Section 1 is important to highlight the effects of emotions. Section 2 is the first path to staying disciplined and controlling emotions by applying a set of stock picking rules. You may not understand some of these rules yet but don’t worry at all about it for now. I will continue to repeat them and accordingly go into the detail later. What I would like to highlight now is that the rules are made up of key fundamentals usually highlighted when a business posts it’s latest financial statements on news sites. In other words, these headline factors are easy to find.
The Grindertrading StockPicking Rules
- Revenue has increased and forecasted to increase (also known as Turnover)
- Profit before tax has increased and forecasted to increase
- Earning per share (EPS) has increased and forecasted to increase
- Net Debt is less than 3 x Profit before tax (credit giving to a Naked Trader rule)
- Free cash flow per share (FCFps) is greater than or close to Earnings per share (EPS)
- Return on capital employed (ROCE) is double figures
- It pays dividends
- The Outlook is positive
- The 1-year chart is on a steady upward trend
Rules 1, 2 and 3 state ‘increased and forecasted to increase’. This is key to the type of stocks that we are looking to invest in. It represents a business that is growing is profitable and is expecting to continue to grow profits.
Rules 4, 5, 6 are quality checks on the strength and viability of the business. A business can grow profitably through acquisitions and mergers; but in doing so may borrow too much money, weaken their balance sheets and run into trouble.
Rule 8 is subjective but is important to check if the directors of the business have a positive outlook and there are no negatives that could damage trading and future profitability.
Rule 9 is a chart rule and indicates that the markets have already taken notice of the business and are buying shares with confidence, causing the steady rise in share price. The share price is on a positive upward momentum – in other words, the business is not under the radar. Investing in under the radar businesses is a completely different style of investing. It requires a completely different skills set, can be more complicated and I will not be covering on how to invest in under the radar stocks here.
A small note on valuation
These rules concentrate on some basic quality factors of the business. The chart (rule 8) focuses on the momentum of the share price movement. You will hear a lot about valuation, which is asking the question ‘Is this stock undervalued, and therefore cheap to buy?’ Valuation is tricky in the stock market and in the short term largely ignored. Often overvalued stocks continue to rise well beyond expectations and it is a shame to miss out of these rises because valuation rules lead us to believe that the stock is too expensive to buy. Grindertrading largely ignores valuation, however, there are portfolio management rules and in particular, the Stop Loss which is used to protect us from large falls on overvalued stocks that suddenly go wrong.
The Price to Earning Ratio (PER) is a valuation metric that we can use and later set up, but always keep in the back of your mind that PER should be taken with a pinch of salt.
Chapter 3 will give a short description of what each rule means before showing how we implement these rules.