Biggest things you look for in a stock?

[michiganfan9]

Now i'm 16 and love to invest. I generally invest in small camp-mid cap stocks because my income isn't that great at my age. I usually look for a steady increase of gross profit, looks for a company with little competition, low p/e ratio and a stock that isn't too overvalued. stocks with free cash flow much greater than their debt (hopefully they have none). And last dividends. I like a stock that gives out dividends because it shows that usually thye are not struggling to bring in cash. What else should I be looking for?

[player24]

[ QUOTE ]
Now i'm 16 and love to invest. I generally invest in small camp-mid cap stocks because my income isn't that great at my age. I usually look for a steady increase of gross profit, looks for a company with little competition, low p/e ratio and a stock that isn't too overvalued. stocks with free cash flow much greater than their debt (hopefully they have none). And last dividends. I like a stock that gives out dividends because it shows that usually thye are not struggling to bring in cash. What else should I be looking for?

[/ QUOTE ]

Congratulations on getting such an early start.

For point of clarity, small-mid cap refers to the size of the company measured in net worth. There is no need for you to avoid large-cap equities because of your limited income. Also, companies with steady increase in earnings do not generally trade at low P/E ratios. These companies, referred to as growth companies, will usually trade at a premium P/E ratio.

You are right to focus on the level of competition. Competitive sectors, with few exceptions, provide limited opportunities for sustainable earnings growth. Probably the worst investments involve growth-oriented companies in highly competitive, mature industries. If there are lots of competitors, the overall market growth is low, and every company is pursuing growth - run in the other direction.

Look at earnings quality by focusing on cash flow as opposed to GAAP earnings. Many companies are forced to invest in physical plant and working capital to an extent that earnings do not translate directly to cash flow. Dividends can be a sign of strong cash flow generation (good earnings quality), but may also indicate that a company has weak growth prospects.

Whatever you do, remember that diversification is the only free luch in investing. Do not concentrate your holdings. I advocate a core-plus strategy in which a chunk of your portfolio is invested in a market index fund....and you selectively overlay individual stock positions which you have carefully researched.

Good luck.

[James Boston]

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I generally invest in small camp-mid cap stocks because my income isn't that great at my age

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There's nothing wrong with small-cap and mid-cap stocks, but don't preclude large-cap because of your income. The two really don't relate.

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looks for a company with little competition

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always a plus

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low p/e ratio

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Don't get trapped into thinking low P/E = good stock. It can mean that, but it doesn't automatically.

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a stock that isn't too overvalued

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I don't know if you listened to what I, and several other posters, told you about the book value hang up you had. I saw you continue to post that advice after having it explained to you that it wasn't a very important metric. I'll say it again though. If you're defining over-valued as "market cap < book value," you don't understand valuation. Free cash flow! Learn it, live it, love it.

[michiganfan9]

I'm done looking at book value now

[michiganfan9]

thanx for the post

[michiganfan9]

quote] Dividends can be a sign of strong cash flow generation (good earnings quality), but may also indicate that a company has weak growth prospects.

[/ QUOTE ]
can you please explain this

[michiganfan9]

How would you be able to look at a company and classify it as large-cap mid-cap etc?

[michiganfan9]

thanx for the post, i'll start looking at free cash flow a lot more

[r3vbr]

You look at the market capitalization. i dont know the exact line that divides one classification from another buy id GUESS that usually smallcaps are worth less than 500 million, 500 mi - 2 billion would be medium cap, and over 2 billion large cap (i think), plz some other poster correct me if im wrong here

[xtravistx]

What is wrong with a stock having debt? Can you explain your reasoning?

-xtravistx

[James Boston]

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What is wrong with a stock having debt?

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Nothing, as long as it's managable. And you don't want, IMO, stock in a company that is too leveraged.

[midas]

MIFan:

When looking at small cap stocks a few comments:

1. You need to look at stocks and how they trade relative to their peers.

2. PE ratio is not as important as implied valuation (market cap + debt - cash) to cash flow (EBITDA or EBITDA less maintenance capex)

3. You need to look at ownership - is management a big owner in the stock? Avoid small caps where managment or the Board has small ownership positions unless the stock is extremely undervalued.

4. If a small-cap is paying dividends something is wrong with the business fundamentals - why don't they reinvest money in the Company?

5. Another metric that is rarely used is cash on cash return (like a bond) If you were to buy this Company right now for its current implied valuation what would your return be if you just held the company for its cash flow?

[michiganfan9]

I just prefer stocks that don't owe any debt. It shows that they will never have to worry about it and are profitable in my eyes.

