Do This Before You Invest In Your Next Stock

Although I love trading stocks, I’d be lying if I didn’t say I had a long-term portfolio.

The truth is…most traders do.

But I make sure to scrutinize each of my long-term holdings.

I primarily use 15 metrics to determine whether I want to invest in a stock.

Here’s a breakdown of them in plain English:

1. Strong Management

Bad management can destroy great businesses.

And strong management can make bad businesses great.

Here’s what strong management looks like:

• CEOs with decades of experience

• Compensation that aligns with the industry (not too high or too low)

• Management personally invests in company stock

If the management doesn’t have conviction in their own company, why should you?

2. Growth Prospects

I like to figure out a company’s growth prospects by asking:

• Is it in a new industry?

• Is the industry declining?

• How are customers acquired?

• How do customers feel about the company?

• Will this business stay in the same market?

The growth potential of the company will equate to the company’s potential returns.

3. Customers

Is their customer base diversified or do they heavily rely on a particular demographic?

When a business has a diversified customer base, it can hedge against competition, free up cash to reinvest, and comfortably meet debt obligations.

A business with multiple customers is safer than a business exposed to an unreliable market.

4. Outside Impact

I want to know what factors outside of the company’s control can impact the business.

Think about:

• Lawsuits

• Competition

• The economy

• Federal reserve

• Government policy

And more.

Anything that can impact the company’s future should be noted.

5. Innovation

Businesses should improve with technology, not be put out of business by them.

If it can’t improve with technology, the business will lose market share to competitors who do.

Companies that leverage new technology are more versatile and adaptive.

This makes them attractive investments.

6. Moat

In other words, the competitive advantage.

Here are some competitive advantages to consider:

• Size of the company

• Barriers to entry

• Production costs

• Customer/Brand Loyalty

• Patents and IP

A sustainable advantage increases your chances of profiting.

7. Stable Market

Volatile markets make it difficult to exit a position.

You’ll have a hard time trying to time it right.

And when it’s hard to time an exit, you risk compromising on your return.

That’s why I prefer stable industries for long-term holds over cyclical ones.

8. Cash Flow

When evaluating cash flow, ask yourself:

• Are they subject to economic cycles?

• Can the cash flow cover debt obligations?

• Does the company have a subscription service and/or a low churn rate?

Questions like this will help you determine a company’s profitability.

9. Quick Ratio

This will tell you if a business has enough assets to pay upcoming debts.

Here’s how to calculate it: Current assets ÷ Current liabilities = Quick ratio

A quick ratio of 1 is normal, but in general, you want a quick ratio above 1.

10. Net Profit Margin

This shows you how much money a company makes for every $1 in sales (Basically profit)

This helps you determine whether there are healthy profits and if operating costs are reasonable.

Here’s how to calculate it:

Net income ÷ Revenue = Net profit margin

11. Return On Assets

Return on Assets shows you how efficiently a company uses its resources to generate profits.

But it varies from industry to industry.

So the best way to find a good Return on Assets is to compare it with companies in the same industry.

Here’s how to calculate it: Net income ÷ Total assets = Return on Assets

12. Earnings Per Share

This shows how much money a company makes per share of stock.

The higher the EPS the more valuable the company.

Here’s how to calculate:

Profit ÷ Outstanding shares = Earnings per share.

13. P/E Ratio

Shows how much a company’s worth & how much investors are willing to pay for each $1 of earnings.

A high P/E ratio means the stock is overbought or investors are bullish.

A low P/E ratio means the stock is oversold or investors are bearish.

Here’s how to calculate it:

Share price ÷ EPS = P/E ratio

14. Price-to-Sales Ratio

This applies mostly to growth stocks with no profits.

The lower the price-to-sales ratio, the more attractive the investment is.

Here’s how to calculate it:

Market cap ÷ Annual sales = price-to-sales ratio

15. Enterprise Multiple

Shows how a company would be viewed before a potential acquisition. A good or bad multiple varies from industry to industry.

So compare it with other companies in the same industry.

Here’s how to calculate it:

Enterprise value ÷ EBITDA = Enterprise Multiple

There you have it!

15 metrics I look for in every long-term position I’m opening.

What criteria do you run your investments through?