4 Quick Ways to Decide if a Company Is Worth Your Investment

Stock analysis can be as complicated as you want it to be. There are thousands of data points available to collect and consider. Sifting through this information may or may not be useful to making a timely, sound decision to buy, hold, or sell. While you shouldn't take shortcuts in investing, there are a few key (and easy to understand) indicators that nearly anyone can use to quickly analyze a stock. (See also: 15 Investing Tips From A #1 Wall Street Stock Picker)

There are two main issues to consider when conducting a review. First, evaluate the strength of the company; that is, determine whether the organization is worthy of owning. Then, figure out whether the price of a stock makes its purchase a wise investment decision.

In financial lingo, looking at the company and relevant economic conditions is called fundamental analysis; considering the stock price (and its possible movement in the near term) is referred to as technical analysis. Having bought great companies at too-high prices, I can attest to the need to consider the general health of a company and whether its stock is overvalued or undervalued in the market place.

Here are four easy and useful ways to evaluate a potential investment.

1. See the Company First-Hand

You can learn a lot about a company by visiting its facilities and talking to employees and customers. For example, shop at stores of companies in the retail sector. Notice whether the sales floor is buzzing with people or nearly empty. Look at its merchandise, comparing its branding, quality, and pricing to competitive offerings. Interact with employees to discern how well-trained and helpful they are.

For non-retailers, talk to friends and neighbors who are employees, customers, or vendors to get a sense of how the company operates and treats those who interact with the firm. Try the business's products and services. Ask industry professionals what they think about a company's product quality, service levels, and innovation.

Store visits, chats with employees, etc. can give you insights into an organization's general well-being. While you won't learn all that you need to know, you can contrast the corporate image with reality and determine if the company is worth further investigation.

2. Look at Financial Reports

Locate a company's financial statements to look at key statistics such as revenue, earnings, and cash flow over the past several years.

Access financial statistics directly at the SEC-EDGAR database (enter the ticker and find 10-K filings associated with annual reports). Alternatively, use online tools to dig into financial performance, such as Morningstar.com or Yahoo! Finance, where financial results and trends can be viewed under the Financials tab.

Ideally, you'll discover a company experiencing steady and strong growth with the capability of continuing this trend. Practically, though, finding a company with a perfect record is unlikely, as most have occasional setbacks, especially during recessionary periods. Still, you should look at the financials.

Notice whether:

  1. net income is positive, indicating that the company is generating a profit;
  2. revenue and earnings have grown over time; and
  3. operating cash flow is positive and growing.

Past performance is not a guarantee but can indicate whether a company may continue to grow and deliver strong returns for shareholders.

3. Look at the P/E Ratio

The Price to Earnings Ratio (or P/E Ratio), which is the stock price divided by earnings per share, gives you an idea of whether you'll snag a bargain or pay a premium for the stock. This number might be referred to as the stock's valuation, which fluctuates due to real and perceived value.

Find this ratio for individual stocks at Morningstar, Yahoo! Finance, and Google Finance. Alternatively, look at charts for individual stocks inside the research section of your online brokerage firm.

According to The Motley Fool, "The median stock in the S&P 500 Index has historically had a P/E ratio of about 15." A lower number than average could indicate a good price whereas a higher number might mean the price is too high.

Many factors can affect this ratio, though, such as a slowdown in earnings or expected growth that is reflected in the stock price. Nevertheless, looking at the current P/E of a stock compared to its historical performance as well as its industry peers and the market in general can give you an idea about current valuations.

4. Watch the News

A glance at financial news can give you insights about a specific company as well as its industry and overall market activity, which can impact a stock's value.

You don't have to watch CNBC all day to get basic but meaningful information. Check Bloomberg.com online or via its mobile app or log in to your online brokerage account to receive headlines relating to global economies, view a market snapshot, note analyst ratings, and read company and industry news.

Take in updates about company earnings along with expansion plans and product introductions. Read about the industry's stagnation or rapid growth. Notice how your potential stocks grow or shrink in value based on movement of market indexes, which can reflect general investor sentiment about your picks.

Selecting stocks for your portfolio should involve making general observations, reviewing financial results, and getting a sense of what people are saying about its future. Then, make an investment decision by forming an opinion based on factors likely to affect the performance of the company and its stock price over the long term.

Do you buy and sell individual stocks? How do you evaluate a company?

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4 Quick Ways to Decide if a Company Is Worth Your Investment


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Guest's picture

I think one idea to add as a common theme throughout the four examples is to benchmark it against other similar companies in the field. Compare P/E ratios, financial reports, and news for the field in question.

Comparing companies across fields rarely makes sense in the big picture when investing...

Julie Rains's picture

I think it makes sense to compare financial stats to past performance and peers within a field or industry. Some general benchmarks may also be helpful for beginning investors. Thanks for commenting.

Guest's picture

Visiting the company is crucial to understand if you'll fit it there.

Guest's picture

I use is "do I personally use the product or company". I like investing in companies I know. Besides there is too much emotions in stock picking. I have seen good companies get slammed in the news/stock market for hearsay and anything changed. Remember stock prices don't always reflect how a company is doing.

Julie Rains's picture

The more you know about a company on a regular basis, the better -- whether by visiting its facilities or using its products (you'll be the first to know when product quality slips or the customer service sours).

News used to make me jumpy but now I am more accustomed to hearing about ups and downs. Still, I like to know about issues that I may not hear about in casual conversation with friends, like whether a company is getting ready to be bought out or if it's declared a dividend.

Guest's picture

Great tips! though I think 3 and 4 can be overdone.

It's possible that some stocks historically have higher than 15 P/E ratios, perhaps due to great expectations from investors. As long as they keep delivering good results in their financial reports, it's not a bad thing.

With regards to news, it's important, but it's equally important to separate the substantial news that have long-lasting implications from the short-term bumps that every business encounters. And of course, sifting through what's hype and what's not.

Julie Rains's picture

Thanks for your insights. There are so many ways to evaluate a stock but I thought these may be great starting points and easy ways to take a quick look.

Sifting through what's hype and what's not as you mentioned is not always easy. And, sometimes the current state points to short-term movement. But hopefully staying in touch with what's going on in the industry, company, etc. can help folks get the feel for what is meaningful for long-term value.