Two great ways to pick a stock
There are many factors to look at and consider when investigating an individual stock. You can look at volume, price, earnings-per-share, different ratios, debt and a lot more. Here are two factors that are very important.
1. Think about the business model
A business model is the basic method of conducting business for a company. An example is Dell Computers. What is their business model? They sell computers direct to consumers and businesses, bypassing the retail channel. What is Office Max’s business model? They sell office supplies, including computers, to consumers and businesses using retail stores and some website sales.
One product (computers) and two models. This model difference affects their balance sheet, net income, revenue and almost every other financial aspect.
You can learn a lot about a companies’ potential for success and survival by understanding their business model. What company probably has a greater chance of survival in an economic downturn (all other things being equal)? A company that sells a low-priced service that a great number of consumers need monthly or a company that sells a high-priced product that only needs to be replaced every five or more years? I would put my money on the low-priced, monthly-replaced business model.
2. Consider companies with high earnings yields
The earnings yield is the opposite of the P/E ratio. It is essentially the E/P ratio. You divide a companies’ total earnings by the total market price of the stock.
For example, if ABC Widget Company has annual earnings of $20 million and a market value of $200 million, then the earnings yield would be 0.10 (or 10 percent). So for every dollar of market value the company is earning 10 cents.
How do you spot potential value with the earnings yield?
Imagine a popular company that everyone adores is making $1 billion dollars every year in net income. That looks very good. But if that business was valued on the stock market for $100 billion the earnings yield would be a paltry one percent! So for every dollar invested the company is actually only producing one penny in net income for you, the shareholder and part-owner.
It could be a great company that is well-managed and liked by the public and probably growing. But is it a smart investment?
Let’s look at the other side. Imagine a different company earning the same $1 billion annually and valued on the stock market at only $5 billion dollars. That would give you an earnings yield of 20 percent. Can you see the better value? For every dollar invested in this stock, the shareholder receives the benefit from twenty cents in earnings.
Since we compare net earnings to market price, we get a more-accurate measure of value to the shareholder. Because of this, I consider the earnings yield the True Shareholder Net Profit and the BEST measure of stock value.
Good luck spotting those worthy stocks.
Ron Phillips is an Independent Financial Advisor and a Pueblo, Colorado native. He and his wife are currently raising their two sons in Pueblo. Order a free copy of his easy-to-read e-book Investing To Win by visiting www.RetireIQ.info or leaving a message on his prerecorded voicemail at (719) 924-5070. Simply mention Promo Code #9001 when ordering.