[michiganfan9]

I agree. The only time i dont' like a stock with debt is when the debt is more than its total cash.

[James Boston]

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The only time i dont' like a stock with debt is when the debt is more than its total cash.

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That's not automatically terrible. You have to look at the big picture. Although, more cash than debt is usually a good sign.

[michiganfan9]

I know that its not automatically terrible. But if some companies future doesn't look to be very profitable then I can't see it being a great thing.

[RocketManJames]

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The only time i dont' like a stock with debt is when the debt is more than its total cash.

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That's not automatically terrible. You have to look at the big picture. Although, more cash than debt is usually a good sign. I know that its not automatically terrible.

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But if some companies future doesn't look to be very profitable then I can't see it being a great thing.

[/ QUOTE ]

I'll jump in here and give my view... I'm hoping that JB will give his view later.

Comparing cash to the amount of debt a company has decided to take on does not really say anything about profitability. Also, theoretically, a company will do the best if it takes on as much debt as possible as long as it can safely handle it and a favorable return can be achieved. When debt is assumed, the goal is to generate a return that surpasses the rate of borrowing. And, over time this difference in rates compounds.

Also, you will see that companies that have been active in acquisitions often have a lot of debt. A couple of companies that have a debt/cash ratio greater than 1 are: Harrah's (HET) and Capital One (COF). Yes, carrying a lot of debt can be scary, but if well managed, can produce superior returns.

Just my two cents. Others may totally disagree with my view on debt. Also, I believe that most people tend to use the Current Ratio or Quick Ratio to analyze liquidity. I personally haven't seen that much use of the Cash Ratio.

-RMJ

[plj8624]

I'm surprised no one has mentioned dividend growth. You mentioned you like companies that pay dividends. Look for a couple large caps that have increased their dividends consistently for at least 10 years.

Read everything you can about investing and finance (books, magazines, internet), but do it with a critical eye. Best of luck.

[James Boston]

[ QUOTE ]
Comparing cash to the amount of debt a company has decided to take on does not really say anything about profitability. Also, theoretically, a company will do the best if it takes on as much debt as possible as long as it can safely handle it and a favorable return can be achieved.

[/ QUOTE ]

You pretty well summed up my view on this. Good management knows how to handle debt. If the debt is taken on with specific purposes, and there is a high likelyhood that those purposes will generate returns above and beyond the cost of the money borrowed, then pile it on. This, of course, is not as simple as I make it sound. I personally wouldn't fell comfortable borrowing money just to re-invest it, but there are some who can. My only concern is if I fell like the money borrowed is primarily used to give the appearance of having more money than you really do, or to be able to give investors a higher return than they really should be getting.

[BadBoyBenny]

What he is saying is that when a company pays a dividend, they are effectively saying that their shareholders could get a better return on their money than if they reinvested it in their business.

[michiganfan9]

[ QUOTE ]
Also, you will see that companies that have been active in acquisitions often have a lot of debt

[/ QUOTE ]
Well Cisco systems has no debt and has acquired
April 27, Sipura Technology (by Linksys) Voice over IP specialist

