A company’s future prospects play an important role in its current share price. Ultimately it’s these prospects that determine whether today’s price is appropriate given its future earnings potential. If expectations change, so too will the share price. When we are researching a company’s future, we look into what the expected growth rates for revenue and earnings are from analysts. Additionally, if a company has just reported its earnings, we look into how this compares with what analysts had forecasted. Lastly, we review if analysts have revised their expectations for the company’s future earnings and revenue given the latest announcements from the company.
When we investigate a company’s profitability, we consider more than just the bottom line. For example, for an unprofitable company, we assess elements like when is it expected to break even and how quickly is it burning cash (to determine if it might need to raise funds). If a company is profitable, we look into how “high-quality” its earnings are (i.e. if there are any one-off items like an asset sale that prop up its earnings in the short term) or how its EPS and earnings have been growing over time. For a company to survive long-term and be sustainable, it needs to generate profits, and by considering all these aspects, we get a better idea of if a stock has that potential, or if profitability is unlikely.
Understanding how a CEO is compensated can help us determine if they are aligned with the company’s best interests or not. When we assess a company’s compensation to its CEO, we want to analyse how much this executive is being remunerated compared to prior years, how much of this is salary vs non-salary (such as stock and bonuses, etc), how the compensation compares to industry peers, and lastly, whether the compensation is in line with the underlying economic performance of the company and total shareholder returns.
If there are any discrepancies, such as a CEO being rewarded handsomely but the stock performance under their leadership has been poor, we can gain insights into the leadership incentive structure and keep it in mind if we’re considering the stock.
Debt is a crucial element to consider when analysing a company’s risk. Companies that take on debt increase the risk of financial distress (depending on how much they take on), whereas other companies that remain debt free mitigate this concern. When we analyse debt, we look into how leveraged a company is through its overall capital structure (debt to equity), its ability to cover the interest costs, how much cash the company has on hand offsetting the debt, how well the company’s EBIT converts into cash flow to pay off the debt and if there are any going concerns noted from the auditors.
Debt can be used in constructive ways to grow a company if it is used wisely, however excessive use of leverage can significantly increase the risks for shareholders since the owners of the debt have priority before shareholders in a worst case scenario like a liquidation.
Many investors love receiving regular dividends into their bank account from the stocks they own, but it’s not as easy at looking at a stock’s “yield” and picking the highest one. There are some companies that have proven themselves reliable dividend payers over time, while others can be dividend traps. So when we analyse dividends, we want to help investors avoid potential yield traps and understand if a company can actually afford to pay a dividend. We look into any upcoming dividends and assess the company’s current payout ratio. We also determine how well a company’s dividend has been growing over time (if at all), if there have been any previous cuts to the dividend and if the company’s underlying earnings and free cash flow have been growing as well to potentially grow the dividend.
We can learn a lot from monitoring stock transactions from those high-up within a company. While a single trade is not necessarily a strong signal, if we see trends occurring we can gain some insights into the insider’s expectation of future company earnings. So when we investigate a company’s insider transactions, we look into recent trades, what price they occurred at vs today’s market price, and determine how much of the individual's personal holding that recent trade represents. We also investigate the trend of buying and selling over the last 12 months to help us determine if there’s any concerning trend of selling, or any re-assuring trend of insider buying. We’ll also look into overall ownership of stock from insiders to see if it’s a meaningful amount, or negligible.
Understanding who is the largest shareholder of a company can be very important when it comes to votes and also how much influence specific shareholders have in that company’s voting decisions. When considering ownership, we look into how much is owned by different shareholder classes, including the public at large, institutional investors, individual insiders, governments, public companies and private companies. By knowing this breakdown, we can determine who has the most say and why that might be important. If we see strong ownership from insiders, it’s usually a good sign.
The ultimate goal of an investor is to buy undervalued companies. Without a rough idea of the intrinsic value of a stock, how do we know whether to buy or sell a stock? If we don’t have an estimated value, we’re just speculating. Our analysis goes through the process of a discounted cash flow model and explains the estimates, and assumptions used to arrive at an estimated intrinsic value. We are by no means sharing this as an indication of whether you should buy or sell a stock. We share it more to outline the process of HOW to conduct a discounted-cash flow model, as well as what assumptions need to be made during the process. Then readers can adjust their assumptions accordingly if they don’t agree with, say, the discount rate, or the expected growth rate.
The current Price-to-Earnings (P/E) ratio is quite a popular metric to measure companies on, but it should not be relied upon solely. It provides a good gauge for current expectations from investors on a particular stock. When we assess a company's current market price, we consider what this means in terms of expectations from investors versus the company’s expected growth rate, and if there is a large disparity between the two. If there is, it can often be because of the time in the market cycle we’re in. In times of market euphoria, investor expectations are very high and therefore they are generally willing to pay up more for most companies. In times of market downturns, market participants are much more pessimistic and usually willing to sell stocks at any price. By knowing the relationship between the current market price and a company’s expected growth, we can sometimes identify market mispricings.
A company's ability to generate returns on its invested capital can tell us a lot about a business's profitability. Can a company continue to invest capital at good rates of return, or is it allocating capital into underperforming initiatives that do little in the way of making money? When we look at a company’s return on capital employed, we want to know how it’s been trending over the last few years (have returns been going increasing, decreasing or flat) and if the company has been increasing the amount of capital it's investing as well. Because if a company can continue to re-invest in profitable initiatives, that is the foundations of a compounding machine. However, some companies can take on large portions of debt to achieve better returns, and so we also investigate if this is the case. Because while returns might look higher, that may come from the cost of increased risk.
While similar to ROCE, Return on Equity (ROE) tells us how well a company is allocating shareholder’s equity (rather than total assets). We investigate how the company’s returns compare with its earnings growth (has earnings growth driven ROE higher), and how they compare to the industry average to get some context. Then we assess if the company is using its retained earnings to reinvest, or if it is paying out the majority of its earnings as dividends (and if this is hampering its earnings growth). Again, companies can take on a larger portion of debt to increase their returns on equity by increasing earnings and keeping equity the same.
Many investors often try to time the market, but this can be a futile endeavour if done incorrectly. However, there are some techniques that can help determine when might be a good time to buy. When considering if now is the right time to buy a stock, we look at a few measures. These include the company’s recent share price moves, its beta (volatility) and its expected future growth. Then we outline what this might all mean for current shareholders, or potential investors who are considering the stock.
When investors find a stock they find interesting but they don’t want to buy it just yet, they often add it to their watchlist so they can buy when the price becomes more attractive. We provide examples of analysis here that may help. First we investigate if a company has growing revenue, earnings and margins. Then we assess if insiders are aligned with shareholders, such as how much of the company is actually owned by them, and what sort of trades they’ve been doing recently (buying or selling), which could provide insights into potential opportunities.