Ratios and weight

With the great rotation from growth to value stocks, it may be an opportune time for the novice stock chooser to pick up some tips when, after reading the news, he believes he has spotted a trend in a sector that is promising for growth and wishes to buy shares in a company. If he is astutute he will go ahead and analyse the financial statements and company history. I can’t recount how often I have made very expensive mistakes by insufficiently researching a stock pick.

But where does the novice start?

First of all the analysis should look into a few aspects of the company, not just it’s value:

  1. the company’s profitability should be measured
  2. so too should it’s efficiency be measured
  3. the short term viability of the company through working capital and liquidity should be looked at
  4. finally the company’s capital and valuation can be looked at

Having looked at the financial position and the performance of a company the last aspect to be looked at is management.

Here are some more ground rules: • Never judge a company on one year’s figures. Always look at 3 or ideally 5 year’s figures. • Never judge a company in isolation. Always compare its performance with others of the same size or in the same sector or country. • Compare like with like - make sure the basis of the data is consistent.

Use the SEC website (www.sec.gov/searchedgar/company) to obtain this information to compare on a spreadsheet.

Finally, don’t invest in a company and sector which you don’t understand. If you can’t understand what the company does, don’t invest. If you can’t see where the profits are coming from, don’t invest.

Using the /Guide to Analysing Companies/ (6th ed) by Bob Vause as a reference, here are some tips:

• Make sure calculations are comparable and consistent • Investigate variations - When the ratios of a company stand out in comparison with other sector and country companies, it is best to assume that this is not a positive signal, so investigate them and discover the reasons. • Never rely on a single ratio • Have as much company history incorparted into your calculations as possible. Try and obtain ten years worth of data. • Watch out for graphs and charts. Often they tell a story, which is not necessarily the truth, but may be part of the storyteller’s illusion. So make your own graphs and look with a critical eye at graphs presented. • Don’t rely on someone else’s analysis. Do your own! - this pertains particularly to the internet and to unpaid, or untrusted analysts. • Use percentages - they present a common size and make it easier to compare the contribution each component has to a total. There is a range of benefits to using this method.