Evaluating a stock

gaffer91

Recently I have taken quite an interest in financial markets. The question I want to ask investors on boards.ie, what is the best way to evaluate a particular stock and whether it is a good buy in the short or long term?

Do people simply look at their P/E ratio? Or do they do a methodological analysis of their balance sheets and quarterly reports? How important is it to evaluate the entire industry and competition and the international economic climate? Is evaluation a mathematical process or are other factors more important?

Obviously I understand this varies from person to person, but if you could give me a general insight into your thought process before buying a stock, that'd be great.

All responses welcome.

bull_ring

gaffer91 wrote: »

Recently I have taken quite an interest in financial markets. The question I want to ask investors on boards.ie, what is the best way to evaluate a particular stock and whether it is a good buy in the short or long term?

Do people simply look at their P/E ratio? Or do they do a methodological analysis of their balance sheets and quarterly reports? How important is it to evaluate the entire industry and competition and the international economic climate? Is evaluation a mathematical process or are other factors more important?

Obviously I understand this varies from person to person, but if you could give me a general insight into your thought process before buying a stock, that'd be great.

All responses welcome.

cold hard statistics appear to mean little in an irrational , fear induced market like we presently have

their are any number of european stocks which are redicolously low priced right now but the crisis in europe is weighing them down , siemens is one that springs to mind

my point is that in times like this , figures mean nothing , then again investments in stock is meant to be a long term thing

pirelli

gaffer91 wrote: »

Recently I have taken quite an interest in financial markets. The question I want to ask investors on boards.ie, what is the best way to evaluate a particular stock and whether it is a good buy in the short or long term?

Do people simply look at their P/E ratio? Or do they do a methodological analysis of their balance sheets and quarterly reports? How important is it to evaluate the entire industry and competition and the international economic climate? Is evaluation a mathematical process or are other factors more important?

Obviously I understand this varies from person to person, but if you could give me a general insight into your thought process before buying a stock, that'd be great.

All responses welcome.

That is the hardest question anyone has ever asked on this forum, and would take a long time to answer.

So many factor's not directly related to the stock may be critical.

It is a lot more complicated than you would at first imagine, and very much depends on what the stock is, and what industry sector it is. Buying stocks like coca cola, and johnson & johnson are quite straight forward and pretty much recession/financial crisis proof. Other stocks like shipping would be very sensitive to a world recession.

While i know you are not a day trader i just want to explain something to demonstrate the many psychologies/strategies, and even principles at work in the market:

There are three forms of day trading;
Fundamental
News
Chart's/technical

So it depends on how long you wish to hold the stock. i.e a few hours,a few days,weeks months,years. Timing is important but that is not always an option.

There are three major types of stock
large cap - mostly low risk
medium cap - moderately risky
small cap - risky
OTC/pinks - extremely risky


Small caps and OTC are very risky but can be very rewarding


The type of stock: some bio techs are very risky particularly those awaiting FDA approval, and you can lose half your money overnight or double it. Cash strapped stocks dilute, and abuse shareholders value, some are just scam's and others are shorted by wall street for whatever reason such as ADR's from china.

You have to check how many shares are issued and depending on the stock might even have to check if their are many warrants out on the stock which would cause future loss of share value. It can get complicated the smaller the cap.

I am guessing you mean large cap, and your first step is to check the financial balance sheets, Google AAPL on google finance, click financials, and click annual balance sheet; and look at it's common shares outstanding. It hasn't changed, (pefect/ideal) and total debt outstanding; (zero) but then look at the asset's they have doubled/tripled every year, and look at it's revenue it's a dream stock just exploding in higher revenue every year. Then go to income statement, annual data; and that is a perfect set up. Growing net income, revenue, and profit margin; and operating margin, and operating profit. You wont beat AAPL.

What I recall as being important in large caps is cashflow and how much money they have and profit margin.

Take RIMM they have zero debt and growing assets much like AAPL and even revenues are quite stable. They have tons of cash but profit margins are going down. Profit margins and cash flow seem to matter but then RIMM has a problem. Rimm has to shift technology and this usually kills a company, and they only have enough cash for two more years to this successfully.

Solar is an example of a sector that suffered a profit margin disaster, and it sent those stocks plummeting. So future profit margin is important.

That's my 2 cent's off the top of my head. Comapare RIMM and AAPL.. If Rimm manages to surprise the market by being able to adapt and change and compete then it would be a cheap and worthwhile buy in my opinion as long as we are not heading into another financial meltdown.

Finally if you look at AAPl cashflow you can see they have been investing less and less of it, so it is important to know where the market in general is going, whether it is a bull market or a bear market and whether we might see another downturn. Also wall street simply doesn't like some stock's.

