Many people consider investing profit a significant global economy like the US. This can be achieved with the S&P 500 stock index of over 500 first-class US companies. That doesn’t seem like a lot set alongside the roughly 5,000 stocks traded on the US market. However, these 500 companies account fully for 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 whole world tracks the index daily.
When it comes to companies (components of the S&P 500 index), everybody knows and uses the services or products of these 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 will be the best investment you can make.
Could it be difficult to construct a profitable stock portfolio on your own?
Indeed, it will seem something unattainable for a non-professional. Anyone desiring to begin investing needs to have extra money, understand and read company reports, regularly make appropriate changes within their portfolio, monitor market share prices, and above all, decide which 500 companies to purchase at the start of their journey as an investor. Yes, there are a few issues, but they’re all solvable.
Share price. This really is the price of a company’s share at a place in time. It can be quite a minute, an hour or so, a day, per week, per month, etc. Stocks are very a powerful instrument. The market is unstoppable, and price is going to be higher or lower tomorrow than it’s today. But just how do do you know what price is sufficient to purchase, whether it is expensive or not or possibly you ought to come tomorrow? The answer is easy, you will find financial models for determining what is called fair value. Each investor, investment company and fund has a unique, but in the middle of these complex mathematical calculations is usually a DCF model. There are lots of articles explaining DCF models and we won’t go into the calculations and examples. The main goal is to locate a currently undervalued company by determining its fair value, that is later transformed into an amount per share. We make daily calculations and discover the fair prices of aspects of the S&P 500 Index predicated 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 the need for robots or automated systems. That 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 important to own at 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 arrives today. The report must certanly be audited and published by the SEC (Securities and Exchange Commission). Predicated on section 8 of the report, we make calculations within our model, substitute values, calculate multipliers, and finally determine the fair value. By all criteria, the organization is undervalued and at this time the share value is significantly lower 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 going back 3-5 years, it would be ideal if it’s been increasing year after year for a decade, nevertheless the proportion of such companies is negligible. We give priority to revenue within our calculations—no revenue – you should not include the organization within our portfolio. We focus on possible fluctuations. For instance, throughout the pandemics (COVID-19), many companies from different sectors have suffered financial losses and the revenue decreased. This really is someone approach, with regards to the industry. The most effective option: revenue growth + 5-10% during the last 5 years.
Net profit. We consider the net profit figure, and it’s good if additionally, it grows, in practice the internet profit is more volatile. In this instance the important factor is that company has q profit, rather than loss, that is 10-15% of revenue. Needless to say, a strong decline in profit would have been a negative factor in the calculations. The most effective option: a profit of 10-15% of revenue during the last 5 years.
Assets and liabilities. We head to the total amount sheet and note 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 will not exceed 45% of assets. On another hand, for companies from the financial sector, it’s not critical, and some feel confident with 60-70% debt. It is focused on someone 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 significantly more than 30%.
Cash flow. We’re immediately interested in the operating cash flow (OCF), growing year by year at an interest rate of 10-15%. We look at capital expenditures (CAPEX), it may slightly increase or remain the same. The principal indicator for all of us is going to be free cash flow (FCF) calculated as OCF – CAPEX = FCF. The most effective option: growth of cash flow from operations, a small increase in capital expenditures, and above all, annual growth of free cash flow + 10-15%, which the organization can invest in its further development, or for example, on repurchasing of its shares.
Dividend. Aside from everything else, we must focus on the dividend policy of the company. In the end, we want it when profits are shared, even just a bit, for the 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%, 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 forward to the multiples of the organization, they’re all calculated using different formulas. When calculating exactly the same multiplier, you can use several formulas with an alternative approach. We often lean toward the average. The critical indicators are 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 main ones. how to invest money in stocks
The number of multiples is enormous and it creates no sense to calculate every one of them. We should take notice and then 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 check out these indicators in dynamics over 5-10 years. The most effective option: price/profit and cash flow ratios are declining or are at exactly the 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 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 critical financial indicators, you can save plenty of time and research all companies in the S&P 500 Index.
We now have a broad idea about the financial health of the company. We made some calculations within our financial model, where we determined the percentage of undervaluation at this time and made a decision whether to purchase shares of the corporation or not. There are no impediments. Allocate 5-8% of your available budget and choose the stock. Remember to diversify your portfolio. Buy undervalued companies, 1-2 in each sector. There are 11 sectors in the S&P 500. Choose only those companies whose business you understand, whose services you employ or whose products you buy. Do not rush the calculations in your model, if you’re uncertain, don’t spend money on this company.
Surprisingly, an undervalued company might not reach its value for a long time. The dividend paid will increase 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 were bad years for companies, but they’re recovering faster than their “junior colleagues” in the S&P 400 or 600. Have a good and profitable investment.