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The Investment Checklist for Stock Picking

For most of the retail investors, investing in few and diversified mutual and index funds will provide a good long-term return. That approach will require a minimum time and effort from an individual investor and should achieve a satisfactory capital growth if the investments are held for a long-term.

However, if you do want to carry out your own stock picking to achieve a market-beating return, then an investor should have his or her own checklist before purchasing any stock.

I have created my own investment checklist and will go through each of the main components in the detail. This is not a final checklist and I am always trying to find other indicators that will help me to choose a better investment.

1) Return On Capital Employed (ROCE) to be at least between 15-20%, averaged for the past 5 years

ROCE is a profitability ratio that measures how efficiently a company can generate profits from its capital employed by comparing net operating profit to capital employed. Higher the number, better its profitability. In a current low-interest environment, where average return on a saving account or from a government bond is yielding 2-3%, I am looking for a company which provides a good return (15 to 20%) compared to the safe but low return from government bond.

ROCE number can be calculated using a company's financial reports or can be obtained easy from websites such as MorningStar.com.

2) No debt or low debt: net gearing is not more than 20%

In an ideal investment, I'm looking for a company which doesn't have any outstanding net debt. However, for a time to time, a company may borrow capital to finance an acquisition or to finance an expansion project. 

I like to see a gearing ratio, which is a ratio of owner's equity to borrowed funds, not more than 20%, as this will give enough capacity for a company to service its debt obligation in severe economic conditions. You can also use Free cash flow to debt ratio to determine the company's capabilities to pay down its debt.

Net gearing ratios for Utility companies are generally higher due to the regulatory framework under which they operate and hence this rule doesn't apply to their valuations.

3) Company management does talk about their mistake

As companies are run by people and not by computers, it is normal for a management team to make a mistake running a company. This could be related to misallocation of capital to a failed project or an expansion or an issue with a business acquisition.

The management always has more information about the company than the investors. And, hence, the management can hide a previous or an ongoing issue to the public and it would be very difficult for an individual investor to find out about this issue until its too late. Hence, I would like to see an honest management team where they are not hesitant to admit their mistakes in annual reports, conference call or in other public forums.

4) Positive Free Cash Flow (FCF) for at least last 4 out of 5 years

In most of the companies, the net income doesn't normally equal to a free cash flow number. Therefore, positive FCF numbers for the past few years will indicate a company's strong ability to generate cash from its profit.

Ideally, a company should have a long history of free cash flow generation for 10 years and an ability to increase cash flow every year. However, it is possible that for a short-term, a company may spend cash generated within the business to expand its products or services and hence may have 1 or maximum 2 years of low or negative cash flow. But, in a long-term, the company's FCF capacity will determine its valuation.

5) What is an exit strategy?

It is very important for an investor to determine the holding period of a stock before he or she decides to buy it. If a company fulfils all of the above 4 criteria and an investor understands the company's competitive advantageous position in the sector, then the investment can be a part of the portfolio for a long-term (5 to 10 years).

However, if the company doesn't fulfil some of the above-mentioned criteria or it fails after a couple of years of holding period, then the investor will need to carry out in-depth valuation again and then to decide whether the company should be part of the portfolio or need to be sold.

Important Information: This is not an investment advice so you need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.

Long-term Investment Portfolio - Part 2

In this second part of my investment portfolio blog, I will give you details about my investments in Active mutual funds. Over the last few years, I've been adding and removing a few mutual funds in my portfolio as I wasn't finding the right balance of enough diversification and at the same time, concentrated portfolio because I didn't want to stretch my time to look after 10s of mutual funds regularly. I think I have now completed the construction of my core holdings and will share my ideas here.

My investment philosophy is to buy and hold. And, hence, naturally, I'm drawn to mutual funds where investment managers have a similar style in their investments, either in stocks or in bonds, with a very low turnover rate. Currently, I'm holding good position sizes in each of the below-mentioned funds.

As with any investment decision, it is very likely that I may change my view on these funds in the future and increase or decrease my holdings. It is also possible that these funds may get a new investment manager or a different stratergy that may change my original thesis. And, hence, you should need to do your own research before you decide if any of these funds are a right choice. I have given a percentage allocation recommendation for each of these funds where I have assumed that I have only these assets in my portfolio.

