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A first stock purchase is an exciting moment in an investor’s life. There’s mystery, opportunity, risk, and reward. I won’t spoil the excitement for you and tell you what to buy. But I’ll give you a starter framework for making a buy decision.
My first stock happened to be a steady earning, dividend paying, and local company of which I was a customer. This company still exists more than 30 years later. The company’s stock came on my radar and I bought shares because the company supplied a staple to my life (electricity), owned infrastructure that enabled it to generate electricity and cash, and offered shares that I could buy with no transaction costs through a direct stock purchase and reinvestment program.
At the time, my choices for buying individual stocks were minimal. I could pay hundreds of dollars to use a full-service broker or do free transactions through a stock-buying program. Things have changed since then! Today, we can buy stocks at zero transaction cost from discount brokers. But we now have seemingly infinite choices of stocks.
So when I suggest this activity, I’m hoping to help you identify possibilities that intrigue you and narrow down your choices. Let’s start with the fun part of making a choice: creating a wish list. Then we’ll move to the intriguing portion of this process, analyzing a few statistics of the company’s financials.
Develop a list of companies
There are many ways to identify potential companies for purchase. You could start with the companies that comprise the Dow Jones Industrial Average, such as Walmart, 3M, and McDonald’s. You could stick with FAANG, Facebook, Apple, Amazon, Netflix, and Google (Alphabet). Alternatively, consider companies that are closer to home to you geographically, personally, or professionally.
Here are a few prompts to get you thinking about companies you’d like to own:
Companies based in or operating in your state or region
I mention these companies because it’s likely that you’ll know a lot about them. Just through casual conversations and observation, you may know:
- what products they sell
- what new contracts they win or changes to operations they make
- whether their CEOs offer capable leadership and strong visions for the future
- how they treat their customers and their employees
- their values, such as whether they take actions to minimize impact on the environment
Plus, you may be aware of happenings in the the company’s culture and the way business is conducted. Some changes may disappoint you, such as stricter product return policies or even layoffs. But being close to the action, you may develop insights into why changes are being made and whether they’ll have a positive impact on the community and your portfolio in the long run.
You can read about characteristics of a company in its annual reports or news sites. But being connected can help you put outsiders’ and media perspectives into context.
Just because a company is local and thriving doesn’t automatically make it an attractive company to buy. But positive attributes can qualify businesses for further consideration.
Based on this criteria, companies that are candidates for me include: Lowe’s Companies, Unifi, Truist, Bank of America, HanesBrands, VF Corporation, and Cree. (Disclosure: I am long in LOW.)
Companies you love
Companies that fulfill your needs and dreams can be candidates for your investment. As a consumer or business customer, you may have insight into the following:
- the quality and consistency of the company’s goods and services
- the reliability of the company in servicing its customers, both in terms of your experiences and those of your friends and colleagues
- the commitment of the company to research, development, and innovation
Just because you and your friends love a company doesn’t mean that you should immediately snatch up shares. And, admittedly, there are many companies with products that you may hate — yet they deliver results to shareholders year after year. Still, if you’re eager to invest in companies that you want to support both as a shareholder and a customer, considering what you buy and love is one place to start.
Companies that come to mind here include: Amazon, Costco, Garmin, Marriott, Netflix, and Schwab. (Disclosure: I own AMZN and COST.)
Companies that supply products and services you use every day
Along the lines of companies that you love because you use their products and services daily are the companies with products and services about which you’re indifferent, yet you still use. This category may also include less visible but still important companies that provide behind-the-scenes support (via infrastructure, parts, etc.) for things you use on a regular basis.
In some cases, I alternate between whether I love or hate, like or feel neutral about a company. I may like its services but dislike its privacy standards. Still, if its products and services are useful to me or the general population, then I’ll consider these companies for potential purchase. I’ve come to understand that no company operates completely in the way that is ideal to me personally. That doesn’t mean I ignore a company’s ethics but rather look at its overall contributions to society.
Companies that make this list include: Duke Energy, Google, Johnson & Johnson, MasterCard, and PayPal. (Disclosure: I own GOOG, JNJ, MA, and PYPL.)
Companies you admire
Here’s the time to consider companies that you admire because of attributes such as groundbreaking research and product innovation, outstanding service to customers, potential for solving thorny world problems, and benefits to their employees.
Your criteria may vary greatly in this category. You might:
- seek companies that provide meaningful employment for people of all backgrounds
- become enthralled with a company’s visionary leader
- find inspiration in a company that offers green energy worldwide
- get excited about a company that has promising treatments for Alzheimer’s or cancer
In this category, a list may include Southwest Airlines, Starbucks, or Tesla because of extraordinary service, benefit packages for employees, and focus on clean energy.
Evaluate these companies
Now that you’ve created a list of companies that interest and intrigue you, and serve the world, you can evaluate their financial worthiness. Not all of the businesses you’d love to succeed will make a buy list.
