You probably don’t have time to carry out hours and hours of analysis on a stock. So, I’m going to give you 5 ways to find a great stock investment.
Listen, I get it, you would love to do a ton of analysis on every company you think about investing in, but the fact is, you just don’t have time.
It takes me about 10 hours to complete a deep dive analysis on a business. That’s precisely why my Membership group pay me a small fee each month to see my analysis. It saves them the bother.
Now, obviously, I can’t simply write a short post and give you everything I do within those 10 hours. That’s just crazy talk.
What I CAN do is give you a very simple framework to use in a rush to know whether or not you are on the right track with a company/stock.
Let’s cut to the chase. Everyone cares about revenue but it’s the wrong metric to focus on if you want a quick-fire analysis of a business to find a great stock. A company can turnover £20 billion a year and everyone’s raving about it. But if it costs them £21 billion to achieve that then they’re a terrible investment. Profit means that after everything has come in, and after everything has come out, what’s left? I want to see big profits. Supermarket chain Tesco [LSE: TSCO] only just make a profit each year, some years making a loss. This is despite raking in billions in revenue per year. The lack of profit and growth opportunity is precisely why the company’s share price is still down where it was 20 years ago.
A beginner investor might be forgiven for thinking all we care about is how much debt the company are carrying. Investors ask me “what’s the limit you’ll accept for debt?”, “£5m, £10m?”. But you can’t just pluck a threshold out of the air. It needs to be relative to the size and strength of the business. After all, a large, highly profitable company can probably afford to borrow far more than a small business barely making a profit each month. What you need to know is how much debt are they borrowing relative to the profit they make each year. A figure of about 5x earnings is a rough limit you can use to work out if it’s too much.
Count up all the companies assets. These include cash in the bank, invoices owed to them, inventory of currently held stock, property, plant, equipment, vehicles etc. Then, count up all the liabilities. These include any short term debt owed within the next year, long term debt owed, deferred tax payments, and invoices to others that have not yet been paid. Once you have these two figures deduct the liabilities from the assets to get the net worth of the business. You want to see this net worth rising. Not falling. A rising net value means assets are growing faster than liabilities. If a company is rising in net worth, we should be willing to pay more for their shares.
Where do all the profits this company make go? Some will go into dividends perhaps to reward shareholders. But if a business is going to grow and expand it can keep giving all its profits back to the shareholders. It needs to reinvest back into itself. Retained earnings is a quick way to see if the company are putting money aside for expansion and reinvestment. Each year the retained earnings is a snapshot. Think of it as a pot of reserve money that accumulates. So if one year it’s £4m, the next year it’s £4.5m then they’ve put an extra £500k in that year. A rising retained earnings is good.
Depreciation & Amortisation
Avoid companies that have to spend more than 15% of their gross profit on depreciation. Depreciation is an accounting term to represent the depreciating value of assets owned by the business. Any company heavily reliant on machinery, plant and equipment will have a large chunk of profits being spent on keeping these assets maintained.
Of course, these 5 ways to find a great stock are not a substitute for real in-depth analysis of an investment you make.
For example, did you know some companies legally bolster their profits by selling off company assets or sometimes entire arms of their business? As a result, what looks like a great year for profit can actually just be a one-off. The company can’t expect to repeat that next year as they no longer have the asset to sell. These companies can go on to talk about their wonderful profits that year, completely omitting the fact they did not solely achieve it through the recurring everyday revenue generated by the business. This sneaky, but completely legal trick is just one aspect of analysing companies that you need to watch out for.
However, when you’re in a pinch and you need a quick review of whether a stock is worth investing in, these 5 ways laid out for you above should steer you in the right direction and away from investing in anything that might end up costing you money.
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NOTE: I reserve the right to refuse any membership application should I feel you are not the right fit for the group.