Value Investing Checklist

Hello you very wonderful and intelligent individuals that make up these forums. I sincerely hope you had a wonderful Christmas.

I was kindly making a checklist and or investment process for what i need to look at when trying to locate good value stocks, that have good business models and trade below their Total Enterprise value.

I please wondered if you would kindly share your process you go through when investing. Such as screening for stocks with High ROIC using a screener, then what documents you read such as Annual Reports, what are you looking for to determine if the business will grow and how many hours you research a stock please? If you kindly had any thoughts on this, regarding the process you go through when investing please, i would be forever grateful and thankful it would mean the world to me.

Hope you have a fantastic 2024, hope you have great health, wealth and lots of joy and happiness. Very best wishes to you and i truly hope all continues to go well for you. With my every best wish.

Grab yourself a copy of the book the Investment Checklist by Michael Shearn - it’ll likely answer future questions you have too.

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There are no perfect valuation metrics, and each method has its downsides. An experienced investor must be able to figure out the right tool for the job, meaning the best method of valuation for a given investment or market, given its unique characteristics.

The relationship between value stocks and growth stocks has been an interesting long-term cycle over decades.

From 1980 to 1988, value mildly outperformed growth. From 1988 to 2000, growth mildly outperformed value. From 2000 to 2007, value crushed growth. From 2007 to present, growth has moderately outperformed value.

This can happen for many reasons. Money tends to pour into what has been doing well. When value does very well as a factor, for example, investors and institutions will happily put more money into value stocks and value funds. But eventually, the valuations on value stocks aren’t even that cheap anymore, so the strategy underperforms.

Likewise, when people get excited about growth stocks, they can reach such crazy valuations that they have nowhere to go but down because they are totally unjustified by their fundamentals, like in the year 2000.

So I would firstly consider whether we are in a Value Cycle or Growth Cycle.

There are thousands of companies out there to shift through so I tend to shortcut this by looking at the compositions of various ETFs for ideas.

The Vanguard Value ETF (VTV) and the iShares Russell 1000 Value ETF (IWD) are some of the largest value-tilted ETFs available. At the moment, they are heavily invested in financials, healthcare, industrials, consumer goods, and energy.

The biggest risk of investing in value stocks is the concept of a “value trap”.

A value trap is a company that looks cheap and is cheap, but ends up being cheap for a reason and thus the fundamentals inevitably fall apart. Maybe the company has too much debt, or a hopelessly outdated product, for example.

Some of the best value investors screen for quality to filter out those types of businesses.

An approach that has been used with success by Joel Greenblatt of Gotham Capital, which he also popularized with “The Little Book That Still Beats the Market”

Greenblatt presents an extremely simple system:

  1. Rank all companies by their price-to-earnings ratio (low to high).
  2. Rank all companies by their return on invested capital (high to low).
  3. Buy the top companies that have the best combination of both (low P/E, high ROIC).

This results in having a couple dozen cheap companies with high returns on invested capital, implying they have a strong business model and economic moat and are unlikely to be value traps. This formula has beaten the S&P 500 for a long time, but like many value strategies has struggled a bit in recent years compared to growth stocks.

The ETF that most closely follows Greenblatt’s type of strategy (that I’m aware of) is the Alpha Architect U.S. Quantitative Value ETF, which is not associated by Greenblatt but has a similar approach.

It applies a quantitative filtering approach to find the top 50 companies that have high ROIC, good balance sheets, and are cheap

Their international version is IVAL, which filters in a stock universe outside of the United States.

Stocks with high shareholder yields are an attractive subset of value stocks, and the Cambria Shareholder Yield ETF (SYLD) passively filters for them. The foreign version is FYLD.

The shareholder yield of a company is the sum of money it is paying in dividends, spending on buybacks, and repaying debt, divided by its market capitalization.

Studies have shown that stocks with high shareholder yields tend to outperform virtually every other classification of stocks over long periods of time.

In addition to generally filtering for value stocks, the emphasis on shareholder yield further filters for companies that have the necessarily catalyst to take advantage of its status as a value stock. In other words, like Altria, companies that pay big dividends or buy back a ton of shares, do fundamentally better when their shares are undervalued compared to when they are more expensive.

And yet like most value strategies, this one hasn’t done well over the past 5 years, even though the backtest shows it would have done amazing over a multi-decade period.

I find that qualitatively looking through companies and performing discounted cash flow analysis on them helps determine which factors are likely to do well going forward, rather than strictly relying on backtesting and quantitative filtering.

