Researching a Stock

Before examining individual numbers, ask: “Why is this stock trading near its 52-week low?”

A lower price can occur for very different reasons, including:

• Temporary market weakness
• Industry weakness
• A disappointing earnings report
• Slowing business growth
• Declining profitability
• Company-specific problems
• A previously excessive valuation becoming more reasonable
• Broader economic or market conditions

Do not assume either that “the market must be wrong” or that “the company must be bad.” The purpose of research is to investigate the reason for the lower price.

Earnings Per Share, or EPS, represents the portion of a company's earnings attributable to each outstanding share. Stock Sage already requires at least 4 of the previous 5 years to have positive EPS for fundamental qualification.

After qualification, look beyond simply counting positive years. Examine the pattern.

Stock Sage requires Total Assets to be greater than Total Liabilities in each of the five years examined. Assets represent resources controlled by the company. Liabilities represent financial obligations owed by the company.

The screening rule provides a basic balance-sheet qualification, but research should go beyond simply confirming that the company passed. Where the information is available, ask whether assets are generally increasing, whether liabilities are increasing, and whether the difference between assets and liabilities is becoming larger or smaller.

The requirement does not mean the company has no debt or financial risk.

Profit margin shows how much of a company's revenue ultimately becomes profit. If a company generates $100 in revenue and ultimately earns $12 in profit, its profit margin is approximately 12%.

Profit-margin information can help investors investigate how effectively a company converts sales into profits. Where historical information is available, consider whether the margin is improving, relatively stable, or declining.

Different industries naturally operate with different profit margins. A margin should not automatically be labeled good or bad simply because it is high or low; consider the company, its history, and its industry.

Book value generally reflects the accounting value of a company's assets after liabilities are considered. It can provide useful context, but its usefulness varies substantially by type of business.

For businesses with significant tangible assets, book value may provide one kind of context. For businesses whose value depends heavily on intellectual property, software, brands, networks, or other intangible assets, book value may tell only part of the story.

Dividend yield compares the annual dividend paid by a company with the current stock price. It can be useful to investors interested in income, but a higher yield is not automatically better.

A stock's dividend yield can rise because the dividend increased or because the stock price declined. An unusually high dividend yield may therefore deserve additional research.

Investors should consider whether the company's earnings and financial position appear capable of supporting the dividend. No dividend is guaranteed.

A stock buyback occurs when a company repurchases some of its own shares. One potential effect is reducing the number of shares outstanding.

Buybacks can be useful information, but they should not automatically be interpreted as proof that management believes the stock is undervalued. Consider buybacks together with earnings, financial condition, valuation, and other available company information.

Historical valuation information lets an investor ask not only “What is the company's P/E today?” but also “How does today's valuation compare with the company's own historical valuation?”

P/E is useful but imperfect. A low P/E can occur because investors expect earnings to decline. A high P/E can reflect expectations for significant future growth. Temporary earnings changes can also distort P/E.

If earnings are extremely small or negative, P/E may be less useful or unavailable.

The 52-week high and low provide price context. The low shows approximately where the stock's lowest price has been during the previous year; the high shows the other end of that range.

Stock Sage focuses on companies near the lower end of their own range, but the previous high is not a future price target.

When analyst estimates or price-target information is available within Stock Sage, it can provide another perspective on market expectations.

Analyst estimates are opinions and forecasts. They can change, they can be wrong, and different analysts can reach different conclusions. Consider them alongside other research rather than treating them as guaranteed future prices.

If free-cash-flow information is available within Stock Sage, it generally represents cash generated by the business after accounting for capital expenditures necessary to maintain or grow the business.

Investors may examine free cash flow because reported accounting earnings and actual cash generation can differ. Where historical information is available, investigate whether it appears consistently positive, improving, declining, or highly inconsistent.

There is no required free-cash-flow threshold in this lesson, and positive free cash flow does not guarantee a good investment. If Stock Sage displays free cash flow after dividends, use the application's displayed terminology when interpreting that information rather than creating a new calculation.