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1. Time to Build Wealth
2. 10 Gems for Value Investor
3. Shorting Stocks
4. How to Invest $20, $100, or $1,000+
5. Stock Pricing Theory
6. 18 Warning Signs to Dump A Stock
7. Investing in Tech Stocks
8. The Michael Murphy Approach
9. The Essential 6 Point Check List
10. The Three Almost Bulletproof Investment Strategies
11. Sell Alert Spreadsheet
12. The Motley Fool Rule Maker
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The Michael Murphy Approach for Tech Stocks |
Philosophy and Universe
The U.S. is undergoing a major revolution in which technology is the major economic driver. Therefore, technology stocks will be the major area of growth. Investors should focus on a small list of superior companies with rapid growth and excellent financial ratios, then wait for them to become cheap.
Criteria for Initial Consideration
- R&D spending of at least 7% of revenues
- Sales growth of at least 15% per year
- Pretax profit margins of 15% or better
- Return on equity (aftertax profits divided by shareholders equity) of 15% or more>
Valuations
Use a company's price-to-growth-flow ratio to determine value:
- Per share R&D + EPS = Growth flow
- Price ÷ growth flow = Price-to-growth-flow ratio
Guidelines for judging price-to-growth-flow ratio:
- Fair: 10 to 14
- Cheap: Below 8
- Expensive: 16 and above
Other guidelines:
- If price-to-growth-flow ratio is a small fraction of price-earnings ratio, the market is most likely mispricing the stock by placing too much emphasis on current earnings.
- If the price-earnings ratio is below the percentage of sales spent on R&D, the stock is worth a look.Pay attention to the actual dollars being spent on R&D. As the sheer dollar amounts get larger, there are few companies that can afford to spend at those levels, which means less competition.
Controlling Risk
Measure the downside risk by taking the average of three worst-case valuation estimates:
- The price-to-sales ratio drops to 1.0
- The price-to-book-value ratio drops to 1.5
- The price-earnings ratio drops to one-third of the growth rate for the last three years
Determine the price to which the stock would fall under each of these scenarios, and take the average of the three. The difference between the current price and the downside price, divided by the current price, produces the percentage risk of the stock-in other words, the percentage amount the current price would fall if the worst were to happen. The lower the percentage risk, the better. A downside risk of 50% is common, and a good buying opportunity is when the downside risk is only 25%.
Portfolio Building
Build a portfolio of 10 to 20 stocks, and make sure to diversify among the seven major groups of technology stocks:
- Semiconductor equipment producers (companies that make the equipment that makes semiconductors)
- Semiconductor producers
- Large computers
- Personal computers
- Software
- Communications, including data communications (computer-to-computer data) and telecommunications
- Medical technology, including both biotechnology and medical devices
To keep the portfolio to a manageable size, add proportionately to existing holdings when adding new money to your portfolio, rather than buying new stocks. If you feel you must buy a new stock, sell your least attractive stock.
When to Sell
On the upside:
Sell if the stock's price-to-growth-flow ratio gets as high as the growth rate. In general, however, sell only when there is a better stock to buy.
If a stock grows so much it represents more than a third of your portfolio, trim it back and reinvest the proceeds in your most attractive other holdings.
On the downside:
If prices fall and the stock is still attractive on a price-to-growth-flow basis, buy more. However, if fundamentals have changed, or management appears to be failing, sell.
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