Investing All-in-One For Dummies. Eric Tyson

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СКАЧАТЬ lower than the prior year? The death knell of many a company has been excessive debt.

      

A company’s financial condition has more factors than the preceding list mentions, but these numbers are the most important. Using the 10-percent figure may seem like an oversimplification, but you don’t need to complicate matters unnecessarily. Someone’s computerized financial model may come out to 9.675 percent or maybe 11.07 percent, but keep it simple for now.

      Evaluating a company’s management

      The management of a company is crucial to its success. Before you buy stock in a company, you want to know that the company’s management is doing a great job. But how do you do that? If you call up a company and ask, it may not even return your phone call. How do you know whether management is running the company properly? The best way is to check the numbers. The following sections tell you the numbers you need to check. If the company’s management is running the business well, the ultimate result is a rising stock price.

      Return on equity

      

Although you can measure how well management is doing in several ways, you can take a quick snapshot of a management team’s competence by checking the company’s return on equity (ROE). You calculate the ROE simply by dividing earnings by equity. The resulting percentage gives you a good idea whether the company is using its equity (or net assets) efficiently and profitably. Basically, the higher the percentage, the better, but you can consider the ROE solid if the percentage is 10 percent or higher. Keep in mind that not all industries have identical ROEs.

To find out a company’s earnings, check out the company’s income statement. The income statement is a simple financial statement that expresses this equation: sales (or revenue) minus expenses equals net earnings (or net income or net profit). You can see an example of an income statement in Table 2-1. (Chapter 4 in Book 3 gives more details on income statements.)

TABLE 2-1 Grobaby, Inc., Income Statement

	2019 Income Statement	2020 Income Statement
Sales	$82,000	$90,000
Expenses	–$75,000	–$78,000
Net earnings	$7,000	$12,000

To find out a company’s equity, check out that company’s balance sheet. (See Chapter 4 in Book 3 for more details on balance sheets.) The balance sheet is actually a simple financial statement that illustrates this equation: total assets minus total liabilities equals net equity. For public stock companies, the net assets are called shareholders’ equity or simply equity. Table 2-2 shows a balance sheet for Grobaby, Inc.

TABLE 2-2 Grobaby, Inc., Balance Sheet

	Balance Sheet as of December 31, 2019	Balance Sheet as of December 31, 2020
Total assets (TA)	$55,000	$65,000
Total liabilities (TL)	–$20,000	–$25,000
Equity (TA minus TL)	$35,000	$40,000

      Table 2-1 shows that Grobaby’s earnings went from $7,000 to $12,000. In Table 2-2, you can see that Grobaby increased the equity from $35,000 to $40,000 in one year. The ROE for the year 2019 is 20 percent ($7,000 in earnings divided by $35,000 in equity), which is a solid number. The following year, the ROE is 30 percent ($12,000 in earnings divided by $40,000 in equity), another solid number. A good minimum ROE is 10 percent, but 15 percent or more is preferred.

      Equity and earnings growth

      Two additional barometers of success are a company’s growth in earnings and growth of equity:

       Look at the growth in earnings in Table 2-1. The earnings grew from $7,000 (in 2019) to $12,000 (in 2020), a percentage increase of 71 percent ($12,000 minus $7,000 equals $5,000, and $5,000 divided by $7,000 is 71 percent), which is excellent. At a minimum, earnings growth should be equal to or better than the rate of inflation, but because that’s not always a reliable number, I like at least 10 percent.

       In Table 2-2, Grobaby’s equity grew by $5,000 (from $35,000 to $40,000), or 14.3 percent ($5,000 divided by $35,000), which is very good — management is doing good things here. You want to see equity increasing by 10 percent or more.

      Insider buying

      

Watching management as it manages the business is important, but another indicator of how well the company is doing is to see whether management is buying stock in the company as well. If a company is poised for growth, who knows better than management? And if management is buying up the company’s stock en masse, that’s a great indicator of the stock’s potential.

      Noticing who’s buying and/or recommending a company’s stock

      You can invest in a great company and still see its stock go nowhere. Why? Because what makes the stock go up is demand — when there’s more buying than selling of the stock. If you pick a stock for all the right reasons and the market notices the stock as well, that attention causes the stock price to climb. The things to watch for include the following:

       Institutional buying: Are mutual funds and pension plans buying up the stock you’re looking at? If so, this type of buying power can exert tremendous upward pressure on the stock’s price. Some resources and publications track institutional buying and how that affects any particular stock. Frequently, when a mutual fund buys a stock, others soon follow. In spite of all the talk about independent research, a herd mentality still exists.

       Analysts’ СКАЧАТЬ