Every day investors are subjected to an endless parade of stock recommendations from analysts, portfolio managers and even celebrities while watching their favorite financial news channel. A 5 minute interview isn’t going to give much detail other than the story surrounding the stock and maybe nothing at all on the fundamental.
Unfortunately, for too many investors, that’s where the research begins and ends. The industry, the products offered, management and the history of the company are all important, but it’s only one part of the decision making process.
As an investor, it’s important to understand just what you are entitled to as the owner of a stock. As a shareholder, you are entitled to your pro rata share of the earnings and or dividends of the company in question. In the end, it always comes down to the numbers.
Individual investors often feel at a disadvantage to the institutional crowd, who have Bloomberg terminals, Factset Databases and an endless number of analysts to talk to. Look, these sophisticated terminals are the work horses of the financial community, and portfolio managers, including yours truly, use them. However, at a cost of $20,000 -$100,000 per year, it’s probably out of reach for most retail investors.
Don’t despair, because right at your fingertips, you have more than enough data to conduct detailed analysis. When I don’t have access to some of the products mentioned above, I go right to Yahoo Finance. Within its stock pages, you will be quickly able to identify healthy growing companies and also zero into the data that puts some of your stocks in the penalty box.
Let’s get started
You’re watching TV, and a talking head you’ve seen before suggests Facebook (FB) is a buy. You know the company and probably use it every day to keep in touch with your family and friends. You’ve heard it is getting into virtual reality, and that sounds promising. So what about the numbers?
This is where it all starts. I get a quick look at the stock price and an interactive chart to look at price history. I can see right away this is a pretty large company with just over $300 billion in market cap, but when I look below I see it has a PE (Price Earnings Ratio) of just under 83 over the last 12 months. It looks expensive, so we’ll have to dig deeper later.
Price performance is important, and there’s no better tool to analyze price history then a good old fashioned chart. Here we can see trends, support levels and much more. I immediately click on a 1 year chart. The chart looks great--it's obviously in an uptrend, but it’s pretty easy to see it’s extended having jumped close to 20% on the heels of a monster earnings report. Preferably, we’d like to buy this stock on some kind of pull back, which might be in the works--but we’re getting ahead of ourselves. Let’s get back to the numbers.
For me, this is the most important page and data set to determine whether or not I’m going to buy this stock. Let’s zoom into EPS Trends and dig in further. This one little section is a wealth of information. I can see for 2016, Facebook is expected to earn $3.14. Take out that calculator and divide it into the stock price, and its current year PE is about 35 for the current year and 27 based on next year’s earnings of $4.12. It's still a lot more expensive than the overall market, but let’s see if its growth justifies that high multiple.
Source: Yahoo Finance
Some quick math shows that Facebook’s earnings are expected to grow about 31% from this year to next. That 35 PE doesn’t look so bad now because it’s PEG ratio, Price Earnings/Growth is just over 1, or 1.09 to be exact. Most growth at the right price, or GARP investors, believe a Peg ratio near 1 is attractive.
Source: Yahoo Finance
EPS Revisions - Are analysts raising their estimates or are they cutting them? Rising estimates can be an indication that fundamentals are improving. In the last 30 days, 45 analysts covering Facebook (FB) have raised their numbers and only 1 has cut.
Source: Yahoo Finance
Sales Growth
Too often, investors neglect this line item. For years companies like IBM have been able to grow earnings in double digits without growing sales using financial engineering gimmicks like stock buybacks and cutting costs. Eventually, your run of things you can cut, and the game is over. A quick look at a long term chart of IBM (IBM) shows that investors have been punishing that stock for years.
Source: Yahoo Finance
Here, in the case of Facebook, there is no such problem. Sales growth is expected to be above 40% this year.
Growth companies like Facebook (FB) often don’t pay a dividend, so let’s look at a couple of income producing stocks. Investors looking for income often turn to the energy sector. Two of the largest, Exxon (XOM) and Chevron (CVX), both have above-average dividend yields.
Source: Yahoo Finance
Source: Yahoo Finance
Exxon comes in at 3.91%, but Chevron’s 5.27% is much higher--so is that the stock to buy?
Like most things in finance, we’re going to have to dig a little deeper. The worst thing that can happen to an income investor is for one of their stocks to cut the dividend. One of the best ways to identify potential problems is to look at the payout ratio.
(Payout Ratio = Dividends per share / Earnings per share)
The payout ratio for Exxon is about 60%. Sixty percent of their earnings are being used to pay that dividend. On the other hand, Chevron is paying out close to 93% of earnings to support the dividend. Not much wiggle room there. Some companies pay out more than 100% of earnings, and the only way to do that is to borrow money and take on debt.
Despite the fact that Chevron has a higher yield, Exxon looks like the healthier choice. Remember, in volatile markets you can lose that dividend in an hour, so make sure you look beyond the yield.
Summary
Next time someone recommends a stock, go to these pages and kick the tires. We’ve only touched on a few investment tools available, and over time you will find many more. Remember there is no Holy Grail, and no one data point can guarantee a good choice. Investing is as much an art as it is a science. Every company has a story, but not every stock has the numbers to back it up.
Disclosure: funds managed by David Nelson are long Facebook. No positions in XOM or CVX.
