8 Key Facts To Know About A Company BEFORE You Invest

posted on 08-05-2019

by Christian Hudspeth

Investing in a stock isn't throwing your money into a poker pot and betting you'll magically become rich overnight.

When you "buy" a stock, you are becoming an owner of the company that stock represents.

If you buy, for example, stock in Apple (NASDAQ:APPL) and profits grow for the next few years, you'll be treated to a rising share price and grow wealthier along with your fellow owners. But if you invest in Apple and the company does poorly over the next few years, your shares will lose value -- and you'll lose money on your investment.

While this concept may sound simple, it's surprising how many investors overlook key indicators about a company before they invest. As a result, they become owners of lousy companies that lose money year after year.

You want to be an owner of a successful company that gives you a return, so why wouldn't you take some time to research it first?

Don't worry, it's easier than you think. Using just eight key terms and spending 15 minutes to analyze a company can mean the difference between reaping healthy investment gains and losing your shirt.

Straight from the InvestingAnswers Financial Dictionary -- the industry's most investor-friendly resource used by one million investors every month -- here are eight key financial terms that will make you a more successful stock investor.

1. Chief Executive Officer (CEO)

Like a ship captain, a company's chief executive officer steers, rights and can sometimes sink the ship, so it's important to know a company's CEO before you buy.

What to look for: You don't need the CEO's biography, just a brief overview of their business background (Do a search on Morningstar.com or an online search engine for help with this).

Ask yourself things like: Do you believe the CEO has the right experience to run a car company for the next 10 years if he ran a retail chain before for the last 10 years?

Is the company's success heavily tied to this person like Steve Jobs was to Apple or Warren Buffett is to Berkshire-Hathaway (NYSE:BRK-B)? And if so, do you feel comfortable that the business can do well after that person leaves the company?

2. Business Model

A business model is essentially the strategy that a company uses to maximize its profit in its industry.

Walmart (NYSE:WMT), for example, offers the lowest possible price so it can sell more products. By contrast, another retailer like Coach (NYSE:COH) sells fewer, higher-quality items but earns a larger profit per product sold.

What to look for: While there is no "right" strategy, be sure you understand and agree with the company's business model, which you can find on a reputable financial website or Morningstar.com.

Think about how well the company's business model might work in recessions or economic booms. Dollar Tree's (NASDAQ:DLTR) business model of selling products for just $1 even through the 2008 recession gave the company record-breaking profits each year from 2007 through 2012 -- and a stock price that soared 352% over the same period.

3. Competitive Advantage

Sometimes called an economic moat, a competitive advantage is when a company has a leg up over its competitors through its superior products, patents, brand power, technology or operating efficiency.

What to look for: Be sure the company you're thinking about buying has a competitive advantage. For example, Walmart offers super-low product prices that are hard for competitors to beat. Coca-Cola (NYSE:KO) has strong brand name recognition and sells a popular product that's hard for competitors to replicate.

A competitive advantage is the wall that keeps competitors from taking market share and keeps that company more profitable -- and makes it a better investment for you -- over the long term.

4. Revenue

Revenue is simply the raw amount of money the company made from sales of its product or service. Revenue is sometimes called a company's "top line" as it's always listed as the first line of every company's income statement. [Here's an example of an income statement.]

What to look for: A company with its revenue trending up each year for the past few years. While it's not realistic to expect a company to increase its sales every single year (especially in a struggling economy), a company with a trend of falling annual revenues signals it has trouble selling its products and services or finding other sources of revenue.

5. Net Income

More casually called profit, earnings or "the bottom line," net income is simply the amount of money a company earned from sales after expenses and taxes have been paid. As its nickname suggests, you can find a company's net income listed on the bottom line of the company's income statement.

What to look for: Net income growth from year to year. A company with growing net income each year shows that the company knows how to effectively sell its products, slash or control its business operating costs or a combination of both.

Companies like AutoZone (NYSE:AZO) and Ross (NASDAQ:ROST) both managed to grow their net incomes through the "Great Recession" and both stocks returned well over 100% during the same period.

5. Profit Margin

Profit margin (sometimes referred to as net profit margin) is simply the percentage of revenue the company takes in as profit (after expenses, interest and taxes have been paid). Apple in its heyday, for example, had a profit margin of 26% -- meaning for every $100 iWidget it sold, it made $26 profit. A company's profit margin is net income divided by total revenue.

