Selecting companies for investment is the best part of investing. I thoroughly enjoy the process of analyzing stocks and wanted to demonstrate the process that I go through. I am not suggesting that my method is correct – it is just the way I do it.
My analysis always begins with a real quick scan of the Mergent database to ensure that the company has been consistently increasing its dividend. In GE’s case, it had.
I then move to some headline scans to see what the news has been talking about for GE. This will tell you some of the major issues the company has been facing and will provide you with some indication of how management deals with certain situations. This step is tricky because you need to be able to sort through the media “fluff” and get down to the real issues and solutions – it can be very subjective and my interpretation on it may be different from the next persons.
< ?php tla_ads() ?>My next step is to open up a software package I use that I bought through the broker that I use. It is called the Stock Selection Guide and in my opinion has been a very effective analysis tool. The analysis within the software is based on the methodologies developed by the National Association of Investors Corporation.
I am able to load up a data set for the companies I want to analyze that includes a ton of data going back a number of years. The information looks like the following (this is just a subset as the image would be way too big to show here):
Once this is all completed, I can start to analyze the fundamentals of the company. I start by looking at the revenue and noting the trends. You can see for GE, the revenue has been increasing steadily – I want to see this trend going up consistently.
I also want to take a stab at projecting the revenue growth. The tool provides me with a field where I am able to input what I think the growth of the revenue will be. For GE, I see that the growth rate from 1993 – 2004 has been 9.3% so I can just use that number or input something else based on my interpretation of the company’s ability to grow revenue. I was comfortable with a 9.3% growth rate out to 2009 and left it.
< ?php tla_ads() ?>I then move on to earnings analysis. Earnings analysis works much the same as the revenue side. Again, I want to see a consistent up tick in earnings. I enter what I feel the earnings growth will be in the future based on the historical data. From 1994 – 2004 GE had an earnings growth rate of 12.1%. However, that growth rate has slowed quite a bit so I was not comfortable using the softwareâ€™s recommended value of 12.1%. I instead used a growth rate of 7% out to 2009 to reflect my thoughts on earnings growth.
With this done I have a good picture of two important factors in stock analysis – revenue and earnings. At the end of the day, these numbers need to move up to. In may sound too simple but at the real basic level, that is what is important.
I then move on to seeing what the stock price has done in the past. The primary metric for analyzing the price is the P/E ratio. This shows me what the P/E ratio has done in the past and allows me to make my own interpretation of what the P/E ratio will do in the future. I input a projected upside P/E ratio 5 years out – in GE’s case I chose a P/E ratio of 26.8.
Next is looking at return, and this is where my favorite part comes in – the DIVIDENDS. This portion of the software tool provides an estimate of the stockâ€™s price in five years and the related rate of return. This return reflects both the potential for capital gains as well as dividend income. What I look for here is a return estimate of at least 14%.
I also look closely to see what the dividend has done in terms of increases in the past – this a further justification of the data I looked for with Mergents but this pictures shows the data behind their reason for calling it a Dividend Achiever. For GE, I inputted a 2.1% projected dividend yield which gave me relative return based on my P/E estimate of 14.4%. Not spectacular, but not bad either.
Next I do some risk analysis. This portion of the tool me with the opportunity to estimate the stockâ€™s potential for a price decline. I compare the downside risk to the upside reward of the stockâ€™s price increasing during the next five years. I want to see at least $3 of reward of every $1 of risk. For GE, there is $3.93 for reward for every $1 of risk. From this the software provides me with some guidelines in terms of price “zones”. GE has fallen within the buy range based on my inputs.
The important thing to consider about the whole process (whether you are using a software package or not) is that the decision to buy a company is based totally on your interpretation of the data. I may look at it totally different than the next person. In addition, while using a tool like this, it is very easy to manipulate the data to make any stock look like a buy – it is only as good as the inputs you use and these inputs are based on your judgments.
At the end of the day, I was comfortable with my analysis and decided to buy GE. Time will tell if this was a good move or not, but at least I will be getting a steadily increasing dividend.
In a few months, I will look to see if the data for GE has been updated and revaluate the company, again looking for trends. This allows me to keep on top of the company and make the appropriate decisions to buy more or sell what I have.
P.S. After rereading this, it may appear that I may be affiliated with the CSA and the software package – I assure you I am in no way affiliated with them and am receiving nothing for this mention.