14 Share selection methodology

Introduction

Warren Buffett on chasing yield: Chasing yield is crazy. Just because you’d like to earn 8% or you’d like to earn 10% or you’d like to earn 6%, the world is not going to adapt to that. You have to think about what is the most intelligent thing to do, and if that produces 5% or 6% that’s the best you are going to do. But to get enticed into some investment that is risky or that you don’t understand because someone promises you a higher yield – I can take you down to the waterfront or something like that and they’ll promise you 15% or something.

CNBC’s ‘Squawk Box’, May 6, 2013.

This chapter sets out an approach to selecting individual shares for investment. The basis of successful investing is the selection of good companies and buying their shares at prices that represent good value.  It is perfectly possible to invest in a good company at the wrong price – timing is important!

The previous chapters have sought to demystify and explain the workings of the stock markets, and to position the reader to develop a successful investment strategy.  Now we have to get ready for the execution. This chapter places considerable emphasis on building market knowledge as well as going into the finer grain of identifying which companies might be a fit with your strategy, and how to assess them.  This leads into buying strategies, which are discussed in Chapter 18 – Managing your portfolio.

Investing when the stock market indices are testing all-time highs is challenging, but as we have seen, the markets are testing all-time highs a great deal of the time.  Sectors as well an individual shares can be subjected to momentum buying, and can become significantly overvalued.  However, within each index there are many sectors and many companies and they do not all reach all-time highs at the same time.  Sector rotation, discussed in Chapter 5, is a reality of the stock markets and continually presents buy opportunities, not least for the alert retail investor.

Major institutional investors with large amounts of money to invest have little choice but to be heavily weighted in large cap companies.  Pension funds in particular rely on the dividends streams from the large caps.  As well as investing in some good, […]