Philosophy to Identify the Best Stocks
Identifying the best stocks from the vastness of the stock market can be very challenging, but there is a way to find them in an easier manner.
Finding the best companies to buy stock in can be challenging, if you’re new to stock trading and the nuances of the stock market. That’s because there are a lot of stats and figures you have to deal with. From all that data, you need to be able to value the stocks and balance the potential growth the stocks could offer you with their risk potential. But experienced investors do have tricks to figure out the right stocks.
Here’s one trick which really works, and is recommended by Motley Fool’s Lee Samaha, which is identifying the stage in its lifecycle a particular company is in. There is a lifecycle for every company. Some are in their nascent stage, some have just established themselves, and others seem to be struggling to keep themselves consistently profitable or at least sustainable.
Companies at Various Stages of Performance
Companies can bounce back from a lack of profitability, and you need to figure out if they are in a position to recover. Others that are brimming with confidence could probably be ignoring hidden cracks which could send them to a bleaker future and lowered stocks. Figuring out in what lifecycle stage the company is could be a simpler means to understand if you need to buy the stock, or wait for it, or just let it pass. You have your investing requirements to consider as well. As a new investor, you’re probably risk-averse, and though you want stocks that grow you need to have a bit of stability as well in your portfolio.
The Lifecycle of a Company
Now let’s look into a company’s lifecycle:
- Samaha reminds that a company usually begins its existence by experiencing high growth and lesser or even negative FCF (free cash flow).
- The next step is usually when it begins experiencing growth along with cash flow and earnings. With further growth, its revenue growth becomes higher than even the country’s GDP, maintaining great cash flow and margin.
- Then it reaches the stage where its revenue growth is either at the level of the country’s GDP or even lesser. But cash flow generation is still high.
You need to be able to evaluate a company at each of the stages it experiences in this cycle. Then you need to figure out if the market value of the company matches the assumptions you have.
Samaha suggests locating a company that is priced like a growth company while actually being a high-growth company. It could also be a company priced like a maturing company but is actually a growth company, or a maturing company that is priced like a cash cow. In all these examples, the stock is priced lesser than what the company is worth.
Understanding the FCF Calculation
The FCF yield is calculated by dividing the FCF by the market cap. A growth company could be valued on an FCF yield of 3% while a maturing company could be valued by investors at a 5% yield, which do represent a fair stock value.
When a company grows, its rate of growth actually begins to slow while generating more FCF and earnings. These are taken into account when investors rate the stock.
This information should provide with some idea about how to value the best stocks and analyze its appropriateness for your portfolio, which can help you in successful stock trading. It is important to also have a great broker to execute your ideas in a timely and cost effective way. TradeZero provides free platform and direct market access trading for free as well.
This content is restricted to site members. If you are an existing user, please log in. New users may register below for FREE.