April 14, Topspin Communications Server Fabric Switches

January 12, Airespace Wireless LAN solutions


2004

December 20, Protego Networks, network security software

December 9, BCN Systems, flexible routing software

November 17, Jahi Networks, Network Management appliances

October 21, Perfigo, Network Access control

September 13, dynamicsoft, SIP software

September 9, NetSolve, IT infrastructure management

August 23, P-Cube, IP service control platforms

July 8, Parc Technologies, traffic engineering solutions

June 29, Actona Technologies, Storage networking solutions

June 17, Procket Networks, router silicon expertise

March 22, Riverhead Networks, Distributed Denial of Service attack software

March 12, Twingo Systems, desktop security with SSL and VPNs


2003

November 12, Latitude Communications, audio and web conferencing

March 20, Linksys Group, Consumer/SOHO access devices

March 19, SignalWorks, Echo Cancelling software

January 24, Okena, Intrusion Detection software


2002

August 20, Andiamao Systems, Storage switching systems

July 25, AYR Networks, Distributed networking software

May 1, Navarro Networks, Ethernet ASIC design house

May 1, Hammerhead Networks, Networking software design house


2001

July 27, Allegro Systems, VPN acceleration

July 11, AuroraNetics, RPR chipset company


2000

December 14, ExiO Communications, In-building CDMA wireless

November 13, Radiata, 802.11a wireless

November 10, Active Voice, Unified communication software

October 20, CAIS Software, Multi-unit building softare

September 28, Vovida Networks, Voice over IP software

September 28, IPCell Technologies, Software for integrated VoIP

August 31, PixStream, Hardware and software for video

August 1, IPmobile, 3G Wireless software

July 27, NuSpeed Internet Systems, iSCSI solutions

July 25, Komodo Technology, VoIP devices

July 7, Netiverse, Content aware switches

June 5, HyNEX, ATM + IP Access devices

May 12, Qeyton Systems, Stockholm, Sweden metro DWDM systems

May 5, Arrowpoint Communications, Content aware switches

April 12, Seagull Semiconductor, Terabit switch semiconductors

April 11, PentaCom, Pre-standard RPR switches

March 29, SightPath, Appliances for content delivery

March 16, infoGear Technology, Info Appliance management software

March 16, JetCell, In-building wireless telephony

March 1, Alantech Technologies, San Jose, California Network management software

February 16, Growth Networks, Switch fabric chipsets

January 19, Altiga Networks, Integrated VPN solutions

January 19, Compatible Systems, Service provider VPN solutions

1999

December 20, Pirelli Optical Systems, DWDM equipment

December 17, Internet Engineering Group, Optical networking software

December 16, Worldwide Data Systems, Consulting and engineering services

November 11, V-Bits, Video processing systems

November 9, Aironet Wireless Communications, Wireless LAN products

October 26, Tasmania Network Systems, Web caching software

September 22, Webline Communications, Contact management software

September 15, Cocom, Cable modems

August 26, Cerent, SONET ADMs

August 26, Monterey Networks, Optical transport products

August 18, MaxComm Technologies, Voice over DSL

August 16, Calista, IP PBX solutions

June 29, StratumOne Communications, OC-192 chipsets

June 17, TransMedia Communications, Media Gateway products

April 28, Amteva Technologies, Unified IP communications sofware

April 13, GeoTel Communications, Nework based call routing software

April 8, Sentient Networks, Voice over ATM systems

April 8 Fibex Systems, Integrated Access Digital Loop Carrier

1998

December 2, Pipelinks, Data oriented SONET ADMs

October 14, Selsius Systems, IP telephony solutions

September 15, Clarity Wireless, Last mile wireless solutions

August 21, American Internet, IP address manangement software

July 28, Summa Four, Programmable switches

May 4, CLASS Data Systems, Policy based Networking Solutions

March 11, Percept Software, IP television products

March 11, NetSpeed, DSL CPE equipment

February 18, WheelGroup, security software

1997

December 22, LightSpeed International, Voice over ATM products

July 28, Integrated Network, (Dagaz business line) New Jersey DSLAMs

June 24, Ardent Communications, San Jose, California Multiservice access products

June 24, Global Internet Software Group, Firewall software

June 9, Skystone Systems, Ottawa, Ontario SONET products

March 26 Telesend, DSL channel units

1996

December, Metaplex, SNA to IP migration

October 14, Netsys Technologies, Network simulation

September 3, Granite Systems, Gigabit Ethernet Networking

August 6, Nashoba Networks, Token Ring switches

July 22, Telebit (MICA products), Cupertino, California, OFDM/DMT modem technology

April 22, StrataCom, San Jose, California ATM based network systems

January 23, TGV Software, Internet software maker

1995

October 27, Network Translation, NAT and firewall solutions

September 27, Grand Junction Networks, Fast Ethernet switches

September 6, Internet Junction, Internet gateway software

August 10, Combinet, ISDN remote access

1994

December 8, LightStream, Enterprise ATM switches

October 24, Kalpana, LAN Switches

July 12, Newport Systems Solutions, Software based routers

1993

September 21, Crescendo Communications, LAN Switches

Just one example

[James Boston]

Proctor & Gamble has about 3 times as much debt as it does cash, and they're acquiring Gillette which has about the same. Yet, your beloved Warren Buffett continues to bet on both. I'm not saying Cisco is a bad company. There are a few debt free companies I've been looking at. I'm just trying to get you out of the mind frame where you seem to set up a stock screener and decide that those who pass are good investments, and those who don't aren't. No one, two, or three metrics are going to tell you what a good investment is. In fact, I find the qualitative aspects of investing to be just as, if not more, important than the quantitative.

[RocketManJames]

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Also, you will see that companies that have been active in acquisitions often have a lot of debt.

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Operative term being "often."

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Just one example.

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Exactly.

Also, Cisco's acquisitions were probably mostly stock deals. At least those during the bubble years 1999-2001. Not sure, as I haven't really followed all their acquisitions that closely, but it would make sense. Using inflated stock currency to buy technology seems like a cheap way to go about it.

Also, how big were the deals in the acquisition list you provided? I haven't looked at any of them specifically, just wondering if you knew. Cisco commands a market cap of $120B+. When it seeks to buy a company for as much as $1B, this is much small potatoes for them.

