DAY8: Finding And Selecting Good Companies

Finding and selecting good companiesHey, tigers:

Let's review what we've learned in the last seven days

DAY1 : Sustainable Competitive Advantages Explained

DAY2 : Lower Costs and Expenses Means Better?

DAY 3 : 4 Major Fraudulent Methods Of Listed Companies

DAY4 : How To Determine The Solvency Of A Company?

DAY5: How To Judge The Profitability Of A Company？

DAY6 : The 4 Most Important Financial Metrics

DAY7：The Main Industry Sectors Of US Stocks

Today's content is very critical, is each of us in the investment phase of the very important key: how to find and select good companies.

In this article, I'm going to teach you how to select stocks using our core method: Three-step approach to stock selection.

Which can hopefully help you identify leading companies in these four industries.Let me show you how this three-step approach works:

1. Identify healthy companies

Here, "healthy companies" are those with healthy financials, stable cash flows, and sizeable income. I'll use Amazon in the IT industry as an example.

We view a company with high profitability as having healthy finances.From the perspective of profitability, Amazon's net income, total revenue , and operating profit were all growing steadily year by year between 2017 and 2021.

(Amazon's net income growth, Source: Tiger Trade app)

(Amazon's total revenue growth, Source: Tiger Trade app)

(Amazon's operating profit growth, Source: Tiger Trade app)

However, a company's current health alone isn't enough to decide whether it is a good target for investment, as it does not reflect the company's future or growth potential.

Without growth potential, even a top company can quickly lose its position in a competitive market.How to see the growth potential of the company? Now let's talk about step two.

2. Identifying companies with strong growth potential.

A company's growth potential refers to its growth in revenue and earnings.

We can analyze a company's revenue growth by the year-over-year trend of total revenue in its financial reports. Similarly, we can analyze its earnings growth by trends of its net and operating profits.

That is...we can simply look at the company's trendlines (the yellow trendlines).

(Amazon's total revenue growth, Source: Tiger Trade app)

(Amazon's net income growth, Source: Tiger Trade app)

(Amazon's operating profit growth, Source: Tiger Trade app)

We can see from the charts that all three indicators declined YoY between 2018 and 2019, but recovered gradually between 2019 and 2021.

We suggest that you lengthen the time span from five years to ten years in such a case, and if the data shows an upward trend in general, it means the company has good growth potential.

There is a third, more qualitative principle based on a company's "economic moat".

Warren Buffett often uses this principle in addition to the two quantitative principles from before.3. Identify a company with an economic moatWhat is the economic moat of the enterprise?

The simple explanation is: finding a company has an economic moat when it has strong brand equity, high technological barriers, or absolute pricing power.Still unclear?

Let's look at a concrete example. Do you guys still remember the long queue outside Apple's stores whenever a new product is launched?

Apple fans are so dedicated to Apple products, that they would queue up overnight to buy the company's latest offerings. And this is an indication of the company's brand equity.

Companies with strong brand equity will have natural advantages in market competition. And the stronger the brand equity, the more likely it is for consumers to prefer the company over competition.

Next, let's talk about the pricing power of a product.

Strong brand equity would give a company better pricing power. Such companies can bring up prices when costs are higher, and consequently pass the additional costs onto the downstream consumers without affecting their sales volume.

A company with strong pricing power can basically have it all in the market.Moat is a very important metric when picking the right companies.

The investment market is defined by the game of winner-takes-all.

So, only companies with the strongest brand equity, highest product barriers and the most technological patents will be able to dominate the market and make money consistently.

That brings us to the end of this article.

By using our three-step approach to stock selection, you will be able to identify the top players in an industry by searching for those with good financial health, high growth potential, and wide economic moats.

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