What to look for: Steady or growing profit margins ensure that a company is profitable and can reward shareholders with returns, even in recessions.

Companies with growing profit margins signal that the company can command higher prices because consumers are willing to pay for their product (Apple enjoys healthy profits because it can sell its devices for a much higher price than competitors).

Companies that can maintain steady profit margins show the company can effectively control its operating costs, keeping the company efficient (Wal-Mart has been able to keep its product prices low and its profit margins steady even through recessions). Steady or growing profit margins ensure that a company is profitable and can reward shareholders with returns.

6. Debt-to-Equity Ratio

With the debt-to-equity ratio, you can find out how much debt a company carries compared to the amount of equity shareholders have in the company.

What to look for: A company with a low amount of debt in relation to its equity (total debt levels that are no higher than the company's total equity levels; a ratio of 1:1 or lower).

Used as a safety measure, the debt-to-equity ratio tests how well the company can repay its debt obligations in the event that the company runs into serious financial problems. Generally, the lower the debt-to-equity ratio a company has, the less risky it is to you as an investor.

7. Price-to-Earnings Ratio (P/E)

Finding a company with strong financials is not enough. Just like you can pay too much for a great car, you can pay too much for a great company -- and that can mean limited upside potential on your gains (and even a loss). With a stock's price-to-earnings ratio (P/E), you can find out if a stock is overpriced. The P/E ratio compares a stock's price to the amount of profit per stock share (earnings per share) the company generated.

What to look for: A company with a P/E ratio that is on par with or lower than the overall market's P/E ratio (which has historically been between 14 and 17) and the company's peers in the industry. In general, a well-run company with a relatively low P/E ratio signals that the company's stock is trading at a fair price or even a bargain.

[Warren Buffett uses this "value" investing approach and has been wildly successful. Learn more about this strategy in Warren Buffett's Golden Rule of Investing.]

The Key Lesson for Beginner Stock Investors

While knowing the importance behind these eight facts won't guarantee success with stock investing every time, they will help you avoid the pitfalls that less experienced and even sometimes veteran investors run into.

Find companies that a) you understand and agree with from a leadership and business perspective, b) operate with strong management and financial health and c) are trading at a good value. These will be key to your investing success.

Readers like you also enjoyed:

Taking 15 minutes to look up these eight things about a stock can mean the difference between reaping healthy returns and losing your shirt.

by Christian Hudspeth What's even better than earning rewards for spending on your credit cards? Getting paid hundreds of dollars worth in sign-up bonuses in three months or sooner -- just for tr...
by Christian Hudspeth Tired of dragging credit card debt around with you? Taking 15 minutes to transfer your debt to a credit card with generous balance transfer perks could save you thousands in...
by Christian Hudspeth If you're going to spend money anyway, then why not get paid for it?Whether you're looking for credit cards with up to 6% cash back, double flight miles, or even a free hote...
by Christian HudspethIn times where interest rates are on the rise, you may start hearing financial advisors and bankers sing the praises of an income strategy called "CD laddering" (short for ce...
by Susan Campbell Those of us familiar with selling property know real estate agents don't come cheap. With real estate agent commission and fees amounting to as much as 6% of the sel...
Beverly Harzog is a nationally recognized credit card expert, author, and consumer advocate. She blogs about credit cards at BeverlyHarzog.com. Being in credit card debt is the pits. I've bee...
by Christian Hudspeth If you haven't already felt the pressure to refinance your mortgage, you're probably really feeling it now. Mortgage rates are still hovering near historic lows. But ...
by Christian Hudspeth If you or someone you know is thinking about getting a home mortgage, you may want to know about the thousands of dollars in hidden charges that some lenders are quietly...
by Christian Hudspeth Money market accounts (MMAs) and savings accounts make great places to set aside your emergency fund money and earn some interest income at the same time.Simply put, these s...
by Christian Hudspeth It's true that auto loans and home loans offer attractively-low annual percentage rates (APRs), while credit cards offer borrowing power without the risk of ever seeing the ...
by Christian HudspethWant to keep your emergency fund safe while earning interest yields that are three to five times higher than a typical savings account? Putting your money into an FDIC-insure...
by Christian Hudspeth Question: Hi there. I need your advice. I'm only 19 and I really need to start investing. Where can I start? -- Tirelo M., Gaborone, Botswana Answer: You've defini...