1. Fundsmith Equity Fund
Terry Smith, chief investment manager, and his colleague, Julian Robins, run this fund with 20 to 30 share holdings. Their Annualized Rate of Return since 2010 has been +19.8%, which is exceptional when you compare it to Index funds or return by other active managers in the similar asset class. Of course, there is no guarantee that the return will be repeated for the next 5 or 10 years, however, the investment team is sticking with their investment philosophy and I'm very optimistic that the fund will generate a good rate of return in the future. I would allocate 25% of my investment assets in this fund.

2. Lindsell Train Global Equity
This fund is similar to Fundsmith and investment managers hold 20-35 companies in this mutual fund. The mutual fund company, Lindsell Train, has a few funds in their portfolios, however, this Global Equity Fund combines the best ideas from their other funds and bring US, Japanese, UK and European companies in one fund. The company publishes very detailed monthly reports and annual report is very educational as well. I would allocate 20% of my savings to this fund.

3. Stewart Investors Asia Pacific Leaders
The above two funds invest in the developed market only. For those who are looking to invest their savings in China, India, etc 'emerging market' companies, I found this fund is the best in class. Similar to Fundsmith and Lindsell Train, this fund has very few holdings and invests in large and mid capitalization equities in the Asia Pacific region (excluding Japan). I would allocate 20% to this fund.

4. Marlborough Global Bond
Marlborough Fund Managers' founder Geoff Hitchin launched this award-winning Marlborough Global Bond Fund in 1987 and remains at its helm today. The fund invests in bonds issued by governments and companies around the world. Portfolio turnover rate is 20.52% and the fund is unconstrained in its allocations to countries and regions. I would allocate 20% of savings to this fund.

5. MandG Emerging Market Bond

At least 70% of this fund's asset is invested in bonds issued by the governments, government agencies or companies of emerging market nations. The fund is currently offering more than 5% of underlying yield. Compared to the above 4 funds, however, this fund may have wider price fluctuations in a short period but this shouldn't concern a long-term investor. I would allocate the remaining 15% of my asset to this fund.

Important Information:  This is not an investment advice and hence you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.

Long-term Investment Portfolio - Part 1

In this blogpost, I will go through my Investment Portfolio, focusing on Index Funds. As a long-term investor, my aim is to preserve and grow the real value of my assets. World's most renowned investors, including Howard Marks & Warren Buffett, suggest low-cost tracker (Index) funds as a best for retail investors to invest their money in. These funds should be used for a long-term investment (5-10 years) and not advised to do short term trade in and out.

Most of the below funds are available as an either income or accumulation share class for the UK investors. Furthermore, most of the funds are also available with another layer of discounts as some of the investment platforms have negotiated further discounts on already low-cost ongoing charges (OCF).

1. BlackRock Corporate Bond Tracker Fund

This is a low cost tracker fund which tracks the performance of the Markit iBoxx GBP Non-Gilts Overall TR Index. The OCF for the fund for a retail investor is 0.16%. The fund is currently yielding just above 3% and gives a good exposure to world's corporate bond market.

2. Legal and General European Index

Legal and General Investment Management has done a great job of providing very low cost index funds across the major investment sectors. This is an Equity index fund tracking the performance of the FTSE World Europe (excluding UK) Index. The Index consists of a broad spectrum of European companies and currently advertised at OCF of 0.12%.

3. Legal and General UK 100 Index Trust

It is a well known fact that most of the investors have a home bias when it comes to investing their savings. Being aware of that and also knowing that a few of my individual stock investments are within FTSE 100 companies, I have a minor portfolio holding in this fund.

4. HSBC FTSE 250 Index

Again, this is one of my smaller portfolio holding. This fund provides tracking of FTSE 250 Index and has OCF of 0.18%.

5. Legal and General US Index

This fund replicates the performance of FTSE USA Index. This index has a few more companies compared to SP 500 index. For the UK retail investor, I found that this fund provides the lowest OCF compared to an SP 500 index fund and hence I have selected this fund over an SP fund.

I do not have any emerging market index tracker funds. There are few reasons behind this as I think most of the emerging market indices do not correctly represent emerging or developing markets. The second reason is that I do not believe that those markets are efficient or free from inside trading.

I hope the above list will give you a good starting point to start constructing a balanced portfolio and than add an active investment funds. It is possible to reduce the number of Equity Index funds from four to a single fund by investing in an International Index Trust if you do not want to allocate your funds to these individual funds.

I will write a separate blog featuring my investments in Active Mutual Funds.

Important Information: I do not give investment advice so you need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.