How to Research Stocks: The Numbers That Matter

You will need to have a strong understanding of a company’s financials if you want to be able to properly put a price tag on it. Financial statements are a collection of different metrics reported by the company. These include the income statement, balance sheet, and cash flow statement. Each of these documents provides the investor with valuable information used in understanding how to analyze a stock.

In this section, I will highlight some of the most important financial disclosures needed in stock evaluation and how to use them. But first, if you are still considering whether you want to learn how to invest into singular stocks, take a look at my post Index Funds vs. Individual Stocks before diving in.

In part 1 of this series we covered the investor mindset and the basics of stock research. Now let’s get into the numbers.

This is part 2 of a 3 part series on stock research. Read part 1 here and part 3 here.

Where to Find Financials

One of the best websites for finding company financials is Yahoo Finance, which makes it very easy to research a stock. Just type in the company’s ticker symbol into Yahoo’s search bar and it will pull up the stock information.

P/E Ratio

The most common and most basic measure of valuing a company is the PE ratio, which stands for price to earnings ratio. This number is calculated by dividing the share price of a company by its earnings per share (EPS). 

The PE ratio is great because it gives you a quick way to look at the real value of a share. A share of one company priced at $500 could be drastically undervalued compared to a share of another company priced at $10. The way we know this is by looking at how much each of those shares earned over the last 12 months, called the EPS or earnings per share. If the $500 share earned $100 over the last twelve months, then its PE ratio would be 5 ($500 / $100 = PE ratio of 5).

Simply, you can view the PE ratio as the amount of time (in years) that it will take for you to make your money back. This is assuming that the company’s earnings will remain the same during this time period. Using our earlier example of the $500 dollar company with an EPS of $100, we can assume that it will take us 5 years for the company to earn our money back.

P/E ratios can be found in the statistics section of Yahoo.

Cash and Cash Equivalents

It is important to check how much cash a company has on hand. Lots of cash usually signals that the company is doing well, and it provides investors with confidence that the company can handle an economic downturn. The amount of cash by itself usually doesn’t matter unless it is put into a ratio like cash per share.

By calculating the amount of cash per share you provide the company with a sort of price floor. If a company is trading for $100 a share and has $100 of cash per share, then you are basically buying the company for free. This is oversimplified, because we haven’t taken into consideration the debt or how the company plans to spend this cash.

Cash and cash equivalents can be found in the financials section of Yahoo, underneath the assets column on the balance sheet.

Debt

A company’s debt is the opposite of their cash on hand. When businesses are loaded with debt it usually is a bad signal to investors. This is because the company will have to use future earnings to pay off debt rather than using it to reward shareholders through acquisitions, R&D, share buy-backs, or dividends.

Debt is usually what kills a stock. A business cannot go bankrupt without any debt (they can get close, but no bankruptcy). A healthy company will usually have enough cash on hand to pay off all of their short term debt, meaning they won’t have to take out any more loans to finance debt payments.

Total debt for a company can be found in the financials section of Yahoo, while current debt can be found underneath the liabilities column on the balance sheet.

Dividends

A dividend is a portion of the earnings that a company chooses to give directly to the shareholders. If a company pays a dividend, it usually means that they are slow growing. Dividends are issued by companies as a monetary value per share that will be paid out yearly. If a company is trading at $100 and pays a $1 dividend, the dividend yield would be 1%. 

It’s important to remember that the yield for a dividend can change with the stock price. If the price of a stock goes up, it doesn’t mean that the monetary value of the dividend will go up either. 

Companies that pay a dividend are usually artificially protecting their stock price. However, businesses reserve the right to cut their dividends at any time, which may tank the stock price and surprise unsuspecting investors. Before buying a dividend paying stock, make sure to research their payment history. Are they consistent? Do they cut their dividend in times of struggle?

Additionally, it is smart to check the payout ratio for dividends. This is the percent of the EPS that is being used to pay out the dividend. If a company pays a dividend of $5 a share but only earns $1 a share, then their payout ratio is 500%. This is an unsustainable payout ratio and will lead to further issues down the road.

Dividends and their payout ratios can be found in the statistics section of Yahoo.

Inventories

This is an important statistic to be aware of if the company you are looking at sells physical products or is in retail. The only sign you have to look for is when inventories increase at a much higher rate than that of sales. This means that a business miscalculated the demand for that time period, usually meaning consumer sentiment has gone down. This is a bad signal and can indicate an incoming period of little to no growth.

Inventories can be found in the financials section of Yahoo, underneath the assets column on the balance sheet.

Shares Issued and Treasury Shares

Every company that is publicly traded on the stock market has a set number of shares issued for purchase. Because supply and demand determine the price of a stock, share buy-backs are a way for companies to reward shareholders. 

By purchasing stock on the open market, a company is reducing the supply of available shares and artificially boosting the EPS. This typically increases the value of existing shares and is one way for a company to increase the value of their stock.

It is important to know that there are many ways for companies to spend their earnings, and if their stock is overvalued at the time of share buy-backs it may be a poor way to spend company profits.

To check if a company is buying back its own stock, look to see if the shares issued value is decreasing from previous years or if the treasury shares number is increasing.

Shares issued and treasury shares can be found in the financials section of Yahoo on the balance sheet.

Earnings Growth Rate

An investor should know the rate at which a company increases its earnings year over year. This is an important metric because a stock’s value almost always follows its earnings in the long run. If a company has increased its earnings at a rate of 5% year over year for the last 10 years consistently, then it is safe to assume that they will continue to grow at that rate unless you have reason to believe otherwise.

Earnings growth rate is a stat that has to be calculated using multiple figures from different earnings reports. You can find these values on macro-trends or by looking at the financials section of Yahoo on the income statement.

Profit Margin

Profit margins represent how much money the company makes relative to how much revenue they took in. Know that profit margins widely vary industry to industry. Compare a company’s profit margins to that of its competitors to see how well it holds up.

Higher profit margins indicate that the company will have a higher survivability rate in times of economic struggle. Lower profit margins indicate the opposite. However, companies with lower profit margins typically have big upswings when the economy is on the rise.

Profit margins can be found in the statistics section of Yahoo.

Institutional Ownership

Institutional ownership tells you the percent of shares owned by big institutions that manage large amounts of money. Companies that have high institutional ownership have less potential to be “realized” by the market. Smaller companies without much of a spotlight typically retain this potential for growth because institutions have not yet recognized their value.

It’s not a crucial component to valuing a company, but it can lead to explosive growth if you uncover a good business before it is discovered by Wall Street.

Institutional ownership can be found in the statistics section of Yahoo.

What Does This Mean?

Okay, that was a lot! You may be wondering how you can piece all this together. It is hard to find a company that meets all the requirements in the financial category. The trick is concluding whether the company is in a good spot financially. If the company is healthy, then you should continue to analyze the company’s attributes away from the financials. That is what the next portion of my guide includes.

If you are curious to learn more about analyzing company financials, check out my book review: One Up On Wall Street, Peter Lynch.

What’s Next?

In the next section of this guide I will uncover how investors think about their companies outside of the financials.

Click here to read part 3, How to Research Stocks: Thinking Like an Investor.

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