Although there is no hard and fast rule, it usually takes 4 analyses to correctly choose a stock.
1. Overall market analysis
This is the analysis that gives you an insight into the overall trend of the market you are going to invest in. For example, if your company is in the CAC40, look at how this index has behaved in recent months, in recent years. Today we are, for example, in a very high market compared to 2012 and with regard to the French economic situation (layoffs, factory closures, rising unemployment, public debt, etc.).
Stock market indices (CAC40, Nikkei, Dow Jones, NYSE, etc.) are supposed to represent the economic health of the country.
Unfortunately, this is no longer the case today (because of mechanisms that allow financial markets to be decoupled from the real economy) and global analyses are becoming increasingly difficult to do.
There are many other factors that come into play but that is not the point of your 1er work for choosing your actions.
2. Qualitative analysis of companies
This is the time to surf all the websites of companies that interest you according to their sectors of activity. For example:
- Automotive industry (Peugeot, Renault, Michelin, etc.)
- Raw materials (Arcelor Mittal, Eramet, Euro Ressources, etc.)
- Banks (SG, BNP, Crédit Agricole, etc.)
- Media (Canal plus, Havas, Lagardère, Vivendi, etc.)
- Oil and Gas (Technip, Total, Bourbon, Schlumberger, etc.)
- Health (Sanofi, Stallergènes, Orpea, Nicox, etc.)
- Consumer goods (L'Oréal, LVMH, Procter & Gamble, etc.)
Try to look at everything related to the management of the company. The number of employees, the shareholders, the news about the company, any layoff plans, etc.
Find out if there are any acquisitions of other companies in progress, any major projects coming up.
Look at whether the business depends on one or more markets.
For example, Bouygues operates in both telecommunications and construction. As a result, despite the slowdown at Bouygues Telecom, the construction sector, which is growing strongly, is maintaining a certain stability.
3. Fundamental analysis
This is the analysis that allows you to know concretely how a company is doing.
Observe the evolution of the company's turnover and especially its net result (net profit after taxes)
The debt ratio
If you can't find it in the company's published figures, the formula is very simple: (Total Debt / Equity) x 100
If this ratio exceeds the 80%, the company is in serious danger and risks bankruptcy. This is the case for many banks which, despite sophisticated refinancing techniques, have a net debt ratio that is far too high:
- BNP Paribas: 89%
- Societe Generale: 90%
- Credit Agricole: 92,3 %
- France : 94% of GDP (that's another debate ^_^)
The PER (Price Earning Ratio or Price to Earnings Ratio)
This data will be explored in more detail in a future article. To summarize, it helps answer the following question: "How much does the stock cost me compared to the company's profits?"
The PER is used to measure the "expensiveness" of the price of a share compared to shares in the same sector. The lower it is, the (less than 10), the more the stock will be considered cheap (undervalued). The higher it is (greater than 20), the more expensive the stock will be compared to the market and the more likely it is to enter a speculative bubble.
Dividends
For investors, the dividends distributed will be of capital importance.
Indeed, if you want to earn income from stocks, this is the best way to do it.
Today the average net return of CAC40 shares (Net dividend per share/Stock price) is of 3,15% (figure that I calculated for the month of November 2014 via boursorama.com).
If you find a stock with a yield higher than 5-6% and you see that the dividends paid increase every year, you have found what you are looking for.
4. Graphical analysis
While analyzing stock charts can be tricky, there are some that can help you know if you're headed for a crash.
If you see a graph like this, you might as well move on, given the current state of this company.
With a negative net result since 2012, a debt ratio of 75%, profits in decline of 62% in 5 years and a non-existent dividend payment, you don't need to be Warren Buffet to know what you have to do: avoid it, unless you are a speculator.
Conclusion
If you can perform these 4 analyses correctly and you know your objectives (medium-long term investing, receiving dividends or speculating), you will have no trouble finding the stocks you need.
As I mentioned at the beginning of the article, this is not an absolute method. It is a method that I use but there are many others.
It's up to you to find the one that suits you best. Some people hate numbers (and I understand that), but as a certain reggae singer said:
“Money is numbers and numbers are endless.”
