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Don't Overlook These Things Before Investing in a Company

Created on 17 Oct 2023

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Updated on 17 Feb 2024

Don't Overlook These 5 Things Before Investing in a Company

Have you ever wondered if that stock you're eyeing is a real steal? Or if the company is a financial superhero or more of a financial zero? These questions often linger, but fear not, for I'm here to decode the mystery!

In this article, we're going on a financial adventure. It's a bit like being on a treasure hunt, but instead of a map, we've got Quantitative Analysis as our trusty compass. It's here to help us uncover valuable gems in the stock market.

Now, I know "Quantitative Analysis" might sound a bit fancy and tough, but don't worry; it's just a tool to make things clearer.
We'll explore why it is so crucial in the context of Value Investing with examples and, most importantly about some essential ratios and parameters that every value investor should consider.

Let's start by understanding...

Why is Quantitative Analysis Important?

Quantitative analysis is like using numbers to figure things out. Imagine you've got a pile of marbles, and you're curious how many blue ones there are. Instead of guessing, you count them. That's using quantitative analysis!

It's super useful, especially in money matters and business decisions. Companies use it to plan how many products to make or predict how much money they might make. It helps them make smarter choices by relying on numbers and data.

It's not about gut feelings but cold, hard numbers. While Qualitative Analysis explores softer aspects, quantitative analysis crunches digits. It's like your financial X-ray, showing a company's financial health. It spots red flags like high debt or dropping profits!

Quantitative analysis helps you calculate the real value of a company's stock, acting as your personal "Is this a good deal?" metre. It's like picking an ice cream flavour – you check all the options. Similarly, quantitative analysis is your menu for businesses, helping you compare different companies to find the best investment.

Understanding quantitative analysis is key, especially in investing. Let's delve deeper into some essential points when it comes to choosing where to invest. Just as personal growth is crucial, companies need to grow to succeed. 💁‍♀️

Uncertain about picking the perfect stocks? No need to stress. Just head over to "Smart Stock Selection: Your Ultimate Screening Guide."

Key Factors to Examine Before Investing:

Before you casually invest your hard-earned money in any company, it's crucial to run through a checklist, beginning with the...

1. Revenue Growth

Checking revenue growth before investing in a company is like making sure the tree you're planting has strong roots to grow. 

It's important because a company's revenue, which is the money it makes from selling goods or services, is like the lifeblood of its business. If a company's revenue is steadily growing, it's a sign that more people are buying what they're selling. 

This growth can lead to more profits and a healthier company in the long run. Just like a growing tree is a good sign for a healthy garden, increasing revenue indicates a company's strength and potential to thrive.

2. Gross Profit Margin 

The next important factor to assess is profitability, and one way to do this is by examining the trend in the Gross Profit Margin to see if it is on the rise.

But first, let us quickly understand Gross Profit and Gross Profit Margin.

So, Gross Profit is the money a company makes from selling its products or services minus the cost it takes to manufacture or provide those products or services. It's the profit a company earns before considering other expenses. These expenses include items like rent, salaries, and advertising.

The Gross Profit Margin is calculated as: 

You need to look at all the financial numbers and how a company runs its business to make smart investment decisions. Just having a growing revenue and profit isn't the whole recipe. So, what's next on our menu?

3. EPS growth

EPS is Earnings Per Share, a financial measure that tells you how much profit a company makes for each piece of its stock. EPS growth is all about how this number is changing over time. 

It basically tells you whether a company is becoming more profitable over time. It's an important factor for investors to consider because it reflects the company's ability to generate returns for its shareholders.

A higher EPS growth is generally better because it means the company is generating more earnings per share. When a company has a higher EPS growth than its peers, it typically means that it is fast-growing and profitable compared to others in the same industry or sector. This can indicate that the company is efficient in its operations, has effective cost management, and is delivering strong financial performance.

High EPS growth alone should not be considered the sole indicator of success or a promising investment opportunity. Other factors like debt levels, growth prospects, and market conditions must also be taken into account when assessing a company's potential.

There isn't a perfect or ideal EPS growth number for every company. Instead, you should think about EPS growth in the context of the company's industry, how it compares to others in its field and your own investment goals. 

Next, we have… 

4. Return on Equity (ROE)

This is a financial measure that tells us how effectively a company is using the money that the shareholders have invested in it. It's like a yardstick for assessing how well a company is generating profits from the money it has received from its owners. 

You can calculate the ROE using the formula:

 

Again, there isn't a specific "right" ROE that applies universally because it varies by industry and company. Some industries naturally have higher ROEs than others. What's more important is to compare a company's ROE to its industry peers and assess it in the context of its historical performance to get a clearer picture of its financial health.

Now that we have seen these four important ratios of profitability and growth, what is the point in finding a company with high growth and profitability but a huge debt on its balance sheet?

It's not enough to focus solely on a company's growth and profitability. Understanding a company's financial health, specifically its liquidity and solvency positions, is equally vital. 

So, when evaluating potential investments, be sure to take these liquidity and solvency ratios into account to gain a comprehensive view of the company's financial stability. And you are good to go!

The Bottom Line

That is it for today’s article. However, it is important to note that the key ratios we've discussed are essential in stock analysis, but they don't apply universally across all sectors. In fact, each sector may have its own set of critical ratios and Key Performance Indicators (KPIs) that are more relevant. Just like how you wouldn't season your dal (lentils) the same way you'd spice up your chicken curry, right?

So, spice up your investment journey, seasoned investors! May your financial dishes always turn out scrumptious. And speaking of dishes, don't forget to come back for more tasty financial bites on Insider by Finology. Happy Investing!

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Sakshi Dhakre

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Sakshi is an adventurous spirit who enjoys both the intellectual stimulation of Finance and the sensory experiences of good food and nature’s beauty. She has a passion for delving into complex financial topics and distilling them down into easy-to-understand insights. When she's not poring over financial reports, you might find her exploring a new corner of the city, trying out new restaurants and cuisines or admiring the beauty of the night sky.

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