If you read the "Funnel Method", you probably realised that in order to invest only in quality companies - we need a filter.
A filter that allows us to exclude poor quality companies from our investments.
That filter is also known as the 8-Point Checklist.
To show how powerful the 8-Point Checklist is, I decided to showcase the companies' performance over 10 years using this checklist.
What I Have Done
The "Funnel Method" starts off with filtering all 500 companies in the S&P 500.
Yup - all 500.
I actually went through every single companies in the S&P 500, and used the 8-point checklist to filter every single one of them (one-by-one).
Can you guess how many companies passed the checklist?
Only 103 companies (at the time of writing this blog post).
Now, let's dive in to see how these 104 companies performed.
What We Found Out.
So to illustrate this point, I added all 103 stocks into my ThinkorSwim Watchlist.
This allows me to quickly go through the stocks to see how these stocks have performed over the past 10 years
Watch the video to see our findings.
So you can see the stocks in the watchlist have an uptrend over the 10 years.
This shouldn't come as a surprise since we are investing in businesses that have an uptrend in earnings.
And as I have always stressed - share price is eventually driven by earnings.
So when we invest in businesses with an increasing earnings trend, we get an unfair advantage to do well in your investments - as long as you have a long term outlook.
However, that does not mean that we invest in these companies right away, because we never want to overpay for a businesses.
That's why, we only want to invest in stocks that are reasonably valued using the Thermostat Method.
You will probably realised that many stocks are overvalued especially during a bull run - for such overvalued stocks, you want to enter cautiously using the Long Call Strategy.
Using call options is great because there is limited risk and yet gives you a leveraged return on your investment. Refer to the Long Call Strategy for a step-by-step guide.
Why The 8-Point Checklist Works
There's one thing about stocks that we have to be absolutely clear.
"Share price is driven by earnings."
What this means is that that if earnings increases over the years, share price will increase as well.
This means that, we want to invest in companies that will have an increase in earnings trend.
This is why one of the must-pass criteria is that the company must have an increasing earnings trend.
I cannot stress this enough.
We want to avoid investing in a business that is not even profitable in the first place.
All 103 companies in this case, have a increasing earnings trend and have a checklist score of at least 5.
Besides an increasing earnings trend, there are a total of 7 other financial ratios that we look at to assess the health of the company such as the companies' debt, cash flow, etc.
If you are not sure what a checklist score means, you might want to take a look at this article in the Stock Investing Hub:
Just a reminder, this case study is accurate at the time of writing (4 Sep 2020) - so if you want to build your own list of stocks, remember to do your own due diligence.
Conclusion
Personally, I do the "Funnel Method" around once a year.
This is because the fundamentals of the company do not change greatly (unless the company suddenly takes on huge debt, which is why it is important to understand the business you are investing in.)
Once I have filtered out the good companies, I then proceed to do the valuations on these stocks in order to decide my strategy.
For undervalued stocks, I will buy and hold them until they reached my exit price.
For overvalued stocks, I will use call options to capture their uptrend momentum.
If you like to find out more, do check out our Stock Investing Hub, where we outline what you need to know our profitable stock investing.
And by the way, if you want a copy of the companies that I have filtered, make sure to join my newsletter - so that you can notified when I publish the list on my website.
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