Foundational Investing Series: Part 2
Click to jump to any section:
- Introduction
- How To Find Stocks: The Discovery Process
- The Basics of Stock Analysis
- Making The Case to Invest: Better than S&P500?
- Conclusion
Introduction
Unless someone has taught you how to find quality stocks and build a great portfolio, getting started in investing can feel daunting, confusing, and uncertain. Perhaps you have come across stocks recommended by a friend or by someone you follow online. But how do you know if a stock is a great purchase? With so many options and uncertainties, it's natural to feel that way. If you're facing this challenge, you're not alone. Many new investors struggle to find and correctly assess the stock market.
In this article, we will guide you through the process of stock discovery & stock analysis. We'll break down the steps to finding stocks and help you understand how to distinguish the good from the bad, and even the great from the good. Whether you're taking your first steps into investing or looking to refine your process, we're going to cover the investing process in basic terms so that you can become a successful investor even when you may not know anything about finance yet!
How To Find Stocks: The Discovery Process
The stock market is vast and discovering potential investments can be a tedious process as there are a lot of stocks to discover! One common way you may come across stocks is through social media, where influencers hold discussions about promising companies. Another way is through finance related news website or through a friend. It's not uncommon to find yourself intrigued by a stock after seeing it mentioned by someone you follow or hearing about it on the evening news.
However, there's another, more systematic approach to exploring stocks that offers a structured method for discovery.
Discover Streamlined Markets
Here at Streamlined Finance, we aim to take you from your current level as investor to a more competent and confident investor. We believe that the only thing standing in the way from you becoming a successful investor is access to the right investing knowledge and the right investing tools. Our Markets page is one of those tools, designed for the stock discovery process and it will help you to find the best stocks and streamline your search for potential investments.
Think of the Markets page as a radar, scanning the stock market and highlighting stocks across various categories, from undervalued gems to high-growth opportunities and oversold assets.
By leveraging the markets page, you can easily uncover stocks that you may have never encountered otherwise. Imagine stumbling upon a hidden gem—a high growth stock, yet flying under the radar. As you'll spend time on this page and revisit time after time, you'll begin to recognize familiar names and spot emerging trends within different sectors.
Learn more about the Markets: An Overview to Spot Opportunities
In order to have the right mindset when it comes to exploring and discovering stocks, please read the following:
In an interview, Warren Buffett said that if he were to come into the investment field today, he would learn about every company that's listed in the United States. Then when the interviewer mentioned that there are 27,000 companies, he famously said to start with the A's, emphasizing that it's a simple matter of uncovering stocks one-by-one.
As you familiarize yourself in the process of discovery, you'll not only expand your knowledge of stocks but also gain deeper understanding of financial markets. With each stock you explore and each sector you navigate, you'll start to see patterns. You'll start to understand which sector is growing and which are highly profitable. Remember, the journey of stock discovery is a continuous process—one that rewards patience, diligence, and a thirst for knowledge. So, whether you're starting from "A" or using our Markets page, keep discovering new stocks and learn as much as you can so that over time your knowledge of companies grows.
The Basics of Stock Analysis
Once you have discovered a stock, the next thing to do is to analyze the stock. Stock analysis is the process in which you evaluate if the company is a good investment.
Our aim here is to provide you with the foundational knowledge to analyze a stock in a matter of minutes. Typically, when you're looking at a new stock, the first question to ask is: What does the business do?
How to Understand the Business
In order to understand what the business does, there are a few things that you can do to gain insights into the company's operations:
- Read The Profile/Bio: A company's profile or biography offers a concise description of its business. This verview typically provides insights into the company's sector, industry, product.& services offerings, origins, values, and strategic direction.
- Visit Their Website and View Their Products & Services: A company's website serves as a portal of its offerings and customer experience. Exploring the website allows you to understand the breadth and quality of its products and services. Dive into product descriptions, specifications, and customer feedback to evaluate competitiveness and customer satisfaction. Additionally, check for news updates or press releases to stay informed about the company's developments.
- Read Their Annual Report (1/2), the Business Overview: The annual report provides a comprehensive overview of a company's financial performance, operations, and strategic initiatives. You can easily access a stock's reports by clicking on Filings in the News section on Streamlined Finance. Once opened, click on the "Business" or "Overview" section to gain insights into key business segments, revenue drivers, and market positioning.