Xolali (Olali) Zigah from the blog eco-pourtous.fr
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Hello Xolali!
excellent article which describes very well in substance the steps to follow to succeed in your investments in the stock market.
On the other hand, points 2 and 3 remain the most important. Point 1, market trends, matter very little in my personal approach.
Good companies will take advantage of these dark market phases to increase their market share to the detriment of other players in the sector.
As for point 4, graphical analysis, very little for me, except to validate certain specific information.
Martin
Thank you Martin,
There are still points to review so that the analyses are truly complete.
It is often necessary to express reservations since the market is often driven by people's psychology and does not always represent the reality of the situation of companies.
Good evening,
Total debt / Equity
For banks this ratio has no meaning, the business of banks is debt and we do not analyze a bank like any other company.
An equivalent for banks is Tier One which you will find in the Balance Sheet or for Euro Banks in the results of the stress test which has just been published.
Patrick.
Hello Patrick,
You are right. I think I should not have included banks. I wanted to give a simplified image of debt because even if the bank's business is debt, they still have a solvency threshold to respect (10% with the new Basel III agreements)
Hello Xolali,
I can only salute your initiative to take up the pen, it is an excellent exercise for learning and progressing.
That said, I have a few additions to make to the content of your article:
1) In your 2nd point, I would have simply added "understand the business" of the company. How does the company make money? If you are not able to answer this question in less than 20s, in my opinion, you should pass your turn.
2) Regarding the debt ratio. This is an avenue to explore, but it seems important to me to take into consideration the company's cash position in calculating debts. Thus, Net debt / equity speaks more to me.
Then, we must never forget that debts are repaid with the cash flows generated by the company, not with its own funds.
So, a company that has a debt ratio that exceeds 100% but which has regular and sustainable cash generation (typically cable operators or all businesses where there is a subscription).
When you take out a loan to buy a house, the banker looks at your assets (= equity) but especially your income (cash-flows). The famous 33% rule is based on income not assets.
The debt ratio as calculated here is meaningless to banks. What debts did you consider to make your calculations? In the case of your calculation, if you take the balance sheet debts divided by the equity you will find something like 1000, 1500 or 2000%…that is in fact its leverage.
It seems more judicious to use regulatory solvency ratios (moreover, no bank communicates on its debt ratio...) which take into account the quantity of equity in relation to assets (mainly loans to businesses).
Finally, you compare with the GDP of France which is a "flow" (the generation of wealth) and not a stock (heritage = equity). It seems to me that cabbages and carrots are mixed...
3) High share price compared to PER.
This is true, in general. Except that there are two things to consider:
– the growth of the company. Paying a P/E of 20 for a company that grows by 30% per year is not expensive. On the other hand, paying 10 times the profits for a company in decline is excessively expensive.
– the economic context and interest rates. In a context of low rates, as currently, PERs will tend to be higher. We should therefore try to put the use of the PER into perspective.
4) Be careful with net results which can sometimes be misleading. They are subject to accounting subtleties (depreciation and amortization, exceptional results, etc.) and are therefore more easily manipulated than free cash flow (result without taking into account D&A but deducting investments (Capex)).
5) Regarding the graph, it seems important to me to provide a counterbalance. Many studies, as well as the reality of the markets, have shown that the stocks that have suffered the most on the stock market, outperform their counterparts over a time horizon greater than 3 years (principle of contrarian investment, developed in particular by David Dreman).
Investing in Peugeot at 20% from your own funds, why not? I don't think this is speculation but deep value investing, typically Graham.
Not making a generalization of course and I didn't say that Peugeot was a good investment either, but let's keep in mind Horace's phrase:
“Many shall be restored that now are fallen and many shall fall that now are in honor.”
An excellent continuation.
Good morning,
Thank you Etienne for this well-reasoned comment. I will try to answer the 5 points.
1) Point 2 could indeed have been called "understanding the business". I had gone with the word analysis, so I kept it.
2) You are absolutely right about the cash flow that allows debts to be repaid. Thinking back, I should have looked at the prudential ratios of Bale III i.e. the capital requirement required by banks (own shares held + reserves).
This is the topic I was working on when I was in investment banking. It is the McDonough ratio which has the following formula:
Bank equity >10 % (credit risks (85 %) + market risks (5 %) + operational risks (10 %))
Equity being composed of Tier 1 and Tier 2 as Patrick mentioned.
