Look At The Companys Financial Statements
Reviewing company financial statements can give you an idea of the future of the company beyond revenues and expenses. In addition to figuring out earnings, knowing where a company spends its money tells you a lot about where management wants to take the organization. If you have an idea of where the company is headed, you can make a better judgement of its long-term prospects. Youll know whether theyre investing for the future with R& D or slashing headcount in order to keep the business afloat. Sometimes you can figure out a lot just by looking at the numbers.
Simplify Your Stock Selection
Stock selection doesnt have to be difficult, but you do need to be flexible. Look for markets that are moving, but also be willing not to trade. Consider going short, as well as long. Finally, and perhaps most importantly, you need to be disciplined. Dont let the inevitable bad trades turn into a disaster. Keep your losses small and live to trade another day.
How Investors Can Use Variations Of The P/e Ratio
Investors, particularly growth-oriented ones, often use a company’s current and past P/E ratios to calculate two other metrics: the forward-looking P/E ratio and the price-to-earnings to growth ratio.
The forward P/E ratio is simple to compute. Using the P/E ratio formula — stock price divided by earnings per share — the forward P/E ratio substitutes EPS from the trailing 12 months with the EPS projected for the company over the next fiscal year. Projected EPS numbers are provided by financial analysts and sometimes by the companies themselves.
The PEG ratio accounts for the rate at which a company’s earnings are growing. It is calculated by dividing the company’s P/E ratio by its expected rate of earnings growth. While most investors use a company’s projected rate of growth over the upcoming five years, you can use a projected growth rate for any duration of time. Using growth rate projections for shorter periods of time increases the reliability of the resulting PEG ratio.
Continuing with our Walmart example, analysts forecast average annual EPS growth over the next five years of 6.29% per year. Dividing Walmart’s P/E ratio of 29.43 into 6.29 produces a PEG ratio of 4.67. A stock with a PEG ratio below 1.00 is considered as exceptionally valuable due to its impressive projected growth rate.
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The Ideal Strategy To Follow While Investing In Penny Stocks
2022 has been a year for volatility for both penny stocks and blue chips.
Even with the volatility, penny stocks have never gone entirely out of fashion.
They keep on drawing attention from retail investors.
Because it’s not unusual for a good penny stock to turn a multibagger in a matter of months.
On the flipside, there is a high risk involved. In a bull market, several junk companies with dubious promoters and poor corporate governance standards also rally.
Investors who are new to the market often get lured into investing in them in the hope of making quick gains.
That is the reason penny stocks are not recommended to those with a low risk profile.
The corpus that one sets aside for penny stocks should not be more than 5%-7% of the total money allocated towards equities.
You need a very strong framework to separate men from the boys in penny stocks. A framework that not only enables you to zero in on the right penny stock at the right price but also helps you avoid those big losers.
If you follow sensible investing principles, no time is a bad time to invest in best penny stocks.
Watch the below video where co-head of Research at Equitymaster and penny stocks guru Rahul Shah discusses his top penny stocks in this market.
Since you are interested in penny stocks, check out our ultimate guide to penny stock investing.
Happy Penny Stock Investing!
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Avoiding Penny Stock Scams
Investors who are promised high returns for low costs should be on the lookout for the following red flags, in order to avoid fraudulent deals:
- Unofficial internet/email promotions
- Promotions brokers offer through boiler room telemarketing calls
- Vaguely-labeled newsletter and online forums touting so-called “hot tips.”
Penny stock investors should be aware of the following potential traps:
- Pump and Dump schemes: This is when promoters claim access to insider information in their efforts to inflate the prices of earlier purchased low-cost lots, that they subsequently attempt to offload for high profits. Gullible investors who act on these tips may end up saddled with high-cost investments that they’ll have trouble unloading.
- Short and Distort: This is a variant of pump and dump, essentially working in the reverse direction. Promoters short sell penny stocks at high prices and then promote negative news about the stocks in a strategic effort to lower the prices and square off their positions for high profits.
- Long-term averaging techniques: A cyclical scheme where investors are advised to continue accumulating a penny stock with each price dip, with assurances of windfall profits once the stock prices take a positive turn.
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They Have Good Financial Fundamentals
A deep dive into a growth stock’s financials can reveal a great deal about its share price potential.
That’s where recognizing a growth company’s fundamentals can help choose a winner. Any fundamental analysis growth stock research campaign should cover the following areas:
- The balance sheet. This shows the assets, liabilities, and capital of a company at a specific point in time, including the balance of the company’s income and expenditure over the preceding period.
