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What's the single most important thing to know about a company
before you buy its stock?
- Bea, Richmond, Va.
This week's question will be answered by
StreetAuthorityinvestment analyst David Sterman:
A. Bea, that's a great question, and I had to chew on that one
because there are several ways to answer that.
For professional investors such ashedge fund managers andmutual
fund managers, the answer is a simple one: quality of management.
These investment pros spend a huge amount of time getting to know
management teams, watching their words and actions quarter after
quarter. By building up a long-term relationship with CEOs and
chief financial officers, they can better understand the company's
vision -- and its ability to execute on that vision.
In fact, it's probably the single greatest investing factor for
investment legendWarren Buffett . Whenever his investment firm,
Berkshire Hathaway (NYSE:
, acquires a company, Buffett is quick to point out the quality of
the management team. Indeed, he insists that these managers stick
around, and keep running the acquired business.
Of course, most of us don't have the executive-level connections
to really assess the quality of management. But here's what you can
do. Listen to what management has said in the past, and see if they
have delivered on their promises. The easiest way is to listen to
the company's three or four most recent conference calls and listen
to the goals and expectations that management lays out for the
company. In subsequentquarters , management should be explaining
how it was able to meet its goals, and not simply apologize for
missed targets. "We'll do better next time," is an oft-heard
refrain from bad management teams. Seasoned investors know that
"next time" never seems to arrive.
But if you don't have the time or inclination to wade through
long conference calls, there is one crucial step you can take to
find winning investments: In a nutshell, the best companies get
high marks for both their balance sheets and theircash flow
Starting with thebalance sheet , it's always wise to focus on
companies with an ample amount ofcash and a manageable amount of
debt. (A good rule of thumb is to look for cash that is at least
twice as much aslong-term debt ). This kind of financial strength
ensures that the company will be able to weather any economic
downturn. Recall that automaker
carried way too much debt when the globaleconomy tumbled in 2008,
and eventually had to declare bankruptcy.
But you also want to be assured that a company's balance sheet
will be getting stronger in the years ahead, and not weaker. And
that means a solid history of positive operating cash flow -- in
any economic climate. Positive cash flow means a company is adding
cash, or subtracting debt from its balance sheet, which provides a
company with several investor-friendly options. A company with
rising cash can boost its dividends, buy backshares or make
Bea, even though you asked about the single most important item
that every investor should look at, I would like to add a another
item to the list: operating profit margins. This is a company's
operating profits divided by itsrevenues . For example, a company
with $150 million in sales and $30 million in operating profits has
an operatingprofit margin of 20% (30/150). The key is to focus on
companies with rising operating profit margins. That's a sure sign
that the company is able to handle more business without a
commensurate rise in expenses. In effect, every new dollar of
business is that much more profitable than the last one.
Conversely, falling operating profit margins are a worrisome
sign. That means the company is spending too muchmoney chasing the
next dollar ofrevenue . Or it means that the company is cutting
prices just to win business.
Action to Take -->
Thefinancial statements can clue you into the health of a company.
It's best to narrow your investment choices to only those firms
which sport bullet-proof balance sheets and expanding levels of
This article originally appeared on InvestingAnswers.com:
Surprising Key To Picking A Great Investment
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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