Friday, April 5, 2013

How to find value in stocks

As the oldest rule in investing advocates investor to buy low, sell high. This essentially means that the goal of all investors is to buy an asset (stocks, bonds, gold etc.) for something less than you can sell it for. In order to do that, investor will have to be able to assess the value of the stock. In this article, we’ll go over the metrics on how to identify value in stocks. Consistent increasing sales, income and cash flow The first step to identify value is to determine if the stock has a history of consistently increasing earnings, sales and cash flow over a period of 5 – 10 years. We will use Cisco as an example in our illustration below. The earnings, sales and cash flow figures can be obtained from financial websites such as Google Finance, Morningstar. Below is a screenshot from Morningstar that shows that Cisco has increasing sales, net income and operating cash flow over the past 10 years.



High Gross Margins
The second metric to look at is the gross margin. Gross margin is defined as a company’s total sales revenue minus the cost of goods sold, divided by the total sales revenue. A high gross margin provides an indication of the economic moat of the business. Cisco below has shown a consistent high gross margin above 60% which indicates that it does has some economic moat as shown by its market leader status in server and routers.



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