Here are six questions that every investor, whether looking for
high-flying growth stocks or beaten-down value plays, should ask
before buying. You can find the needed information on many financial
1) Real Business?
What is your candidate’s main business? You probably know what
Wal-Mart does, but what about ICON (ICLR) or Knoll (KNL)?
You can find out by checking the Description shown on MSN Money's
Company Report (Fundamentals menu), which describes each company
in enough detail to give you a feel for its business. For instance,
ICON provides outsourced clinical trial services to pharmaceutical
companies and Knoll makes office furniture.
How do you use that information? If you’re looking for growth stocks
you might find ICON of interest. Value investors, however, knowing
that the market ignores unglamorous industries, might consider Knoll a
potential undervalued gem.
2) Real Revenues?
Although the market focuses on earnings at report time, in the end,
earnings come from sales (revenues). Thus, annual revenues (Company
Report) are an important selection factor.
Risk-averse investors should require at least $500 million in annual
sales. Those more adventurous could go lower, but the risk meter goes
off the chart when you get below $100 million.
You can't apply this criterion to banks and similar institutions
because their income comes from interest earned, which doesn't show up
in the revenue totals.
3) Really Profitable?
For stocks, profitability means more than not losing money. Here’s
Consider two hypothetical companies, Company A and Company B. Both
earned $10 million last year. However Company A’ shareholders only had
to invest $30 million to turn that profit compared to $60 million for
Company B. Thus, Company A’s investors realized twice the return of
Company B for each invested dollar.
Return on equity (ROE), the ratio of a company's 12-month net income
to its shareholder equity (book value), is a widely used profitability
gauge. You can see ROE in the Investment Returns section of the
Key Ratios report (Fundamentals). Require a minimum 15% ROE and
higher is better.
If you’re a growth investor, use the current number (top line).
However, since value stocks may have recently stumbled, value
investors should use the 5-year average ROE.
4) Making Real Cash?
Operating cash flow measures the amount of money that moved into, or
out of, a firm's bank accounts attributable to its business
Cash flow is a better profit measure than earnings because it's harder
to finagle bank balances than numbers like depreciation schedules that
figure into earnings. In fact, many companies that report positive
earnings are actually losing money when you count the cash.
annual cash flow statements (Financials) and require a positive
number for “cash from operating activities.” While any positive number
is okay, it's better if the operating cash flow exceeds the net income
(top line) for the same period (be sure to use the
annual statement, not the quarterly).
5) Too Much Debt?
Many experts see higher interest rates coming. Should that happen, the
resulting higher carrying costs would cut into earnings of firms
carrying high debt loads.
The financial leverage ratio (total assets divided by shareholders'
equity) is an all-purpose debt gauge. A company with no debt would
have a financial leverage ratio of one, and the higher the ratio, the
more debt. The average leverage ratio for companies making up the S&P
500 index is 3.8. Avoid firms with leverage ratios above 4.0 and lower
is better. Find the leverage ratio in the Key
Ratios report (Financial
You can't apply debt measures to banks and other financial
organizations. For them, borrowed cash is their inventory. Financial
firms always carry high debt compared to other industries.
6) Sagging EPS Forecasts
Analysts usually forecast earnings (EPS) for stocks that they follow.
MSN Money displays consensus forecasts, which are the average
forecasts from all analysts covering a stock, on its
Consensus EPS Trend report (Earnings menu). MSN shows the current
numbers as well as estimates going back as long as 90 days.
Positive changes in consensus forecasts almost always move share
prices up, while falling forecasts usually crush share prices. What’s
interesting is that consensus numbers often move in trends. That is,
forecasts that have already moved up are likely to move higher, and
Check the fiscal year estimates going back
90 days and compare the current estimate to
the 90-day ago number (ignore one-cent changes).
Look for stocks with rising trends and avoid stocks with estimates
going the other way.
Checking these six items will help you make better investing
decisions, but they are just a start. Dig deeply and learn all you
can. The more you know about your stocks, the better your results.