How to research stocks like a pro

Black Enterprise, August, 1996 by Juliette Fairley, Tariq K. Muhammad

Your portfolio is only as good as the research that goes into it. Here are tips on finding information to help you make informed stock market decisions that can increase your returns.

IF YOU HAD BEEN ASKED LAST YEAR TO invest in the company that produced that season's computer-animated blockbuster Toy Story, wouldn't you have considered that a good pick? Certainly you would have been in good company. Many unsuspecting investors thought so and bought stock in Pixar, the film's producer, which issued a public offering--at $22 a share--around the time the film was released. Within the first day of trading, Pixar rose to $49 and then dropped to $29. As initial shareholders cashed in their gains, latecomers were left holding the bag.

How did that happen? Often what looks like a safe bet on Wall Street requires much more scrutiny and investigation. Stocks should not be bought on the strength of rumor or popular opinion. When investing, the best research wins the greatest returns.

To pick stocks successfully, you'll need to be knowledgeable about the industry or company that you may be investing in. Start by scanning the financial pages. Financial publications offer stock tables of the various exchanges to keep you abreast of market changes. These tables tell you four key pieces of information: the 52-week high and low prices of the stock; the percent yield; the price/earnings ratio (P/E); and the number of shares traded the previous day.

The highest and lowest prices that an individual stock sold for over the previous 52 weeks are reported daily. The range between these prices is a measure of the stock's volatility. Volatile stocks are riskier investments because of their potential to make or lose a great deal of money within a relatively short period of time. For example, a stock that has shifted in price from 18 [.sup.7.sup./.sup.8] to 47 [.sup.7.sup./.sup.8] over 52 weeks (about 150%) would be considered volatile.

You can use stock price patterns, along with other fundamental measures, to assess potential growth, says Pierre Dunagan, associate vice president of investments at Dean Witter Reynolds in Matteson, Illinois. Although he doesn't always advocate this approach, Dunagan comments, "What you want to ask is, did the stock make a new high and did it make that high on strong volume? If the stock is making new highs, and its volume is more than usual, then it might be a good play."

The market's interest in a particular stock can be measured by the volume of shares traded. An unusually large number of shares traded may mean that buyers and sellers are reacting to some new information, such as a shift in the market or a change in investor confidence in a particular security or industry.

Evaluating a stock's current value is important in determining future growth. The percent yield column on the financial pages tells you how much dividend you get as a percentage of the current price. This number also lets you compare the earnings of a stock with the earnings of other investments. But it won't tell you your total return, which is the sum of your dividends plus increases or decreases in stock price.

The P/E ratio is the relationship between a stock's price and the company's earnings for the last four quarters. To arrive at this figure, divide the current price per share by the earnings per share. For instance, if a stock has a P/E ratio of 14, this means its price is 14 times its annual per share earnings, which is about average. Financial analysts use the P/E to make projections on revenue estimates. It can be a rough guide as to whether the stock market is valuing the stock fairly, and if it's properly priced.

However, the P/E ratio reports past, not future, earnings. Two companies with a P/E of 12 may have two very different futures. One may be posting higher earnings and the other headed for a loss. A small emerging company could have a high P/E and be an attractive investment, while a mature company could have a low P/E and be a bad investment.

"If it's a high number, it means the stock market is optimistic and is anticipating growth in the earnings of the company. The earnings denomination is how much the company is earning a year per share," explains Brian Borders, president of the Association of Publicly Traded Companies in Washington. "The average P/E ratio is about 13 or 14. Below that is low and above that is high. Hot stocks are ones with a high P/E ratio." For example, Netscape's P/E ratio is 50, which means analysts have high expectations for the future earnings growth of the company.

An annual report can be the single most important tool in analyzing companies whose securities you may want to buy, hold or sell. You should obtain a company's annual report before you invest, not after you become a shareholder. In fact, it is recommended that you look at a company's annual report from the last three years.

Borders says the annual report is the investor's best friend. "It's a means for the company to deliver both mandatory and voluntary information to the shareholder, to give an accurate picture of the company's performance over the past years, and to provide a window into the future," he says.