Finding a stock worth investing in for the long term is one of the most crucial parts of investing. Like knowing when you should sell a stock, knowing whether one is worth your time and money in the first place is an important skill to master if you want to make the most from your portfolio.
Just like the pros who pick the most promising company on Shark Tank, deciding whether a stock has a bright future includes assessing the company’s financials, digging into its leadership, and scoping out the fellow competition.
To begin your research, have a look at the company’s fundamental financials. Companies are required to submit reports of their finances to the securities regulatory authorities in Canada.
It can be easy to get overwhelmed by all the numbers in these reports, but focusing on the following key areas can provide crucial insights into a stock’s potential.
One of the first things you’ll see on a company’s financial report is its revenue. This is the amount of money that the company has made. Revenue is often called the “top line” as it is one of the first items on a company’s income statement.
It can be split into operating revenue, which is made from a company’s core business and non-operating revenue, which comes from one-off sales not directly from operations. As an example, revenue from Apple’s iPhones is operating revenue, however, revenue from selling off office furniture would be non-operating revenue.
The next thing to look for is net income. While revenue is referred to as the top line, net income is often called the bottom line, as it’s found at the end of an income statement.
Net income is income made after operating expenses, taxes, and depreciation are subtracted from revenue. While top-line growth means a company is increasing its gross sales and revenue, bottom-line growth illustrates that a company is better at managing operational expenses.
Earnings per share
If you’ve been looking into investing, you’ll likely have heard the term earnings per share (EPS) before. It’s one of the key things that investors look for when assessing a stock.
To calculate earnings per share, divide a company’s earnings by the amount of shares that are available to trade. The reason EPS is such a useful measurement of a company’s success is because it indicates profitability, however, what it can’t tell investors is how a company decides to spend its capital.
Another popular tool to assess a stock is called its price-to-earnings ratio. This key figure ultimately helps one determine whether a stock is overvalued or undervalued. It tells investors how much other investors are paying to buy $1 of the company’s current earnings.
Analysts and investors will often look at a P/E ratio to determine if the share price accurately represents the projected EPS. To find a company’s P/E ratio, divide a company’s stock price by its earnings per share over the last 12 months.
ROE and ROA
Other important measurements to look for when assessing stocks are their Return on Equity (ROE) and its Return on Assets (ROA).
A stock’s ROE will show investors how much profit a company can make per dollar invested by shareholders (their equity). The ROA, on the other hand, illustrates what percentage of profits the company makes per dollar of its assets.
Both the ROE and the ROA can tell investors how efficiently the company is making money. To calculate both, divide a company’s annual net income by one these measures.
While all of these factors provide important insights into a company’s profitability over the long term, there are always going to be many things to consider when picking a stock.
In addition to assessing its fundamentals, always do as much research as possible into the company’s competition, its management, and what its plans for the future are.