When you decide to invest in the stock market, how do you refine the huge list of available equities down to just the most promising candidates?
First, you keep in mind something professional analysts must remember—investing always requires weighing potential risk against potential reward in any situation.
Analysts use certain criteria in an effort to focus their stock selection process. In broad terms, analysts generally weigh three issues: fundamental business factors, the technical position of the stock, and intangible factors that may provide a sense of how reliable a stock may be.
You can use these same criteria yourself when fine-tuning your stock picks.
Fundamentals. Business fundamentals are the first factor to consider. For example, does the company have a projected earnings growth rate substantially better than the 7 percent typical of U.S. publicly held corporations?
Is the company first or second in its industry in terms of market share for its products and services?
If not, is it gaining market share against its larger competitors? Is the company the lowest-cost operator in its industry?
Don’t forget the intangibles. Does the stock have the aura of a winner of a loser? For example, does the company have a growth record that can capture the imagination of other investors? Does it seem likely it will attract institutional buyers? Can you live with this stock through the downswings most stocks have from time to time?
On a more objectionable level, is the stock widely followed by Wall Street analysts, or is it followed by only a few firms, possibly making it more vulnerable to an analyst’s downgrade in the future?
Finally, you need to consider the stock’s performance history. What were the causes of any large sell-offs over the past decade? Were they related to company or industry developments or the consequence of general market weakness?
Take valuation into account. Is this stock you’re considering just a trading vehicle, or are there enough positive answers to the previous questions to suggest it may have the potential for an enduring rise?
If your answer is the latter, but the stock’s price/earnings ration (P/E) seems too high, there’s another factor you should consider. The further into the future you can project a stream of growing earnings, the more likely it may be the stock that in the future could trade at a high P/E ratio for an extended period of time and, quite possibly, outperform many issues that look less expensive.
The information given here is for general guidelines only. Many stocks won’t measure up to standards like these, but taking these criteria into account when evaluating a stock may provide the potential for rewarding investments. IBI