If you are just starting to learn about stocks or want to learn about businesses in general, it can be an overwhelming task to analyze a company. What do you look for? Where do you find this information? What are the most important factors? These are all questions that may be running through your mind. In order to aid you in this process, I’ve put together a few key areas that you should explore whenever you are looking for growth in a company.
Michael Porter, a Harvard professor, created what is known as the Porter analysis. It is a framework that analyzes the level of competition in a given industry. Within this framework, there are 5 forces at play:
Thinking about a company’s industry by using this framework will give you a better feel of whether or not it will grow. It will give you a better understanding of the industry, the things that can go wrong, and the potential for profit. The higher the competitive forces, the more difficult it will be for a company to compete within that industry. Although the framework isn’t quantitative, it can help you assess the relative attractiveness of one industry or company versus another industry or company.
Think about the supply and demand for the products and services that a company offers. Is there even a demand for it? How great of a demand? What other companies are supplying these products?
Does the company have a well thought out and articulated growth strategy? Have they been able to execute successfully so far? Check the investor presentations on the company website for a growth strategy.
Does the company have a track record of strong management? The right management will be able to adapt to changing situations and find a way to be profitable despite competition and market turmoil. The right management will drive innovation and growth even in tough times. Read about the background of the executives. Look at the major decisions they have made in the past and how those decisions have impacted the company. Also, look at how much ownership stake the management has in the company.
The best presentations and marketing in the world can’t hide poor financials. Go on sites such as Yahoo Finance or Morningstar, or go straight to a company’s SEC filings to get a historical view of a company’s revenue, earnings, cash flow, debt, etc. Investopedia is a great place to learn about these numbers.
How is the company financing its growth? Is it taking on too much debt? Check out its balance sheet and research the various balance sheet ratios. Investopedia is a great place to learn about these ratios.
Finally, you want to make sure that you pay the right price for a company before you buy stock in it. You wouldn’t want to pay $100 for a sweater that’s worth $50, however you would love to pay $25 for it. Ratios such as price-to-earnings and price-to-book can be compared within an industry to compare valuations.
This post is only a start to evaluating companies. With more experience, you’ll develop your own techniques and methods to analyze companies. You’ll find resources that work the best for you. There are many other websites and books out there to help you continue this journey if you are interested.
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