Today we have a special treat here on TRB. As soon as I heard that Charles Rotblut was writing an investing book, I added it to my mental reading cue. Charles is the editor of the AAII Journal from the American Association of Individual Investors. In his brand new book Better Good Than Lucky, he takes key lessons from some of history’s greatest analyzers of stocks and distills them for investors of all experience levels.
I asked Charles to tell us why he wrote the book and what we can get out of reading it. Enjoy!
Four Questions to Ask When Analyzing A Stock
By Charles Rotblut, CFA
The one need many investors have – outside of more winning stocks, of course – is information on how to properly analyze a stock. Despite an exponential increase in the amount of financial data, many investors find they lack a set of time-tested guidelines for determining whether a stock truly offers potential profits or is destined to lose money for them.
It was for this reason that I wrote Better Good than Lucky. I wanted to give investors a book that is easy to read and is based on sound financial theories and thought. No gimmicks. No special trading strategies. Just a clear explanation of what attributes reduce a stock’s risk and increase its potential reward.
What are those attributes?
- Attractive Valuation
- Strong Business Model
- Good Financials
As simple as these traits may sound, they originate from the work of some of the greatest investment minds of the 20th century. Harry Markowitz won a Nobel Prize for explaining how diversification can lower a portfolio’s risk and increase its return at the same time. Benjamin Graham, who taught Warren Buffett, emphasized the importance of low valuations throughout his whole life. Philip Fisher, another investment guru who influenced Buffett, stressed the importance of a good business model. As for good financials, that is a common theme throughout all quality investment literature.
How do you apply these concepts? Simple: spend a little time looking at a company before you invest in it and ask some basic questions.
- Does the company operate in an industry or sector that you are not already invested in?
- Are the price-to-book (P/B) and the price-to-earnings (P/E) ratios at reasonable levels? (I prefer stocks trading below a P/B of 3 and a P/E of 20.)
- Does the company sell products that fulfill needs, is it profitable and how able is it to fend off the competition?
- Do current assets exceed current liabilities (look at the balance sheet), is its debt at reasonable levels (look at the balance sheet again) and does the company generate positive cash flow from operations (look at the cash flow statement)?
If the answer to these questions is yes, then the stock is worthy of further research. If the answer to most of these questions is no, find another stock. Since there are thousands of stocks to choose from, you have little incentive to spend time on a stock that could potentially cost you money.
The most important thing to remember is that you can properly analyze a stock. You just need to focus on the traits that really determine a stock’s risks and rewards.
I provide more information on how to analyze a stock like a professional, including a helpful scoring system, in “Better Good Than Lucky: How Savvy Investors Create Fortune with the Risk-Reward Ratio.” The book is published by W&A Publishing/Trader’s Press and is available on Amazon.com.
Charles Rotblut, CFA is a Vice President with the American Association of Individual Investors and the AAII Journal editor.