- Read Their Annual Report (2/2), to Discover Risks, Growth Prospects and its Competitive Landscape: Annual reports also highlight potential risks that may impact the company's performance. These risks could include regulatory changes, market volatility, or competitive pressures. Understanding these risks is crucial for assessing the company's resilience and long-term viability. Additionally, annual reports often provide insights into the company's competitive landscape, including key competitors and market dynamics.
By utilizing these methods—reading the company's profile, exploring its website, and analyzing its annual report—you can develop a holistic understanding of the company's business model, growth prospects, and risk factors. This is the part that's called qualitative analysis, and now, you can move on to the next step which deals with the business' financials which is also called: Fundamental Analysis.
The Key Financial Metrics: Earnings, Revenue & Valuation
When it comes to fundamental analysis, the most important thing that gives you confidence into the business is when the business grows! Positive growth in earnings, revenue, assets, and free cash flow tells you that the business is thriving.
Here are the first set of financial metrics to look at:
- Earnings Per Share (EPS): Reflects a company's profitability on a per-share basis.
- Revenue: Represents the total income generated by a company from its core business activities.
- Assets: Signify the resources owned or controlled by a company, providing a foundation for future growth and investment.
- Free Cash Flow: Indicates the amount of cash generated by a company after accounting for capital expenditures, offering insight into its ability to pursue growth opportunities and reward shareholders.
Ideally you want all of these metrics to show growth, but this may not always be the case. Especially high growth companies may opt to reinvest their profits into their business which can result in negative free cash flows or even negative earnings!
In any case, these metrics are easily accessible on our platform: Streamlined Finance. You will be able to easily visualize the growth trends of these financial metrics, which in turn will enable you to gain insight into the company's fundamentals.
Valuation Metrics:
After assessing the first set of metrics for a company, the next step is to evaluate its valuation. The most sought-after valuation metrics are:
- Price-to-Earnings (P/E) Ratio: This ratio compares a company's current share price to its earnings per share and provides insight into its valuation relative to its earnings. However, it's important to note that the P/E ratio can sometimes be misleading. Some companies experience temporary fluctuations in earnings or may choose to reinvest heavily in order to grow and therefore you should also look at the P/S Ratio.
- Price-to-Sales (P/S) Ratio: This ratio measures a company's current share price to its revenue per share and offers an alternative valuation metric to the P/E ratio. This is especially useful for companies with lower profit margins or those in early growth stages.
While there are other valuation metrics, these 2 metrics both offer a quick indication into the current valuation of a company.
Whenever you find a company and you see that it has a very low or a very high valuation, the first thing that you should ask is: Why does the market value the company this way?
In many cases, the market knows something that you don't, so it's best to first uncover why the valuation is the way it is by checking news on the company, its press releases for potential revised earnings to the downside and its recent earnings that may have been disappointing.
Futhermore, when it comes to valuation, there are a couple important notes that you should be aware of:
- Companies with bigger market caps have higher valuations
- High growth companies have higher valuations
- This is because their valuation is based on their expected future value.
These effects mean that you cannot directly compare the valuations of a small market cap company with a large market cap company and that you cannot compare the P/E ratio of a growing company with a stagnant company.
Financial Health Indicators:
In addition to growth and valuation metrics, assessing a company's financial health is paramount. The key financial health indicators include:
- Debt Ratio: This compares a company's total debt to its total assets which provides a gauge into its level of financial leverage and ability to meet debt obligations. A lower debt ratio generally indicates stronger financial health and reduced risk.
- Quick Ratio: This assesses a company's short-term liquidity by comparing its liquid assets (such as cash and marketable securities) to its current liabilities. A higher quick ratio suggests greater financial stability as it would be able to pay for any unforeseen costs and the ability to cover short-term obligations without relying on external financing.
Growth Rates: EPS Growth vs. Revenue Growth
When evaluating the growth potential of a company, you should focus on two key metrics: Earnings Per Share (EPS) Growth and Revenue Growth. EPS growth measures the increase in a company's earnings per share over a specific period, reflecting its ability to generate profits for shareholders. On the other hand, revenue growth indicates the rate at which a company's total sales or revenue is increasing, providing insights into its top-line growth trajectory.
