Before you start trading, you need to understand the variety of factors that are going to influence your trading tactics. In this article, I will dive into how Invezo can optimize your stock selection process. This process will take place through eight steps.
Step #1: Think About Your Personality as an Investor
When you’re looking at the stock market, you should try to buy stocks that reflect your personality and your daily habits. For example, if you’re a 27-year-old living in San Francisco and you use rideshare services quite often, you should look at investing in either Uber or Lyft. Noticing trends like this in your own daily habits or even across your peers will allow you to realize what companies can make a real jump in their stock price over the next several years.
Step #2: Look at Trends in Earnings Growth
Pretty simple rule of thumb here. If a company’s earnings appear to increase each successive quarter for 1-2 years, that’s generally a pretty good indication that they’re doing something right. However, it gets a bit more complicated once you do the research to understand the true value of the product/service being offered by a given company. At this point, you should consider the value of the company’s future cash flows, which are influenced by the product/service being offered, the magnitude of the target market, and the cost structure being implemented. This step allows you to determine a company’s competitive advantages, market opportunity, and future sustainability in the market.
Step #3: Compare Across the Industry
This is extremely important. This step helps you identify the unique edge a certain company has over the rest of their industry. The goal of any business is to climb to the top of their industry and dominate the market. Invezo’s Industry Comparisons feature will allow you to establish if there’s potential for substantial growth in the company’s industry. Once you look at these comparisons, you should decipher the competitive advantages that a company has over the competition. Do they stand out? They should. The unique insight you find is what should make them stand out from their competition. For example, Amazon has an edge over the competition in e-commerce due to their convenience and offering a vast selection of products at competitive prices. In this situation, Amazon’s return on assets (ROA) would be their differentiating statistic that gives them an edge over the competition.
Step #4: Check to See if Debt-to-Equity Ratio is in Line with Industry Norms
Invezo’s Industry Comparisons feature also includes the debt-to-equity ratio, which indicates the relative proportion of shareholders’ equity and debt used to finance a company’s assets. Basic rule of thumb here is to find a company who has a low debt-to-equity ratio. Financing with equity rather than debt is the goal for any business because it results in greater financial stability for the organization.
For example, a debt-to-equity ratio of 0.5 means a company uses $0.50 of debt for every $1 of equity. This is a great situation to have for any company. However, there are exceptions to this rule. Continuing with our example from earlier, according to Invezo’s Industry Comparisons, Amazon’s debt-to-equity ratio is 2.127 while the industry sits at 1.635. Despite Amazon’s higher debt-to-equity ratio relative to the tech industry, Amazon still dominates the tech space.
Investors with a low risk tolerance should look for the debt-to-equity ratio to be 0.3 or less for a given company. Investors with a high-risk tolerance are comfortable investing in companies with a debt-to-equity ratio greater than 2.0.
Step #5: Analyze Price-to-Earnings Ratio to Understand Market Value
Invezo’s Industry Comparisons feature also includes the price-to-earnings (P/E) ratio, which is used to measure a company’s share price relative to its per-share earnings. The P/E ratio provides true insight into whether a stock’s market value is either under- or overvalued. A higher P/E ratio shows that investors are willing to pay a higher share price today because of growth expectations in the future.
Comparing Amazon’s P/E ratio to the market is a great example of how a P/E ratio can be misleading. According to Invezo’s Industry Comparisons, Amazon P/E ratio is 68.155, which is absurdly high compared to the rest of the tech industry, which sits at -0.572. Amazon’s P/E ratio isn’t realistic for the average company to achieve, but it’s a reflection of Amazon’s efforts to expand aggressively on wide scale. This has kept Amazon’s earnings slightly suppressed and the P/E ratio high.
Step #6: Check the Frequency the Company Offers Dividends
Dividends are a distribution of profits by a company to its shareholders. When a company turns a profit, it’s able to pay a proportion of the profit as a dividend to shareholders. Having a high dividend yield is good for investors to know they will be receiving constant income from their investment. However, a really high dividend yield can mean a company may be desperate for extra cash flow. This isn’t always the case, but this can happen to companies who are going through economic hardships.
Note that not all companies offer dividends. For example, Amazon and Airbnb don’t offer dividends because they both are focused on growth and expansion. Dividend payments to shareholders would take away the funds necessary to continue expansion.
Step #7: Judge the Effectiveness of Executive Leadership
Executive leadership are the people who can most directly determine whether you earn a profit off your investment or not. So, it makes sense to do some research on these people and determine whether you believe they can lead the company in the right direction. Some factors that will be telling include past experiences, demonstrated competency, past accomplishments, developed action plans, and that they intrinsically motivated to execute their job effectively to ensure that they aren’t just motivated by sales targets and profit margins.