FISCAL FITNESS

MICHAEL J. DONNELLAN King Financial, Inc.

THE FUNDAMENTALS OF STOCK INVESTING

This month I wanted to get back to the basics on a few of the important things investors should look for when analyzing a company’s stock.

All publicly traded companies are required to disclose quarterly and annual reports, which give investors insight into a company’s operations. Here are the main items to look for when analyzing a company’s fundamentals…

Revenues – The amount of money a company actually receives during a specific period. Examples of revenue accounts include: Sales, Service Revenues, Fees Earned, Interest Revenue and Interest Income.

Gross Income – Total revenue minus the cost of goods sold. Costs of goods sold usually includes the material, labor and overhead that goes into producing the good or service.

Net Income – The profit remaining after selling expenses, taxes, interest expenses, etc., with the remainder being the profit or loss. You may hear this being referred to as the bottom line, because it is the last line of a company’s income statement.

Earnings Per Share – The amount of net income divided by the number of common shares of stock of the company. A number that shows the profitability of each piece of the pie.

Market Capitalization – The total value of a company that is traded on the stock market, calculated by multiplying the total number of shares by the current share price. continued on page 14

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Price/Earnings Ratio (P/E Ratio) – A valuation of the company’s share price compared to the per share earnings.

Price/Earnings to Growth Ratio (PEG Ratio) – A valuation metric to compare the company’s Price/Earnings Ratio to its growth rate.

Dividend – A sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits (or reserves). A cash dividend would be paid out in a dollar amount. The Dividend Yield is the amount of the dividend divided by the stock price (ex. $1.00 dividend divided by $25.00 stock price = 4.0% dividend yield).

Let’s apply the above terms to a fictitious, blue-chip company. XYZ Inc., which has revenues of $33 billion, compared to $30 billion last year. That is revenue growth of 10%, which is pretty good growth for an established company which generally has more stability and let’s say, pays a 2.0% dividend.

Scenarios illustrated are hypothetical in nature, results may vary. Investing is subject to risk which may involve loss of principal. Past performance is not indicative of future results.

Last year, XYZ had $24.00 billion in cost of revenue, which resulted in $6 billion in Gross Income. After paying everything else XYZ had $3 billion remaining. That’s the Net Income.

If we divide that by the number of shares outstanding, which were 300 million shares, that means each share earned $10 per share. This is called the Earnings Per Share and is the bottomline number an investor can use to compare the fundamentals to the stock price.

The current stock price is $150 per share. Divide the stock price by the earnings ($150/$10) and you have a P/E Ratio of 15. Looking forward to the next year earnings of $11 you will arrive at a Forward P/E Ratio of 13.6 ($150 price divided by $11 in earnings).

We already determined XYZ is growing revenues at an annual pace of approximately 10% last year and the estimates are for revenue growth of 10% this upcoming year. Earnings increased 10% last year and are expected to grow 10% this year. The PEG Ratio is 1.36. That means that XYZ might be a little expensive compared to their growth rate. The company is growing at 10% but you are paying a premium to own the stock. As an investor, you would be looking for the company to increase their revenues or profit margins above Wall Street expectations.

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Many investors will look at the stock price and think a company is too high. But you really need to look at the Market Capitalization. A company may trade at $2000 per share but has ten million shares outstanding ($20 billion Market Capitalization). Company B may trade at $40 per share but have five billion shares outstanding ($200 billion Market Capitalization), which is ten times larger than Company A!

You can use the same simple analysis to start your fundamental understanding of any stock.

Michael J. Donnellan specializes in stock selection and retirement planning. Feel free to contact him with any questions or comments at the M3 Wealth Management office at 17601 W. 130th Street – Suite 1 in North Royalton, Ohio. Phone number (440) 652-6370 Email: donnellan@m3wealthmanagement.com

Securities & advisory services offered through L.M. Kohn & Company Registered Broker/Dealer Member FINRA/SIPC/MSRB 10151 Carver Rd. Suite 100 – Cincinnati, Ohio 45242 (800) 478-0788

The M3 Wealth Management Office does not provide legal or tax advice. Consult an attorney or tax professional regarding your specific situation. The information herein is general and educational in nature and should not be considered legal or tax advice.