And I’m interested in factors that haven’t done well recently, rather than ones that have. Basically, I ideally want to know what the next cycle of outperformance will be, rather than focusing on what has done well recently.

There are all sorts of ratios and metrics that investors can use to determine whether a stock is undervalued relative to the investment returns it is expected to produce.

The most commonly-used one by far is the price-to-earnings ratio, often referred to as the P/E ratio.

P/E ratio of a company tells you very little by itself. You also need to know its growth rate, among other things.

For example, if a stock has a P/E ratio of 10 but is stagnating or shrinking, that might not be a very good investment. On the other hand, a stock that is growing tremendously but has a P/E ratio of 40 might still be an exceptional investment. Clearly, we need to factor in growth.

The famous mutual fund manager Peter Lynch popularized the “PEG ratio” as one of his key stock valuation methods.

You can further improve this with the dividend-adjusted PEG ratio. Stocks that pay dividends usually grow at slower rates, but their dividend makes up for that. The standard PEG ratio doesn’t factor in dividends though.

The dividend-adjusted PEG ratio (which is what I prefer), adds the current dividend yield to the growth rate. In other words, if a company is growing earnings at 8% per year and pays a 3% dividend yield, then you plug 11% into the PEG equation as the growth rate.

For example, consider a stock with a P/E ratio of 16. It is growing at 8% per year and pays a 4% dividend. The PEG ratio would be 16/8, which is 2. However, the dividend-adjusted PEG ratio would be 16/12, which is 1.33, which makes it correctly look a lot more attractive.

There is a range of appropriate dividend-adjusted PEG ratios for companies, depending on how risky they are and what your realistic target rate of return is. As a general guideline, an investor would do well to be skeptical of buying stocks with a dividend-adjusted PEG ratio above 2.

The gold standard for valuing stocks or anything that produces cash flow is discounted cash flow analysis. Pretty much everything else is a shortcut of that method.

The cyclically-adjusted price to earnings ratio, better known as the CAPE ratio or Shiller P/E ratio, is a longer-term calculation for the P/E ratio of a stock or stock market. Useful for knowing where a stock stand in relation to it’s peers.

There are a lot of other valuation metrics available than the ones listed here, including the dividend discount model or the equity risk premium model, as two examples.

Discounted cash flow analysis is the closest thing an investor has to a universal valuation method for anything that produces cash flows, but even that requires some human assumptions and decisions for inputs. These various methods are all short-cut ratios or metrics that are worth being aware of for most investments, and many of them are easier to apply on a broad scale.

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Thank you so very much for your amazing and helpful response Contra. That is the most helpful response i have ever received on any forum. You are outstanding and that has answered my questions perfectly on how to create a criteria or process for Value Investing. My heart goes out to you, thanks so much for such a detailed response, that is very kind of you.

I love the idea of screening through stocks ranked by their price-to-earnings ratio (low to high) and their return on invested capital (high to low). As documented by Joel Greenblatt of Gotham Capital also popularized with “The Little Book That Still Beats the Market” thanks ever so much for sharing this, it really is highly appreciated.

The idea of filtering for value stocks that have an emphasis on shareholder yield further filters for companies that have the necessary catalyst to take advantage of its status as a value stock, is wonderful. Like companies that pay big dividends or buy back a ton of shares, these do fundamentally better when they are undervalued. I really appreciate your thoughts on this, thanks ever so much.

Can i kindly please ask quickly how you can determine if we are in a Value Cycle or Growth Cycle please? Lastly is there a criteria to filter for stocks that might be growth stocks, as i am assuming a low price-to-earnings ratio and high return on invested capital is just for the value stocks. Could this kindly be changed slightly please to look for growth stocks that could beat the market? If you kindly had any thoughts on this it would mean the world to me and i would be forever grateful.

My heart goes out to you Contra thanks for helping get things correct in my mind and build a process for value investing. What a truly wonderful and amazing person, you should win an award on this forum. Wishing you an amazing end to the year and hope you have a fabulous 2024. Very best wishes to you, family and friends. All the very best to you.

I use a Y chart comparing the Russell 1000 Value Total Return (^RLVTR)/Russell 1000 Growth Total Return (^RLGTR) levels.

Shareholder yield looks at all the ways that companies can return capital to their shareholders.

In addition to the dividends that are included in a standard yield calculation, it also includes share buybacks and debt paydown. Since it covers multiple methods that a company can use to return capital to its shareholders, many consider shareholder yield to be a superior measure to dividend yield.

