8 Key Facts To Know About A Company BEFORE You Invest
in a isn't throwing your into a poker pot and betting you'll magically become rich overnight.
When you "buy" ayou are becoming an owner of the company that represents.
If you buy, for example,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 lose value -- and you'll lose on your .
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 year.year after
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 canlosing your shirt.the difference between reaping healthy gains and
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 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 before you buy.
What to look for: You don't need the'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 thehas 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, , 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 for you -- over the long term.
Revenue is simply the raw amount of 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 . [Here's an example of an .]
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 annualsignals it has trouble selling its products and services or finding other sources of .
5. Net Income
More casually called profit, earnings or "the bottom line," net income is simply the amount of 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 .
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
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 canupside 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 ratio compares a stock's price to the amount of profit per stock share (earnings per share) the company generated.limited
What to look for: A company with aratio that is on with or lower than the overall 's 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 ratio signals that the company's stock is trading at a fair price or even a bargain.
The Key Lesson for Beginner Stock Investors
While knowing the importance behind these eight facts won'tsuccess with stock every time, they 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. Thesebe key to your success.
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Taking 15 minutes to look up these eight things about a stock can mean the difference between reaping healthy returns and losing your shirt.