When shopping for stocks, you need to do a little bit of homework before buying them. Your goal is to find good value, especially if you aim to hold it for a while.
You don’t need to be an expert in analysis or dig too deep, but the more you know, the better your investing journey will be.
So, let’s ask the first question. What essential information do you need to know?
Long-term investors depend more on the company’s fundamentals than its short-term price movements, which are analyzed by technical analysis. The two key fundamental approaches are
- Quantitative analysis
- Qualitative analysis
Investors explore and assess the financial status and health of the company through quantifiable measures. It is usually expressed by ratios that evaluate crucial terms in its financials. Some of the questions that quantitative analysis answers include:
- Is the company growing? How profitable is it?
- Can the company pay its short-term and long-term financial obligations? Any red flags?
- Is the company fairly priced?
These questions could be answered by looking at some of the below measures:
- Profit Margin: is a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue. The higher the profit margin, the more the company can control its total costs efficiently.
- Return on equity: is a common profitability metric. It measures the company’s net income divided by shareholders’ equity. A high ROE means the company can generate net profits for its shareholders. The higher the ROE relative to its peers, the better the management of the company is at creating profits for its shareholders.
- Dividend Yield: Many investors consider dividends as a source of passive income. If that’s you, then the dividend yield is quite an important metric to look at. It is calculated by dividing the annual dividends per share over the current share price. The higher the yield, the more dividend value you will captivate from each share you own.
- Debt-to-equity: The D/E ratio is a leverage metric. Debt is not always bad. If it is used to fund a high ROE project, then it may be a cheap source of funds particularly given the fact that interest expense is tax-deductible. Yet, if the debt is a reflection of persistently negative operating cash flow, then the firm may be relying on a lifeline to remain alive and this may increase the risk of financial distress. Typically, a ratio that ranges from 1-2x equity is acceptable. Higher ratios – without a strong justification – should make you alert.
- Price/Earning (P/E): is a valuation ratio that helps investors know the share market value compared to its earnings. It represents how much investors are willing to pay for each USD 1 of income. A P/E ratio of 15, means that investors are willing to pay USD15 to get 1 USD of profit. Generally, a lower P/E ratio (below industry average) means that the stock is undervalued and might be a good opportunity to buy, but also might indicate that the company’s profits are declining.
- Price/Earnings/Growth (PEG): is P/E divided by the company earnings’ growth rate. This is a more sophisticated metric than the standard P/E because it accounts for the company’s growth potential in the company valuation. A PEG is less than 1.0 generally means that the stock is undervalued, and if it’s above 1.0, it’s overvalued.
In qualitative research, you want to deep dive into the less concrete company details, which are not stated explicitly in financial statements, and not quantifiable like financial ratios. When you look at the qualitative analysis of a company, you need to try and comprehend the business rather than just its numbers. To do a basic qualitative analysis, you need to answer those four questions
- How does the company generate its revenue?
- What is the company’s market position?
- Who is the management team?
- What are the relevant recent company and industry news?
How does the company generate its revenue?
This can seem obvious, an automobile company makes money by selling vehicles, but it also can make revenues from financing their customers by giving them loans to buy their dream cars and the interest on that loan is a revenue stream. McDonald’s (NYSE: MCD) for example generates higher income from real estate than fast food.
What is the company’s market position?
How is the company doing relative to its peers & competitors? Is the company an established market leader like Coca-Cola(NYSE: KO), Pfizer(NYSE: PFE), or Apple (Nasdaq: AAPL) in the US and CIB(EGX: COMI) in Egypt?, Is it a disruptor in the space and growing rapidly like Tesla (Nasdaq: TSLA) in the automobile sector? Or it is neither of them?
Does the company have a competitive advantage that helps them survive & thrive in their markets? For example, a strong trusted brand name might help in pricing in the consumer sector, while patents can give protection from competitors in the pharmaceutical sector.
who is the management team?
What is their vision for the company? Are they capable of achieving it? Tesla (Nasdaq: TSLA) was a loss-making company for years but its stock price has gone up due to the investors’ belief in Elon Musk’s vision and his ability to make it happen.
What are the relevant recent company & industry news?
Make sure you see what was the most relevant news about the industry and the company in the past period. Is the company experiencing a sequence of negative news? How is it affecting the share price? Is it temporary or long-term?
Now, that you know what information you need to know, the next question is how do you get them?