How To Find The Best Stocks
Let’s get something clear first.
The notion of special software or statisticians being the only sources for picking the best and highest performance stocks is incorrect. Remove that perception from your mind all together. Stock picking is not rocket science or solving a Rubik’s cube blindfolded. It is simply a matter of analysis and understanding of key metrics that determine the current and future state of a company’s stock.
The Business Matters
Above all ingredients that make up a great stock is the business itself. Many investors or beginners forget what they are actually putting their money into. It is the business you are investing in, the brand, not the stock ticker you see on television or the newspaper. It is not the hot new item being advertised with an uphill stock price chart that gets your cash. It is the core operations, products or services, competitive stance, market position, and innovation that all play a part in the success of the business, and ultimately the stock’s value.
For example: A company can have the best new electronic product to hit the market in years and completely change that specific product’s category. The shelves are being emptied and online retailers are shipping out orders faster than any product in that category. It is an innovative, great product that performs the job better than any other gadget before, plus more amazing features. The stock price soars on the reception of this awesome product.
The big fish in the same industry notice the momentous reaction the new company is receiving from the consumers, so they replicate the key features that made the new product special, legally. Now, the big fish has a competitive product with stronger resources to push either the price down for consumer affordability or massive marketing. This causes the little fish to recoil with nothing else to do, but make a far more superior product.
The problem is the company is a small fish in a big ocean and has this one product to stand up to the giant industry leaders. One product that can easily be duplicated, and then sold for a lower price.
So what does this new innovative company do now? Pour loads of cash into research and development to attempt to gain back their momentum with another game changer. This is the cardinal debauchery of fast growing companies. They lose control of the level of cash adding to their expenses. Years later, the company’s financials are so deflated their profitability and return on equity are so shaken they are deep into the red (negative). This once clear-cut growth stock opportunity has turned into an abomination as the stock price plummets to near zero.
The business of every company cannot be placed in the background. It is the core operations that were forgotten in the case above. As a publicly traded company, shareholder’s value is right at the top of corporate importance. When the financials are ignored, investors retreat in surges causing the price to drop drastically. Therefore, without maintaining strong, stable, and consistent financials the company will suffer in the long run.
What To Look For
Finding the diamond in the ruff is not about the company with the most attractive product, reeling in massive amounts of sales, or amongst the highest in earnings per share. In fact, there are a series of key elements that make up an excellent stock. In no particular order of importance an excellent stock shows a competitive advantage, strong profitability, superior return on investor’s capital, low long-term debt, steady earnings growth, stable assets which rarely ever decline, and a positive linear cash flow statement.
When a stock is first researched the summary page is the initial information seen. And typically we glance at the price performance chart to see how it has been going. Just giving it a glance is natural and okay, but clicking on other time intervals and expanding the graph to truly gauge how the stock has been moving will interfere with your judgement whether it is a buy option – before even checking out its financials.
If research and development is high, what is its percentage of the overall expenses? A company’s total expenses will climb as the business expands, but when the profitability shrinks, then there is an issue. The profit a business earns allows for two major things to occur: reinvestment into the operations and dividends for shareholders.
It truly comes down to the basics. When earnings increase each year it shows the business is likely producing more revenue from sales and finding smart ways to minimize expenses. An industry leader holds a place in the market where they can assure a reasonable portion of overall sales in that industry. The simplest way to achieve the best profit margin in your industry is to take hold of the market share.
When companies initially go public, the process of establishing shares for investors to acquire is done mainly for the company to raise money for expansion. The capital raised through this process is trusted by investors to return a profit over time. And as an investor a company must continue to execute a return on investment in order for the public to maintain its belief in the company’s future outlook. A poor return on investment or equity shows the lack of results on the money investors poured in to help expand the business.
Looking only at key statistics will not provide the comprehensive analysis you will need to locate the best possible stock for your portfolio. Financial statements are a must read to determine how money is spent, flowing in the business and out of the business, and the pattern of key categories. If there is a great deal of fluctuation over a five-year period, then it can be a cause for concern the company lacks consistency. It is impossible to tell if a company’s debt is rising over the years without checking out prior year balance sheets. Stock prices change every day, but quarterly and annual financials are inked for reference for years.
Dividends Tell A Piece of The Story
This section goes for all investors; it does not exclude dividend growth investors. It is understood that the viewpoint of strict high dividend investors is to seek out companies paying top-level disbursements with relatively consistent growth. However, there are cases where all other key metrics are ignored simply due to the history and forecast of the dividend schedule. This often times will maintain solid dividend payments, but also risk the chances of not acquiring an appreciating stock.
Regularly, investors point to high yield dividend stocks as value positions. The rationale is that when a company decides to use a large amount of profits to issue shareholders their “share”, then the focus of the business is not aggressive expansion. This is true for many large corporations, but not all. Just because a company shells out dividends does not automatically eliminate them as a growth stock. The ratio between total dividends paid out and retained earnings for a determined period of time is the important part. The greater the ratio leans towards dividends, the less profits are being reinvested into the brand.
By no means is the message sending a warning to stay away from investing in high paying dividend stocks, rather clearing up the notion of what they represent and how to actually determine whether it is a growth or value stock situation. Dividends are a strategic play to have alongside other positions to help soften the volatile periods.
Best of Both Worlds
To help identify the difference between stocks that show rapid increases in price and those who display a steady appreciation over time, experts classified the two types as growth and value stocks. Growths being the stocks that have previously shown a fast price leap and are fairly young on the stock exchange. Value stocks are the ones that have previously experienced steady upticks in price with above average dividend yields.
As a true long-term investor the search should always be for the combination of growth and value. That is the only way to invest. A value position does not have to be a stagnant player in your portfolio. Grab a few strong companies with continuous earnings growth, a competitive advantage, excellent profitability and return on investor’s equity with manageable low long-term debt, and you will benefit from outstanding returns over time.