Stocks — Doing Your Homework

When you include stocks in your investment portfolio, it pays to study up. “Although this may take some time, it is time well-spent,” says Pat Swanson, CFP® and families specialist with Iowa State University (ISU) Extension’s Invest Wisely Project (www.extension.iastate.edu/investwisely). “You don’t need to act immediately to take advantage of a hot tip. Good stocks tend to stay good, so take the time to do your homework.”

Swanson explains that stock selection should be based on the underlying value of the company rather than speculation.  “Speculators often buy because of a whim.  During the dot-com boom of the late 1990s some stocks were selling at astronomical levels far beyond what a fundamental analysis would support.  This boom did not last and some stocks lost most if not all of their value.”                       

To find out about a company’s basic value, check out its  financial statements. “This may not be exciting reading, but these financial statements contain a wealth of information,” Swanson says. And it’s free.  The Securities and Exchange Commission (www.sec.gov) provides these statements at no cost in their EDGAR database. Also, a company’s annual report is available simply by calling the company.

It’s all in the numbers, Swanson says. “Use these financial statements to calculate financial ratios. These ratios will help evaluate a firm’s performance, profitability, debt utilization, and ability to generate cash. Some of these important ratios are price-to-earnings (PE) ratio, dividend yield, and return on equity.  These ratios are available on Internet Web sites such as www.wsj.com.”

For example, if you are an investor wanting the income that dividends can provide, you will want to look at the dividend yield of a company. Dividend yield is the company’s dividend expressed as a percentage of the share price. If a stock sells for $50 a share and the company pays $1.50 a year in dividends, its yield is 3 percent.  A stock’s current dividend payout and yield is included in the daily stock listings in many newspapers and available on the Internet. Swanson adds that one ratio by itself may not tell you much, but several ratios used together can give you a clearer picture of a company’s strengths and weaknesses.

Swanson explains that it is important to choose a benchmark with which to compare a company’s financial ratios. One benchmark is to compare the ratio for the same company from past years. It also is helpful to compare a company’s ratios to those of other companies in the same industry.

If interested in learning to read financial reports, there are many resources to help you. Swanson suggests you look at the information provided on the Web sites of the Securities and Exchange Commission (www.sec.gov) and the Investor Protection Trust (www.investorprotection.org).

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The ISU Extension Invest Wisely Project provides a series of newspaper, radio, and web resources for investors.  It is funded by a grant from the Investor Protection Trust (IPT).  The IPT is a nonprofit organization devoted to investor education.  Since 1993 the IPT has worked with the States to provide the independent, objective investor education needed by all Americans to make informed investment decisions.  www.investorprotection.org.