With an ever expanding suite of metrics and ratios available to retail investors, deciding how to size up a prospective position in a company has never been more complicated. But does it have to be?
Peter Hodson, the founder and CEO of 5I Research joined BNN Wednesday to discuss the five basic things he looks for when analyzing companies.
RETURN ON EQUITY
It’s the amount of net income returned as a percentage of shareholder equity. Basically, it’s a measure of how much money you are making from a company versus how much money you put in.
“A good number is 20 percent, but some of the great companies can come in with 45 or 50 percent which basically means they are exceptionally profitable and you are making a lot of money from what’s being put into the company. It’s my favourite ratio by far,” said Hodson.
COMPANY GROWTH VERSUS INDUSTRY GROWTH
When a company is growing faster than its peers, you have a sure fire sign that something good is going on. It could be anything from a better product, to a faster growing consumer base, to better sales people. It doesn’t really matter, growth is growth.
“Magna International (MG.TO -0.13%) recently had a profit growth of 13 percent and volume growth of about the same versus the auto industry as a whole, which is growing at three or four percent. They are multiples better than the industry right now,” said Hodson.
PERFORMANCE DURING THE RECESSION
How a company weathers tough times says a lot about its fundamentals. Chances are if it fought its way through the worst economic conditions seen in a generation, it will continue to do reasonable well in more prosperous times.
“Priceline.com (PCLN-O) tripled their profits in the middle of the financial crisis. It’s a travel company and nobody was travelling,” said Hodson.
STOCK OWNERSHIP BY MANAGEMENT
It’s a good show of faith if the executives have some real skin in the game – not stock options – actual positions that show they believe in the company. If they drop the ball, you want them to hurt as bad as their shareholders.
“Constellation Software Inc. (CSU.TO 3.38%), it’s one of the best performing stocks on the TSX. The CEO owns about $360 million worth of stock and the executives are forced to put some of their bonuses into stock, not options, just pure stock. They are on the line with investors as well,” said Hodson.
MANAGEMENT’S ABILITY TO EXECUTE
Has the company met analyst expectation? Have they hit that mark consistently? Look for companies that regularly beat the street. It sounds simple, but that’s why Hodson likes it.
“What we look for is momentum, a company that can under promise and over deliver,” said Hodson.