- Cash flow. A company’s cash flow represents the net amount of cash flowing inside and outside of a business. Cash flow is key to a company’s financial growth prospects, as its ability to generate sustainable positive cash flow is a good indicator of solid financial health and usually leads to share price growth.
- Income statement. A company’s income statement is a basic document that shows a business’s profit and loss along with a statement of earnings. The income statement is deemed by economists to be a company’s most important fundamental financial document, as it reports the company’s revenues, expenses, gains, losses, and the final net income for the company in a specific period
Revenue And Earnings Growth
A stock with a low valuation may seem like a great investment. But what if the valuation is low because the company has had a history of stagnant revenue and earnings? Or worse, what if the company has seen revenue and earnings decline over the past several years?
In these cases, low valuations serve as a warning sign rather than a buying sign.
Before making an investment, look at the past four earnings reports at least. The more history you look into, the better off you are. When digging through the earnings reports, look for the companys revenue and earnings growth, or lack thereof.
If you find that the company is relatively stagnant or going backward in terms of revenue and earnings, its time to go back to the drawing board to find another opportunity, because the stock of a stagnating or shrinking business is likely to produce losses over time.
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With That In Mind Here Are Three Other Essential Components Of Stock Analysis That You Should Watch:
- Durable competitive advantages: As long-term investors, we want to know that a company will be able to sustain its market share over time. So it’s important to try to identify a durable competitive advantage — also known as an economic moat — in the company’s business model when analyzing potential stocks. This can come in several forms. For example, a trusted brand name can give a company pricing power. Patents can protect it from competitors. A large distribution network can give it a higher net margin than competitors.
- Great management: It doesn’t matter how good a company’s product is or how much growth is taking place in an industry if the wrong people are making key decisions. Ideally, the CEO and other main executives of a company will have successful and extensive industry experience and financial interests that align with shareholder interests.
- Industry trends: Investors should focus on industries that have favorable long-term growth prospects. For example, over the past decade or so, the percentage of retail sales that take place online has grown from less than 5% to more than 11% today. So e-commerce is an example of an industry with a favorable growth trend. Cloud computing, payments technology, and healthcare are a few other examples of industries that are likely to grow significantly in the years ahead.
Penny Stocks Investment Tips For Beginners
Finding good penny stocks involves doing many of the same things you would if you were looking for good stocks in general.
Our how to invest in stocks for beginners guide is a great place to get started if you arenât familiar with that process. But here are some other tips to help you on the way.
1. Look for future growth sectors – Old industries donât mean a business is bad by any stretch but if you want to narrow your options down, look for companies that are active in sectors you think are going to grow a lot in the future. Green energy or graphene companies might be an example of this. You could even look at alternative income sources too.
2. Who is running the business? – It may seem obvious but do research on the background of the company executives. Maybe theyâre serial entrepreneurs with lots of experience. Or maybe theyâre less savoury characters with a long history of failures. It pays to know.
3. Check the finances – Penny stock companies may not have to adhere to the same regulations as bigger players but they still need to publish some accounts. Check them. See if the business is making money and doesnât have huge debts. If it does have debt, make sure it has the money to pay it off.
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Blue Chip S& p 500 Leaders And Best
The S& P 500 and benchmark indexes have not only recovered but surpassed prior highs from every bear market. However, keep in mind, the benchmark indexes always get adjusted to kick out the losing stocks and add winning stocks. Therefore, dont assume your stocks will all recover based on the benchmark indexes. The best-of-breed stocks in the S& P 500 index are the most likely to lead the recovery. Always look for quality stocks with fortress balance sheets, relevant trends, leadership positions in the industry, and liquidity.
Put It All In Context
With this sizable amount of information about a stock, you can start to assess whether its a fit for your investing goals. Here are a few scenarios that can help spark ideas to decide what sort of investing goals you want to pursue.
- Income investing. If a particular stock has buy ratings across the board, solid financials and sound leadership but cut its dividends to zero during the pandemic, you might consider a different well-rated stock in the same asset class with a long history of consistent dividends.
- Growth investing.If your favorite sneaker company consistently puts out new products but doesnt show signs of long-term financial growth, you could consider this stock for a different part of your portfolio or skip it since its not going to meet the growth you need to meet your financial goals.
- Value investing. Value investors look for underpriced stocks. They believe the stock market overreacts to events that impact individual companies, and that short-term developments drive moves in stock prices that dont always reflect a companys long-term fundamentals.
- Socially responsible investing. If your research into an agricultural company demonstrates that theyre not proactive with watershed protection and dont have plans to build out an overall EGS strategy, a well-rated stock with an excellent returns history might not make the cut.
