Researching a stock seems difficult. But it could be really simple when used to it. These steps is a quick way to judge a stock. I will provide a simple but effective information to research in a stock before investing.
Checking for a stock using this steps should take around 10 to 20 minutes. After 10 to 20 minutes, you should have a lot of understanding on how much a stock should be.
The best way to researching a stock is by reading its 10-K and 10-Q. This article provides a quick way for newbie investors on how to value a stock in the simplest way possible.
Revenue Growth
Revenue is probably the most important thing to research on a stock. Basically, revenue is the total sales. It is how much a company received from its customers before paying expenses. Revenue is different from earnings.
Takeaway (Estimates only)
- Revenue growth of 50 percent or more – Extremely fast growing
- Revenue growth of 25 percent or more – Growth stocks
- Revenue growth of around 10 – Decent growth
- Revenue growth of 1 or 2 percent – No growth
No growth has much lower ratios than growing companies.
Whether it is only 2 percent or 50 percent growth, it is important to know if the company is growing or not.
A stock is usually more expensive when it has a lot of growth. Companies that is growing at least 30 percent in revenue every year are considered to be Growth Stocks.
Growth stocks are usually more famous since it is more exciting. These stocks can twice or triple in a year. Also, these kind of stocks can go down by 50 percent if revenue growth slows.
Also, many growth stocks looses money since they are focusing on revenue growth. In order to raise cash, they may have to issue more shares in the future, or issue bonds to have more debt.
That’s why growth stocks can be riskier.
On the other hand, value stocks usually have lower growth. Most value stocks pays dividends. These stocks usually has between 1 to 5 percent revenue growth.
Stocks that is not growing are more likely to pay dividends and cheaper. There are a lot of factors why revenue grows or not.
How Revenue grows
- New player in the industry
- Small Company compared to competitors
- Whole industry is growing
- Raising Prices
- Expansion to Other Countries
- Launch of a New Product or Service (most common)
Why Revenue Growth Declines
- Market saturation (everyone that will buy already bought)
- New competitors
- Lowering Prices
- Industry is dying
Importance
High revenue growth means more expensive stock (higher ratio). Lower revenue growth usually means lower ratio.
A stock that has a high P/E ratio should have high revenue growth. If a stock has no growth but high ratios, it is over valued.
On the other hand, a stock that has low ratio and high growth can be considered undervalued.
For example, if a stock has only 2 percent growth and has a P/E ratio (see below) of 50, then it is undeniably over valued. (as long as earnings remain the same)
Revenue growth is one of the most basic metrics to value a stock.
Earnings growth
Earnings is the goal of every business. At the end of the day, the goal of every business is to make profit.
Many companies today is losing money. In those case, we are trying to figure out when will it be profitable.
If a stock is growing its earnings, more investors will be interested in buying it. Thus, there is a high chance for the stock to go up.
If a stock is not growing its earnings, or declining earnings, investors might sell. Thus, causing a stock to go down.
P/E Ratio
P/E ratio is the most basic type of valuing a stock. The historical average for P/E ratio is around 15. A stock that is growing by 1 to 3 percent on revenue and earnings are usually valued at P/E ratio around 15.
In general terms, a higher ratio means more expensive while a lower ratio means it is cheaper. A price of a stock does not mean anything, but P/E ratio does.
A stock that is growing 30 percent usually has ratio around 30 or 40. At the same time, a stock that has revenue or earnings growth of 70 percent can have a P/E ratio of around 100.
Of course, it depends on the industry and the company itself. This is just a general guide.
Stocks that is not growing but has a P/E ratio of 30 is extremely over valued. While a stock that is growing its revenue and earning by 40 percents but has a P/E ratio of 30 is extremely under valued.
To know the P/E ratio of a company, simply google the name of a stock. It is listed in the quick results.
Most stocks is losing money. Thus, it has no P/E ratio. In this case, P/S ratio makes more sense.
P/S Ratio
Most stocks that has no growth usually has a Price to Sales ratio of 1. On the other hand, most stocks that is growing more than 50 percent every year has a P/S ratio of more than 10.
For better understanding, here is an example of a company that has a P/S ratio of 10 and why it could make sense.
A company is valued by the stock market at $10 billion. It has sales of $1 billion. This company has a P/S ratio of 10.
If a company is not growing, it is insane to pay a P/S ratio of 10. But, if a company is growing 100 percent (doubles) in revenue every year, then it might make sense.
Assuming that company is doubling its revenues every year…
On Year 2, revenue will be $2 billion.
On year 3, revenue is $4 billion
On year 4, revenue is $8 billion
All of a sudden, paying 10 times sales is not that expensive when a stock is growing fast. If a stock is growing slow but has a P/S ratio of 10, then it is more likely to be severely over valued.
Market Cap
Market Capitalization is how much the market is valuing a stock. For example, if a stock has a market cap of $100 billion, it means that the market is valuing a company at $100 billion.
If you would to buy all shares of a company, you would need $100 billion for this example.
If you bought a stock at $50 per share and has a market cap of $100 billion, it means that you are valuing a company at $100 billion.
If that same company became a $1 trillion in market cap years from now, then the stock price would be around $500. Share price moves together with its market cap.
Owning 1 share worth $50 on a company worth $100 billion means you own 0.00000005% of the company. Usually a mutual fund or a CEO can own 10% of a company. 10% of a company on the same example means owning 200 million shares.
Balance Sheet
Reading the balance sheet seems intimidating at first. But it is actually really simple. You can find it on 10-k of a company. To search for it, simply type into google the name of a company then balance sheet.
- Check out the total assets and total liabilities.
Total assets should exceed total liabilities. If total liabilities exceed total liabilities, it is an indication that a company may be in a financial trouble.
If total assets is double the total liabilities, that is extremely good balance sheet.
2. Also, check out Current Assets and Current Liabilities
If Current liabilities is more than current assets, it is a red flag.
A good balance sheet has its current assets more than current liabilities. If current asset is double current liabilities, then it is an extremely good balance sheet.
Those are the basic ways to read a balance sheet. Of course, it depends on the industry especially when a business has investories.
As a general rule, assets should be more than liabilities (debt). The more assets than the liabilities, the better.
CEO
A competent CEO has a lot to do with a successful company. Research about that CEO. What’s his/her track record? Has he/she been involved with a great company in the past?
Does the CEO own shares of a company? Is he/she has bonus when the company succeeded?
The CEO has a lot to do to drive the company forward. After all, he or she is the face of the company. Investing money in a stock means trusting that CEO to do his or her job.
Risk Factors of a Company
Every company has risks and opportunities. It is important to learn about the risks of a stock and see if you could handle it.
The Risk Factors is listed on the 10-K of a company. Usually, it is in the first 10 pages of 10-K and is two pages long. Reading risk factors gives you more knowledge about the company.
You can search on google, “name of stock” + “10-k”, or you can find it in Investors Relations Page of the site of a company.
Investing in stocks comes with risks since no business is guaranteed to succeed. Start with the basics and go from there.