The Dublin Whale

bull_ring wrote: »

cold hard statistics appear to mean little in an irrational , fear induced market like we presently have

their are any number of european stocks which are redicolously low priced right now but the crisis in europe is weighing them down , siemens is one that springs to mind

my point is that in times like this , figures mean nothing , then again investments in stock is meant to be a long term thing

Just wondering why you think Siemens is undervalued? They're trading at 14 times earnings and have recently given a very bearish outlook for the foreseeable future.

pirelli

bull_ring wrote: »

cold hard statistics appear to mean little in an irrational , fear induced market like we presently have

their are any number of european stocks which are redicolously low priced right now but the crisis in europe is weighing them down , siemens is one that springs to mind

my point is that in times like this , figures mean nothing , then again investments in stock is meant to be a long term thing

I think the answer ( in fear induced markets) is a strong cashflow, zero debt and high profit margin. Good growth prospects not essential but helpful.

bull_ring

pirelli wrote: »

I think the answer ( in fear induced markets) is a strong cashflow, zero debt and high profit margin. Good growth prospects not essential but helpful.

microsoft has excellent cash flow and not much debt yet the stock has gone nowhere since 2000

previous earnings are no indication of future returns , owning a large cap or a mega cap like apple doesnt shield you from a downturn like we had in 2008 , almost everything dropped by 40% back then

i own apple , i planned to sell it after last weeks earnings as this is a good traders market but results were delayed and the price had dropped by thirty dollars from one second to the next , i intend to sell it in the coming days as i think it will come off by about 10% in the short term , will get back in somewhere below 540

pirelli

bull_ring wrote: »

microsoft has excellent cash flow and not much debt yet the stock has gone nowhere since 2000

previous earnings are no indication of future returns , owning a large cap or a mega cap like apple doesnt shield you from a downturn like we had in 2008 , almost everything dropped by 40% back then

i own apple , i planned to sell it after last weeks earnings as this is a good traders market but results were delayed and the price had dropped by thirty dollars from one second to the next , i intend to sell it in the coming days as i think it will come off by about 10% in the short term , will get back in somewhere below 540

Microsoft has had many stock splits in the couple of decades.It has 8 billion shares outstanding. 8 billion is more than the entire world population. APPl has less than a billion. The market has been going sideways since 2000 not just microsoft. Microsoft is an elephant that has slowly been falling behind and hasn't introduced any new exciting products. It just plods along with the market.Still a solid enough stock.

bull_ring

pirelli wrote: »

Microsoft has had many stock splits in the couple of decades.It has 8 billion shares outstanding. 8 billion is more than the entire world population. APPl has less than a billion. The market has been going sideways since 2000 not just microsoft. Microsoft is an elephant that has slowly been falling behind and hasn't introduced any new exciting products. It just plods along with the market.Still a solid enough stock.

no question its a solid stock and unlike apple , pays a very decent dividend so even it went nowhere since 2000 , your still better off owning it than having money in a savings account

apple has seen such spectacular growth this past number of years , it seems extremley unlikely it can maintan the same dynamic , im not saying it wont reach $700 but i dont believe it will by year end , if we get a big market sell off in the next few months ( which is very likely ) , apple will suffer like any other company , its around 575 at the moment , should edge towards 600 in the next couple of days in anticipation of further stimulus from the fed ( which wont come ) and then sell off by about 10% , below 550 is a good place to get back in as their will be no real large gains untill around the time of the release of i phone 5

Buzzliteyear

gaffer91 wrote: »

Recently I have taken quite an interest in financial markets. The question I want to ask investors on boards.ie, what is the best way to evaluate a particular stock and whether it is a good buy in the short or long term?

Do people simply look at their P/E ratio? Or do they do a methodological analysis of their balance sheets and quarterly reports? How important is it to evaluate the entire industry and competition and the international economic climate? Is evaluation a mathematical process or are other factors more important?

Obviously I understand this varies from person to person, but if you could give me a general insight into your thought process before buying a stock, that'd be great.

All responses welcome.

A glib response is hardly appropriate here. My process is very much in the focus / value investor approach. But I learned this through mistakes and research. I believe what you put in is no more than you can expect to get out. If I was starting all over again a perfect starting point is the Intelligent Investor by Ben Graham. But remember that you have to work on your process system to the point that you can objectively stand back from the markets frequently. Thats the discipline you'll require in buckets if you're investing for long term success. Happy hunting!

bridgepeople

'The Intelligent Investor' is a classic.

Also try 'Warren Buffett and the Interpretation of Financial Statements: The Search for the Company with a Durable Competitive Advantage' too by Mary Buffett (slightly cynically cashing in on your surname). That book is written in plain english for novice investors and explains pretty clearly what you should be looking for.

In one sentence, I would say the best companies have sustainably high returns on capital with low capex requirements. Once you have found such a company, you must then decide if it is good value.

Microsoft is a good example actually. It has had a return on capital of over 20% for probably 20 years now (80%+ gross profit margins) and its capex is very low relative to sales. So why has its stock fallen in the last decade? Because during the dotcom bubble tech stocks were trading for ridiculous multiples. I think MSFT was around 80x P/E at one point. So even though profits have quadrupled or more since then, the stock has fallen as the P/E muliple is now down to 10x.