What Stock Should I Buy?
By Conner W. Mays
The First Quarter (Q1) of 2017 is in the books and thus we begin the first earnings season of 2017. Earnings season refers to the first few weeks after a quarter (3 Months.) US publicly traded companies are required to file quarterly financials with the Securities and Exchange Commission (The SEC.) Arguably the most important number contained within those filings is Earnings-Per-Share (EPS.)
There are a number of factors that vary from firm-to-firm which make a direct comparison of EPS between firms meaningless. To evaluate a company’s EPS you will need a few other data points.
- Firm Guidance – A range the company forecasted and communicated to the investing public that they are expecting to earn. There is an argument that guidance is a conservative measure. You wouldn’t tell your boss you would reach a goal you didn’t think you could.
- Consensus Estimates – Some investment firms employ Equity Research Analysts to forecast earnings for various companies. Analysts will talk to the firm’s management team, suppliers, customers, etc… in an attempt to know everything they possibly can about a company. Their goal is to forecast an accurate EPS over the next few quarters, media companies such as Bloomberg or Reuters take all of the analysts’ estimates for a company and find a consensus or average EPS the firm is expected to earn and publish that number to the public. Once a firm publishes quarterly earnings, their actual EPS is compared to consensus to decide if they beat or miss expectations.
EPS is not the only number people care about. Depending on the type of company, EPS may not actually be the most important number. For example, social media companies are often evaluated by their Daily Active Users (DAUs) vs. their EPS. A Biotechnology or Pharmaceuticals firm may blow consensus EPS out of the water but if test results for their newest drug are subpar, the stock will likely take a beating. Knowing the important metrics for each industry is extremely important, most of which are thought to be indicative of future earnings – we will discuss this further next week.
The point here, like everything in financial markets, a single data point is never enough to tell you the full story.
Types of Companies
In the grand scheme of things there are two main types of stocks Growth stocks and Value stocks. One of the first questions you must ask yourself before entering financial markets is “what type of investor am I?” A lot of people never bother to stop and think about it, they just want to buy the stock that will make them the most money, which is an attitude that can lead to unwise investments and potential losses. There isn’t a rule book that divides value vs. growth stocks but there is a general framework that can help you make decisions that fit your investment style.
Think Procter & Gamble, Coca-Cola, etc.. Value Stocks are generally characterized by lower than average earnings and sales growth rates and price multiples, such as the price-to-earnings ratio (PE ratio.) However, their earnings are stable and more predictable. Investors that purchase value stocks are often called value investors, they look for companies that are undervalued and pay a consistent reliable dividend. Dividends are a portion of the company’s earnings that are paid out to shareholders. These companies are usually large companies that we would likely recognize.
Think Amazon, Netflix, etc… Growth Stocks are in many ways the opposite of value stocks. Growth companies are either young companies that are expected to take the market by storm (Amazon vs. Wal-Mart) or companies that have exciting new growth prospects due to a new product or access to new markets (Netflix entering China.) Growth companies usually have higher than average PE ratios, investors are willing to pay more for today’s earnings because they expect the firm’s earnings and sales growth will be above average. An important item to note here is that young growth companies may not have positive accounting profit due to high expenses and investing in the company. Growth investors seek returns in the form of capital gains, meaning they sell the stock for more than they bought it for.
Sale Price-Purchase Price=Capital Gain
Growth Stocks usually don’t pay dividends because they have to invest their earnings back into the company to meet their growth prospects, which is one of the many reasons growth stocks are considered to be more risky vs. value stocks.
Growth vs. Value
Many investors, myself included, diversify across value and growth stocks. Deciding the right mix for you is an extremely important part of the decision to buy a stock and add it to your overall portfolio.
If you have any questions / comments or general topics you would like me to discuss please let me know. Shoot me an e-mail at firstname.lastname@example.org
Thanks for reading!
I wrote this article myself, it expresses my own personal beliefs and opinions. Nothing contained herein should be considered actionable investment advice relative to specific securities. I am long Netflix (NFLX), Amazon (AMZN) and Coca-Cola (KO).