The commonly accepted notion that a great deal of expertise and background knowledge is required to know how to research stocks is simply wrong.
Anyone can learn how to research stocks
Instead, we at Ziggma argue that by using the best stock research website, finding the highest rated stocks is accessible to anyone. The reason for this claim is straightforward. Stock research is in large part about fundamental analysis of companies’ financials. What sounds complex at first, is not when you think about it. As any company, we all have income and expenses, assets and liabilities. The basic framework for a company’s finances and our own is essentially the same, albeit at a different scale and with fewer layers. Add in the comprehension of a few notions for stock valuation and profitability and you are already in good shape.
Not convinced or still not confident? Then we got you covered by doing the work for you with our proprietary stock ratings. But more on this later.
The argument for investing in stocks
First, let’s examine the question why it is useful to understand the basic notions of how to research stocks. If you read this article, you are surely aware of the great deal of value that has been created for shareholders by the likes of Apple, Amazon, Facebook, and the list goes on. As public companies, anyone with a brokerage account can participate as a shareholder in the tremendous value and riches produced by these companies and the brilliant minds that work in them. And you have surely heard, the cost of buying shares has gone down to virtually zero.
We argue that with some degree of familiarity with the basic notions of how to research stocks and equipped with the best stock research tools, literally anyone can participate in the value that great companies create for their shareholders.
No end in sight for massive structural value creation
We are in a period of great structural change and innovation. It would be redundant to name the many great companies here that have been creating a tremendous amount of value for their shareholders over the last decade. Major innovations happen every day and societal issues are being addressed head on with heaps of money and a great deal of brain power. Think climate change, cancer research, autonomous driving, cloud computing, Internet of things, just to name a few. There will be many a company with brilliant people and amazing ideas that will create a lot of value for their shareholders.
How to research stocks – Taking the first step
To back up the claim made earlier, looking for good companies or stocks is not rocket science. From a financial analysis point of view, there are four key areas to focus on:
- Financial Position
We address each of these categories in the following.
Without any need to further elaborate, to create value there must be growth. There are three reporting items for which growth is most crucial. These are revenue, net income and operating cash flow. You can conveniently find these in the Analysis view of any stock profile where you can also switch from annual to quarterly data. Quarterly data is available on the free plan on Ziggma.
As is the case for your personal finances, it’s best to be in green at the month or year end. The most frequently used profitability measures in fundamental stock research are roe (return on equity, computed as net income divided by the company’s own funds) and net margin, which is simply a coefficient of profit divided by revenue. These and other profit metrics are also conveniently displayed in time series tables of any stock’s Analysis view.
It turns out that high dividend yields are too good to be true. Even though a high dividend yield is very enticing, the financial performance of companies with high dividend yield rarely is.
With valuation it gets a little trickier. But have no fear. We are still a far cry from rocket science or molecular biology. The first ratio most investors look at to judge a company’s valuation level is its PE ratio. It reflects the value of a share, i.e. the stock price (or marketap) divided by a company’s annual earnings, specifically earnings per share. The way to conceptualize the PE ratio is straightforward. Image you bought the entire company and all of the profit was yours. Then the PE multiple reflects the number of years of profit it will take to earn your money back. In real estate the analogous example for an investment in real estate is the number of years of rent it will take to earn back the cost of the real estate investment.
Some companies are traded with a high PE or even very high PE ratio, while others are trading with PE ratios in the low double digits. The difference is almost always explained by growth. The reasoning is that when there is growth, the earnings component of the PE ratio (the denominator) will grow and the price paid for the share will become ever more attractive. The only catch, the growth has to be there.
There is a ratio that will bring valuation and growth together. It is called the PEG ratio, in which the PE ratio is divided by earnings growth. As a very basic rule of thumb, companies with a PEG ratio below 1, i.e. an earnings growth rate that is greater than the PE ratio, can be considered as highly attractive.
Now comes the tricky part. Some companies’ earnings will not properly reflect its true earnings or future earnings power. The main reason for this lies with investments. In certain industries, such as chipmaking or biotech, massive upfront investments in R&D are necessary. Naturally, real estate also requires a great deal of upfront investment. At the opposite end of the spectrum, starting a consulting business will require very little upfront investment.
To get a better picture of a company’s earnings power, an investor will shift his or her focus to the cash flow statement, and in particular to cash flow from operations. To make it short, cash flow from operations will reflect the company’s cash earnings, after adjustment for amortization of investments. Think about it this way: Since the cash for a completed research facility or factory has already been spent, its amortization, which appears as a cost in the income statement, is added back when doing the “walk” from net profit to operating cash flow (see image below).
On Ziggma, you will find the income statement conveniently situated next to the cash flow statement enabling you to conveniently see the “walk” from net profit to cash flow from operations. Hence, in certain industries it makes sense to value a company based on price to operating cash flow.
This begs one very important remark: When carrying out stock comparison, do not compare stocks’ valuation levels across industries. Each industry has its specific growth profile, investment intensity or profitability levels. By way of illustration, it makes absolutely no sense to compare stocks’ PE ratios across industries. Yes, JP Morgan’s PE ratio is much lower than Nvidia’s, but this says little about the two stocks’ relative valuation. One has to compare a stock’s valuation level against industry peers to be able to draw meaningful conclusions.
