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Friday, October 16, 2015

How To Analyze Stocks

Welcome amigos!  This next financial literacy piece is on how I evaluate or analyze stocks for purchase consideration.  Every investor should have metrics for measuring the quality of an investment, and this includes shares of common stock for sale on the U.S. stock exchange.  I happen to enjoy doing my due diligence on a potential stock to add to my portfolio.  It's fun!  Some people would rather go off someone else's research or "tip."

For example, there are many main street investors who watch Mad Money and would rather have Jim Cramer recommend a stock purchase.  That may be because they trust Mr. Cramer's analysis, have had one or two of Cramer's stock picks pan out and feel he's a winning horse, or they simply do not know how to do the analysis on their own and need someone else to do it.  I must admit, Cramer has steered me into at least looking into a particular stock or two, but his picks usually do not fit my own criteria.

First, let me share where I get my stock ideas.  I subscribe to Barron's magazine, and they provide stock ideas every week.  I prefer the information I get from Barron's over any other media source because they have great analysts who follow companies and know how to convey their research in well-written articles.  Stock ideas are just the beginning.  If I like a story, so to speak, I then look outside of Barron's for additional information, and to construct a profile of a stock.  My stock profiles include fundamental analysis data like:

1.  A stock's Price to Earning's ratio, or, P/E, in context with that of direct competitors.  For example, United Technologies Corporation's (UTX) P/E versus that of Honeywell (HON).  Keep in mind that though they may be in the same sector (in the previous example both are, "Industrials"), the comparison may not be apples to apples.

2.  The Price to Earning to Growth or PEG ratio.  I give more credence to the PEG ratio than I do a stock's PE ratio because the former takes into account the earning's growth rate of a company.  Again, I compare the PEG ratio in context, i.e., in a matrix with that of those of other competitor's.  For example, Ford (F) has a PEG ratio of 0.41.  GM has a PEG ratio of 0.33.  Ford (F) has a higher PE than GM, 16.5 versus 12.24, so on a P/E basis, Ford is substantially better...on the brink of being a growth stock.  The PEG ratio paints a different story.  GM may be the more undervalued of the two with a lower PEG ratio.  End of year earnings estimates must be examined for a more thorough analysis.

3.  Growth Estimates are just that...estimates.  Nonetheless, they are useful to get a vibe of a company's future earnings performance as predicted by multiple analysts.  Using GM versus Ford again, and the Analyst Estimates page on Yahoo: GM+Analyst+Estimates, we see that GM's "Growth Estimate" for next year is 16.30%.  Ford's "Growth Estimate" for next year is 13.50%.  Although the 5-year Growth Estimate is available, looking at what analysts believe about the next five years is pretty much a waste of time.  Looking that far out into the future is pointless as no one can prognosticate with any realistic measure of certainty beyond a year.  But back to the Ford versus GM comparison.  Once again, the growth estimate validates GM being a better option for investors.

4.  Management Effectiveness.  To look at how company leaders are running the ship, I look at Return on Assets, Return on Equity, and Return on Capital.  For these, I like to use MSN-Money.  Here are the returns for Ford: Money/stockdetails/analysis/F.  I glanced at GM return metrics and with the exception of Return on Equity, GM is again the victor.

5.  Cash.  Ignoring how much cash a company has available, i.e., in its coffers is a recipe for losing money.  Ford's "Free Cash Flow" at end of 2014 as Money/stockdetails/financials/F.NYS reports is 7.044 billion.  GM's was 2.967 billion.  Should GM investors be worried when taking Ford's free cash flow into comparison?  Not necessarily...

6.  Debt!  The Current Ratio is my go to window when I want to see how capable or incapable a company is in fulfilling its short-term and long-term obligations.  Essentially the current ratio is a measure of a company's financial health and whatever it happens to be, you want it to be close to the industry average.  GM's CR is 1.22, below the industry average of 1.27.  Ford's CR is 3.03...whoa!  No before you go dumping all of your Ford stock, you may want to dig deeper.  Is Ford more levered for a reason?

7.  The story.  This is a non-numerical, i.e., an intangible that I like to look for in a company's released statements and conference calls.  What are the company leaders saying about the company's future?  Are they up-beat?  Do they sound passionate and positive about changes they've made...e.g. cutting costs, spending more on R & D, buying back shares, and so on?  Or are they playing the blame game when they miss on a quarter?  You can tell a lot about a company's management from listening to a CEO on a conference call...so don't tune these out!

Okay, there you have it.  This is how I analyze stocks at a rudimentary level.  A more sophisticated approach would be to attempt to determine a company's intrinsic value in its shares.  The discounted cash-flow method requires the use of Excel, but it can provide you with additional insight others may not have.

Thanks for reading!  See you back here soon.  Don't forget to subscribe to this blog on your way out.    

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