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Research The Company Before Engaging In Stock Market Investing
Always research a company and the industry it is in before you invest in stocks. Dont just trust a hot tip, but instead conduct due diligence. An excellent place to start is by reading the companys most recent annual report.
You can also look at the following:
- SEC filings
- Press releases
- Recent news articles showing public opinion
The brokerage firm youll use to buy stocks should also have additional information, such as ratings or grades from popular investment analysis companies.
Consider looking up the companys competitors to see how it stacks up in comparison. See if a company pays investors dividend payments you can make use of immediately or reinvest. As you conduct your research, take note of the valuation metrics explained below.
What Stocks Should Beginners Avoid
There are some stocks that represent a higher risk and could spell disaster for new investors.
Penny stocks: Penny stocks are very cheap. They may be from brand-new companies or ones that may or may not recover from taking a massive stock hit for one reason or another. While its true that you could end up with a profit boom, the stocks end up being a bust too often to recommend.
Cyclical stocks: These are stocks from companies that end up going in cyclical patterns with the economy or some other force like the weather. Examples of these types of stocks might be those tied to farming, which is very reliant on weather patterns. Another example would be hotels. Business booms when the economy is good and people have disposable income, but they arent so good in a downturn.
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Identify Companies With Strong Competitive Advantages
A competitive advantage is a companys ability to stand above its rivals with desirable traits that keep customers loyal to its products or services for a long time. Some call competitive advantages wide moats, since they defend a companys market shares from competitors.
Most people know intuitively that companies have competitive advantages, though they may not know what these advantages are called.
Typically, competitive advantages will fall into one of these four buckets:
Value Stocks Investing Is More Advanced
A beginning investor doesnt normally want to put his money in undervalued companies. Hes attracted to rapid growth.
Value stock investing is more advanced, more analysis is in required. A value investor must efficiently analyze a companys fundamentals and also have the discipline and patience to wait for the results.
This may not sound too attractive to investors that seek quick profits.
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Gather Your Stock Research Materials
Start by reviewing the company’s financials. This is called quantitative research, and it begins with pulling together a few documents that companies are required to file with the U.S. Securities and Exchange Commission :
Form 10-K: An annual report that includes key financial statements that have been independently audited. Here you can review a companys balance sheet, its sources of income and how it handles its cash, and its revenues and expenses.
Form 10-Q: A quarterly update on operations and financial results.
Best stock research websites
The SECs Electronic Data Gathering, Analysis and Retrieval website provides a searchable database of the forms named above. Its a valuable resource for learning how to research stocks.
Short on time? Youll find highlights from the above filings and important financial ratios on your brokerage firms website or on major financial news websites. This information will help you compare a companys performance against other candidates for your investment dollars.
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The Economic Cycle And Interest Rates
It can pay to check out the big picture. For one, consider the economic cycle , which Donovan learned about when he first started investing. This chart has stuck with me for over 30 years and the markets have continued to show its worth,” he says. Depending on the stage the economy is in, certain asset classes can perform better for example, bonds can provide superior returns when interest rates are high and falling, and stocks can be particularly strong buys when interest rates are at their lowest. Donovan adds that having a balanced portfolio will help you take advantage of the economic cycle over time, with less risk during the ups and downs of the market.”
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Combining All Value Stock Screener Criteria
- Price to Earnings Ratio below 15
- Price-to-Book Ratio below 1
- Return on Equity above 10%
- Dividend Yield above 1%
- Debt Equity Ratio below 0.5
- Current Ratio above 1.5
- Price to Sales Ratio below 2
- EPS Growth Next Five Years above 10%
- Low Price to Free Cash Flow
Identifying value stocks is a subjective task. Your interpretation and analysis are more important than blindly following someone elses figures.
You may want to add other ratios or eliminate some criteria. Value investing is not a precise art and every investor has its own tools and methods to spot a value stock.
You can play with these criteria on a stock screener like Finviz. A Stock screener is a tool that selects the stocks which match the selected criteria from the whole pool of stocks. The stocks screener scans the entire stock market and shows you what stocks meet your criteria.
This could really speed up the process of finding the values stocks. However, use this tool only as the preliminary first step in your research.
After you selected the potential stock value candidates, dig deeper. Research the company, understand its business model, the quality of the management and its competitive advantage the company has over its peers.
Try to understand why the company is not so popular and appreciated by the market. Try to find out why the company slowed down, what were the causes that led to this situation etc. Before putting your own money in this company you must look at the bigger picture.