When you are investing in the stock of a company, you need to understand the past earning record of the company. The objective should be to avoid the companies that have been losing money from your consideration set.
Grab last five- ten years annual reports of the company you are researching and go through them. If you are not able to get the annual reports, with a little research on the internet, you will find many sources where you can get last ten years earning record of all listed companies.
The company should have a consistent record of positive earnings for the last ten years. Many companies are able to give one or two years of good performance, and then they start giving erratic performance. Do not trust these companies with your money.
Consistent record of positive earning is a necessary condition but not necessarily a sufficient one for you to trust a company with your money. Ideally, a company should be considered only if it has been growing its earnings over the last ten years. Adding this filter will help you make your consideration set a lot safer.
Another thing to look for in a company’s past performance is the cash it is generating from operating activities. You will get these details in the Cash flow statement of the company. There are three heads of cash flow- Operating Activities, Financing Activities and Investing Activities. Cash flow from the operating activities is the most important cash flow component. This is the actual cash the company is generating from its business. Cash flow from investing activities is the cash flow from investment in financial markets or the cash consumed by investment in capital assets such as machinery, plant, etc. Cash flow from financing activities is the cash flow resulting from issuing stock dividends, taking or paying debt and issuing stocks. If a company is not able to fund its growth from the cash it generates from its business, and is instead relying on loan, it may not be a great thing. Of course, if a company is in its early stages, it may have to fund its growth through loans or issuance of stocks. However, growth funded through cash generated from operating activities is a lot safer than the growth funded through cash generated from financing activities. Here, you need to take a call based on your own judgment of the situation.
Understanding the stability and growth of earnings of companies helps you wean out the losers from your list of stocks to invest in and ensures that you are not investing in stocks that may bleed you later.
This is it for today..
Sunday, February 8, 2009
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The notion of the perfect stock where nothing can go wrong. This is a false idea and a grave misconception that to many investors have about stocks. Even great companies can get into serious trouble. One of the most important things to remember when investing n stocks is to spread your money around never keep more than 10% of your money in an single stock regardless of how much confidence you have in the company' because just as I have stated things can and things do go wrong even at the best of companies.
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