The Basics of Investing: Characteristics of a Goood Stock

By Ryan James

Economic Moat

An economic moat describes a company’s dominance over its competitors and ability to maintain market share. When choosing a stock that you believe will perform well, it must have a wide moat that looks to increase in size. If a company has a small moat, it has little ability to protect itself from its competitors; however, companies with large moats exert market dominance and are not as threatened by their competitors. A narrow-moat stock may perform very well if it experiences significant growth in its moat, allowing it to increase its edge over its competitors.

Profitability

Typically, a better, safer investment is in a company that has achieved profitability. If the company cannot make more than it spends, it will be difficult for it to grow and succeed. Oftentimes profitable companies will distribute dividends to their shareholders or will perform share buybacks to boost the stock. A profitable company tends to have more cash flow with which it can grow and/or reward investors. Profitability is often a sign of a healthy company. Many attractive stocks, especially growth stocks in riskier sectors like technology, will not be profitable for a long time. This forces them to take on significant amounts of debt, leaving them more vulnerable to varying economic conditions like changes in interest rates.

The Three Financial Statements

It can be very helpful to do thorough research, in part, by examining a company’s three main public financial statements, their balance sheet, profit and loss (P&L) statement, and cash flow statement. These statements are specific to a specific time period, usually a fiscal quarter or year. These documents present investors and prospective investors with an accurate depiction of the company’s financial well-being. A balance sheet depicts all of a company’s assets and liabilities in addition to other statistics such as shareholder equity. It is essentially made up of everything that company owns. A profit and loss statement summarizes the money made and lost by the company, including expenses, costs, and revenue. The cash flow statement provides data regarding the money coming into and out of the company.

Earnings

Public companies are required to disclose their earnings during an earnings report. They announce the earnings for that period, announce major news and the factors to which they attribute the results reported and set a forecast for the next earnings call. These events typically cause major fluctuations in a stock depending on how the company performed relative to investors’ expectations.

Other Characteristics

It is important to also look at other quantitative and qualitative factors when performing equity analysis. Data such as the P/E ratio (a metric that determines how overvalued or undervalued a stock is), how the sector and the overall economy are performing, and so much more play a massive role in the success of a security.

News Affecting The Market

Recession fears are gripping the US economy and inflation remains rampant although it is beginning to cool down. Internationally, inflation has yet to peak, such as in the United Kingdom where the consumer price index (CPI) for October 2022 was at 11.1% year-over-year. The US inflation rate has fallen from 9.1% in June to 7.7% in October. The Federal Reserve is still increasing interest rates by seventy-five basis points (bps) at every meeting but is showing signs that it is willing to start easing the hikes a little. While a recession seems likely, one can be avoided. If one does occur, much money can be made coming out of it. A common finance saying is, “Recessions make millionaires.” Although a recession would be painful, many people could end up benefitting.

“If you’re an individual considering purchasing a big-screen TV, you might want to wait, hold onto your money, and see what transpires. The same is true with a new automobile, refrigerator, or whatever else. Just remove some risk from the equation.” — Jeff Bezos, Executive Chairman and former CEO of Amazon

Bottom Line

Thank you for reading to the end of this article. Many different characteristics of a stock are at play in affecting its future performance and can be great indicators of this. It is important to perform diligent research before picking a stock.

Disclosure: All statements and opinions expressed in this article are objective and my own. I am not a financial advisor. I do not recommend the trade or use of any particular stocks or services. I acknowledge the risks of investing.