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Financial consultant relies on economic profit analysis to find value stocks

Aman Raina, 41

Occupation

Financial consultant

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Portfolio

Includes shares in Johnson & Johnson, McDonald's, Broadcom, Potash Corp., Tiffany & Co., Apple and Teva Pharmaceutical Industries; also includes exchange-traded funds such as iShares MSCI Emerging Markets Index Fund

The investor

In 1996, Aman Raina got a job working at the Toronto Stock Exchange, where he witnessed "Bre-X stock plunge from $10 to 50 cents within milliseconds during one fateful afternoon." That environment motivated him to elevate his investing knowledge beyond the finance textbooks he had read in university.

The end result was the development of a database that calculates economic profit (EP) for individual public companies. EP deducts the cost of capital from profits. It shows how much wealth a firm creates or destroys when it strives to generate earnings.

How he invests

Mr. Raina seeks to invest in companies with consistently positive EP, particularly if they are well managed and dominant in their industry. They should also have minimal debt and goodwill on the balance sheet.

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Gauges of market sentiment, such as ratios of put-to-call options, are used to identify positive-EP companies that are unpopular. "When I find these great companies, I try to buy them when they are on sale – this normally occurs when markets are down or companies are out of favour with analysts on Bay or Wall Street," he explains.

After purchasing a stock, Mr. Raina sets the maximum loss he is willing to take. "The reality is you will make investment decisions that will not go the way you expected, so you need to manage the loss.

"When I don't have the time to read financial statements and I want to get exposure to a certain market, I will use simple, low-cost ETFs."

Best move

"Buying oil stocks in the late 1990s when oil was at $10 a barrel."

Worst move

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Buying Mega Brands Inc. at $24 (prior to a 1-to-20 share consolidation) and averaging down during the decline (in the days before he used loss limits).

Advice

Use EP analysis to identify companies that are truly creating wealth for their shareholders; use an understanding of investor psychology for entry and exit points.

"Once you build the core knowledge, it becomes an iterative process that can be done in minimal time," Mr. Raina says. For more detail on EP and sentiment indicators, see sage-investors.com.

Special to The Globe and Mail.

Want to share our strategies?

E-mail mccolumn@yahoo.com

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