Finding good companies to invest in using Fundamental Analysis Part 1

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Last time we discussed the Reasons why we have more chance of success than the professionals. That’s the way the system is set up – crazy I know – but great for us. And so liberating to know that we can do this! This time around, in Part 1 of a 2 part series, we want to show you how you can find some good companies. These are not necessarily ‘the best in the world’ but good solid companies we can start making some money with using the strategies we have been writing about in this blog. Most people are looking for WHICH company to invest in i.e. a healthy company with good ‘fundamentals’. Fundamental Analysis shows us the current health of the company and the rational behind it is that if you find a good company then the share price will go up eventually. This is more of a long term strategy – what most people don’t realise is that you can find the best company in the world, but that does not mean that the share price will go up in the short term. What is equally important is the short term sentiment of the market – so it might go down for weeks or even months before going back up. That is why we use Technical Analysis, i.e. WHEN to get into that healthy company. The key is to find a good healthy company to buy using technical analysis and then to time the entry as best you can using technical analysis.

Let us start with Fundamental Analysis – finding great companies. There are well over 8,000 public companies out there. The aim is to create a more manageable list called a Watchlist of companies, say 50 or less we can whittle it down to. These are the companies we will focus on.

What are the kind of things that you think that we might be looking at when we are looking at the health of a company? Below are some ideas of where to start using Fundamental Analysis. It will not surprise you that Earnings – which is American for Profits – is used several times:

1. PEG RATIO

The PEG is the Price Earnings to Growth Ratio. The ratio is made up of three parts.  1. P = Price; 2. E = Earnings per Share (These 2 together form the famous PE Ratio); and 3. G = Earnings Growth

Price / Earnings per Share

___________

Earnings growth

Let’s say we have a P/E ratio of eight.  As a shareholder you want know how much Earnings (profit) you have for one share i.e. I own one share, how much is the profit? For example, let’s say the price of this particular stock at the moment is $24 dollars and that year we made Earnings per Share of 3 Dollars.

So, $24 / 3 means that we have a P/E ratio of 8 which means that the person who’s going to buy the stock right now will pay $8 for every $1 (that’s the same as $24 for every $3) that the company earns. So you are paying for future earnings. The higher the PE Ratio the more you are paying now for future earnings.

The G stands Earnings per Share Growth i.e. the amount the Earnings per Share are projected to grow in % terms.

Confused? Don’t worry. All you need to know is the PEG ratio has to be lower than 1.5 or even lower than 1 if you’re really strict. If the PEG ratio is at 1 it is considered fairly valued i.e. the valuation is fair. Below 1 and you are looking at a stock that is undervalued.

2. Earnings Growth

In PEG we have Earnings Growth (G) projections. But it is so important that it deserves a section by itself. We need to be asking ourselves, “Are the profits growing and are they going to be more next year than this year?” We want to see year on year growth in earnings for the next five years. If the earnings are going up, it is likely that investors will buy the stock in the future and if they are going down, they will most likely start selling. So how do we know that what future earnings will be? Good question. Here we have to rely on expert Analysts that estimate this for us.

So, we’re looking for five year earnings Growth on the Earnings per Share (EPS) between 15% and 30%. Anything higher than that is not sustainable over time.

3. Debt

We also want to ensure that a company has debt. This might seem strange but if it doesn’t have debt it means it is not expanding fast enough i.e. it is not using the resources it has at hand to maximise everything it can. On the other hand we don’t want it to have too much debt or else it won’t be able to pay it off and go bust.

So we are looking at the debt ratio that indicates the percentage of the company’s assets, what they own, that are provided for by its debt.

Debt Ratio = Total Debt / Total Assets   X 100 (to get it in %).

A debt ratio of greater than 100% indicates that a company has more debt than assets. Meanwhile, a debt ratio of less than 100% indicates that a company has more assets than debt.

So, we’re looking for a debt ratio which is below 35%. If a company’s debt levels are more than that, it often proves extremely difficult for the management to be able to borrow more at a certain price in order to expand the company even more, and without expansion into new markets, which is normally done by debt, corporate growth will eventually slow down and then the stock price will be affected.

Companies with lower debt often have better prospects for future expansion because they can still raise debt but remember we still want companies to have a certain amount of debt.

The next one is less important but it’s interesting to know:

4. Institutional Ownership. 

What percentage of the company is owned by the big boys, the institutions, the pension funds, the mutual funds, the unit trusts?   Because on the one hand you don’t want there to be too many of them but on the other hand, you don’t want to be investing in a company that no one knows about and no one checked out, you never ever heard before.

You want to make sure that you are actually investing in a company where people who have more market experience than us have done the research and are investing.  Does this make sense?   A bit of institutional ownership is a good thing.

So, we don’t want too high, we don’t want too low, we want in the middle, so between 25% – 55%

Final one:

5. Price

I want the price to be above $5, preferably $10. It has to be above ten dollars because I want to make sure it’s not what’s called Small Cap stock i.e. small capitalisation.   I want to there to be enough liquidity i.e. buying and selling. Also did you know that no stock below $5 is going to be looked up by the majority of institutions?  And I want them to cover my stocks.  I want them to write about my stocks.   “Why do I want the institution to write, to publish, to talk, and to tweet?” It’s marketing and everybody else is going to know about them and is going to invest as well.  So it has to be over $10.

So would you like to know how to find these companies”? We can filter them on FINVIZ.com 

This is a FREE stock screener where we screen through 6720 stocks out there that meet the criteria we are looking for (above) to find the best we possibly can.

 

It might look confusing at first sight, but on the next post, in part 2 we will look at how to use the filter and choose the best companies. By the way, you can also use it to find the worst companies as well. You can ‘short’ those companies. Not a bad idea as you can make money fast when the price goes down. More on that next week.

In times like these it is a MUST for you to learn more about what trading and investing in stocks, commodities and precious metals has to offer. We are having a series of 1 day events where we go through the strategies so you can take control of your own finances. But first, why not go ahead and download your FREE STRATEGY REPORT:  www.investment-mastery.com/wealthwatch

 

Until next time,

Marcus

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