Whether you’re looking for an investment that yields the best possible returns or one that’ll help safeguard your assets against inflation, finding the right investment vehicle is a largely individualized process.
Not everyone will have the same risk tolerance, so you’ll often hear different—maybe even opposing—investment strategies depending on who you ask.
And, oftentimes, these pieces of advice can be of unsound quality. In fact, it’s been said that 90% of people who participate in the stock market will wound up losing money rather than earning from it. This is why it’s critical to know exactly how to screen investment opportunities before injecting your hard-earned money into one.
In this article, we’ll help you sift through the investment landscape by discussing a few considerations when assessing a financial opportunity.
1) Current and Projected Profitability
When picking a company’s stock, it’s vital to have a good grasp of how they’re currently performing and whether they are positioned to maintain profitability in the coming periods.
For a start, you can find a company’s current profitability by looking at its cash flow and financial statements. These data points can give you an indication of a company’s overall health and whether it can pay out dividends (i.e., profit sharing) to shareholders.
Cash flow per share is a particularly useful metric to look at as it tells you how much cash is generated for every share outstanding. A cash flow per share less than 15 to 20 is generally ideal —any more than that may mean that the company is over-valuing its stock.
No one wants to invest in a dying company, so you’ll also want to take a look at how the company matches up against its competitors. You may review industry-specific news and trends for this. This will help you ascertain future developments and the current outlook of the firm, which can greatly influence your investment decision.
2) Earning Momentum
Pinpointing the company’s recent earnings is only half the story. It’s important to review past data to see if there’s an upward or downward trend in the company’s net income.
Let’s look at two firms in the same industry as an example. Firm A is valued at $10 per share, Firm B is valued at $8 per share. Firm A has been around for longer, but it has been experiencing a downward trend in its earnings since its last peak, say, six years ago. Firm B is newer, but it has shown a consistent increase in earnings over time.
Even though Firm A is currently valued higher, investing in Firm B isn’t out of the question. It may even be better in the long run. Firm A may be experiencing pressure from other firms in its industry, or it might not have adapted to changes in consumer preferences. Firm B, on the other hand, may have risen in popularity due to a new and innovative product, increasing brand sentiment. Just based on that single factor, Firm B would likely be the better investment.
3) Brand Sentiment
While the market value is an incredibly important metric, you shouldn’t make your investment decision purely on this basis. You’ll want to investigate the company’s brand sentiment as well.
To do this, you’ll want to ask yourself a few questions: Is the company’s brand reputable? Do customers love or hate the company and its products? Are there any impending lawsuits that could damage the company’s image?
Researching a company’s brand sentiment will give you some idea of how consumers feel about it. A company with a strong brand is more likely to have customers that remain loyal, thus keeping the company afloat and thriving in various market conditions.
4) Financial Ratios
The best way to categorize stock value is by looking at a company’s financial ratios. These ratios provide insight into a company’s leverage, liquidity, and profitability. Financial ratios are essential in conducting a comprehensive analysis of a firm.
Four commonly used financial ratios can determine a company’s health. This includes:
- Price to earnings (P/E) ratio: This is calculated by measuring a company’s stock price divided by the earnings per share.
- Price-to-book (P/B) ratio: This is retrieved by measuring a company’s stock price per share divided by its book price per share.
- Price-to-earnings growth (PEG) ratio: This is calculated by measuring a company’s P/E ratio divided by its growth rate for the period.
- Dividend yield: This measures a company’s annual dividend payments to its shareholders.
The ideal benchmark for these ratios will depend on the industry. Nonetheless, it’s important to undergo a thorough analysis of factors outside the ratios as there are numerous types of market manipulation that can occur to make a company look healthier than it actually is.
5) Asset Utilization
You’ll also want to investigate a company’s asset utilization. This will give you some idea of how efficiently the company is using its assets to generate revenue.
Typically, shareholders should seek companies that have a high asset utilization rate, as this indicates that the company is effectively using its resources. This, in turn, can lead to higher profit margins due to a more systematic allocation of resources.