My stocks don’t have to meet all of the criteria below, but I use this as a checklist to quickly screen out garbage. I’ll then drill down to see exactly what I have and build an investment case as a core holding or special situation.
Low Price and Low Volume
- No market interest
- Stock trading under $5 with a market capitalization below $250-million in Canada
- Very little volume. If I were to buy the shares I would move the price of the stock
This is very much personal preference. I’ve recently started looking at companies that have gone dark on OTC market but I realize that’s not for everybody.
Share price recently tanked because of …
- Broad market sell off that is not directly related to the company
- Market manipulation
- An obvious one-off event that nobody will remember in 18 months
- Large shareholder is flooding the market
No coverage allowed!
I used to work in the BNN newsroom. If the stock is so small that I would get in trouble for mentioning it on the air, then I have something. Bonus points if the original underwriter no longer covers the stock.
Clean Balance Sheet
- Lots of cash with almost no debt
- Assets that can easily be turned into cash or easily valued. Bonus points if these assets fool the debt/equity screeners included in online trading platforms.
Shares outstanding — it depends
I’m looking for one of the following …
- Is it a small amount of shares that stays constant? Or is reduced on a regular basis by share buybacks? This shows that they treat their stock as a valuable resource.
- Founders, management or a large investor own a big block of shares. Bonus points if someone has attempted to take the company private.
- No options overhang and the company isn’t using its stock to buy office supplies or coverage from Agoracom. If they don’t value their stock, then why should you? You probably also want to avoid companies where a low stock price has allowed management to issue itself a bunch of super-cheap options.
- I don’t want to see constant share issuances to pay for acquisitions, pay down debt or “cash up ahead of the big breakthrough.” Unless the company is a capital intensive roll up like a REIT there is no reason to take a chance on the inevitable blow up, which brings us to…
- An explosion of new shares, possibly billions of them. This usually means the company just wiped out its old shareholders by paying off debt with stock. While that sucks for the old shareholders, this will often leave a company with a very clean balance sheet, trading for pennies at a 52-week low with an influx of free cash flow that was previously used to service debt.
Low P/E and P/Book ratios
- This is pretty obvious. Otherwise you need a good reason for the lack of earnings in combination with a sound fundamental business. Bonus points if the company is in an industry with a decent future and growth prospects
Management
- Apparent apathy with very little news being released
- New management
- Shell company conducting new business
- Financials are up-to-date and company is in regulatory compliance
The key thing to remember is there is more than one way to make money in the market, what works for someone else may not work for you.
My preference is to look to the balance sheet and prospects of the business behind the stock certificates.
