Which Stock to Buy?
A framework to make decisions
Hi Partner 👋
I’m Pieter and welcome to a 📈 paid edition 📈 of Compounding Quality.
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Investing is simple, but not easy.
How can you decide which stocks you should buy?
Let’s figure it out together in this article.
Step 1: Start from the Buy-Hold-Sell List
We love buying quality companies at the right price.
But even great companies can be bad investments if you pay too much.
Let’s take Walmart as an example.
In 2000, Walmart was already a great business.
The only problem with the company? The stock was very expensive.
If you bought at the top, it took over a decade (!) to get your money back.
This while Walmart’s intrinsic value tripled.
So, which companies should appear on your radar?
We've got you covered.
We made a Buy-Hold-Sell List with nearly 150 quality stocks.
19 stocks are currently undervalued according to our valuation metrics:
(Click on the picture to expand)
Step 2: Pick your interesting companies
You already have a list of interesting companies trading at attractive valuation levels.
The next step is to see which companies interest you.
For each company on the list you should ask three questions:
Do I understand how the company makes money?
Does this company interest me?
Can I make an educated guess about where this company will be in 10 years?
If you say 'no' to any of those questions, skip that company and move on to the next one.
The most interesting companies according to me?
Adobe, Domino’s Pizza, Fortinet, Kainos Group, Lululemon Athletica, Qualys and Visa.
Adobe: Makes software for creating and editing photos, videos, and graphics
Domino’s Pizza: Delivers and sells pizzas and other fast food around the world
Fortinet: Protects computers and networks from hackers and online threats
Kainos Group: Builds software and provides IT services to help businesses work
Lululemon Athletica: Sells athletic clothing, like leggings, for workouts
Qualys: Helps companies find and fix security problems in their online systems
Visa: Lets people pay for things using credit cards, online, or apps
These companies are within my circle of competence and might be attractive to invest in.
Step 3: Make a comparison
To measure is to know.
Now we are going to compare the stocks we selected.
This comparison will help you to see which company stands out.
We will give each company points depending on their performance on each metric.
This will help you find the best company to buy right now.
1. Balance Sheet
We love to invest in companies with a healthy balance sheet.
Companies with a healthy balance sheet? Fortinet, Kainos Group, Lululemon Athletica, Qualys, and Visa (goodwill is not too much).
Companies with quite some leverage or goodwill? Adobe (a lot of goodwill) and Domino’s Pizza (quite some debt).
1 Point = Fortinet (+1), Kainos Group (+1), Lululemon Athletica (+1), Qualys (+1), and Visa (+1)
0 Points = Adobe and Domino’s Pizza
2. Capital Intensity
The less capital a company needs, the better.
Companies with a low capital intensity? Adobe, Domino’s Pizza, Kainos Group, Qualys and Visa.
Companies with a high capital intensity? Fortinet and Lululemon Athletica.
Every company gets a point except for Lululemon and Fortinet.
2 Points = Kainos Group (+1), Qualys (+1) and Visa (+1)
1 Point = Adobe (+1), Domino’s Pizza (+1), Fortinet, and Lululemon Athletica
3. Capital Allocation
Capital allocation is the most important task of management.
Look for companies that put shareholders' money to work at attractive rates of return.
Every company mentioned in the table above has a ROIC > 15%.
The company that stands out?