Many people consider investing profit 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 like a lot compared to the roughly 5,000 stocks traded on the US market. However, these 500 companies take into account around 80% of the full total capitalization of the US stock market.
The Standard & Poor’s 500 is the principal US stock indicator. Its performance influences the GDP of exporting countries and wage growth along with many derivatives. The entire world tracks the index daily.
As for the companies (components of the S&P 500 index), everyone knows and uses the services or products of the companies, among those are Microsoft, Mastercard, Google, McDonald’s, Apple, Delta Airlines, Amazon and others. In the event that you spend money on securities of such major US companies, it could be the best investment you are able to make.
Could it be difficult to construct a profitable stock portfolio by yourself?
Indeed, it will seem something unattainable for a non-professional. Anyone desiring to start investing will need extra money, understand and read company reports, regularly make appropriate changes inside their portfolio, monitor market share prices, and most importantly, decide which 500 companies to buy in the beginning of these journey being an investor. Yes, there are several issues, but they’re all solvable.
Share price. This really is the price tag on a company’s share at a place in time. It could be a minute, an hour, per day, a week, a month, etc. Stocks can be a vibrant instrument. The marketplace is unstoppable, and price will soon be higher or lower tomorrow than it’s today. But just how do guess what happens price is good enough to buy, whether it’s expensive or not or possibly you need to come tomorrow? The answer is easy, you will find financial models for determining what’s 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 won’t go into the calculations and examples. The key goal is to find a currently undervalued company by determining its fair value, that will be later converted to a cost per share. We make daily calculations and learn the fair prices of the different parts of the S&P 500 Index based on annual reports, track changes in the index and update the data.
For the forecasting model to work well, we need financial data from companies’ annual reports. We process this data manually, without using robots or automated systems. This way, we dive in to the companies’ financials completely, read and discuss the report, then feed that data into our forecasting model, which determines the fair price. It is vital to own at the least 5-year data and look closely at the dynamics of revenue, net income, operating and free cash flow. The decision to possibly buy company comes only after determining the company’s current fair value and value per share. We consider companies with a possible in excess of 10% of fair value, but first things first.
Beginning. So, the company’s annual report comes out today. The report should be audited and published by the SEC (Securities and Exchange Commission). Predicated on section 8 of the report, we make calculations inside 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 much less than the calculated values, let’s go deeper in to the report.
Revenue. Let’s look at revenue dynamics (it is really a significant factor). Revenue has been growing the past 3-5 years, it could be ideal if it has been increasing year after year for a decade, but the proportion of such companies is negligible. We give priority to revenue inside our calculations—no revenue – no need to include the business inside our portfolio. We focus on possible fluctuations. For instance, during the pandemics (COVID-19), many companies from different sectors have suffered financial losses and the revenue decreased. This really is an individual approach, with regards to the industry. The most effective option: revenue growth + 5-10% throughout the last 5 years.
Net profit. We go through the net profit figure, and it’s good if it also grows, but in practice the web profit is more volatile. In cases like this the important factor is that company has q profit, rather than a loss, that will be 10-15% of revenue. Needless to say, a solid decline in profit will be a negative element in the calculations. The most effective option: a gain of 10-15% of revenue throughout the last 5 years.
Assets and liabilities. We go to the total amount 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 one other hand, for companies from the financial sector, it’s not critical, and some feel more comfortable with 60-70% debt. It is focused on an individual approach. We consider only short-term and long-term liabilities, credits and loans, leasing liabilities. The most effective option: growth of company assets, total debt < 45% of assets, company capital more than 30%.
Cash flow. We are 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 all of us will soon be free cash flow (FCF) calculated as OCF – CAPEX = FCF. The most effective option: growth of cash flow from operations, a slight upsurge in capital expenditures, and most importantly, annual growth of free cash flow + 10-15%, which the business can invest in its further development, or for instance, on repurchasing of its shares.
Dividend. Besides everything else, we must focus on the dividend policy of the company. All things considered, we want it when profits are shared, even just a bit, for our investments in the company. If the dividend grows from year to year, it only pleases the investor. Additionally, the entire return on investment in companies with a dividend should increase. Many investors prefer a “dividend portfolio,” buying 15-20 dividend companies with yields of 4-6%, in addition to the growth in the value of the shares themselves. The most effective option: annual dividend and dividend yield growth, dividend yield above the average yield of S&P 500 companies.
Multipliers. Moving on to the multiples of the business, they’re all calculated using different formulas. When calculating the exact same multiplier, you need to use 2 or 3 formulas with an alternative approach. We often lean toward the average. The critical indicators would be the 3, 5 and 10-year values. The index for a decade has the lowest influence in the calculations along with the annual. In today’s economy, we consider 3 and 5-year indicators to be the most important ones. invest in the stock market
The amount of multiples is enormous and it generates no sense to calculate every single one of them. We should take notice and then the major ones. One of 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 is necessary to check out these indicators in dynamics over 5-10 years. The most effective option: price/profit and cash flow ratios are declining or are in the exact same level (these ratios should be less than 15), efficiency ratios are increasing year by year and moving towards 30, other ratios are above average in this sector.
This is a small set for investors. Needless to say, there are many 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 critical financial indicators, you are able to save plenty of time and research all companies in the S&P 500 Index.
We have now a broad idea about the financial health of the company. We made some calculations inside our financial model, where we determined the percentage of undervaluation at this time and made a decision whether to buy shares of this company or not. You will find no impediments. Allocate 5-8% of one’s available budget and purchase the stock. Remember 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 realize, whose services you use or whose products you buy. Do not rush the calculations in your model, if you should be unsure, don’t spend money on this company.
Surprisingly, an undervalued company might not reach its value for a long time. The dividend paid will improve the situation. Avoid companies with information noise. Generally, they talk a great deal but don’t do much.
The S&P 500 index of companies has been yielding a typical annual return of 8-10% for a lot of years. Needless to say, there has been bad years for companies, but they’re recovering considerably faster than their “junior colleagues” in the S&P 400 or 600. Have an excellent and profitable investment.