Top tips for investing in shares

I love the outdoors. I grew up in Alaska and every weekend during my high school years and university I was out in the wilderness. I loved everything: backpacking, mountain biking and especially hiking big mountains. After a while, I decided to combine my love of travelling with hiking. The first international mountain I hiked was Mount Fuji in Japan. Fuji then led to a trip to Mount Kilimanjaro in Kenya and then to the tallest and toughest mountain to date: Cerro Aconcagua in Argentina. 

What I've learned from hiking these mountains is that more effort goes into preparing for the climb than actually doing the climb. By the time you take your first step up a mountain, especially a big mountain, you've already climbed it in your head 100 times. You've put in long hikes on other mountains to prepare your legs. You've studied maps and maps and maps on maps. You've purchased gear, tested the gear and packed it all neatly away in a large backpack. Before you go out and hike a big mountain you know that mountain intimately.

Similarly, before you go out and buy shares in a company, you need to know that company. Buying single shares is an upfront endeavour — you'll need to do most of your work before buying anything. Do the research beforehand and you'll make the most informed decisions you can, giving you the greatest chance at investing success.

How I invest in single shares

When I invest in shares for my long-term portfolio, I look for high-quality companies. I define the best businesses as ones that have strong, almost monopolistic positions. Warren Buffett calls this 'moat'. I want companies that have high barriers to entry, are popular brand names that I know and like, have cash-rich balance sheets, can scale, have strong organic revenue and have pricing with predictably high returns.

These businesses are more often than not gatekeepers and industry leaders. They are the top companies in their industries and therefore their returns are more predictable and repeatable.

Here are my tips for picking single shares.

Invest in companies you know and like

I don't always invest in companies I like, but I do start my selection process with ones I like. To go from a company I personally like to a company I buy, that company has to flow through a few other value-based metrics as well. Companies that I like include Apple, Google, Costco, Amazon, Chipotle, Uber, Airbnb, Microsoft, Mastercard, Visa ... and more. What companies do you like as a consumer? Perhaps ones that you use daily or weekly? That could be a starting point for your watchlist.

Buy high-quality companies and focus on long-term durable earnings and cash-flow growth

This may seem obvious, and it may also seem like everyone is doing this, but many investors put most of their focus on the P/E ratio alone and ignore the other ratios. This is fine, and it can work — it just isn't the same thing as buying shares in high-quality companies while focusing on long-term durable earnings.

P/E talks about the price of a company, but as we know, price isn't everything. A Ford car is going to be cheaper than a Ferrari. That doesn't mean it is better. A P/E under 20 is deemed a good value, but that doesn't mean it's a good buy for your portfolio.

Warren Buffett often said at Berkshire Hathaway annual meetings that it's better to buy a great company at a reasonable price than a reasonable company at a great price.

So, in both Berkshire Hathaway's portfolio and my personal portfolio and watchlist there are companies trading at higher multiples than other shares out there because I sometimes buy companies that are more expensive if I am basing my value off the next 12 months' earnings per share. I try to have a longer-term EPS outlook — again, this is because I prioritise the quality of the company along with earnings and cash-flow growth.

Instead of buying a stock because it is cheap (according to the P/E ratio), I look for and buy shares in companies that have proven to compound their earnings year-on-year. I call these companies 'compounders'.

When looking for a compounder, I aim for the following:

• Return on capital invested: 20%
• Gross margin: above 55%
• Operating profit margin: above 20%
• Cash conversion: above 85% — the more above 85% it is, the better
• Interest cover — a debt and profitability ratio used to determine how a company can pay interest on its debt. I like to see a ratio of more than 10, indicating that the company can pay its debts easily.

To find interest cover, look at the company's financials, find the EBIT (earnings before interest and tax) and divide it by the interest expense. For example:

COST (Costco):

EBIT 9,248,000/571,000 (interest expense) = 16.19

Costco meets the threshold of being over 10 so it fits this criteria.

Most of these markers and financial ratios can be found on websites such as Yahoo Finance, or a share screening website such as finviz.com.

Company shares aren't always cheap, so buy them when they are

Because compounder companies are more often than not gatekeepers and industry leaders, they are not cheap with regard to their P/E, but over the long haul they should prove to be great investments. Every once in a while you will be presented with a buying opportunity to scoop up a company on your watchlist for a lower-than-the usual P/E ratio, and you should be ready to buy when that opportunity presents itself.

I still find it hard to figure out when to wait for the share price to dip and when to dollar cost average into shares. Typically, when the media is calling for a recession I have to fight the urge to hold cash and wait. For example, during the entire 2023 investing year the media was calling for the recession that never came and many people left great buying opportunities on the sidelines.

Look for dip buying opportunities

When I look to add a company to my portfolio from my watchlist, I typically just buy an allotment and then hold some cash back and wait for a dip in price. So, if I want to buy $10,000 of a company, I might buy half today to get started and then look to add the other $5,000 on a dip.

Many dips happen within a day or so after a company reports earnings. Even when a company has good earnings the stock will often fluctuate. So being ready to buy after quarterly earnings is something to look for. The dip I'm looking for might be if the share price falls to the 50-day moving average (MA). To find the 50MA, go to your favourite finance website, pull up the chart and select the 50MA indicator. Come hell or high water, if a share on my watchlist falls to the 200-day MA I will borrow money from my neighbours, cousins - little sister if I have to - to add into a position I am confident is a good buy.

This is an edited extract from The Quick-Start Guide to Investing (Wiley $32.95), republished with permission.