How do you do value investing? The first step of my method: why filtering is crucial

Welcome to the first chapter of a journey into the heart of my way to do value investing. I have read and listened a lot about value investing over the years, and I always wanted to know more about how - in a concrete and practical way - some investors shaped value investing theories in their daily lives and in the valuation of companies. It is very fascinating to talk about "competitive advantage" or "margin of safety"; but in reality how to do it? I, like almost everyone else, have learned my own way of approaching this universe. A personal, subjective, imperfect and constantly evolving method. Today, I'm pulling back the curtain on the initial phase of this five-step process for evaluating the stocks of listed companies. I hope it can be useful to someone in improving or defining their way of investing in stocks for the long term. First of all, it is good to note that Mr Market does not only offer large companies such as Google or Tesla, which are constantly talked about. Even an expensive and overly optimistic market may have some sectors or companies that do not enjoy much publicity and go through a "sale" period. This allowed me to gain at times, but it also made me lose by underestimating the reasons behind this moment of market unfavorability, reasons which perhaps persisted over time and further depressed the share price. In any case, there is an ocean of opportunities ahead and we will see in this article how to make it more concrete and within our reach.

Part 1: The Essential Filter

The first step in my approach is akin to setting a sieve beneath a waterfall of opportunities, catching only those that meet specific, stringent criteria. This filtration is critical; it's the foundation upon which all subsequent analysis is built. My trusted ally in this endeavor is the comprehensive database provided by Financial Times' Markets Data. It is easy, accurate, and fast. Here the filters I apply for my research.

The results of this filtration process are meticulously logged into an Excel spreadsheet. This document becomes a living record of stocks I want to track.

Part 2: Analytical Deep Dive

With a curated list in hand, it's time for a more granular analysis. Here, I delve into the financials, seeking answers to a critical set of questions:

Revenue Resilience: Are the company's revenues stable/growing year over year?

Earnings Evaluation: Does the company ensure high and, ideally, increasing earnings and gross margins? Are fixed costs relatively small and under control (both as % of revenues and as absolute amounts)?

Cash Flow Consideration: Is the Free Cash Flow to the Firm (FCFO) robust when compared to earnings, dividends, and FCFI? Debt Analysis: Is the level of debt under control when compared to FCFO? How is the current ratio? How is debt evolving over the years? I also apply another ratio that is for me a proxy of the worst case scenario (a sort of Covid-19 situation): no revenues but still a lot of costs. I call it "Equity Coverage" and it is: (2/3 of COGS + Fixed Costs + Interest Expenditure) / Equity. It could be expressed in years. Certainly in current times it is also important to know the type of debt contracted by the company: its maturities and whether it has a fixed or variable rate. The constant increase in interest rates has already driven many companies with high debts and low margins out of the market.

Part 3: Understanding Risk The final piece of this initial puzzle is to revisit the market price volatility and change. . Coupled with the most recent news, this analysis helps to identify any immediate red flags that could signal a decline in the stock's value. Especially News: I've undervalued bad news impact over long-term prices of stocks. It is important to understand the overall risk behind some news and recent dynamics that are having an impact on company results. Always ask yourself: are there recent developments or news that could impact the stock price or indicate potential risks?

The Purpose of this Filtering

This first step is a safeguard, a means to separate the wheat from the chaff. In a world rife with investments that could turn worthless, this filtering process is my due diligence to avoid the pitfalls of poor choices. It's not about finding the perfect stock but eliminating those that could jeopardize the integrity of my portfolio. MY RULE NO.1: avoid to buy s***, reaching this would be already more than 50% of the job.

A Word of Caution

Before I conclude, let me be clear: I am not a professional investor. The insights I share are born from personal experience and a deep-seated passion for value investing. This article is not an investment recommendation; it is an expression of my investment philosophy and approach. It is not tied to any economic interest or business—it is a hobby, a personal pursuit shared in the spirit of education and community.

Investing is a personal journey, one that carries inherent risks. Always conduct your own research and consult with a financial advisor before making investment decisions.

Thank you for joining me on this first step. Stay tuned for the next installment, where we'll delve deeper into the art of value investing.