Stock investors confront a difficult decision when deciding where to invest. Reviewing the vast quantity of data available on public firms and knowing essential items like corporate actions are essential to make a good decision and developing their portfolio effectively.
Individual investors interested in purchasing stocks are faced with a more difficult task: conducting personal due diligence or assessing their suggestions if they have advisors. Developing a simple set of evaluative criteria for stocks can make the process significantly less stressful.
Historically, the issue for individual investors was obtaining sufficient information without purchasing expensive subscription services. Investors now have access to free, real-time data at the push of a button, courtesy of the Internet.
The difficulty lies in accurately selecting the appropriate information for evaluating a particular stock.
Profitability is excellent. When selecting equities, it is vital to evaluate a company’s financial fundamentals, such as earnings, operating margins, and cash flow. Collectively, these criteria can offer a credible picture of the company’s current financial health and its near- and long-term profitability.
On the earnings side, investors should analyze the stability and trajectory of the company’s earnings and learn about corporate actions. Higher operating margins are often preferable to lower operating margins in terms of gauging the operational efficiency of a business. Examining the company’s cash flow numbers, particularly cash flow per share, is useful for determining profitability. It is also a method for determining if a stock is overvalued or undervalued.
Fair asset usage. Positive asset utilization is the ratio of a company’s revenue to its total assets. Different ratios are advantageous in certain sectors. Like the operating margin, the asset utilization ratio measures the efficiency of a business over time.
Conservative capital structure. Capital structure is how a business finances its operations through debt and equity. A corporation with a conservative capital structure allocates its capital to generate sufficient short-term liquidity to cover operating expenses while reserving sufficient funds to finance expansion without considerably increasing long-term debt.
The momentum of earnings. Current or recent earnings, the obsession of many investors, are merely snapshots of where a company is or was at a particular time. Look for trends of earnings momentum — the slowing or acceleration of earnings growth from one period to the next — to determine where companies are likely heading.
Examine earnings reports from the prior eight quarters and study analyst estimates for future earnings to identify these tendencies.
Intrinsic value. Analysts assess intrinsic value using complex absolute and relative valuation methods. Individual investors can get this information online to cut through market noise and determine a stock’s true value. Perception and behavioral investing characteristics drive short-term differences between intrinsic and market value.
Learn more before selecting stocks
These guidelines are helpful but cannot tell whether a stock is suitable for your portfolio.
Corporate Actions. They are actions taken by publicly listed companies that typically have some impact on shareholders. CAs can be either mandatory or voluntary, and the common CAs include cash dividends, dividend reinvestments, stock splits, rights issues, share buybacks, and mergers and acquisitions.
Are this company’s enterprise, industry, and sector compatible with your asset allocation? If this is the case, even if the investment is high-risk/high-potential-reward, you may make a larger purchase proportional to your overall portfolio allocation if you have 20 years until retirement rather than five years.
Are the stock’s risk characteristics within your risk tolerance, regardless of time horizons? Would a sudden, sharp decline in the stock market lead you to lose sleep? Losses in equities purchased within the constraints of a suitable asset allocation should not disturb you, as gains in the equity portfolio will offset losses.
Consistently selecting successful stocks and predicting company actions are exceedingly difficult, if not impossible. That’s why it’s important to do ample research about stocks and corporate actions to make a smart decision.
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