While investing can be as complicated as you'd like to make it (stochastics anyone? perhaps collateralized debt obligation swaps instead?), the basics are very simple, especially for stock investors. Here are a few questions you can consider before buying or selling any stock.
1. Does the company sell anything? Laugh all you want, but this one question (and its answer) can save you lots and lots of money...and grief. If you look at most biotech companies, they don't sell anything except hope. They have no revenues, but their stories are fantastic. Investors can get carried away with the promise (not the revenues or profits) of these sometime miracle producers. Most often, the promise turns to pffffft; the stock goes to zero. If a company doesn't have revenues, it doesn't mean you don't buy it (though you should have very good reasons), it only means you buy very little of it....if you must, and you can't help yourself, and you've temporarily lost your investing compass.
2. If it does have revenues, are they increasing? Great companies have a way of selling more goods and/or services every year, no matter what the economy does. In order for profits to improve, sales have to keep growing. But sales growth alone isn't enough. You have to look into how the sales are growing. If the company expands by acquisitions (known as external growth), then there are always integration pains. Sometimes the pains are fatal. The best growth is internal, the kind where a company is selling more of what it makes because the market, and the opportunities, keep getting larger.
3. Does it have any cash? Cash is always good, personal or corporate. There comes a point when too much cash is a problem (see Microsoft, MSFT, in the early part of this decade when investors got upset with the cash hoard). Too much cash means the company can't find enough growth opportunities, internally or externally. Very few companies have this problem. Having a large amount of the green is good. It gives management flexibility to buy back stock, start or raise a dividend, purchase other companies, or increase Research & Development projects. While some debt is desirable because it allows the company to leverage its assets (debt doesn't mean there's no cash, it just means the company has decided not to pay off the debt). Having no or little debt at this point in the economic cycle is great because interest payments are only going higher when rates start their inevitable upward trend. Cash in the bank is very comforting for investors. More cash is better.
4. Does it make a profit? When you know that a stock price is theoretically the present value of all future profits, it really hits home that profits are essential to a stock's (and your portfolio's) well-being. No stock can continue higher if there are no profits, no matter how promising the premise. Without profits, a company can't grow. Investors like to see increasing profits, no matter the economic conditions.
5. Are profits increasing? This is even better than profits. Increasing profits in today's economy tells investors management is capable of steering the corporate ship through the most treacherous waters or that the product or service it provides is immune from economic cycles. Increasing profits should come from increasing sales, not just from cost cutting. While cost cutting is positive and necessary, there is only so much a company can cut. After a while, quality diminishes whether it's in the materials used or the number of workers needed to fulfill tasks. The best increasing profits come from higher sales and lower costs. That shows the company is getting more efficient as it grows.
Where can you find these data points and information? All of the financial sites like AOL Personal Finance (AOL) or Yahoo!Finance (www.finance.yahoo.com)(YHOO) or MarketWatch (www.marketwatch.com) (NWSA) or Google Finance (www.google.com/finance)(GOOG). Just enter the name or symbol of the stock you are investigating, and then open all the links to find what you need.
To summarize: good stocks have sales, increasing sales, profits, increasing profits, and cash.
This is only the beginning of researching a stock. There are lots more questions to ask (next week, I'll give you 5 more). And they're still only starting points, not enough to make a decision on whether to buy or sell a stock. But they will save you a lot of time (as well as money) and help you decide whether the latest hot tip from the shouting head on TV makes sense for your portfolio.
- Ted Allrich
October 26, 2010