Saturday, June 30, 2007

Identifying potential stock investments

What do you need to know to determine which stocks are
potential investments? To get started, stick with stocks relating
to your own interests or knowledge. If you frequent particular
stores or restaurants and you use and like their
products, find out if they are publicly held companies. Start
identifying and watching these stocks. That advice doesn’t
mean that you should buy their stock right away. You still
have some homework to do.

The following list tells you what to look for when investigating
potential stock investments.

 Find out if the industry is growing. Some industries
aren’t. News stories on the industry in question can tell
you the state of the industry and so can the company’s
annual report.

Company shareholder departments and the Securities
and Exchange Commission (SEC), the Washington,
D.C.-based regulator that oversees public companies, can
provide you with copies of annual reports and the quarterly
reports (called 10Qs) that companies must file.

Find primary competitors. Don’t look at a stock in isolation.
A company that looks enticing by itself may look
like a 100-pound weakling when you evaluate its
strengths and weaknesses next to the leading competitors
in the industry. Check out at least two competitors
of any stock you’re evaluating.

 Check out annual earnings and sales. This is key in
deciphering how quickly a company is growing over oneyear,
three-year, and five-year time periods, and whether
its earnings are keeping pace with sales. Look for growth
rates of at least 10%.

Look at the stock’s price-to-earnings (P/E) ratios. This
is the primary means of evaluating a stock. The P/E ratio
is derived by dividing a stock’s share price by its earningsper-
share. The result tells you how much investors are
willing to pay for each $1 of earnings. Those stocks that
have faster earnings growth rates also tend to carry higher
P/Es, which means that investors are willing to pay
through the nose to own shares. The value of a P/E ratio,
however, can be subjective. One investor may think that
a particular company’s P/E ratio of 20 is high, while
another may consider it low to moderate.

 Find out the price-to-book value (P/B) ratio. The P/B
ratio is the stock’s share price divided by book value, or a
firm’s assets minus its liabilities. This ratio is a good comparison
tool and can tell you which companies are assetrich
and which are carrying more debt.

A low P/B ratio can be an indicator that a stock may be
a good value investment.

Check out the stock’s price-to-growth flow ratio. This
ratio is the share price divided by growth flow (annual
earnings plus research-and-development costs) per share.
This is a useful measure for assessing fast-moving companies,
especially in the technology sector, where management
often puts profits back into product
development.

Look at the stock’s PEG ratio. The PEG ratio is a company’s
P/E ratio divided by its expected earnings’ growth
rate and is an indicator of well-priced stock.
In a soaring stock market, like the one that dominated
the 1990s, a PEG ratio below 1.5 suggests that a stock
may be a good value. A PEG ratio above 2 can indicate
that a stock may be overheated.

 Look ahead. Projections of five-year annual growth rates
and five-year P/E ratios can tell you whether analysts
believe that the companies you’re evaluating can continue
to grow at their current rate, can beat it, or will start to
fall behind.

Make a list of the stocks you are interested in and watch their
performance over time. Doing so gives you a feel for how the
stocks respond to different types of economic and market
news. You can also see which stocks’ prices move around and
are more volatile.

So does your own analysis indicate that you have a winner
on your hands or a dog? If you’re unsure, sit tight and watch
what happens in the weeks and months ahead. Watching several
stocks over a period of time not only tells you how well
they’re doing, or not doing, it can also show you how well
you’re honing your own stock analysis skills.

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