Academic research has shown that stocks with high shareholder yields typically outperform the market over time.

Shareholder Yield = (Dividend Yield + Net Buyback Yield + Debt Paydown Yield)

No individual source is perfect, but all of these tools are powerful sorting methods, and if you find stocks that keep showing up on multiple sources, it is a strong candidate to investigate further.

Magic Formula Investing (
Joel Greenblatt’s Magic Formula Investing website is a great source of stock ideas. Users with a free account can use the screening list to find companies that rank well in his system, which means they have high returns on capital (a metric of quality) and high earnings yields (a measure of low valuation). Using his website, I like to look at companies with a market capitalization over $3 billion that meet his criteria.

One of Greenblatt’s hypothetical strategies involves investing in the top 30 or top 50 on that list, but that can be a very high turnover approach. Investors that want a more buy-and-hold approach can use this list as a starting point for stock ideas while realizing that some of them simply are not very high quality despite having high returns on capital at the current time. and both list returns on invested capital (ROIC) for many stocks. If you are interested in a specific stock, such as Home Depot with the ticker “HD” for example, then google the term “morningstar HD key ratios” and look at their key ratios page for that stock. Their key ratios table has an incredibly helpful set of data in one place. You can also google the term, “HD ROIC guru focus” to get their historical 5-year calculations of a company’s (in this case Home Depot’s) ROIC over the last few years (or up to a decade for premium members).

Other sites to play with are:

Finviz Stock Screener (Free Stock Screener)
On their “fundamental” tab, I like to look for stocks that meet these criteria by default:

• EPS growth past 5 years over 5%
• EPS growth next 5 years over 5%
• Sales growth past 5 years positive
• Return on investment over 15%
• P/E ratio under 30
• Forward P/E under 30
• Price/Free Cash Flow below 30

Value Line Stock Screener (
You can filter for companies that have certain growth, dividend, and value characteristics, among other metrics. I like to look for stocks that meet these criteria by default, although sometimes I remove the dividend metric and increase the growth metrics:

• 5-year dividend growth over 5%
• 5-year book value growth over 0%
• 5-year sales growth over 2%
• Return on equity over 15%
• Current P/E ratio below 30
• Dividend yield over 2%
• Projected 3-5 year EPS growth rate over 2%
• Projected 3-5 year sales growth rate over 2%

Zacks Stock Screener (Stock Screener Tool - Zacks Investment Research)
Zacks Investment Research has a freemium stock screener that includes a
powerful free version as well as extra variables for premium members. This
screener is arguably the best of the bunch. For their free scanner, I like to use
these defaults:

• 5-year historical sales growth over 2%
• 5-year historical dividend growth over 5%
• Current ROI (TTM) over 12%
• Dividend Yield over 2%
• P/E ratio below 30

The reason I use rather low historical and forward growth rates for my screens by
defualt is that I do not want to eliminate cyclical companies that are in a rough
patch currently. Growth rates over 5-year periods can be distorted by
macroeconomic and cyclical events, so I like to keep my results broad and go
through them with my own analysis. However, if I am specifically looking for
growth stocks, I ramp up my growth requirements.

By using several of these sources of stock screening, you can find companies with high returns on capital, reasonable valuations, and various dividend, growth, or quality requirements to narrow down your search to a couple hundred stocks out of several thousand stocks. From that point, the process becomes more hands-on, where you need to read company annual reports and presentations to become familiar with what the company does. You should examine its balance sheet in detail, check how quickly the company is growing, how it is using capital, what the management situation is, and what analysts are saying about it.

Morningstar is a good free or premium source at this point to look at historical
financial statements and valuation metrics in one place. Seeking Alpha and similar websites are worth a read to get qualitative commentary on the company and what their current opportunities and challenges are. Some articles are better than others, but it is important to check what other people are sayingto ensure you are not missing anything unique, and to read opinions on the company that might oppose your view, so you can see all sides of the argument and make a decision.

Valuation is not an exact science; it is a mathematical art. The reason that it is not exact is because the fair value of a company is relative to many variables including your target rate of return, your estimated growth rate of the company’s earnings or cash flows, the quality of its financial situation, and prevailing interest rates over the course of the investment. For this reason, the fair value of a company is best thought of as a reasonable range of values based on a variety of outcomes, rather than a precise value.

