How do the pros find good stocks that make them big profits? What are the steps in good stock picking?
Warren Buffett, the second richest person in the world and super-investor, uses a set of questions to judge a stock even before valuing it. If it doesn't meet his checklist, he stops there and moves on. He has passed up a number of successful businesses- even Walmart- because they weren't in his "circle of competence", or didn't meet his strict criteria.
Here are two of the questions he might ask to see if he understands the business. In addition, I have included two companies that satisfy the questions and could be strong stock picks for your portfolio.
1) Is the stock a commodity-type business or does it produce something unique and specialised?
Commodity businesses are predominantly driven by product price and discounting. Miners BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) are successful companies, yet they have no control over iron ore or coal prices. They're price-takers that have to follow the dictates of global supply and demand.
On the other hand, Sirtex Medical Limited's (ASX: SRX) specialised liver cancer treatments are made only by the company, so Sirtex can charge a premium for the product. Buffett usually likes to see big profit margins and protective barriers around the business.
CSL Limited (ASX: CSL) is also unique with its specialised blood related products and vaccine development. The biotechnology company regularly records net profit margins of over 20%. The stock is on the rise and could be a good investment choice.
2) Does the business fulfil a repetitive need and have brand-name appeal?
This time the products may not be one-of-a kind, but they have been linked to the company's strong brand name. Ansell Limited (ASX: ANN) easily comes to mind thanks to its latex and plastic gloves as well as other protective wear products. Hospitals, for example, can go through many boxes of latex gloves every day, so Ansell has great repeat business. The company is also a global supplier and market leader in most of its product categories.
SEEK Limited (ASX: SEK) has the number one brand name for job search websites – seek.com.au. Many people visit the site repeatedly, to keep up with the latest job listings. That drives advertising revenue and attracts even more new job listings to the site. The company is also known for its high margins and strong earnings growth (usually over 20%). Currently expanding into Asia, Seek has very attractive growth prospects.