Reliability of EPS Growth:
While EPS growth is a fundamental measure of profitability, it may not always provide a reliable indicator of a company's growth potential, particularly in the early stages of development. Companies undergoing rapid expansion often reinvest their profits into business operations, research and development, or market expansion initiatives, which can suppress short-term earnings growth. In such cases, focusing solely on EPS growth may not fully capture the company's growth trajectory.
Alternative Growth Metrics:
If a company's yearly revenue growth falls below 5%, investors can explore alternative growth metrics to assess its performance. For instance, a company may still be growing its assets which implies the company's investment in future growth opportunities. Additionally, monitoring share buyback initiatives can signal management's confidence in the company's prospects and its commitment to enhancing shareholder value. By reducing the number of outstanding shares, companies can effectively increase their earnings per share, even in the absence of significant revenue growth.
Benchmarking Against S&P 500:
The average yearly revenue growth rate of the S&P 500, approximately 5.19%, serves as a benchmark for assessing revenue growth. If a company's sales or revenue growth rate falls significantly below this benchmark, it may indicate potential underperformance relative to market expectations. However, by considering alternative growth metrics and assessing the company's overall strategic direction, investors can gain a comprehensive understanding of its growth prospects and investment potential.
Margins: Net Margins
When evaluating the profitability of a company, one of the primary metrics to consider is its net margins. Net margin, expressed as a percentage, represents the portion of revenue that translates into net income after accounting for all expenses, including operating costs, taxes, and interest payments. A higher net margin indicates that a company is more efficient at converting its revenue into profits, making it a desirable characteristic for investors.
Industry Variances:
It's important to recognize that net margins can vary significantly across industries. For example, industries such as import/export and shipping typically operate on lower margins due to the nature of their business operations. While these companies may have lower net margins, their total revenue could still be substantial, making them valuable businesses in their respective sectors.
High Margin Companies:
On the other end of the spectrum, certain companies are renowned for their ability to maintain exceptionally high net margins. One notable example is Apple Inc., which has consistently demonstrated robust profitability driven by its premium product offerings and strong brand loyalty. Additionally, companies like Alphabet Inc. (Google), Microsoft Corporation, and Visa Inc. are also recognized for their high net margins, reflecting their competitive advantages and efficient business models.
Bookmark this: Fundamental Analysis
What we discussed above outlines the essentials when it comes to fundamental analysis. If you properly internalize the process and learn these metrics inside out as an investor, you will be able to determine whether a stock is an interesting prospect in a matter of minutes. If this is new information to you, you may want to bookmark this page so that you can revisit it later on.
Compare with Competitors
Once you've learned what the business does and how it operates in both qualitative and quantitative terms (the fundamentals), the next step is to figure out who its competitors are.
Understanding a company's competitive landscape is crucial to make sure you're making the best investments. Identifying competitors and comparing them with the target company provides insights into how well the companies are operating compared to its competitors and to spot the differences in their financials.
1. How to Identify Competitors:
As we previously touched upon, the 10-K annual report is full of information, but did you know that it also includes a section on competition?
Furthermore you can find out the competitors of a stock by scrolling down to the "Discover More" section on a stocks page of our platform.
2. Assess Market Leaders:
When exploring a new stock, identifying who the market leaders are within the same sector or industry is another important step. This can often be determined by factors such as market capitalization or total assets. Market leaders typically have the biggest market cap and/or have the highest amount of total assets. You can learn a lot by comparing stocks with their market leaders and by analyzing the differences in their financial metrics.
3. Utilize Comparison Tools:
On Streamlined Finance, we've made comparing stocks very easy and it can be done in three different ways:
Split Compare:
This allows you to compare stocks side by side. This way you can easily see the differences in price action, volatility, maximum drawdown, quantitative scoring, and fundamental metrics. Visual comparisons of fundamentals makes it much easier to interpret than by comparing raw numbers and the ability to put stocks side by side is a great tool for that.
Financials Compare:
On any of our stock pages, you can also quickly compare financial metrics with other stocks (or even ETFs like SPY). This feature enables financial comparisons while staying on the stock's page.
