Investing in the stock market is risky. There is no simple and short way to succeed in this. Hence, investors invest in the stock market based on the advice of brokers, research reports and tips from friends or family. However, identifying and investing in good stocks is not easy.
We are going to summarize the most difficult part of investment i.e. analysis before investing in companies, and we are going to try to explain it in a way that everyone understands perfectly. How should we analyze the shares of a publicly traded company according to professional investors? Let’s get into it.
How to analyze a stock to know if it is a good idea to invest in the company?
First of all, investors should pay attention to the financial data of the company. It is advisable to select stocks that you are aware of and whose financial performance is increasing. This can help you a lot in the selection of shares. Investors should consider these factors before choosing shares –
1. The company must be at least 10 years old.
This is the first premise that even Warren Buffett considers towards a company before analysing other essentials. Every stock investor should always try to avoid investing in companies that are not at least 10 years old, as professionals believe that a smart investment cannot be made in a start-up company, which may or may not be very profitable. Nobody can know, and therefore, it is when the investment depends in a way on luck.
Before investing in a company’s stock, its prospects should also be explored. You can identify the factors that may have a bad effect on the stock in the future. That is why Warren Buffett does not feel secure to invest in newly raised companies.
For example Coca-Cola, we know that it has survived several severe recessions over 100 years, it will almost certainly be there for another 100 years.
2. The simple business model.
While a professional investor doesn’t rule out investing in innovative companies with a complex business model, he really likes simpler companies. Those types of companies in which anyone can know how they make money. This is an important thing to consider in the beginning of analysis for a long-term investor.
You must be able to explain in 30 seconds what the company in which you invest is dedicated to. And that everyone present in a room can understand where the profits of the company comes from.
For example, Ford manufactures and sells cars. I think everyone understands where Ford’s profitability comes from.
3. Value-based products / services
The company must offer something different from its competitors. And have a product that is perfectly distinguishable from the competition. Buffett assures that there is a future in this type of company. On the other hand, if the company’s product is very difficult for competitors to replicate, this would be totally profitable for stockholders of that company. And it is what Warren Buffett loves, the more distinction, the more difficult it will be for that competitor to access.
For example, many have tried to imitate Coca-Cola. The one that is closest is Pepsi, and if Pepsi has not been able to do it yet, it will hardly be possible for another new company. We can say the same for smartphone manufacturers.
4. Analyze ROE and compare it with your competitors.
ROE is the ratio of the economic benefit to the resources necessary to obtain this profitability. Professional studies the ROE to detect the operational capacity of that company in question by analyzing and comparing it with other companies in the same industry (competitors).
For this analysis to be effective, a minimum of 5 to 10 years of functioning of the company must be analyzed.
Compare the stocks you have identified with their competitors. This will help you a lot in deciding whether to make a potential investment. Instead of investing in second or third tier companies, one should invest in leading companies.
5. Consistent profit margins.
For Buffett, there is no successful company if it does not demonstrate clarity and consistency in its profit margins.
The profit margin is calculated by dividing the total of the income obtained by the net sales. We should look for a graph of the last 5 or 10 years. If we find an upward trend (increase in profit margins), this is a well-managed company.
Of course, if profit margins are static but very wide, and this has been the case for the last 5 years, having an effective management, since we only have to wait for the company to sell more to earn more.
6. Spotting an undervalued company.
This is the part that has probably made investors like Buffett and Graham unique. In Buffett’s case, he is an expert in this type of analysis.
Before investing in a company, an investor must evaluate the intrinsic value of the company. To do this you must include the profits, income and assets of the company. The intrinsic value of the company is generally greater than the liquidation value of the company.
Buffett compares that value to the company’s current market capitalization. Buffett says that if the intrinsic value analyzed is 25% greater than the market capitalization of the company, it is an excellent investment opportunity, since the market will end up giving it the value that company deserves.
We must say that we will rarely find a company today that meets this Warren Buffet requirement (if anyone finds it, please advise others !!!)
7. Increase in profits.
Stock investors must go for the companies that have the ability to consistently increase profits and create shareholder value. To do this, we must also analyze the trajectory of the company since it was founded.
But Buffett cautions that even excellent performance in the past does not show similar performance in the future, although the historical performance of the company helps us predict the future of the company by setting a trend. If for 50 years a company has had an upward trend in its sales and profits, the chances are that that company will continue its trend.
8. Companies with very little debt.
Buffett is very clear as an entrepreneur and investor that debt is the cancer of both personal and business finances. That is why every investor looks for companies with little debt, so that it is profitable for stockholders, only if the company manages to grow for the most part with its own funds and not with borrowed money.
In the same way, it analyzes the debt / equity ratio, the higher the number, the higher the debt ratio, and therefore, the more volatile income as it spends more expenses for debt interest.
Be careful with those companies that do not give decent profits and that refinance their debts for the long term, hoping that the company’s growth will spike.
9. A good manager.
Most investors do not take into account the CEOs of the company and forget to analyze them in the same way that we analyze the company in which we are going to invest. We must also take into account the trajectory of a new CEO. Where does he come from, what has he achieved, how does he think, what contacts do he have, etc.
However, Buffett himself often says: “Invest in companies with a product so perfectly salable that even an idiot can run it, because sooner or later some idiot will run it.”
10. Excessive spending on R&D
While most managers praise spending on Research and Development, as it is a way to be in constant discoveries and future improvements within the company, many investors prefer to invest in companies that do not dedicate much budget to R&D.
According to Buffett, companies that allocate large amounts of money to R&D are usually companies where technology and innovation are key to the operation and future of the company. And let’s say that the business must be simple and where the company has a marked advantage over its competitors.
Conclusion
Analysis and consideration of all points is an important part of the investment process before buying a stock. It is necessary to consider these 10 points before investing. By adopting the right process, identifying good stocks makes it much easier for investors to achieve profits.
