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Because there are literally hundreds of things about a company to examine when analyzing its stock, it is tough to know where to start. Most investors are good at evaluating
earnings, growth rates, revenue, and the P/E ratio, but they also tend to overlook
other aspects that can be just as important. Here is our list of five items on
which the average investor does not place enough emphasis:Cash Flow -
This represents the constant flow of money in and out of a company.
All companies provide separate cash flow statements as part of their
financial statements, but cash flow can also be calculated as net income
plus depreciation and other non-cash items.Proper cash flow levels vary
from industry to industry, but a company not generating the same amount
of cash as competitors is bound to lose out. A company without available
cash to pay bills is in real trouble, even if the company is profitable. By using
the cash flow-to-debt ratio, which compares the amount of cash generated to
the amount of outstanding debt, you can judge the health of cash flow.
This comparison reflects the company's ability to service their loan and
interest payments. For more details on analyzing cash flow, see the article
"Learn to Look at the Cash Flow" Management - This is one aspect of a
company that can make a world of difference. Think of management in
terms of sports: Michael Jordan might not have been the "whole show"
during his reign at the Chicago Bulls, but he was undoubtedly a huge
contributing factor to their success. The same is true for the management
of a business: good management doesn't do everything, but it certainly is
an integral part of the company. Sam Walton (of Wal-mart) and Jack Welch
(of General Electric) are examples of people who led their firms through
thick and thin, recessions and booms. This doesn't mean you should buy a
stock purely based on management, but do consider the significant value in
proven, long-standing leadership. Accounts Receivable - AR represents
the sales for which the company has yet to collect the money. Sales drive
accounts receivable, so when sales are growing, accounts receivable
will grow at a similar rate. Problems arise from an AR that is increasing
faster than sales, which indicates that the company is not receiving payment
for its sales and thus leaving itself short for handling the expense of producing
those sales. In an extreme case, AR can tell us whether a company is
"stuffing the channels," which is the practice of a company sending excessive
amounts of extra goods to retailers and recording the shipment as a sale.
The purpose is to to try and make it appear as though sales are increasing,
but eventually the goods will be sent back because retailers cannot sell the
excess supply, ultimately creating a blowup. Inventory - Inventory is the
finished items available for sale and ties in closely with accounts receivable.
High inventory is bad for several reasons. Firstly, there is a cost associated
with storing the extra inventory: increases in inventory cause higher storage
costs. Secondly, a growing inventory can indicate that the company is producing
more than it can sell. Like AR, inventory should increase at a rate similar to
that of sales. "The Big Picture" - The technique of looking at the overall company
and its outlook is sometimes referred to "qualitative analysis,"
and it is a perspective that is often forgotten. Peter Lynch once stated that he
found his best investments by looking at the trends his children follow.
(Read more on Peter Lynch here.) Whether it's Pokemon or Big Macs, you can't
argue against real life. Brand name is also valuable. Coke, for instance, is the most
popular brand name in the world, so the financial value of its name is measured
in the billions of dollars and therefore cannot go overlooked.Assessing a company
from the fundamental/qualitative standpoint is one of the easiest and most
effective strategies for evaluating a potential investment, and it is as important
as looking at sales and earnings. ConclusionThese five overlooked areas are by
no means the only things investors need to evaluate, but looking at more than
just the obvious will give you that extra advantage over other investors.
Earnings are important, but earnings are also the most widely published financial
figure for any company, so why base an investment decision solely on what
other people already know? The moral here is always to dig deeper by
doing solid research so that you can aim to be a step ahead of the crowd.
Cheers,