Okay, so you are looking over some companies that you think would fit great in your stock portfolio… but how do you know if they are undervalued or not? After all, you probably don’t have access to a Bloomberg terminal (like myself), so all you really have is the internet. Is this enough? YES!

Don’t let the experts tell you what you are capable of in estimating value. I’m going to take you through a typical Rule #1 valuation, a method that I use frequently, and often prefer over the technical discounted cash flow model. So lets get started buying a dollar of value for fifty cents, always following rule #1, “don’t lose money!” Let’s find a good stock first…

1. Does this business have meaning to me?
Never, (and I mean never!) should you buy a company that you don’t understand. If you are buying shares of a company’s stock, you better actually want to own a piece of it. We have to think like owners. If you read something amazing on Yahoo Finance (or wherever you are searching) about how fast X-firm is going to take off… don’t think you are smarter than the market by buying it up when you don’t know squat about what they actually do. I’m into technology, so I am going to buy lots of tech companies like Apple and Google. If I like dining on weekends, I’m going to look at restaurant stocks like Cheesecake Factory and Applebees. If I’m a rock star (or at least think I am), I’m going to look into the likes of XM and Harley Davidson. Throw the “portfolio diversification” myth out the window, if you don’t understand what you are buying, you might as well kiss your gains good bye.

2. Does this company have a “moat” (a future guarantee)?
As Phil Town, author of “Rule #1,” found it… a moat can be one of five things: brand, secret, toll, switching, and price. Basically, these are factors that say hey, this is a unique company, and they have something special that means they will be around ten years from now. The most common is a brand moat. Harley Davidson may not offer the cheapest or fastest bikes, but nothing is more of a status symbol if you love to ride. You are going to buy a H-D because of the brand, there is their moat. A secret moat can be considered like a secret recipe, something unique like a new technology (think Intel) that nobody else can do quite right. A toll moat is when a business has exclusive control of a market, such as a your local utilities company. A switching moat occurs when a business has become so integrated with your life that you can’t let go. Think about Microsoft (in the good old days), when almost every piece of software was essentially tailored for their systems. Finally, a price moat happens when a business offers prices so low, that others just can’t compete. That’s right, Wal-Mart. Find a stock with a good moat, and you are well on your way!

3. Does this company have good management?
How exactly can you figure out if a company has rock-solid leaders or not? Stalk them. There, I said it. As investors, we need to know who is handling our money. Is the CEO someone who is going grow our investment as if his life depended on it, or is he going to be the overpaid manager looking to get in and get out. It’s easy enough to find the name of your CEO, now run a Google search on him/her and see what you can dig up. We are looking for an honest worker who sincerely wants the business to succeed. If they’re in the original family, its looking good; but even if they’re not, we need to see someone who releases quarterly notes to the investors saying where they went wrong (if anywhere) and how they are going to fix it. What we don’t need is someone telling us all the great things they accomplished while “forgetting” that their growth margins fell off a cliff.

4. Is the company a “performer”? Are they undervalued?
Once you have a company that you are confident in, you need to look at its numbers. Plain and simple, they could be the most amazing company in the world, but if they cannot produce gains we want nothing to do with them. In part 2, we will discuss the actual evaluation. But before doing that, we want to know if its even worth our while.

The five numbers we need to look at in order of importance are: ROIC (return on invested capital), Equity (or book value), EPS (earnings per share), Sales and Cash. We need to look at the growth rates and see if the company is turning profits year-over-year. Basically, we need an annual growth rate of 10% or more in each category every year for the last ten years. If we can’t get close to 10% in at least 4-out-of-5, then we move on to a different company. Getting these numbers is best done through MSN Money or Yahoo! Finance. Lets head on over to part two so we can get our target price and appropriate purchase price.

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