I wanted to present you with one more gem from my friend Nancy
Zambell. This is probably one of the best articles written on the
key metrics necessary to evaluate small cap stocks. Follow the
advice below and you will be well on your way to finding a few
hidden gems in the small cap market.
You only need to turn on the TV to see gurus and best-selling
authors who can't wait to sell you their latest stock market
gimmicks that promise you "instant millions." Their 'guaranteed'
technical trading systems, proprietary methodologies, complex
economic models, and even some that chart astrological systems, are
generally not worth the paper they are written on.
In my years of investing, I have yet to see any of these "systems"
consistently beat a good old-fashioned look at a company, its
industry and how it relates to the current and projected economic
If a business is fundamentally strong (i.e. it actually makes
money), has a diversified product line, and is in a solid position
in its market, you are 90% of the way to finding a good investment.
The remaining 10% is just a matter of looking at a few parameters -
no matter what the company does - to determine if it's the best
stock for your investment dollars.
In this column, we'll review seven key metrics that should be
reviewed before buying any stock. These indicators should help you
get most of the way in understanding a company, its operations, and
its underlying business.
. Pension funds, mutual funds, hedge funds, insurance companies and
corporations that buy and sell huge blocks of shares can create
tremendous volatility in prices. To lessen this risk in your
investments, try to buy shares in companies where institutions own
less than 40% of their shares. You can find this information at
, in the Institutional Holders section.
. Another indication of future share volatility is the number of
Wall Street analysts covering a stock. Analysts - like the big
institutions - have a herd mentality. When one sells, so do the
rest, resulting in great numbers of shares changing hands, and
usually leading to price declines. It's best to avoid companies
with more than 10, or fewer than 2 analysts following them. (You
need some analyst interest or you may be waiting a long time for
price appreciation, even in the strongest and most undervalued
company) . You can locate the number of analysts - and which firms
they work for - at
; then select Analyst Opinion.
Price-earnings ratio (P/E)
. The price of one share of a company's stock divided by four
quarters of its earnings per share, the P/E ratio is of utmost
importance in determining if a company's shares are over- or
under-valued. For the best perspective, go to
, then select Ratios and compare the current P/E of the company to
its average P/E for the last 3-5 years, to its estimated future P/E
and to the average P/E of its industry or sector. One note: If a
company's P/E is more than 35, it might be too pricy. You may want
to stick with companies that are trading at lower P/Es,
particularly if you are fairly new to investing.
4. Cash flow. One of the most important parts of a financial report
is its Statement of Cash Flows, which is a summary of how the
company made and spent its money. Go to
, Financials, then to Cash Flow and select Annual or Quarterly,
depending on which period you want to review. Then find Total Cash
Flow From Operating Activities, which represents the cash the
company took in from its primary business operations. If it sells
clothes, it's the cash collected from selling clothes.
It's important that this number be positive, or at least trending
positive over the course of a year. After all, if the business
isn't making money from its primary product - not from investing in
real estate or the stock market - then you probably want to pass it
5. Debt/equity. This ratio is how much debt per dollar of ownership
the business has incurred. Compare the firm's historic debt/equity
ratios, so you can find out if its debt level over the past few
years has been rising too rapidly. Debt isn't bad, as long as it is
used as a springboard to grow sales and earnings. Next, contrast
the company's ratio with its competitors and its industry so you
can further determine if your company's debt position is
reasonable. These ratios can also be found at
, under the Ratios tab.
6. Growing sales and income. A rule of thumb that has always served
me well: Buy shares in companies whose sales and net income are
growing at double-digit rates. I cannot emphasize this enough, as,
appreciation in stock prices is generally precipitated by growth in
earnings (which usually follows expansion of sales) . It's
certainly possible to buy stock in a company that has no earnings
growth (a new business, or a tech company in the late 90's, for
example) and still make money on the shares - short-term - but it's
not a formula for serious, successful long-term investing. This
ratio can also be found on
, on the Ratios page.
7. Insider activity. Investors will also want to review the buying
and selling activities of a company's insiders - its top officers
and directors. A sudden rush to sell large quantities of the firm's
shares may be a good indicator that the business is falling on
rough times. Likewise, a large increase in purchases may mean good
news is on the way. The website,
, under the Insider Transactions tab, lists all the recent insider
activity at the company, as well as the number of shares remaining
after the sale - an extremely important figure.
I would like to leave you with one last thought on using these
indicators: Remember that no one ratio will determine the validity
or potential of your investment. It is of utmost importance that
you take a complete look at a company's financial strength and its
future prospects, by conducting a thorough analysis - over time -
usually a 3-5 year track-record.
With these 7 critical factors in hand, it won't be long before you
feel very comfortable in analyzing stocks in almost any industry.