How Do I Know What Companies to Invest In?
By: Cristina Fernandez
While the economy has been in recession for a few years now, any investors are starting to have faith in the stock market again and are ready to invest in stocks and bonds. Purchasing stocks or bonds from a company is a great way to make a little extra profit. Many investors, however, often run into the question, “I want to buy a stock, but how do I know what company to invest in?” There are many factors that determine what companies have a higher risk stock and what companies’ stocks have lower risk. Here are some pointers:
1.Look at the balance sheet! Get a hold of the company’s balance sheet which can be obtained on the companies website or annual report. The balance sheet will provide information such as assets, liabilities, and shareholders equity.
2.Examine companies’ assets and liabilities! There are two different categories for assets and liabilities: current and non-current items. Current liabilities are the payments the company has to make within that year. This includes paying employees, suppliers, taxes, and providers of short-term finance. Current assets are the amounts of input the company will be receiving that year. This includes inventories that will be sold within that year. Inventory is a huge part of a company’s assets; therefore it is important that a company manages their inventory in a smart way. A company handles their inventories well when a company minimizes the level of inventory for the given level of sales. A company may also maximize the level of sales for their level of inventory. If you see a company’s inventory value fall with a higher increase in sales, this shows you that the company is managing their money well.
Non-current liabilities and assets are expected to extend longer than one year. Examples of non-current assets are machinery, buildings, land, and other equipment that the company may need to run its business. Non-current liabilities are payments such as equipment leasing contracts, other items borrowed, bank loans, etc. If the company’s non-current liabilities exceed its non-current assets, this isn’t a good sign.
3.Another area to look when examining the balance sheet is the current ratio. This is the total current assets divided by the total current liabilities. Many analysts use the current ratio to determine the company’s ability to pay its short-term obligations. The ratio should be at least one because if not then its liabilities must exceed its assets. Companies usually try to reach a current ratio of around two to prove a healthy and stable cash flow. The bigger the better rule does NOT apply with the current ratio. If a current ratio is too large, the company may have an inefficient use of cash and high liquidity.
4.The shareholder’s equity is another important factor in determining the growth of a company. This is the total assets subtracted by the total liabilities. The shareholder’s equity may also be called the book value or the accounting value. It is based off of the capital given by shareholders, or profits earned by the company; it represents the interest in assets that is distributed to different shareholders after all liabilities are paid off. A negative shareholder’s equity is never good.
5.Investors can determine if a company’s shares are overpriced, underpriced, or just right by comparing the market value to the book value. The market value is market price per share. A low Market-to-book multiple shows that a company has a strong financial position in comparison to its price tag. It is proven that companies with lower market-to-book value do better than those with higher multiples. In order to compare the company’s market-to-book multiple, it is important to compare other companies’ book-to-market ratios.
It is important to research what companies are stable, healthy, and have a good cash flow before investing. The worst mistake any investor could make is investing in a company either without researching or going into buying stocks blind-folded. If you want a higher chance of return or profit, first take the time to look into companies that you believe will bring you the best returns.
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Image Credit: marketinghackz.com
