November 24, 2017

Finance 101 for stocks

Michael Stadler from Osteopathy Central wants to know which financial ratios he should take into account when choosing a stock.

The most important financial facts can be divided into two categories. Those that make sense and those that are mostly based on hope.

The financial facts that make sense can be explained rationally. For instance, a company with big profits has more value than a company with small profits. Similarly, a company with a large turnover or a large dividend usually has more value than a company with a small turnover or a small dividend.

These fundamental variables can be analyzed and show how valuable a company is. To determine the value of a company, Obermatt analyzes four variables:

How expensive is the company compared to the dividend?

How expensive is the company compared to the profits?

How expensive is the company compared to the invested capital (properties, machinery, etc.)?

How expensive is the company compared to the sales?

These key figures are compared with those of similar companies and a ranking list is created based on these criteria. This clearly shows which companies are favorable compared to the others (good value rank).

As a stock selection principle, it is important to focus on the value rank, because your decision isn’t based on emotions but on positive financial facts.

That being said, there are also cases where you have to think for yourself. One example is companies that we expect to develop differently than is generally assumed.

This can be illustrated in the case of Apple. If Apple has an average value rank, you have to think about how they will develop in the future. The market thinks that Apple’s future is mediocre because their value rank is average. If you think that Apple will grow above-average in the future, you can also buy Apple with an average value rank, because you expect Apple to growth more than the average. In a case like this one, it’s possible to buy a stock even if its value is not very good.

However, be careful! Don’t buy a stock just because you think the product is good. A good product does not automatically mean that the stock will develop above-average because the stock could simply be much too expensive. There is a big difference between the products and the future return on a stock.

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