the dividend policy of the company. All things considered, we want it when profits are shared, even just slightly, for the investments in the company. If the dividend grows from year to year, it only pleases the investor. In addition, the overall return on investment in companies with a dividend should increase. Many investors prefer a “dividend portfolio,” purchasing 15-20 dividend companies with yields of 4-6%, along with the growth in the worthiness of the shares themselves. The most effective option: annual dividend and dividend yield growth, dividend yield above the typical yield of S&P 500 companies.

Multipliers. Moving forward to the multiples of the business, they’re all calculated using different formulas. When calculating the exact same multiplier, you should use 2 or 3 formulas with a different approach. We tend to lean toward the average. The critical indicators would be the 3, 5 and 10-year values. The index for 10 years has the cheapest influence in the calculations in addition to the annual. In today’s economy, we consider 3 and 5-year indicators to be the most crucial ones. invest in the stock market

The number of multiples is enormous and it creates no sense to calculate every single one of them. We must take notice only to the major ones. Among them are Price/Earnings ratio (P/E), Price/Cash Flow ratio (P/CF), ROA and ROE, Price/Book (P/B), Price/Sales, Enterprise Value/Revenue (EV/R), Tangible Book Value, Return on Invested Capital (ROIC). It’s necessary to look at these indicators in dynamics over 5-10 years. The most effective option: price/profit and cash flow ratios are declining or have reached the exact same level (these ratios must certanly be significantly less than 15), efficiency ratios are increasing year by year and moving towards 30, other ratios are above average in this sector.

This is a small set for investors. Of course, there are many indicators in a company’s annual report, the important ones include operating profit, depreciation, earnings before taxes, taxes, goodwill and many others. We prepare the main element and most significant financial indicators, you can save a lot of time and research all companies in the S&P 500 Index.

We now have a broad idea concerning the financial health of the company. We made some calculations in our financial model, where we determined the percentage of undervaluation right now and determined whether to buy shares of this provider or not. You can find no impediments. Allocate 5-8% of one’s available budget and buy the stock. Remember to diversify your portfolio. Buy undervalued companies, 1-2 in each sector. You can find 11 sectors in the S&P 500. Choose only those companies whose business you understand, whose services you employ or whose products you buy. Don’t rush the calculations in your model, if you should be unsure, don’t spend money on this company.

Surprisingly, an undervalued company may not reach its value for a long time. The dividend paid will improve the situation. Beware of companies with information noise. Usually, they talk a great deal but don’t do much.
The S&P 500 index of companies has been yielding an average annual return of 8-10% for many years. Of course, there were bad years for companies, but they’re recovering faster than their “junior colleagues” in the S&P 400 or 600. Have an excellent and profitable investment.

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