Contrast with larger acquisitions... here are few to serve as examples:

Eastman Kodak buying Creo for about $1B
IAC Interactive buying AskJeeves for around $1.9B
Oracle buying Peoplesoft for roughly $10B
Washington Mutual buying Providian for $6.5B

-RMJ

[James Boston]

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Also, Cisco's acquisitions were probably mostly stock deals. At least those during the bubble years 1999-2001.

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This was my first thought, but I wasn't up for digging into it to see if I was right.

[AceHigh]

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The only time i dont' like a stock with debt is when the debt is more than its total cash.

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Debt is often good. Companies need to borrow to grow. Well managed companies with debt are often good companies. Management should react to oppurtunities as they become available, not wait until they have the cash on hand to exploit them.

On the other hand, companies with lots of cash and no debt usually have little or no growth. A growing company would have oppurtunities put the cash to good use.

[adios]

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I agree. The only time i dont' like a stock with debt is when the debt is more than its total cash.

[/ QUOTE ]

This shouldn't exclude buying a company's stock necessarily. What about if a company issues new debt as fast as it's paying it off but the cash and equivalents is far less than it's current debt? The truth is that the proper capital structure for a business is open to debate a lot but it is influenced by the type of business a company is in along with other factors like market share and volitility of earnings. Look at the bond ratings for the company to get a clue as to the riskiness of earnings. Debt gets favorable tax treatment, pure and simple, so it makes sense for companies to use leverage. For a discussion on how leverage can be utilized to increase earnings I refer to Damodaran's Investment Valuation opus. BTW having no debt isn't a panacea to making great investments. I've maintained for a long time that MSFT has a sub optimal capital structure and this is one of the reasons that the stock has gone nowhere for so long FWIW.

[michiganfan9]

I'm not saying that stocks that I run through screens are good investments and others aren't. I know that I'm wrong if I would say that. I love P and G and think that the acquisition with Gillette was huge. Two extremely well managed companies joining forces. I don't really run that many stock screens anyway. In my mind it can be decieving. I found a stock that had over 10 billion dollars in sales yet was trading at $8. There was a big reason why it was trading there and that is why I don't think that particular stock was a good investment. I probably am not just thinking before I type, and i'm sry for that. I want to learn everything about the market and that is why i'm asking you guys.

[michiganfan9]

That is why you are probably right. Cisco's acquisitions were nothing more than $200-600 million dollar companies, local around the california area. I skipped over the word often which he did point out. My fault

[michiganfan9]

good post

[michiganfan9]

If I looked and researched a stock and liked him that much and saw that it had more debt than free cash, I would still buy it. Now that I have read all of your posts I see where debt can be a good thing. KEEP POSTING!!! /images/graemlins/smile.gif

[RocketManJames]

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I don't really run that many stock screens anyway. In my mind it can be decieving. I found a stock that had over 10 billion dollars in sales yet was trading at $8. There was a big reason why it was trading there

[/ QUOTE ]

This is a particulary dangerous thought, and you need to move away from it. You say that a company has $10B in sales, but it trades at $8. This does not really tell you enough. The stock price in and of itself does not tell you anything about the valuation of a company. You really need to focus on market capitalization if you're going to throw numbers around like this. And, what you are implying can be stated using a price to sales ratio. Basically, the P/S ratio is way too low, which triggered a few red flags in your mind. Remember that without data normalization, many numbers are useless.

-RMJ

[michiganfan9]

That screen was just very basic. I would never invest in anything without spending hours or research to understand the company fully.

[RocketManJames]

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That screen was just very basic. I would never invest in anything without spending hours or research to understand the company fully.

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I think you missed my point. If you didn't you can ignore this. I am not challenging the use of a screening tool, or the particular screen that you ran.

My point was that data that is not normalized is usually useless. If I told you, stock A trades for $30. And, stock B trades for $12. What do you know about them? My view is that you know very close to nothing. Why? Those numbers don't mean anything unless they are viewed with respect to the total number of shares outstanding.

This is similar to taking a sales figure without normalizing it to a "per share" basis. Take a company that has $1B in sales. Think of how differently you'd look at this figure if you were to find out that the company had 800MM shares outstanding versus 80MM shares outstanding. The same goes for earnings or any other such value. Without normalizing the data in some fashion, comparisons become difficult, if not impossible.

-RMJ

[michiganfan9]

I understand now, thanks for the post

[michiganfan9]

I agree with dividend growth, as long as the company isn't like phizer who pays 60% roe on dividends,they can spend the money more productively