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How To Make An Intelligent Stock Investment

Aug 17, 2007
There's a big difference between buying a stock for a quick trade, and making a true stock investment. With so many friends and neighbors focused on the quick profits of day trading, people have forgotten that making a stock investment makes them part-owners of real, live businesses.

If you view stock investments from this perspective, you need to be concerned about things beyond MACD, support and resistance, and other technical indicators. You have to be certain that the business is one you can entrust with your hard-earned money, for the long term.

Review the Company's Income Statement Before Making a Stock Investment

Day traders almost never bother with financial data, but true investors should always review both the income statement and balance sheet of a company before making a stock investment.

Start by looking at the past three to five years of income sheet data. Is the company's income growing? If so, is the growth accelerating or decelerating?

Always look at the company's gross margins before making a stock investment. Gross profit is the company's total sales minus its cost of goods sold. Gross profit as a percentage of sales is gross margin - is this number going up or down? Once you evaluate all of this information, you will be better prepared to make a stock investment.

If a company's income statement is erratic, income growth is decelerating, and its gross margins are being cramped, it can still be a good stock investment.

This is because other investors have probably abandoned the company, pushing the price of the stock down. Generally, companies that have consistently accelerating growth and improving gross margins are pricier stock investments. You have to evaluate all of the data and determine what you think the stock is really worth.

Don't Forget the Balance Sheet When Making Stock Investments

Reviewing the income statement is never enough when making a new stock investment. The balance sheet is always at least equally important, and in the case of companies with weak income statements, the balance sheet is even more important.

Consider the liquidation value of a company before making a stock investment. This is most important for companies under distress. What would happen in the worst case scenario and the company went bankrupt?

Look at the balance sheet and subtract intangible assets and total liabilities from total assets. What's left are the items that could be sold if the company ceased operations. If the liquidation value per share is close to the trading value of the stock, then you have downside protection on your stock investment.

If you think the company has a chance to turn things around, then it could be a great buy.

Should You Only Look For Damaged Companies When Making a Stock Investment?

No! While the balance sheet is most important when considering a stock investment in companies under distress, the income statement is paramount when making a stock investment in growing firms. Growth stocks aren't just for traders, they can be for investors too!

Consider Hansen Natural (HANS). This stock quadrupled from $7 a share in April of 2004, to $28 per share a year later. This would have been great for a trade, but traders would have really missed out if they sold for $28.

Over the next 15 months, the stock went all the way to $200 per share! Investors who took a look at the company's financial statements and carefully considered its tremendous growth prospects, could have turned a $10,000 stock investment in 2004 into more than $285,000 today.

It pays to buy and hold when you do the homework and you're confident that you're right.
About the Author
William Smith the author provides additional financial information on many subjects as well as the secret to his success in the market along with 5 Free power stock picks emailed daily so grab your Free subscription on his website at Stock Picks (All is Free)
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