Keeping It Simple......Part 2


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Last week's column gave 5 questions for investors to ask before they buy or sell a stock.  Here are 5 more to help start any research.  They'll help save a lot of time and more important, money and loss of sleep.

6. What is Price To Book?  This measures the price you pay compared to the amount of equity that's in the company.  Equity is all the money investors have put in plus all the profits.  When you can find a company that is selling for a Price to Book of less than 1, it means you are buying the equity in the firm for less than it's worth.  It's like buying $1 for less than a dollar.  Hard to find these stocks?  Not now in the Financial sector.  Look at Bank of America (BAC).  It's Price to Book is .54.  That means you're paying 54 cents for every $1 of equity.  Of course, investors think there could be many more charges against that equity before the bank stabilizes, but if they're wrong, an investor might be picking up a real bargain here.  Other examples: JP Morgan Chase (JPM) at .89; Citibank (C) at .74. 
7. Any accounting issues?  You don't have to be an accountant to determine if there are accounting problems.  Just look at the headlines.  Every quarter, a public company releases earnings.  It gives all kinds of information in that press release.  If there are accounting issues such as backdating options or restating earnings or changing accountants, they will be part of the news.  Not that the latter two are always bad.  Sometimes earnings need to be restated because accounting standards change or of other, normal industrywide requirements.  But if earnings are restated because of investigations from a regulatory agency or some reason that suggests revenues were overstated (or earnings) due to management discretion, then a red flag should wave. 

Changing accountants, especially after years of being with the same one, may also give pause.  It may mean that the accounting firm won't do what management wants because the accounting firm doesn't think management is telling the whole story.  This is not to say that companies don't change firms for good reasons.  They do (mostly because of cost).  But dig into why accounting firms were changed.  It may be reason for concern.

Accounting issues have a way of lingering....and getting worse.  Don't stay with a stock that has them.

8. How good is management?  Good here means how well does it manage capital, not how nice they are.  Two numbers will tell you a lot: Return on Equity and Return on Assets.

Return on Equity measures how much management is making on the equity it controls.  Equity is what investors put into a company.  It's your money.  When you invest, you want to know how well management is using your funds.  That's Return on Equity.  The higher this number is (expressed as a percent as in 20%....which would be great), the better.  To really measure management, look at the industry average for Return on Equity.  If your stock has the highest for a sustained period it means management is superior.

Return on Assets is another good measure of management.  It tells you how well it's utilizing the assets (such as trucks, machines, computers, etc.).  A high return on assets says management knows what to do with the assets it buys.  Different industries have different levels of return.  In the banking business, a return on assets of more than 1% is considered decent.  In software, the number better be well above 10%.  Microsoft (MSFT) has 19.73%.

It would be great if you could also measure how honest management is.  That would have helped holders of Enron, MCI and Tyco.  But there is no way, and it's only after the fact that we know.  Dishonesty is part of the risk of investing.  Fortunately, it's very rare.
9. How diverse are revenues?  A company that has only one customer can get in trouble quickly.  For example, there are many firms that sell only to the government, local, state or federal.  If that's their only client, then when tax revenues are lean, as they are now, business is hurt, dramatically.  Or if the company sells to one of the departments at the federal level, such as defense, and an administration change occurs, then maybe new politicians will cut back on that department.

The best companies have a wide array of clients, and no one of them represents more than 10% of revenues.  Many great companies also have different sources of revenues that aren't correlated so that when the economy moves down, not all divisions are hurt.  Look at how many customers a company has and how many products and services it offers.  Too few can be devastating in a down economy.  But too many products and services can also make valuations more difficult and keep a stock's price down.
10. Are insiders selling?  Not one or two but all or most of them.  If they're dumping, there's a reason....and it isn't good.  Insiders are officers and directors of the company that know what's happening at the firm.  They make the decisions to make things happen.  They know what will happen, and they know the numbers.  While they can't sell during blackout periods which are around the release of data, they can sell most times during a quarter.  So if all the directors and officers are selling large amounts of stock, beware.  It could mean some bad news is about to descend on all shareholders.  If it's just one or two directors or officers, then it's most likely they're re-adjusting their portfolios, buying a new home, paying taxes or making any other payment that requires a large outlay.  When they all are selling, look out below.

Where can you find these important data or information?  At most financial
Web sites like AOL (AOL) Personal Finance or (NWSA) or Yahoo!Finance (YHOO) or Google Finance (GOOG).  Just look at the links provided and click on them.  It's all in there.

While this list of ten questions isn't anywhere near exhaustive, if you spend the time to find the answers, you'll save yourself a lot of time (and money and grief).  These are simple to answer questions with information on the Internet.  They'll make you a better investor.

- Ted Allrich
November 2, 2010

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks , Investing Ideas

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Ted Allrich

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