“The person that turns over the most rocks wins the game. And that’s always been my philosophy.” ―Peter Lynch
In chapter 15―The Final Checklist―of the book One Up on Wall Street, Peter Lynch summarizes the things that you as an investor would like to know about stocks in each of the six categories, as follows.
Stocks in General
• The p/e ratio. Is it high or low for this particular company and for similar companies in the industry.
• The percentage of institutional ownership. The lower, the better.
• Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.
• The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where the earnings may not be important is in the asset play.)
• Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it’s rated for financial strength.
• The cash position. With $16 net cash, I know Ford is unlikely to drop below $16 a share. That’s the floor on the stock.
• Since you may buy these for the dividends (why else would you own them?) you want to check to see if the dividends have always been paid, and whether they are routinely raised.
• When possible, find out what percentage of earnings are being paid out as dividends. If it’s a low percentage, then the company has a cushion in hard times. It can earn less money and still retain the dividend. If it’s a high percentage, then the dividend is riskier.
• These are big companies that aren’t likely to go out of business. The key issue is price, and the p/e ratio will tell you whether you are paying too much.
• Check for possible diworseifications that may reduce the earnings in the future.
• Check the company’s long term growth rate, and whether it has kept up the same momentum in recent years.
• If you plan to hold the stock forever, see how the company has fared during the previous recessions and market drops.
• Keep a close watch on inventories, and the supply-demand relationship. Watch for new entrants into the market, which is usually a dangerous development.
• Anticipate a shrinking P/E multiple over time as a business recovers and investors look ahead to the end of the cycle, when peak earnings are achieved.
• If you know your cyclical, you have an advantage in figuring out the cycles. (For instance, everyone knows there are cycles in the auto industry. Eventually there are going to be three or four up years to follow three or four down years. There always are. Cars get older and they have to be replaced. People can put off replacing cars a year or two longer than expected, but sooner or later they are back in the dealerships. The worse the slump in the auto industry, the better the recovery.
• Investigate whether the product that’s suppose to enrich the company is a major part of the company’s business. It was with L’eggs, but not with Lexant.
• What the growth rate in earnings has been in recent years. (My favorites are the ones in the 20 to 25 percent range. I’m wary of companies that seem to be growing faster than 25 percent. Those 50 percenters are usually found in hot industries, and you know what that means.)
• That the company has duplicated its success in more than one city or town, to prove the expansion will work.
• That the company still has room to grow.
• Whether the stock is selling at a p/e ratio at or near the growth rate.
• Whether the expansion is speeding up (three new motels last year and five this year). For stock companies which sales are primarily “one-shot” deals―as opposed to razorblades which customers have to keep on buying―a slowdown in growth can be devastating.
• That few institutions own the stock and only a handful of analysts have ever heard of it. With fast growers on the rise, this is a big plus.
• Most importantly, can the company survive a raid by its creditors? How much cash does the company have? How much debt?
• What is the debt structure, and how long can it operate in the red while working out its problems without going bankrupt?
• If it’s bankrupt already, then what’s left for the shareholders?
• How is the company supposed to be turning around? Has it rid itself of unprofitable divisions?
• Is the business coming back?
• Are costs being cut? If so, what will the effect be?
• What’s the value of the assets? Are there any hidden assets?
• How much debt is there to detract from these assets? (Creditors are first in line.)
• Is the company taking on new debt, making the assets less valuable?
• Is there a raider in the wings to help shareholders reap the benefits of the assets?
Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.