If you are reading this article, you’ve finally decided to build a stock portfolio with an aim to achieve financial freedom. Aristotle’s proverb “Well begun is half done” is something to watch out for as an amateur investor. The beginning can be very difficult for a stock investor but if you get the beginning right, the journey ahead could be easier and rewarding.
The most common problem with every new investor is whether or not the stock they are interested in is the right bet. If you are struggling with the same dilemma, below are a few signs which suggest that you’ve picked gold-
- Good profitability
The price of a stock or a company’s worth is proportional to the profit that the company makes in the long-term. While sales and revenue are important too, profits are what make a company, unless you are looking at a company which has a lot of assets which they can sell to earn profits.
For instance, there is a company with sales worth $5 billion but will lose money perpetually and there is another company worth $10 million with profits to the tune of $1 million, what will you pick? The latter is the better option as a company losing money perpetually would probably be out of business in future. So, if the company you’ve selected has good net profit margins, it is definitely a good sign.
- Returns on the money invested
As mentioned above, a company’s value is directly proportional to the profits it generates and its growth. Returns from the money invested are what determine the money a company is making from their investments.
Prefer companies with excellent returns on the capital they invest as these companies are allocating the resources efficiently and would continue to grow in future. If the returns exceed the borrowing costs of a company or the capital cost, it is an excellent indicator.
- Cash flow of the company
While cash flow is related to the profits, it is arguably more critical. Due to the current accounting standards, earnings or profits might not always result in cash flow at all. Recording of the sales and earnings can be done before any payment is actually received.
So, it is essential to note that the cash flow and profits can significantly differ in the short-term, making it imperative for an investor to check if the trend is negative or positive.
- Estimates beating ability
Brokerage firms release estimates of EPS (Earnings Per Share) of companies. The average of this EPS by various firms is known as a consensus estimate. A company which exceeds the estimate is known to outperform markets.
If the company you’ve selected regularly beats this consensus estimate, you might have found yourself a smart pick.
- Balance sheet
It is through the balance sheet that you can know the assets and liabilities of a company. The balance sheet determines the overall financial health of the company. Companies that have little debt are generally better as they do not have a lot of interest expense and obligations. This means that they can re-invest more money from the profits they earn to grow the business.
Always ensure that the company shortlisted by you has little debt or is able to service the debt comfortably.
There is no single way to know the quality of a stock. How to invest in stocks is an art which you’ll learn with time. If you are beginning your investment journey and finding it difficult to pick a stock, the signs mentioned above are a great way to begin.