As our own finances, a company’s financial position must be sound. In some instances, checking out a company’s financial position is very straightforward. Some successful companies, such as Facebook (FB), are run without recourse to debt financing. So as a growing, profitable company without debt, FB’s financial position is extremely solid.
Other companies, by the nature of their business, need to work with lots of debt. Take a utility, such as NextEra (NEE) for instance. Benefitting from a marketcap that exceeds that of any oil major NEE invests heavily in renewable energy production. For this the company needs a lot of third-party financing, read debt.
Employing a lot of debt financing is by no means equivalent to a bad financial position when a company has sustainable cashflows that are secured well into the future and used to pay down debt over time.
Judging a company’s financial position may be the trickiest part when learning how to research stocks. To evaluate a company’s financial position, an investor must not only look at a company’s overall leverage (essentially debt over assets) but also at its short term liquidity (the main metric being the current ratio: the higher, the better) as well as the long term debt servicing capacity (essentially cash flow relative to debt servicing cost).
But don’t despair, we got you covered. By combining meticulous fundamental analysis looking at many different metrics and their evolution over time with big data analytics techniques, Ziggma calculates the financial position score for you. Ziggma’s financial position score reflects on a scale of 0 to 100 how financially sound a company is relative to its industry peers. This financial position score is a component of our proprietary stock ratings we refer to as Ziggma Stock Scores.
Stock ratings by Ziggma
The Ziggma Stock Scores are the product of unbiased, algorithm-driven analysis on around 3,000 stocks, powered by cutting-edge data processing technology. Our stock analysis software ranks stocks on scale of 0 – 100 within each of 32 different industries. Developed by a team of seasoned financial analysts and programmers, our stock ratings let Ziggma users benefit from institutional-grade, unbiased, quantitative stock research. Supported by a massive investment in high quality data, our systems crunch millions of data points within the categories growth, profitability, valuation and financial position on a daily basis to update stocks’ scores within their industries.
How to research stocks with Ziggma’s free stock screener
When it comes to searching for investing ideas, looking through all the opportunities that are available can be an arduous if not impossible task. But there is a tool that can help you get results fast. Enter the power of Ziggma’s free stock screener.
What makes it so powerful, you may ask. Here’s why Ziggma offers what we believe to be the best free stock screener on the market:
- Ultra fast thanks to sliding scales
- Focus on the essential metrics, selected by seasoned financial analysts
- Leverage Ziggma’s research tech thanks to integrated Ziggma stock scores and sub-scores
- Quick review of results with sortable key metrics and tool tip enabled company profiles
The following image shows a robust sample setting for our free stock screener. The key search settings can be explained as follows:
- Market capitalization greater than $ 500m to eliminate small, potentially fragile companies
- Growth: Earnings and revenue growth greater than 10% and 3% respectively to screen for companies with solid growth rates
- Profitability: Return on equity of at least 15% and net margin greater than 24% to screen for highly profitable companies
- Financial position score greater than 70 to retain only very financially sound companies
Qualitative factors for top stock research
Beyond the financials there are some qualitative factors that have been proven conducive to stock returns, such as insider ownership, i.e. management owning a significant number of shares. Put differently, with a significant share ownership management has skin in the game. It is easy to find insider stakes on a best-in-class stock research website, such as Ziggma.
Qualitative factors for top stock research
A relatively recent addition to the tool set for how to research stocks is the area of socially responsible investment. It introduces criteria related to sustainability into investment decisions, in contrast or in addition to classic stock selection that focuses solely on financial criteria. Sustainability criteria are nowadays commonly organized around three major themes: environmental, social and corporate governance (abbreviated ESG).
In fact, studies have shown that there is a positive relationship between elevated ESG scores and stock returns. These are some of the potential explanations for this:
1. Companies with a strong ESG profile are likely to be more competitive than their peers. This can be explained by some or all of the following factors:
a. More efficient use of resources
b. Better innovation management
c. Superior long term strategic planning
2. Companies that perform well on ESG criteria have a lower risk profile, as they tend to have a tight grip on business and operational risk. The robust risk profile translates into less volatile stock prices
3. Companies with a strong ESG profile tend to benefit from higher valuation multiples. The straightforward rationale for this is that the market will reflect companies’ strong performance as per points 1 and 2.
Academic research has found that socially responsible investment pays off. Firms with sound environmental policies and good corporate governance tend to outperform. A good example is a study by Professor Alex Edmans during his tenure at the Wharton School at the University of Pennsylvania. He built a portfolio based on the ‘100 Best Companies to Work For’ in order to check for a relationship between employee wellbeing and stock returns. His findings indicate that this portfolio earned an annual alpha of 3.5% in excess of the risk free rate between 1984 and 2009 and 2.1% relative to industry benchmarks.
These findings suggest that by targeting the best companies from both a financial analysis and ESG point of view you clearly shift the odds in your favor.
In this article we explain and show why it is accessible to anyone to learn how to research stocks on the right stock research website. To facilitate things, we have built a suite of the best stock research tools comprising both innovation and iterations on functionalities that already existed in the marketplace. Some of these, such as our Institutional grade stock research, our free stock screener, high-quality data, intuitive visualizations and ESG data are mentioned in this article. The Ziggma platform holds yet many more tools and features that make portfolio management and investment research easier for everybody.