Lots of people think about investing money in an important global economy like the US. This can be done with the S&P 500 stock index of over 500 first-class US companies. That doesn't seem such as 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 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 as well as many derivatives. The entire world tracks the index daily.
When it comes to companies (components of the S&P 500 index), everyone understands and uses the services or products of the companies, those types of are Microsoft, Mastercard, Google, McDonald's, Apple, Delta Airlines, Amazon and others. In the event that you invest in securities of such major US companies, it may be the best investment you are able to make.
Is it difficult to create a profitable stock portfolio on your own?
Indeed, it'll seem something unattainable for a non-professional. Anyone desiring to start investing needs extra money, understand and read company reports, regularly make appropriate changes within their portfolio, monitor market share prices, and most of all, decide which 500 companies to get in the beginning of their journey being an investor. Yes, there are some issues, but they are all solvable.
Share price. This really is the price of a company's share at a point in time. It can be quite a minute, an hour, each day, weekly, monthly, etc. how to invest money in stocks Stocks are very an energetic instrument. The marketplace is unstoppable, and price is going to be higher or lower tomorrow than it is today. But just how do do you know what price is sufficient to get, whether it is expensive or not or even you ought to come tomorrow? The solution is easy, you can find financial models for determining what is called fair value. Each investor, investment company and fund has a unique, but in the middle of the complex mathematical calculations can be quite a DCF model. There are lots of articles explaining DCF models and we will not go into the calculations and examples. The key goal is to discover a currently undervalued company by determining its fair value, which is later changed into a cost per share. We make daily calculations and find out the fair prices of aspects of the S&P 500 Index centered on annual reports, track changes in the index and update the data.
Investment algorithm.
For the forecasting model to work nicely, we want financial data from companies' annual reports. We process this data manually, without the need for robots or automated systems. This way, we dive into 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. The decision to possibly choose company comes only after determining the company's current fair value and value per share. We consider companies with a potential of more than 10% of fair value, but first things first.
Beginning. So, the company's annual report comes out today. The report must certanly be audited and published by the SEC (Securities and Exchange Commission). Based 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 at this time the share value is a lot lower than the calculated values, let's go deeper into the report.
Revenue. Let's look at revenue dynamics (it is really a significant factor). Revenue has been growing for the last 3-5 years, it could be ideal if it has been increasing year after year for ten 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 focus on possible fluctuations. Like, through the pandemics (COVID-19), many companies from different sectors have suffered financial losses and the revenue decreased. This really is someone approach, depending on the industry. The very best option: revenue growth + 5-10% throughout the last 5 years.
Net profit. We look at the net profit figure, and it is good if it also grows, however in practice the internet profit is more volatile. In cases like this the important factor is that company has q profit, rather than a loss, which is 10-15% of revenue. Of course, a solid decline in profit is a negative aspect in the calculations. The very best option: a gain of 10-15% of revenue throughout the last 5 years.
Assets and liabilities. We head to 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 focus on the company's overall debt, it should not exceed 45% of assets. On the other hand, for companies from the financial sector, it is not critical, and some feel confident with 60-70% debt. It is about someone approach. We consider only short-term and long-term liabilities, credits and loans, leasing liabilities. The very best option: growth of company assets, total debt < 45% of assets, company capital a lot more than 30%.
Cash flow. We're immediately thinking about the operating cash flow (OCF), growing year by year at an interest rate of 10-15%. We look at capital expenditures (CAPEX), it could slightly increase or remain the same. The primary indicator for people is going to be free cash flow (FCF) calculated as OCF - CAPEX = FCF. The very best option: growth of cash flow from operations, a slight increase in capital expenditures, and most of all, annual growth of free cash flow + 10-15%, which the business can devote to its further development, or for instance, on repurchasing of its shares.
Dividend. Apart from the rest, we must focus on the dividend policy of the company. In the end, we want it when profits are shared, even just slightly, for our investments in the company. If the dividend grows from year to year, it only pleases the investor. Furthermore, the entire return on investment in companies with a dividend should increase. Many investors prefer a "dividend portfolio," investing in 15-20 dividend companies with yields of 4-6%, along with the growth in the worth of the shares themselves. The very best option: annual dividend and dividend yield growth, dividend yield above the common yield of S&P 500 companies.
Multipliers. Moving forward to the multiples of the business, they are all calculated using different formulas. When calculating the exact same multiplier, you should use 2 or 3 formulas with a different approach. We have a tendency to lean toward the average. The critical indicators will be the 3, 5 and 10-year values. The index for ten years has the best influence in the calculations as well as the annual. In today's economy, we consider 3 and 5-year indicators to be the most important ones.
The number of multiples is enormous and it creates no sense to calculate every one of them. We ought to 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 consider these indicators in dynamics over 5-10 years. The very best option: price/profit and cash flow ratios are declining or have reached the exact same level (these ratios should really be less than 15), efficiency ratios are increasing year by year and moving towards 30, other ratios are above average in this sector.
This can be a small set for investors. Of course, there are numerous 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 important thing and most important financial indicators, you are able to save lots of time and research all companies in the S&P 500 Index.
We have now a broad idea in regards to the financial health of the company. We made some calculations in our financial model, where we determined the percentage of undervaluation at this time and made the decision whether to get shares of the corporation or not. You will find no impediments. Allocate 5-8% of one's available budget and choose the stock. Make sure to diversify your portfolio. Buy undervalued companies, 1-2 in each sector. You will find 11 sectors in the S&P 500. Choose only those companies whose business you recognize, whose services you utilize or whose products you buy. Do not rush the calculations in your model, if you should be not sure, don't invest in this company.
Surprisingly, an undervalued company might not reach its value for an extended time. The dividend paid will improve the situation. Watch out for 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 has been bad years for companies, but they are recovering faster than their "junior colleagues" in the S&P 400 or 600. Have a good and profitable investment.