The bedrock of valuation theory is discounted cash flow analysis. Even if you
never use it in practice, you should understand how it works. There are many
more straightforward valuation methods that are easier to use in practice but to understand the mathematical art of valuation at its core, you need to understand the concept of discounted cash flow analysis at a basic level.

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Thank you very much Contra for another spectacular and very helpful response, i am very grateful for the time you took to reply. That is very kind of you, thank you from the bottom of my heart.

I very much like the idea of using the Joel Greenblatt’s Magic Formula Investing website. Looking at stocks that rank well within his system, which means they have high returns on capital and high earnings yields. Then it would be interesting to look at other analysts reports and review the company further. Thank you very much for mentioning this, it is highly appreciated.

I thank you very much for also providing the details for Finviz, Value Line Stock Screener and Zacks Stock Screener. I also found it interesting that you use a rather low historical and forward growth rates for your screens as you don’t want to eliminate cyclical companies that are in a rough patch currently. Thanks again for all your help, you have been amazing. I now have some ideas for building a checklist of what to look for in growth and value stocks, thank you ever so much.

Can i kindly ask lastly please what kind of checklist or process do you have when looking through Annual Reports, presentations please, i find this really tricky to be consistent? For instance what examples of things would you highlight as a positive from the company documents and what are some risks that would put you off an investment please? If you kindly had any thoughts on this final question it would mean the world to me and thanks for being a wonderful person.

Sending you lots of good wishes and i hope you continue to generate massive success with your investing. Very best wishes to you and thanks for your wonderful and helpful posts you have made here. All the very best.

I have no set checklist that I follow as I go through reports and presentations, but In general the criteria I am looking for are:

The company has above average returns on invested capital, both in
general and for its industry.
The company has a strong balance sheet and solid historical performance during recessions.
The company benefits from long-term trends and has little foreseeable risk of obsolescence within the next ten or twenty years.
Stable earnings or cash flow and a relatively low multiple of debt to earnings or cash flow.
The company has a durable economic moat so that it can maintain its
high returns for the foreseeable future.
If it pays a dividend does the company has a safe dividend payout ratio so that it does not need to cut the dividend during recessions.
Quality Management and Insider Ownership.

It doesn’t need to tick every box but would need most of these characteristics.

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Thank you very much from the bottom of my heart Contra, you are an amazing person. I am so glad you kindly replied to my post. Happy New Year to you and i sincerely hope you have a fantastic year.

That makes complete sense what you have said about you have a general criteria in what to look for when researching a company. As you mentioned, above average returns on invested capital, both in general and for its industry, a strong balance sheet and solid historical performance during recessions alongside other factors. Thats really wonderful advice, thank you very much.

Can i kindly ask lastly do you use any indicators or charts to see if the S&P 500 could be overvalued please? Like i know you mentioned you use the Russell 1000 Value Total Return and Russell 1000 Growth Total Return to look if we are in a growth or value cycle. Further do you please look at any indicators that might signal we are heading into a recession please? As i note these factors could also influence when you buy Value or Growth stocks. If you kindly had any thoughts on this i would be forever grateful and thankful it would mean the world to me.

Thanks again for being such a rare, kind and wonderful person Contra. You are touching people lives and helping them and i have considerable respect for you. Sending you lots of good wishes and i truly hope everything continues to go well for you.

I pay more attential to fundamentals than technical charts, I focus on long-term fundamentally-driven outcomes, wherever they happen to be. I still use Point and Figure charting!

I look at the whole world and alhough you may get recession in one part, others will see growth. I look at Economic Indicators in the main.

Economic indicators are thrown off by the unusually wide divergence between fiscal policy and monetary policy. Very large fiscal deficits are acting as a stimulating force for many sectors of the economy that are not sensitive to interest rates, while Central Banks tight monetary policy is acting as a recessionary drag on sectors that are sensitive to interest rates.

Looking forward I can see a period of correction or consolidation.
For the US the “Magnificent Seven” Apple, Amazon etc. seem to be running out of steam with only Alphabet being argubly undervalued, but futher growth will probably come from other areas in the market that had been left behind. The test will come in February and March when companies report earnings and in particular as to whether management teams may look to lower the bar on the market’s expectations for earnings growth in 2024 as the rate of economic growth is poised to slow.

Europe is showing more firm recession indicators across the board (weak production and consumption), while China has strong production but weak consumption, in part because it has loose monetary policy and tighter fiscal policy, which is the opposite of the United States which in general has weak production but strong consumption.