Article Date: 1/1/2001

Test Your Stock Picks
A few minutes of simple analysis can tell you if a company's stock is worth purchasing.



Investors who consistently profit in the stock market may have different styles, but they all have one trait in common. They don't just buy stocks; they invest in solid companies.

What's to know?

In the past few years, lots of investors decided that they really didn't have to know much about the companies whose stocks they were buying. If a stock was moving up rapidly, it was good enough for them.

This approach became known as "momentum" investing -- and it didn't take long before it was discredited, as the fledgling Internet and technology companies crashed back to earth in a matter of months. Now that sales, profits, products and good management are back in vogue, here are three ways to tell if a company is a solid prospect for your portfolio:

1. The balance sheet. What's the company's financial health? The balance sheet will tell you. A company's balance sheet is easily accessible by looking up the company's profile on the Yahoo Finance Internet site. It's also easy to understand. It spells out what assets and liabilities the company has, and how much short-term and long-term debt it owes.

A company with a "clean" balance sheet has a good ratio of assets to liabilities, little or no debt, and substantial cash. Proven companies with cash and no debt can be held through good times and bad because they earn interest on the money they have instead of making interest payments on the money they owe.

2. Revenue growth. Sometimes you'll see a company that has a clean balance sheet but not much in the way of sales. These are almost always young, unproven companies in fields such as biotech and high technology.

These companies raised cash from investors through a public stock offering, but have yet to come up with a winning product or service. Their stocks are high- risk because such companies can burn up their cash before ever turning a profit.

An investor looking for real growth wants to see a steady pattern of revenue gains. Companies that consistently increase their sales are connecting with the marketplace.

Large sales gains accompanied by small profits aren't a good sign, but are often explainable. A company could be pouring money into expansion and new product development, or a company may need to be operated more efficiently. Companies with big sales and small profits shouldn't be dismissed. When a company finds a way to bring more of those sales dollars to the bottom line, the stock can become a big winner.

3. Growing profits. For an investor, the best of all worlds is finding a company with a clean balance sheet, steadily increasing sales and a record of double-digit annual earnings growth. When you find a company like this, your key decision is whether the company's stock is reasonably priced.

Back in 1980, you could buy shares of rapidly growing blue-chip companies at 15 to 20 times the most recent year's earnings. If a company had earned $2.00 a share for the past year, you could probably purchase the stock somewhere near $35.

Steady growth

Today, high-tech, high-growth companies like Cisco Systems can sell for 100 times earnings. But do a little digging using the Yahoo Finance site and the stock tables of the Wall Street Journal, and you can identify sound, growing companies selling at reasonable earnings multiples.

If you can find the combination of a clean balance sheet, steadily growing sales and ever-increasing profits in companies with reasonable earnings multiples, you won't go far wrong in your stock purchase selections.


Jerry Helzner has written more than 50 articles on stock investing for Barron's. He has been a regular stock market columnist for other business publications and was a member of the equity research department of a major regional brokerage firm. In addition, he's an associate editor for Ophthalmology Management.

Optometric Management, Issue: January 2001