A bit on Value Investing and using screeners

I am a student of Value Investing. I seek out businesses by (paraphrasing Benjamin Graham) thoroughly analyzing a company, and the soundness of its underlying businesses, before I buy its stock.

There is a famous quote from Warren Buffett: “Risk comes from not knowing what you’re doing.” So seek information wherever you can and utilize everything from books, newspapers to tech. Which brings me to the next point. Stock Screeners.

There are many ways which technology can help a value investor find good businesses with undervalued prices. One way is to use a stock screener. Google Finance has one. So does Yahoo Finance. There are more screeners avaliable on the internet.

I normally use the following filters on the screener:

  1. Price/Book Value <80%
  2. ROE > 15%
  3. TTM Debt/Equity < 50%
  4. 5 or 10 year EPS growth rate > 10%
  5. Div yield >5%

Some people feel that filtering on certain criterias, for example EPS, might block out some good companies, so tweak it according to your risk appetite.

I don’t know about you, but I can (almost) guarantee that I will almost end up with the same companies most of the time. Sometimes, I might get a few different companies popping up due to certain tweaks, but mostly they are the same.

This is what I called the first pass. Run through the list and note down those companies which you can afford at this time. Be realistic. Not everyone can buy Google shares. I mean some can, but like me, I don’t want to own just a few Google shares and end up with those as 50% of my entire portfolio! So you might want to add stock value as a filter. Play around with the filters and they can throw up some gems.

Once you have listed some companies into your research list, that is when the real work begins. You need to analyze these companies in detail. Get to know their business. It helps if these businesses are in your circle of interests.

As the mighty Warren Buffett says: “Never invest in a business you cannot understand.”


Selling a Call (Part 2 of Options as an Income Generator)

Last week, I wrote about options being exercised. Normally, if you do your analysis right, that should happen infrequently. But it could and does happen. And if it does, what can you do?

Let me recap my strategy: Earn income by selling PUTs OR own good stock at a good value.

So what happens when the options get exercised? You get to own good stocks at a good value. This is why it is important to do a proper company analysis in before we sell the PUT. It is equally important that you already have the funds in place in case your PUT options get exercised!

Once you have the stock on hand, you can turn it into an advantage: Selling the CALL.

A call option is an agreement that gives an investor the right, but not the obligation, to buy a stock, bond, commodity or other instrument at a specified price within a specific time period. (Courtesy of Investopedia).

Again, my example of KMI:

  1. PUT option which was exercised on 22 Feb 2016. I got the KMI shares.
  2. Sold a $18 CALL @ .42 due 26 Feb 2016.
  3. Option expired, I sold another a $18.5 CALL @ .60 due 18 March 2016.
  4. On the expiration date, this option was exercised.

On the sale, I made $0.715/share. Including the $0.42 and $0.60 that was made on the options, a total of $1.735/share. Worked out to 9.76% of the initial investment. Not too shabby for one month.

Of course one could argue that if I had kept those shares and sold them later, I could have made more as KMI did go higher than $19 at some point. But that is speculation and I prefer to deal with some margin of safety. Also doing this allows me to make my options trades per week or month and not have to worry too much on the whims of Mr. Market.

Options as an income generator

If you are looking for a way to generate income, why not give options a try?

Strategy: Earn income by selling PUTs OR own good stock at a good value.

By simple definition, a put option is an option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. (Courtesy of Investopedia).

Rules: For me, premium > 2% of strike price would be safe. (I always aim higher)

  1. Find a stock. I find my inspiration from the guys who do their homework. (read Warren Buffet, Peter Lynch, etc)
  2. Look for a stock which you are willing to buy. Best choice is if it is currently undervalued.
  3. The strike price I choose is always below the current stock price.
  4. Sell a PUT at a price with a premium which can give you > 2% of strike price. (This gives you a margin of safety)
  5. Collect premium and wait for the option expiration date.

What just happened?

I sold a contract to buy stock at a certain price (strike price). If the option date reaches maturity, it expires or gets exercised. Expire means that I don’t get the stock and exercised means that I get to buy good stock at a good price. Either way, I keep the premium.

You can keep doing this over and and over again. Take for example:

I sold PUTs of KMI at strike price 17.5 for .55 due on 15 April 2016. (3.14% of strike price).

Options expired and I again sold PUTs of KMI at strike price 17.5 for .57 due on 20 May 2016 2016. (3.25%)

Lets do the math here:

Assuming 3% return every month, in one year, that is a return of 12×3%=36%.

When you sell a PUT, you should reserve money for that PUT (in the event of an option exercise). That’s your “capital”.

36% of that “capital” would be my premium before commissions. And if you compound this every month, i.e, use the premiums to increase the number of PUTs you can sell or use for other PUTs…. you can imagine.

OK, so in this scenario, the sell PUT options were not exercised. The reason was obvious, the price of KMI on 15 April was $18.16. When I sold the PUT, the logical price which the seller would exercise the option was if the price reaches $16.95 and below (taking into account that he paid a premium for my PUT option). At the time of this post, KMI is trading at $19.16, which is $1.66 above my strike price for May 2016.

There are others who claim that they can do more than 200% – 300% in a year. But it probably takes a lot more work and strategies. I am lazy and contented with 36%.

If you do your homework and analysis, options being exercised should happen infrequently. But it could and does happen. And if it does, what can you do? That’s another topic for another time.

How I value a REIT

One of the very first stock I bought was Far East Hospitality Trust. (SGX:C61U). With my first stocks, I wanted to be really safe so that I would not get discouraged in the first play. For me that’s important.

Here are my criterias on which I value a REIT in order of priority.

  1. The REIT Price is Undervalued. (Price / NAV < 80%).
  2. Dividend Yield (> 7%)
  3. Gearing Ratio (< 40%)
  4. Interest Coverage Ratio (> 5)
  5. Consistent Growth in Free Cash Flow & DPU (5-10 years)
  6. NPI Yield (NPI / Revenue > 95%)

In my real life example, I bought Q5T on 5 Feb 2016 @ S$0.645. At that time, Price/NAV was about 0.665. Yield was 7.25%. Gearing was 32.5% and Interest coverage ratio was 5.6. There was consistent DPU since the start of the Trust. However NPI yield was at 90%. This demands a closer look in the future, but for now, I am OK with it.