Securities Investments Overview: What to look for in a stock.

i.imgur.com_qbogwqc.jpg Picking the right stocks can be difficult, and it should by no means be a get rich quick scheme. Getting informed about the business you’re interested in owning is the most important step you can take in your pursuit to a healthy net value for yourself. Winning stocks tend to display most of the same certain criteria regardless of share count, price, volume, or industry. However it’s critical to maintain the mindset that you are investing in businesses, not stocks. One share of stock represents limited ownership in a business, and therefore should be thought of as placing working capital in the hands of a business. If research indicated that a business is likely to be profitable, it’s safe to assume that the share price will rise alongside the business’s net worth.

With the following criteria I aim to highlight aspects of winning stocks. All future analysis of businesses and stocks will be based on these same criteria.

Stock Classifications

Dividend paying, value, growth, and blue chip are all terms you may hear when researching individual stocks. These terms help to understand the assumptions institutional investors have about a stock’s behavior. It’s useful to classify the investments that are currently fighting for a spot in your portfolio, however these are relatively vague terms and many stock can be classified by several of them.

Dividend Payers

A Dividend is the payment a business pays out to shareholders for simply owning the stock. These payments are paid out from the excess cash generated after accounting for expenses and losses. Not all businesses will pay dividends, this is up to the discretion of the board. If it’s determined that profits would be better spent through reinvestment, dividends will not be announced. There is no obligation to pay a dividend to shareholders, so many dividend payers are companies that have long established histories of profitability and steady earning (think GE, Microsoft).

Value Stocks

Stocks that are being overlooked by the market and are said to be “underpriced” are often classified as Value Stocks. The share price of a company in an efficient market should represent the balance sheet, earnings, and future profitability. However our markets are far from efficient (it’s human nature, the markets work!) and at times there are businesses whose share price is below that which would be expected when taking assets and earnings in to consideration. When the market takes note of the business, share prices will adjust making the value investor capital gains.

Growth Stocks

The companies who reinvest earnings and do not pay dividends in order to fund Research and Development are called Growth Stocks. To put it simply, a growth stock is any stock which has expected earnings noticeably higher than that of the relevant industry average (think Tesla). These stocks prove to be some of the most profitable investment vehicles, but where there is potential for profit, the potential for loss is equally present.

Blue Chip Stocks

Blue Chip stocks are in the same Dividend Payer’s classification more often than not. However a true blue chip need only be a company who has established a strong brand and recognition with the general public. In addition Blue Chip’s have a proven track record of financial stability and profitability even in the face of a bear market.

Knowing these terms helps to organize research in to groups while comparing companies for potential investment. In addition a balanced portfolio has always been a good friend to the novice investor. Concentrating all of your money in only growth stocks could prove to be a poor investment choice if the market experiences a downturn. To a different extreme, focusing only on Blue Chip stocks might not generate the required return you demand as an investor. Classifying the companies you are comparing for investment is the best way to assure that your portfolio will have exceptional capital gains while defending it’s net value against adverse economic conditions.

Understanding the Business

  1. What does this business do?
  2. How does this business make money?
  3. What is the business model, customer base, and target market?

These are all important questions you should ask yourself when considering investment. Without a clear idea of what the business does and how it makes it’s money, the decision to invest would be pure speculation. Ideally, you would want to be able to explain the business to a child in a quick and concise thesis statement of sorts.

Knowing the target market and customer base can be critical information and tell a lot about future outlook for a company. Imagine a situation where the business you’ve invested in targets heavily to the upper class, if there were new tax legislation that suddenly made upper class disposable income decrease heavily, not knowing the target market could cause an investor to hold a stock that is likely to have lower than expected future earnings.

Who runs the business?

i.imgur.com_2pfpkra.jpg The CEO and accompanying board of a company play the largest role in conducting business. They not only control operations, but they represent the company themselves as well through their actions at all times. Charismatic, driven, experienced entrepreneurs on the board are always a great sign that the underlying business is in good hand. What you would want to avoid is a board full of executives who have no relevant experience in the industry, little to no interest in the product, history of negative publicity for any reason, or any combination of the three.

Reading about the executives, listening to earnings reports, watching interviews, and getting a general feel for the people behind the business is a great way to predict the efficiency of a company. There are some key factors to keep an eye out for when reviewing the board.

  • How long have the executives sat on the board?
  • Are any members of upper management founders, or descendants of founders?

All of these questions provide invaluable insight in to the health and future growth of a company. It’s no coincidence that modest, business-minded individuals like Warren Buffet have been able to grow the most successful businesses in today’s economy. Simply by finding a company that is in the hands of management that has a vested interest in the growth and health of the business, you can snap a piece of the next economic superpower.

Looking at the Financials

The financials of a company are almost always the most powerful evidence and investor has when deciding whether or not to invest. There are several key numbers that can give a detailed outlook on what a stock has in store for your portfolio.

The Balance Sheet

Do a quick Google search for a business you have in mind, google finance is a great resource when searching for the financial statements of a business. The balance sheet shows clearly the assets of a company as well as it’s liabilities. In general you want a business to have manageable debt, if any at all, as well as healthy asset value and cash on hand.

The Income Statement

To find out how much revenue the business is bringing in take a look at the income statement. It’s good to have as much data as possible when it comes to statements like this and the balance sheet. 5 years to compare is good, but 10 years of data is great. The more data you have showing that the company has had steady growth and revenue, the better the chances that they will continue to do so. You want to see businesses that are bringing a lot of revenue, and have reasonable expenses. The lower the expenses relative to the revenue, the better.

So as to keep this overview relatively vague I don’t want to go in to too much detail, but there are some ratios and numbers that an investors can look at that help to solidify the financial picture painted by the income statement and balance sheet.

The income statement and balance sheet are very important financial statements, but be sure to do a google search for the company’s debt to equity ratio, working capital ratios, and quick/acid ratios. Compare these number to that of industry competitors and you’ll be able to see who is making the most out of their money.

When to buy, sell, hold, and everything in between.

i.imgur.com_jfhon7h.jpg This is where your individuality really starts to shine. When you buy or sell a stock is entirely up to your discretion based on the financial goals you have set for yourself. If the goal is to make a couple thousand dollars quickly and get out in order to make a large purchase, then you won’t be too concerned with buying to hold. However keep in mind that the average recommended holding period for a stock is 3-5 years. This is because capital gains taxes, broker fees, and liquidity will all play a major role in what money you actually get back when selling a stock.

However, as a rule of thumb, when you have adequately researched a stock, you will have an idea of the intrinsic value of that stock. This meaning the fair price, not the market price. In other words, your research has determined that XYZ stock is priced lower by the market than what that share of the business is actually worth, based on the value of the assets on hand and potential future earnings of the company. This would be a buy opportunity. When the market has noticed the stock, and the price rises to, or even above the fair market price you have determined, WAIT. Reevaluate the stock and see if the intrinsic value has risen. When the intrinsic value of the stock is less than that of the market price, this would indicate a sell opportunity.

All in all, when looking for stocks make a checklist that looks generally like this:

  • What do I know about this company, and how do they make money?
  • How is this stock likely to behave based on it's classification?
  • Who is running this company? Are their interests the same as mine?
  • What are this companies strong points? Weak points?
  • What do the financial statements and ratios tell me about the healthy and future of this business?
  • Is the intrinsic value, based on detailed research, below or above the market price?

Investing in what you know, with research to back up your opinions is the best way to get started. These are the principles I have used in my investing strategies over the years and so far they have held true to the claims of the great minds like Buffet and Lynch. Buy good businesses at fair prices and your portfolio will grow steadily for the duration of your investing.

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