Many individuals think of investing money in an important 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 compared to 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 in addition to 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 those companies, among those 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 could be the best investment you can make.
Can it be difficult to create a profitable stock portfolio on your own?
Indeed, it’ll seem something unattainable for a non-professional. Anyone desiring to begin investing will need extra cash, 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 buy at the start of the journey being an investor. Yes, there are a few issues, but they’re all solvable.
Share price. This really is the buying price of a company’s share at a place in time. It could be a minute, an hour, each day, weekly, a month, etc. Stocks can be an energetic instrument. Industry is unstoppable, and price is likely to be higher or lower tomorrow than it’s today. But how do do you know what price is sufficient to buy, whether it is expensive or not or maybe you should come tomorrow? The answer is straightforward, you can find financial models for determining what’s called fair value. Each investor, investment company and fund has its own, but in the centre of those complex mathematical calculations is generally a DCF model. There are numerous articles explaining DCF models and we will not go into the calculations and examples. The key goal is to locate a currently undervalued company by determining its fair value, which can be later changed into a cost per share. We make daily calculations and learn the fair prices of all components 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 very well, we want financial data from companies’ annual reports. We process this data manually, without the need for robots or automated systems. That way, we dive 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 possess at the very least 5-year data and look closely at the dynamics of revenue, net income, operating and free cash flow. Ab muscles decision to possibly buy company comes only after determining the company’s current fair value and value per share. We consider companies with a potential greater than 10% of fair value, but first things first.
Beginning. So, the company’s annual report happens today. The report should be audited and published by the SEC (Securities and Exchange Commission). Centered 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 company is undervalued and at the moment the share value is a lot lower than the calculated values, let’s go deeper to the report.
Revenue. Let’s look at revenue dynamics (it is a significant factor). Revenue has been growing for the last 3-5 years, it would 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 in our calculations—no revenue – no need to include the company in our portfolio. We focus on possible fluctuations. As an example, throughout the pandemics (COVID-19), many companies from different sectors have suffered financial losses and the revenue decreased. This really is a person approach, depending on the industry. The best option: revenue growth + 5-10% over the last 5 years.
Net profit. We go through the net profit figure, and it’s good if additionally it grows, but 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 can be 10-15% of revenue. Of course, a powerful decline in profit would have been a negative aspect in the calculations. The best option: a profit of 10-15% of revenue over the last 5 years.
Assets and liabilities. We head 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 another hand, for companies from the financial sector, it’s not critical, and some feel comfortable with 60-70% debt. It is all about a person approach. We consider only short-term and long-term liabilities, credits and loans, leasing liabilities. The best option: growth of company assets, total debt < 45% of assets, company capital more than 30%.
Cash flow. We are 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 likely to be free cash flow (FCF) calculated as OCF – CAPEX = FCF. The 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 company can invest in its further development, or for instance, on repurchasing of its shares.
Dividend. Apart from the rest, we have to focus on the dividend policy of the company. After all, we like it when profits are shared, even just a little bit, for the investments in the company. If the dividend grows from year to year, it only pleases the investor. Furthermore, the overall 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%, along with the growth in the worth of the shares themselves. The best option: annual dividend and dividend yield growth, dividend yield above the average yield of S&P 500 companies. stocks investing
Multipliers. Moving forward to the multiples of the company, they’re all calculated using different formulas. When calculating exactly the same multiplier, you can use 2 or 3 formulas with a different approach. We tend to lean toward the average. The critical indicators would be the 3, 5 and 10-year values. The index for a decade has the best influence in the calculations in addition to the annual. In today’s economy, we consider 3 and 5-year indicators to be the most important ones.
The amount of multiples is enormous and it creates no sense to calculate every one of them. We should give consideration 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 consider these indicators in dynamics over 5-10 years. The best option: price/profit and cash flow ratios are declining or are at exactly the same level (these ratios must be significantly 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 key and most significant financial indicators, you can save a lot of time and research all companies in the S&P 500 Index.
We have now an over-all idea about the financial health of the company. We made some calculations in our financial model, where we determined the percentage of undervaluation at the moment and made a decision whether to buy shares of this provider or not. You can find no impediments. Allocate 5-8% of one’s available budget and purchase the stock. Make sure to diversify your portfolio. Buy undervalued companies, 1-2 in each sector. You can 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 uncertain, don’t invest in this company.
Surprisingly, an undervalued company may not reach its value for an extended 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 an average annual return of 8-10% for many years. Of course, there has been bad years for companies, but they’re recovering even more quickly than their “junior colleagues” in the S&P 400 or 600. Have an excellent and profitable investment.