Tuesday, 7 June 2016

How To Research Stocks

How I Analyze My Stock Picks

  When I go looking for companies in which to purchase shares in I start out by compiling a list of stocks which I am interested in and try to balance them within my portfolio's sector weighting.  Once I have selected a Watchlist of company's I look at a few key pieces of financial information. All of which are readily available either on the company's website, or Google Finance, your brokerages research tools and/or additional sources of financial information. 

    Google Finance provides easy access to summarized company Income Statements, Balance Sheets and statement of Cash Flow; however for full detail statement with notes you should read the companies quarterly reports, which is usually available from the company website.

    The usual information that I look for are the trading price range and volume of shares traded, market capitalization, the price to earnings ratio, dividend and yield, earnings per share, the percentage of shares owned by institutions and financial statements

Here is my breakdown of each and what I look for within each category: 

1) Daily Range and 52-Week Trading Range: These two bits of information tell you what the stock was trading for that day and how far it is from its lowest and highest point within the last year. The spread between the low and high against its current price can offer some useful insight into where it might be going, and at least where its been.

 2) Trading Volume is generally more useful when trading lesser known companies, or for exchange traded funds. Big, well known companies generally have an easier time of achieving large trading volumes. Lesser known companies or ETF's with lower trading numbers have the possibility of running into liquidity issues. Where buying or selling stocks, particularly in very large, or very small quantities have the potential to have trouble buying or selling those shares due to a lack of demand. 

    Higher trading volumes also tend to create a less volatile stock as it is easier for buyers and sellers to match their corresponding trades and reduces the chance of a seller being forced to sell at a lower rate due to a lack of buyers. With higher volumes of shares traded, the spread between the bid and ask tend to be closer together.

 3) A large Market Capitalization, similar to trading volume tends to distinguish established, stable companies from newer ventures. Think 'blue chip companies', they've been around for ages paying out stable dividends and have large market cap, ex. P&G;227billion, KO;194billion, RY;104billion! 

4) Price to Earnings (P/E) is the ratio of the current market price of a stock against its earnings on a per share basis, which ties into the Earnings Per Share(EPS) and number of shares issued of the company. The higher a stock is trading in comparison to its EPS the higher the P/E ratio will be, so a stock trading at a P/E of 20 is twice as expensive as a stock trading at a P/E of 10. 

    When comparing two companies based on their P/E and EPS however it can get a bit tricky due to variances between them. For example in the case of Bank of Nova Scotia(BNS) and Toronto-Dominion Bank(TD), BNS has an EPS of 5.57 and TD's EPS is 4.39. The easy conclusion is that BNS is earning more and you should buy them, especially considering their P/E is ~1.5 lower. However looking further, BNS has about 600million fewer shares than TD and with the stock price trading at about 10$ more. Had you done the same comparison for 2013 TD's EPS would have been much higher since it has since then completed a 2 for 1 stock split, which doubled its number of common shares.
5) Percentage Institutionally Owned is a small detail that I like to look at about a company, it refers to the % of a companies common shares owned by large institutions such as banks, pension funds and investment management companies such as Vanguard and Blackrock. funds. If the so called 'smart money' of professional investment bankers and fund managers are confident about a company, then perhaps I should be as well. This figure is also noticeable if you go looking through common ETF and mutual fund holdings; where many of them hold nearly the same top 10 holdings as each other.  Perhaps just build your own mutual fund or ETF, minus the fees.

6) Financial Statements are a very important when evaluating individual businesses and should never be skipped over. Remember it is crucial that you do your own research and keep up to date on major company events that may affect your investments. Reviewing a company's income statements, balance sheets and cash flow help to give an understanding of where they have been and the general direction that they are heading. Important lines to look at:

i) Income Statement: Focus here is on Income versus Expenses over time.
- Revenue; are they increasing their income over time?
- Cost of Revenue: are costs increasing at pace with or lower than the increased revenue?
- Total Operating Expenses; is the company managing their expenses reasonably?
- Diluted Normalized EPS; is the company earning more per share consistently? This figure excludes income and expense from one time transactions. The closer DN-EPS is to EPS the more stable the company is thought to be.

ii) Balance Sheet: Comparing change in company assets and debt management.
- Total Assets: Has the company been investing in its own growth, or just coasting on what it has?
- Total Liabilities: Is the company managing its debt and cost payments well? Hopefully liabilities are going down or at least keeping pace with growth.
- Total Shareholder Equity: Are shareholders being rewarded over time for holding onto their shares with increased equity within the company? If not then why? If its gone down some further researching may reveal why, eg. the company sold a division and made a one time cash dividend payout to shareholders. Which would decrease their shareholder equity on the balance sheet since the capital left the company, but might not have been bad for shareholders at the time.

iii) Cash Flow: Depicts in closer detail where income is coming from, and where expenses are incurred including non-cash items such as amortized expenses and depreciation of asset value.
- Net Income: Is income per quarter progressing steadily, or does it fluctuate within the business year? Important if the company is a retailer, it may be that a big chunk of their earnings comes within a particular season so revenue may be lower than the average if that time has not come yet.
- Cash from Investing/Financing Activities: Is the company getting a good return on their other investments? Are they spending too much on projects and/or subsidiaries?
- Total Cash Dividends Paid: When compared to income, are the dividends being paid from cash on hand, or are they being financed by debt or new equity? Particularly important when looking at REIT's as you want their free cash flow, aka money available on hand after all other expenses to be able to cover their monthly distributions without having to issues debt or equity. The same goes for any company though. You do not want them to be supporting the dividend through debt or diluting their shares. 

    Another key measure of evaluating a REIT's success, or viability is the adjusted funds from operations (AFFO). Where financial performance is measured through its funds from operating against the companies cost to manage and maintain their properties. 

     A very simplified example is how a landlord may make $1,000 per month off their tenant, but have to spend $1,200 in a year to keep the property habitable. The adjusted income of the landlord would be $900, more than enough to warrant renting out the room.

   These are just a few of the pieces of easily accessible and fairly straightforward bits of information to look at. All of which are accessible through free, online sources such as Google Finance, or Yahoo Finance, although there is some variation in formatting and information shown at a glance. 

    Alternatively if you find going through company financial statements daunting or confusing, as some of the lines within them can be quite hard to understand Investopedia is an amazing resource for financial definitions and information to help you go through and learn more. And as many of you know, there is a large number of great and informative blogs out their, I follow a few of them on my Twitter, and have a few more on my Blogroll which I update, if you would like to be added send me a PM on Twitter or Facebook.  

    Overall though, this is a guideline on a few of the variables that I look for when doing my stock purchases. I also do look at other factors. And there are certainly a lot of other ways to research, analyze and select stocks and you utilize whichever method(s) that you are comfortable with and stay within your risk level. Always take the time to do your research and due diligence before rushing into a 'hot stock pick'.


  1. Very insightful article about researching stocks for investment. I never thought of the no. 5 before. Will look on that too.

    1. Thanks! Glad you got something new from it. I wish I knew a bit more on how Google actually calculates that %; which shareholders it counts as an Institutional investor or not. I would have thought that RY would have more than 52% owned, BNS 58% and TD only 33% considering so many Canadian ETFs/MF's hold them in most of their top 5 positions.