As an example, I was once enthralled by a local company that was conducting clinical trials for the treatment of Alzheimer’s, Parkinson’s, and other neurological diseases. The idea behind the company’s efforts was that nicotine from tobacco plants could be beneficial in targeting brain receptors and making positive changes to reverse or slow down diseases. My local economy could benefit from the increased demand for tobacco while the world would benefit from the therapeutic treatments.
I pulled for this company to thrive. But when I reviewed its financial statements, I couldn’t bring myself to buy its shares. Eventually, as clinical trials disappointed researchers, my interest disappeared.
Still, I was happy to discover the company and consider its possibilities. My research there reminded me to check the financials and not just invest for love. You can do the same with the companies on your lists. Here are some indicators to consider:
The company is profitable
This guideline may seem too simple. But there are many seemingly desirable companies that aren’t making money. You can tell at a glance by looking at EPS (earnings per share) of the business you’re considering; if this number is negative, then the company is losing money. You can also go to the financial statements and income statements to determine if the net income is positive (profitable) or negative (unprofitable). Find this information at your brokerage firm’s website or go to a financial news site like MarketWatch.com and enter the company name or ticker symbol.
Now, just because one year is bad doesn’t mean the company is always a bad investment. The company may have dealt with some unusual circumstances in a particular year or made loads of capital investments (increasing depreciation) over the past several years. Further, its cash holdings may be strong. This strength, combined with a solid business model, may allow the company to thrive in the coming years. Still, it makes sense to check for profitability so you know what you’re buying.
An example of a popular yet unprofitable company is Tesla (TSLA). Many people have made money through trades on this company. But I’ve decided not to invest because of its uneven profitability.
Checking for profitability is a simple hurdle and speeds up my decision making.
The company has consistently strong gross margins
Strong gross margins and consistency in those margins may indicate that a company 1) offers products and services customers value highly and 2) structures its pricing and controls its costs with mastery.
You can find gross margin percentages listed with key statistics. You can also calculate gross margin by dividing gross profit by sales. This number indicates how much the company generates in product or service profits for each dollar in sales.
Consumers and business customers may pay a premium for the company’s products and services because they’re unique in the marketplace or superior in terms of design, quality, reliability, and other attributes. Alternatively or perhaps as a complement to relatively high prices, the business may have firm control of its supply chain. It continues operations even when others in its industry can’t or it may have developed relationships with extraordinary suppliers, for example.
There are companies that operate effectively on low margins, such as Walmart. But if a business is not a high-volume one or well-established in its industry, I like to see high gross margins of 50% or more. More importantly, though, I appreciate a business with a consistent gross margin over the past several years. This consistency tells me that the marketing, operations, and financial groups are likely to be in sync, a positive sign.
The company isn’t loaded down with debt
When I’m evaluating a company, I like to look long-term debt as well as short-term debt.
To find these numbers, go to the financial statements, then balance sheet. There you’ll see current liabilities and long-term debt along with shareholders’ equity, cash, and accounts receivable.
A certain amount of long-term debt during periods of low-interest rates (like now) may be beneficial. Borrowing at a low cost allows the business to expand and increase profits without issuing more shares (and watering down or diluting the value of existing shares). But debt can be a burden. Cash is needed to repay loans, which may be more difficult in challenging times.
To consider the level of debt for the company, look at the debt-to-equity ratio, which shows the long-term debt compared to shareholder’s equity as a percentage. What’s appropriate is subjective and depends on the industry but below 40% indicates relatively low debt.
The quick ratio can give you an idea about whether the company can pay its bills on time. For this measure, look at cash, accounts receivable (money expected from customers), and current assets except inventory as a percentage of current liabilities (which includes money owed to vendors). I like this ratio to be 1 or more.
The company generates income from multiple areas
This checklist item comes from my own experience. Investments in companies with multiple product lines or a broad geographic base fare much better than ones with a single focus, no matter how worthy, unique, or valuable that focus is.
Newer companies often have a limited offering or reach. Broadening products, services, and locations doesn’t guarantee they’ll do well. But it shows the capacity, ability, and willingness for growth, which are useful in the companies you hold in your investment portfolio. Dive into annual reports to identify whether a company generates profits from multiple sources.
The company’s shares of stock are selling at a good price
All of the things mentioned can help you identify a strong company worth owning. If you decide to buy shares, then you could set aside a certain amount each month and make purchases without consideration of the share price. This approach is often called dollar-cost averaging and it’s one that I’ve practiced through much of my investing life.
Another approach is to identify a target price for the shares and buy when the price is at that level or below. This technique involves patience and educated guesswork in regard to determining a good price and then waiting until the shares reach or fall to this level. I use a discounted cash flow model to estimate a fair price. This process involves determining the present value of the company’s cash flow in the upcoming years. Read more about doing these calculations on your own here.
You can also find price valuations using financial websites. MarketWatch, for example, publishes average target prices for stocks under its Analyst Estimates heading. These are useful but they do change periodically. By doing the calculations myself, I have a better feel for not only what the market expects but also why in terms of expected growth. So when the markets are volatile, I can remember why my price still makes sense.
What interests and intrigues you about companies that you’re considering for investment?