The biggest question in the stock market hasn’t changed for years. Every body wants to know, how to pick a dream stock, which can make him super rich. Actually it requires education, skill, patience and a little luck to be a successful investor. An investor needs to work hard intelligently and with discipline to recognize opportunities other professionals may have missed. Picking the ‘Jack Pot’, in the stock market requires down to earth attitude like the shopping style of a bargain hunter. You need to buy an undervalued stock with strong fundamentals and then to sell it at a high price. This means to win a ‘Jack Pot’ in the stock market, you need to be a value investor.
Most of us may think that it is very simple to buy a stock at Rs. 100 and sell it at Rs. 125 after some time. Warren Buffett is doing it for more than fifty years. He is known as the greatest investor in the history. He has amassed the great wealth by applying value-investing style in stock trading. A value investor looks for stocks with unjustifiably low prices and strong fundamentals. He is like a bargain hunter. He searches for those stocks, which he believes are undervalued. His philosophy is simple buy low and sell high. It seems to be very simple and logical.
Like bargain hunters, you simply need to go through the list of listed companies and select under priced stocks. But this is not the complete game. These under priced companies should have strong fundamentals.
So if you want to win a ‘Jack Pot’ in the stock market, follow your mother’s strategy. She goes to the vegetable market and behaves like a value investor there. She goes to many shops and thoroughly checks vegetables, in terms of quality and prices. Then she purchases vegetables from those shopkeepers, who offer good quality at comparatively low prices.
So keep in mind, your mother’s strategy and search for stocks that are undervalued and have potential to give value over the period of time. You have to do this before majority of the other investors recognize the potential in that stock and prices go high.
Now question arises, how to know which stock is undervalued and which one is overvalued. The stock, which is trading for less than its intrinsic value is undervalued and trading above its intrinsic value, is overvalued. It’s so simple and you have to search for those shares, which are trading for less than their intrinsic value. Stock market is a wonderful place. This market overreacts to good and bad news. And good news about your undervalued share would do the magic. Price of your stock would jump high and you will become rich. There is always an opportunity for value investors to profit by buying when the price is deflated.
The problem before small investors is, how to find the intrinsic value of a stock. Mutual funds and foreign institutional investors employ Technical analysts to keep an eye on the potential stocks. So what should a small investor do?
Here is the secret of the most successful investor in the history. By keeping in mind Warren Buffett’s style and method, small investors can also earn money in the stock market. Buffett looks for the following things:
First, Is company consistently performing well? Are shareholders earning income on their shares? To find this rate Buffett checks return on equity (ROE). ROE is a wonderful instrument to find out whether or not company has consistently performed well in comparison to other companies in the same industry. All finance newspapers publish ROE of the different stocks.
The investor should view the ROE from the past five to 10 years to get a good idea of historical performance.
Second, Does Company has excess debt or it has successfully avoided it?
The debt/equity ratio is another important factor, Buffett considers carefully. He prefers small amount of debt.
A high level of debt compared to equity means volatile earnings and large interest expenses.
Third, Profit margins must be high and they should be increasing.
Buffett prefers to buy stock of company, which has high profit margins. Consistently increasing profit margins shows sound financial health of the company. This margin is calculated by dividing net income by net sales. To get a good indication of historical profit margins, investors should look back at least five years.
Fourth, Share is trading at discount or premium to its real value.
The most important and difficult part of value investing is to determine weather stock is undervalued or overvalued. Buffett is expert in this skill and that’s why he has become the most successful investor in the history.
According to Grahamand Dodd, ’Intrinsic value of a security is that value, which is justified by the facts, e.g. assets, earnings, dividends, definite prospects, including the factor of management of the company.’
Buffett compares intrinsic value of the company to its current market capitalization. If intrinsic value is 25% higher than the company's market capitalization, then Buffett considers company’s stocks have potential to be traded a high value in future.
So, it was the secret of Buffett’s success in stock trading. Value investing made him third richest man in the world today and the most successful investor in the history. But remember millions of other investors have lost money in the past trying to guess stock price movements. But value investing is a proven success method, which can make you rich, if you apply it carefully.
