Stock
Prequalification Checks
Stock research and analysis
Fundamental
investing requires spending time gaining an understanding of a
company’s business and its growth prospects. So you’ll save time if
you eliminate weak candidates before you do your serious research.
I’ve
developed a group of quick rules that I use to pre-qualify investment
candidates. These rules resulted from my own research and experience,
and may not be jibe with the advice of market experts.
Here's a list
of my favorite sites for the getting the information, but except
for Morningstar’s grades, the same data can be found on a variety of
sites.
|
Websites
for Prequalification Checks
Multex
Investor (www.multexinvestor.com):
my favorite site for financial data and for analysts’
consensus forecasts and buy/sell ratings. Enter a ticker symbol
to get started, click on company information, and then select a
report from the menu on the left.
Morningstar
(www.morningstar.com):
although known primarily for mutual fund ratings, Morningstar is
also a good source of fundamental data on individual stocks. As
with Multex, enter a ticker symbol and then choose a report from
the menu on the left.
Yahoo!
Finance (finance.yahoo.com):
Yahoo!’s stock price charts are easy to use. Enter the ticker
symbol and select Chart from the dropdown menu. |
Operating
Cash Flow
You can find this on the Morningstar site by going to the Cash
Flows report. Operating cash flow measures the cash moving in or out
of a company’s bank accounts resulting from its basic operations such
as selling coffee if it’s Starbucks, or producing software in the case
of Microsoft. Companies often report positive earnings when, in fact,
they’ve lost money on a cash basis. Companies with positive operating
cash flow are safer investments than cash burners (negative cash flow).
Avoid companies showing negative cash flow for the past 12 months (TTM).
Financial
Health Grade
Morningstar analyzes
a variety of a company’s financial statement factors and evaluates
them using easily understood grades A through F. You can find them on
the Snapshot
page.
The Financial
Health grade considers a company’s cash in the bank, cash flow, debt
levels, and like items. Companies earning an “A” grade have solid
financials. In this market, invest, don’t gamble! Eliminate candidates
with less than an “A-” financial health grade.
Growth
Grade
Morningstar’s
evaluates a company’s historical five-year sales growth compared to
other companies in the same industry sector, with the best grades going
to those with consistent high growth. All other things being equal,
companies with strong historical growth rates are your best bets, but
considering what has transpired in recent months, you have to give your
candidates some slack. Look for companies with “A” or “B” growth
grades.
Valuation
The valuation ratios on Morningstar’s Snapshot
page compare a company’s stock price to measures such as per-share
earnings (price/earnings ratio), or book value (price/book ratio) to
determine if a stock is undervalued, overvalued, or trading at fair
value (just right). My favorite valuation measure is sales per share
(price/sales) because sales (revenues) are less subject to arbitrary
accounting decisions than earnings or book value. Definitions vary, but
most experts would probably agree that a stock with a P/S above 10 is
over-priced for this market, so avoid stocks with a P/S of 10 or higher,
and lower is better.
Institutional
Ownership
Institutional
ownership is a measure of the percentage of a company’s shares that
are owned by mutual funds, pension plans, and the like. Low
institutional ownership means that most of those professionals don’t
think they can make money owning the stock. Why would you want to own a
stock shunned by these seasoned investors? You can find institutional
ownership information on Multex’s Institutional
Ownership page. Avoid stocks with less than 30 percent institutional
ownership.
Number of
Analysts
Research analysts
have taken a lot of heat lately because, last year, as a group, they
advised buying most of the stocks that only months later went down in
flames.
Even so,
analyst coverage is an important consideration. A stock price goes up
when more investors want to buy shares than want to sell, that is,
demand for the shares exceeds supply.
Analysts’
recommendations influence demand, because many buyers, especially mutual
funds and other institutions, learn of a stock from analysts’ reports.
Insufficient analyst coverage can mean a company’s accomplishments
will go unrewarded because they don’t come to the attention of the big
buyers. There’s no hard and fast rule as to how much is enough, but
certainly three or less analysts is too few.
Look in
Multex’s Earnings
Estimates section and avoid stocks if less than four analysts are
currently making buy/hold/sell recommendations, and more is better.
Stock
Price Action
A stock’s price
chart, as found on the Yahoo! site, can tell you whether a stock is
currently moving up (uptrend), down (downtrend), or treading water
(consolidating).
We’ve all
heard that we should “buy low,” but buying a stock in a downtrend is
dangerous because it will likely move lower.
Chart readers
consider a stock to be in a downtrend when its price is below its moving
average, and in an uptrend if above. Yahoo!’s stock
price charts display both the 50 day and 200-day moving averages,
but I find that the 50-day MA is the better indicator. Don’t take
chances! Avoid stocks trading below their 50-day moving average.
These rules
will help you eliminate losing stocks, but they are only a start. You
still have to do further research on the survivors. We’ll describe how
in future columns.
published 7/9/01 |
