Predicting a stock’s success always involves a level of uncertainty, but understanding what typically leads to a winner will help you sift through the potential options.
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There are a number of aspects that experienced investors look for in a company to decide if it’s worth their attention. When it comes to a wall street winner, Investopedia said that uber investor Warren Buffett looks for health and growth as reflected in profit margins and a value proposition expressed as a competitive advantage or undervaluation relative to the company’s intrinsic worth.
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Health and Growth
When you’re looking for financial health and stable growth, key indicators are those with year-over-year revenue increases. Quarterly increases suggest faster growth, though you want to have an idea of the larger picture. On a similar note, you want a company that is profitable, thus ensuring that the shares can be reinvested or you can be paid dividends, according to Moneyworks by Investor’s Business Daily. This growth tends to go hand-in-hand with having products that consumers want. If the company is an industry leader, they are likely to see faster price growth for offering something novel.
Value Proposition
To bolster our understanding, we can also consider the advice of Peter Lynch, a prominent value investor with a top-tier track record. Between 1977 and 1990, he returned almost 30% on average per year for Fidelity Investments. He views six types of companies that make up stock market investments.
The first category is fast growers, which are companies that can grow their earnings per share by 25% on average per year. He says to prioritize the underappreciated ones not owned by numerous institutions — be mindful and withdraw if the growth slows down.
The next category, slow growers, involves relying on dividends. Ideally, the dividend payment grows each year. For industries that have steady cash flow and slower growth, a good ratio could be up to 75% or more, according to The Motley Fool. For fast-growing companies with volatile cash flows, it’s better to look for those less than 50%.
Stalwarts are companies with growth rates between the first two categories. According to Lynch, these companies have better survivability when it comes to recessions, like discount stores are those that sell necessities such as health and hygiene products.
Cyclical companies have profits that regularly move up and down, like an oil industry company which sees its prices fluctuate in this way based on the current supply and demand. The key here is to purchase when the prices are down, and withdraw when they are high.
Turnarounds are poorly performing companies with a potential to improve – how strong their balance sheet is would indicate the ability to have a turnaround.
The final category, asset plays, has to do with determining which company assets are underappreciated. Understand the balance sheet and avoid companies that take on too much debt, which could reduce those assets’ values.
Bottom Line
Focus your search for a winner among underappreciated companies, ones that don’t necessarily have significant coverage from analysts. These stocks won’t be traded at premiums and are capable of drastic appreciation.
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This article originally appeared on GOBankingRates.com: What To Look for in a Wall Street Winner