How To Do A Basic Stock Evaluation

By Stuart Mcconnachie

There are a few common variables to assess when evaluating a stock:

1) Profitability: Does the company make a lot of money? 2) Growth: past, present, future—major driver of stock price 3) Financial Health: Strong Balance Sheet—the company can weather a storm. 4) Value: the stock is available at a discount (on sale) compared to its historical value, compared to its competitors, compared to its intrinsic value.

1) Profitability: (Return on Capital and Return on Equity) (ROC) & (ROE)

Return on Equity (ROE) (ROE) Low numbers (> 12%), especially if declining, (Look elsewhere) Steadily increasing ROE speaks well of company management.

Measure of profitability Also indicates internal growth potential (ability to self-finance growth without borrowing money or issuing new common shares)

2) Growth: Earnings and Sales Per Share (EPS) Primary determinant of share price movement Rapid and consistent growth is highly desired (harder to manipulate through accounting practices than earnings) Look at Value Line Charts (visual of cash flow growth) issue of more common stock (dilutes EPS)

The next step would be to compile a list of your top stocks and then do a comparative analysis and evaluate the Qualitative variables. This and other strategies are discussed at the best investment advice blog.

Dividend Growth Some companies pay out too much in a good year and then reduce them in a bad year (can hammer stock)

3) Financial Strength Capital Structure: Excessive debt? Shareholder risk increases with the proportion of debt in a company’s capitalization A company with zero debt can’t go bankrupt! (Free Cash Flow Per Share): Cash Flow – (dividends + Capital spending): Capital Spending requirements that deplete CF over long haul is bad, Short term good.

Long Term Debt: Examine long-term debt load in terms of absolute numbers and its trenda`stable or declining trend suggests good financial health

Current Position To asses solvency: pay attention to cash and marketable securities; monitor receivables closely. Receivables increasing at rate faster than sales (perhaps some money owed to company is not being collected) Inventories: should not grow faster than sales (Red Flag)

4) Value: High/Low The valuation of a stock relative to its own history: P/E, Price/Cash Flow, Price/Sales, Price/Book Value compare past 5 years (Watch out for cyclical companies) The valuation of a stock relative to others in its peer group: compare to see if stock is above of below where it traditionally sites in terms of the entire market of stocks Quickest way to evaluatea` compare cash flow line (the value line) or earnings line to see if company is above or below the line (stocks at or near line may be undervalued)

A Sauder School of Business Graduate specializing in Real Estate Finance with a vivid interest in the Stock Markets and Stock Investment Strategy. For more information about me and the strategies I implement please visit my blog: <http://www.investcanada.blogspot.com Investing in Canada: Best Investment Blog>.

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Published at Sep, 28 '07 , Read 752 times.

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