Stock market ups and downs.... How to find the "ups" among the "downs" !

Hi Gordon!

Great story! :)

It really shows something... It shows that even when the market indices are down, not ALL stocks are down. In fact, some go up!

If you know how to pick the right stocks, you don't have to fear. You can invest with security and confidence. That's the way I like to invest....

But first, the shocking news! Then I'll explain how to invest with security and confidence. :)

I was shocked about a week ago to read that out of the top 35 or so market indices world wide, about 28 of them were down over the year for 2000. These indices are the famous American ones -- like the Dow Jones indes, the S&P 500, as well as overseas indices, like the ASX index here in Australia. Most were DOWN over the course of the year!

Why was I shocked? It's because I tend to only look at my own stocks.... and all my stocks were up! I had no idea things were so bad, because I was doing so well. I've made great profits over the last year in my stock market investments....

So, while some others are in turmoil, I'm feeling very secure. I invest based on the fundamentals of a company, and I also try to pick companies which are already undervalued in their price.

Here's one example, to help explain things..... I don't invest very often, but when I do I first do my homework.

My last investment was to buy shares in Resmed (RMD) -- listed on both the NYSE and also on the ASX in Australia. Look it up if you like.

In the FIVE months I've had Resmed shares, they've gone up in price around 48%. You can look it up yourself on one of the various stock market web sites. I'm quite happy about that.... and I STILL think they are undervalued, so I'm holding on to my shares.

In fact, ALL my shares went up (in Resmed, and in the other companies I have shares in). I just mention Resmed because it was my most recent purchase. (It was also my best performer, though the others weren't far behind.)

Here's how I invest with security and confidence, for those who might want to try this approach too....

First, I like to take a long term view. I see purchasing shares as buying a part of a business.

If I bought part of a small business, I probably wouldn't buy it one day, sell it the next, then buy it again. I'd probably hold it for a while, and I treat shares the same way. That's because, buying shares really is buying part of a business.

Secondly, I check to see if the company is making a profit. (You can find this data in their annual financial reports, often bundled in with the annual report.)

If the company isn't making a profit, I immediately reject it. It may mean I miss out on some profits, but I like to look for safety and security in what I buy, so I look for companies which are already making solid profits.

(I didn't buy any internet shares based mostly on this. I saw that most of them weren't making any profits, and that they were speculative buys, so I didn't buy any of them.)

Thirdly, I look at the company's profits for the past 5 to 10 years. What's the trend? Do their profits stay the same? Do they go in a cycle? Or do they keep going up? I look for companies whose profits have a trend of going up EVERY year.

Fourthly, I try to figure out why the company's profits keep going up. Is there a logical reason for it? If so, is it likely to continue? That is, I really try to understand the guts of the business.

Fifthly and finally, I do some calculations, based on the tables you can find in the back of "The Warren Buffett Way" by Robert Hagstrom, Jr. Unfortunately, he doesn't really explain what he's doing there, I had to go through it and figure it out myself.... The point of this step is to see if the company is undervalued or overvalued. If it is significantly undervalued, then I'll consider buying it, but if it is overvalued, I don't.

For example, let me go through it using Resmed as an example.

I did my own analysis of Resmed around six months ago. Here are the conclusions about Resmed which caused me to buy shares in it....

I got Resmed's annual report -- available free from their web site, www.resmed.com . Many listed companies nowadays have their annual reports available online in PDF format.

I checked if Resmed was making a profit, and they were. They passed that test!

Then I looked at their past profits. I calculated at the time that Resmed was INCREASING its profits by an average of about 40% every year. That's a very big increase! Another pass!

Then, I looked more closely at Resmed's business. They are the second largest manufacturer of devices which help with a problem called sleep apnea. That's a medical condition where you stop breathing in the middle of the night, it's often associated with snoring. (Their main competitor is a company called Respironics.)

Anyway, sleep apnea is a problem which could not be treated until very recently, with the invention of these devices. Sleep apnea is a relatively common problem. Because of this, the market for these devices is huge, and that's why they have been selling more and more of their devices every year.

I felt that this was the main source of their increasing profits every year. I think they are still a long way from saturating the market. By my estimates, the market should keep growing for a long time to come, as awareness of these devices increases.

Lastly, I did my financial analysis, to see if Resmed was undervalued. My analysis said it was, so I bought the shares! Although they've gone up in price by about 48% since I bought them, I still believe Resmed shares are significantly undervalued, based on my analysis....

I hope this helps you to also invest with security and confidence too.... :)

Here are the steps again....

1. Take a long term view. Intend to hold your shares for five years or more.

2. Is the company making a profit? If NOT, reject it.

3. Is the company increasing its profits every year? If NOT, find one which is.

4. What is the reason WHY its profits increase every year? Try to understand it. Does it seem likely that the profits will continue to increase?

5. Calculate to see if it is undervalued. If it is significantly undervalued, then buy!

By the way, Steps 4 and 5 are the toughest parts for most people. Almost everyone can do steps 1 to 3.

If you can't do step 4, and don't understand how the business works and why their profits are increasing, then it is probably better to look at businesses you feel that you can understand.

Even if you can just do steps 1 to 4 (without step 5), you'll still probably do alright if you take a long term approach, and hold them long enough, and if you didn't make any big mistakes in your analysis.

But if you're mathematically inclined, you can do step 5 by looking at the tables in the back of "The Warren Buffett Way" and trying to work out what he's doing.

Or alternatively, if you have problems with step 4 or 5, you can invest in my upcoming investment company. :) Gordon recommended that I start one, and I'm going to do it!

Happy investing in 2001, with security and confidence!

Oh yes, and when the market is down, it can be a good time to pick up some bargains.... :)

- Dien Rice