How to research stocks like a pro

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

From the annual report, you can find out about a company's profitability, the character and experience of its management team, its methods of operation, the types of products and services it offers and future prospects. The report is divided into five principal sections: the CEO's letter, business segment information, management's discussion and analysis, financial statements and footnotes. The shareholder's letter should spell out the company's past performance and its future prospects. Compare last year's letter to this year's facts. Did the company meet its goals? Watch out for vague explanations or cliches. Beware of a letter which is overly optimistic or fails to mention and address any problems or areas of concern.

Check all financial statements carefully. Examine the company's assets and liabilities, stockholder's equity, long-term debt, net earnings and net revenue. The company's balance sheet will paint a picture of the assets and liabilities at the end of the year compared with previous years. It will tell whether cash or liquid assets are diminishing and if accounts receivable, inventories or total debts are rising. The goal is to determine if the total assets are greater than total liabilities. Divide the current assets by the current liabilities; a ratio of 2:1 or more is a good indicator that there are enough assets to cover immediate debts.

Also, consider why profits may be up or down. Is it due to industry price wars? Poor management? Product expansion? Cutbacks in personnel or expenses? The general rule of thumb: Increases in new manufacturing plants, products, personnel and programs are all positive signs.

Ideally, you want a company that has a manageable amount of long-term debt. Whether it's manageable or not depends on the company's assets and sales. For example, $500,000 in long-term debt would be more manageable for a company with $10 million in sales than one with only $100,000 in sales. The more debt a company has, the harder it will be for it to weather any financial storms.

Eric Standifer, president of Robert Van Securities in Oakland, California, says these numbers are all relative to the industry and the size of the company. "There are no absolutes when it comes to any financial computation," he explains. "They are tools that you can use to arrive at a decision as to whether a company represents good value or is a good investment."

Annual reports paint a rosy picture most of the time, warns Henry Dodson, a stockbroker with Barron Chase Securities in Atlanta. "But the numbers will tell the truth," he adds. "Look at the bottom line by checking net income and net revenue. Net income will show you income before expenses and taxes, while net revenue will tell you whether a company is profitable or not."

In addition to comparing annual reports each year, Dodson suggests taking into consideration the net earnings of a company. "That determines the value of a stock," he says. "If it's lower than the year before, there may be a problem with the company. In most cases it should always be going higher."