Analyzing a Company’s Stock

Stock selection is part art, part science. There are many factors that must be considered when evaluating a company including its finances, the industry it operates in, and various valuation metrics.

Stock selection is part art, part science. There are many factors that must be considered when evaluating a company including its finances, the industry it operates in, and various valuation metrics.

What makes a company a good investment? Investment professionals consider several factors when they’re selecting companies to include in a stock portfolio. Here are some of the criteria they’re likely to use.

A Company’s Finances

A strong financial position on the part of the issuing company can make a stock attractive to investors. Analysts typically look at the company’s cash flow to evaluate how much money the company spends, how much it brings in, and how much “free” cash is left after the bills are paid. Reviewing revenues, net income, and earnings per share helps analysts assess the company’s history of sales and earnings growth. Another gauge of financial health is the amount of debt the company has compared to equity.

A Look at the Business

Stocks of companies that are leaders in their industries generally are desirable choices for a portfolio. Analysts look for profitable companies with limited competition whose products or services are valuable to customers. Keeping an eye on earnings estimates helps analysts determine whether the company is likely to experience rising profits or unexpected slowdowns in the future.

Valuing Stock

Analysts use different calculations to assess a stock’s relative value. Some of the most common include:

Price-to-earnings ratio (P/E) shows the relationship between the current stock price and the company’s projected earnings. The P/E is one of the most widely used ratios, and it is used to compare the financial performance of different companies, industries, and markets. The company’s forecast P/E (its P/E for the upcoming year) is generally considered more important than its historical P/E.

Price-to-book ratio (P/B) is a stock’s current price divided by its book value (i.e., total assets minus total liabilities) per share. Both can help identify potentially undervalued stocks and also may be reliable indicators of investor sentiment. Like most ratios, it’s best to compare P/B ratios within industries. For example, tech stocks often trade above book value, while financial stocks often trade below book value.

Return on equity (ROE) is calculated by dividing a company’s earnings per share by its book value per share. The ROE is a measure of how well the company is utilizing its assets to make money. Understanding the trend of ROE is important because it indicates whether the company is improving its financial position or not.

Dividend payout ratio is calculated by dividing the dividends paid by a company by its earnings. The dividend payout ratio can also be calculated as dividends per share divided by earnings per share. A high dividend payout ratio indicates that the company is returning a large percentage of company profits back to the shareholders. A low dividend payout ratio indicates that the company is retaining most of its profits for internal growth.

The Personal Factor

While metrics are critical to analyzing a company’s stock and whether it may be a good addition to an investor’s portfolio, personal circumstances — e.g., an investor’s other portfolio holdings, goals, time frame, and risk tolerance — should always be considered when determining whether a stock is right for a particular portfolio.

Growth Investing – Your Long-Term Strategy

Growth investing is a strategy in which an investor selects stocks based on strong track records of earnings growth. These stocks generally don’t pay high dividends, but instead reinvest their earnings for the future.

Growth investments are key to a long-term investment strategy. Learn more about using them in your portfolio.

Growth investing is a strategy in which an investor selects stocks based on strong track records of earnings growth. Long-term investment goals are as unique as the people who set them. Some investors set their sights on building a dream home; others may be looking to launch a new business. Still others seek the more traditional long-term goals of a comfortable retirement or funding a child’s education.

No matter how they differ, all long-term investment goals have one thing in common – the need to accumulate wealth. One way to pursue long-term goals is to build a portfolio around a core of growth-oriented stocks.

The Potential Power of Growth

Growth investing is a strategy in which an investor selects stocks based on strong track records of earnings growth. These stocks generally don’t pay high dividends, but instead reinvest their earnings for the future. Such companies typically are well-established, serve growing markets, lead their industries with consistent market share gains and technological innovations, and produce strong financial returns.

Growth stocks are generally differentiated from other stocks, such as value stocks, based on their higher price-to-earnings (P/E) ratios. These measurements reflect how much investors may be willing to pay for a stake in a company’s present and future success. The higher the ratio, the more investors are likely to spend.

While growth stocks tend to be more expensive, history suggests that they have often rewarded those willing to pay the price. While past performance cannot guarantee future results, for the 30-years ended December 31, 2014, growth stocks returned an average of 11.37% per year.

Manage Risk Intelligently

All stocks involve a certain level of risk. That’s one reason why growth stocks may be more appropriate for investors with long-term time horizons. The longer you hold on to these investments, the lower the risk may be that short-term losses will significantly affect your bottom line.

Another way to manage risk is to diversify your portfolio with other types of investments. For instance, consider dividing your stock allocation among large-cap, midcap, and/or small-cap stocks. Then think about adding bonds and cash instruments as well. An investment mix that uses all three traditional asset classes may help you pursue desired returns while maintaining a comfortable level of volatility.

A Sound Strategy for a Variety of Needs

A well-crafted investment strategy built around a core group of growth stocks may help get you well on your way toward your long-term goals – whatever they may be.