Table Compare:
For comprehensive comparisons across multiple companies' financials, use the Table Compare option. Say goodbye to Excel sheets; with just a few clicks, you can delve deeply into the differences in growth rates, valuation metrics, financial health indicators, and other financial metrics.
By leveraging these comparison tools on our platform, you can really improve your investment process, gain valuable insights, and make confident investment decisions based on data.
So, be curious and compare! Once you have compared many different companies you will certainly find a new level of confidence in your investments.
Making The Case to Invest: Better than S&P500?
When considering an investment opportunity in individual stocks, it's essential to weigh its potential against the performance of broader market benchmarks, such as the S&P 500 index. Here’s why:
Comparative Analysis:
The S&P 500 serves as a reliable yardstick for measuring the performance of the overall stock market. Its diverse composition of 500 leading companies across various sectors makes it a robust representation of market movements. When evaluating the potential of an individual stock, comparing its historical performance and projected future returns against the S&P 500 can provide valuable insights into its competitiveness and growth prospects. You will have to make the case that the stock has outperformed the broader index and will continue to outperform it in the future for it the be a viable investment candidate.
Volatility Considerations:
One significant advantage of the S&P 500 index is its relatively lower volatility compared to individual stocks. Volatility, often measured by metrics like price standard deviation or price drawdown, reflects the degree of fluctuation in a stock's price over time. While individual stocks may exhibit higher volatility due to company-specific factors, the S&P 500’s diversified portfolio tends to offer a smoother investment experience. When investing in a company you have to make sure that the additional gains that you would get from the stock will offset the volatility.
Outperformance Expectations:
To justify investing in an individual stock over the S&P 500, you must be convinced that it has the potential to outperform the index. This conviction can stem from various factors, such as:
- Undervaluation: Identifying undervalued stocks with strong fundamentals and growth prospects can present compelling investment opportunities. If a stock is trading below its intrinsic value, there may be potential for significant upside as its market value aligns with its true worth.
- Growth Potential: Some individual stocks may possess unique growth catalysts or competitive advantages that could enable them to outpace the broader market. Whether it's disruptive technology, expanding market share, or innovative products/services, identifying companies that have potential for above-average growth can lead to superior investment returns.
- Industry Leadership: Investing in companies that dominate their respective industries or exhibit exceptional management can offer a strategic advantage. Industry leaders often have greater resilience during economic downturns and possess the resources to capitalize on growth opportunities, positioning them for long-term outperformance.
- Dividend Yield: For income-oriented investors, stocks with attractive dividend yields may present an alternative to the S&P 500’s average dividend yield. Companies with a history of consistent dividend payments and potential for dividend growth can provide reliable income streams and enhance total return potential.
While comparing individual stocks to the S&P 500 is a critical aspect of investment analysis, it's important to recognize that each investment carries its own set of risks and rewards. By thoroughly evaluating the factors discussed above and conducting comprehensive due diligence, you can make informed decisions that align with their investment objectives and risk tolerance levels. Ultimately, the goal is to construct a well-diversified portfolio that maximizes returns while mitigating risk.
Conclusion
Throughout this article, we've covered the essentials of stock selection, analysis, and comparison, showing you with how the process looks like and which tools you can use.
Here's a recap of what we've covered:
- Finding Stocks: We've discussed various methods for identifying quality stocks, from scanning annual reports to leveraging Streamlined Finance's Markets page to discover promising investment opportunities.
- Analyzing & Comparing Stocks: By exploring key financial metrics, growth rates, valuation methods, and competitive landscapes, you've gained insights into evaluating the potential of individual stocks and comparing them with peers. Remember, the S&P 500 serves as a valuable benchmark, and the goal is to outperform this index.
As part of the foundational investment series, the next step is portfolio optimization and management. This involves strategically constructing a well-diversified portfolio tailored to your financial goals, risk tolerance, and time horizon. Stay tuned for the next installment of our series, where we'll explore advanced techniques for optimizing and managing your investment portfolio effectively.
In the meantime, keep learning, stay informed, and make informed decisions that align with your long-term financial objectives. With dedication and diligence, you're well on your way to achieving investment success.
~ Team Streamlined