While I’m not a huge fan of stock picking, I have made a few rather modest investments in individual companies. It’s not something I do a lot of, but it is something I dabble in on occasion.
If you decide that you want to try your hand at stock picking, it’s important to do your homework. You want to choose something that’s a good value—especially if you plan to hold on to the stock for a while. As you consider your options, here are seven things you should know about a company before you decide to invest:
1. Earnings Growth
Check the net gain in income that a company has over time. Look for trends. Does the earnings growth generally increase? Even if the increase isn't dramatic, a company that has steady and consistent earnings growth over time can be a good bet for the future.
Every company is going to have periods where the stock loses value. This is natural, especially during times of economic difficulty and market upheaval. Instead, look for the overall stability as it relates to the economic conditions. Is there a great deal of fluctuation? If so, that could be a red flag. If, however, the company only seems to have real trouble when the rest of the market is struggling, you might do well to consider the stock.
3. Relative Strength in Industry
Take a look at the company’s industry overall. Does the industry that the stock is in show promise for the future? If so, look closer at the company. What is the company’s relative strength in the industry? Is it well placed against its competitors? Take into account the industry has a whole, and the company’s place in it.
4. Debt-to-Equity Ratio
All companies carry a debt on the balance sheet. Even the richest companies carry liabilities. However, you want to be wary of companies with high amounts of debt. Look at the company’s balance sheet, and compare the debt-to-equity ratio. You want a company that has more assets than liabilities. If you want an investment that is likely to present a lower risk, consider a company with a debt-to-equity ratio of 0.30 or below. You can look into companies with higher ratios if you have a little bit higher risk tolerance, or if a higher ratio is acceptable in the industry (construction companies, for example, are known for higher ratios, since they use a lot of debt funding).
5. Price-to-Earnings Ratio
Consider how well the stock’s price is doing in relation to its earnings. The P/E ratio is often considered one of the most important considerations when it comes to fundamental analysis, and value investing. This ratio looks at the company’s current price, and compares it to the per-share earnings of the company. You figure the P/E ratio as follows: Take the current share price and divide it by the earnings per share. So, if a company is trading at $40 per share, and the earnings per share are $2.50, the P/E ratio is 16. Understand that the higher the P/E ratio, the greater the expectation that there will be higher growth in the future. While you don’t want to rely entirely on this factor, it can be helpful in comparing a company to others in the same industry.
How well is the company managed? Do you feel that those in charge are competent? What is the general culture? Is the company is innovative? Also, consider whether or not scandal could harm the company. Keep in mind, too, that some scandals only harm the company in the short-term. If the company is likely to recover from the setback, you can get a really good deal on the share price in the midst of such difficulties.
A company that pays dividends is often one with a certain amount of stability. However, be wary of companies with very high yields. That can be an indication of coming instability. Additionally, a company that pays a lot in dividends might not be reinvesting in the company. Look for companies that pay modest, but regular (and increasing) dividends over time.
Miranda is a freelance contributor to several investing and personal finance web sites. She also writes for her own blog, Planting Money Seeds.