This is how you really measure the solvency of a bank.
However, this requires additional knowledge that beginners would have difficulty understanding.
It would have been more judicious, I grant you, to analyze the indebtedness of companies even if I had not thought of those of the operator type (thanks for the info)
3) I take note of the PER. I think it remains a good indicator. Afterwards, I grant you the context must be analyzed.
4) There, I totally agree. The market is never perfect and often when you invest against the trend, you can find yourself greatly rewarded. I will look a little more into contrarian investing. However, for Peugeot, it is difficult to imagine that the action dates back to 60 euros as in 2008 within 3 years (given the recession or even depression that is looming before us). You never know, it's the market that decides.
5) I don't understand very well because for me, the net results are supposed to be the most reliable precisely. When they include depreciation provisions and all intermediate results have been taken into account (turnover, gross margin, EBITDA, etc.)
Thanks anyway for your feedback, I have new study topics thanks to you 🙂
Hello Xolali,
2°) Concerning banks, we can today, thanks to the action of regulators, obtain the different regulatory ratios by consulting the information given by the banks themselves.
4°) Let's not make a general case with Peugeot of course, neither you nor I, nor anyone else, is able to say what the stock market price will be in the coming years.
If you are interested in contrarianism, Dreman's book is very good. For a real-life example, I can also recommend you to study the career of John Templeton, the master in the field.
5°) D&A are not “cash” expenses, there is no withdrawal of money from the bank accounts.
What should interest us, as investors, IMHO, is the real cash generation, therefore the free cash flow, not the accounting profit.
Along the same lines, EBITDA, which is very often used these days, should be taken with caution because it does not take into account the company's investments. I prefer to work with EBITDA-Capex.
It also seems to me that we need to pay attention to exceptional items (sale of a subsidiary or legal compensation, for example) which have an upward or downward impact on the company's one-off profit capacity and not its "normalized" profit capacity.
Sorry to give you work Xolali ;).
I understand better, thank you.
No worries about work. You always have to learn new things to progress 🙂
Hi Xolali and thanks for this first article.
– regarding point 1: investing in dividend growth stocks that traditionally have a beta lower than 1, I do not focus excessively on the market value. This means that I can continue to buy stocks as long as they are of quality and still affordable, even if the market is high. However, it is true that my purchases are less frequent at the moment. I keep a little cash aside for the next sales that are a little late… To measure the market valuation, I rely mainly on the market capitalization / NBI ratio: http://www.dividendes.ch/evaluation-du-marche/
– regarding point 2: I am above all a follower of the tangible and the quantitative… it is not for nothing that I like dividends. Qualitative is only of interest if it is reflected in the figures. I therefore do not dwell on company websites.
– regarding point 3: I am not interested in the debt ratio either. As Etienne said, it can easily change depending on the company's income. The PER and of course the dividends are much more interesting to me.
– regarding point 4: of course they say that you can’t catch a falling knife. I got caught out several times at the beginning of my investing career thinking I was making good deals because a stock had just fallen. After that I swore to myself that I would never again buy stocks that are sinking. Now I am a little less categorical. If the fundamentals are good, the company is historically reliable and of quality, and the stock goes down (a little) I am a buyer. I have learned to be wary of technical analysis.
Hi Jerome,
Thanks for your feedback.
It is true that qualitative analysis is very subjective. Companies always embellish their business and their situation. I have never seen a website saying: " Be careful, we are going bankrupt soon and there have been scandals in our group"
For the debt, as I answered Etienne, I think I should have done the analysis differently. However, when a company depends on 100% lenders (except in special cases), its financial charges are likely to have a bad impact on the company's net result. It is therefore necessary to remember all the same (even if the money itself is debt) that this is not a positive point.
For stocks that fall, as Etienne said, the principle of contrarian investment can sometimes apply. It is still necessary that the company is not on the verge of bankruptcy, and has the possibility of recovering depending on the economic context.
I don't think that about Peugeot, that's why I put it as an example.
See you soon
"Be careful, we are going bankrupt soon and there have been scandals in our group"
Yes, but you just have to open the annual report and look at the balance sheet, in general it is a start!