It’s the quintessential question for investors and traders. Conventional wisdom is not all that helpful – buy low, sell high. Well, duh! How about something with a little more meat on it?
For starters, check out the company’s last two earnings reports with specific attention paid to the following:
Related: THE BID-ASK SPREAD
Using Earnings Reports
The use of corporate earnings reports to evaluate companies and their stocks is not new. But it is worth reviewing the components of those reports that really matter.
Sales – Are sales growing and if so is it real sales growth? In other words, did the company sell assets or actual products. Was it internal growth or some external event?
Margins – More importantly, why are the margins doing what they are doing? If a company is entering a new business line, growing pains could hurt margins. Alternatively, bad management can also hurt margins.
Guidance – Compare company guidance with Wall Street expectations. Is the company likely to surprise or disappoint in the future? Look for long-term guidance as a more important signal of whether the stock will do well in the future.
Buyback – When a company buys back stock that usually means the company believes the stock is undervalued. There’s always the chance the company has other motives – such as reducing total share count in the public market to boost earnings.
Share Count – It’s better to see the total number of outstanding shares either stay the same or fall. The reason is simple – more shares means more investors sharing the same profits.
New Products – Any announcement of new products needs to be examined carefully. By the time the company announces, R&D is probably already baked in. Investors generally get excited about new products and help boost share prices higher – at least in the near term.
Wording – Words like “opportunities” are positive while words like “challenges” can spell trouble. Look for what’s behind the choice of words in the company press release. Was guidance raised or lowered? Are there new products coming? Don’t be taken in, however. If the release is overly upbeat, be suspicious.
Technical Indicators – This will tell you whether the stock typically trades lower at certain times of year. Is it currently trading above or below its 50 or 200-day moving averages? Is it thinly traded or heavily traded? Decreasing volume, for example, could portend a dropping off of share price.
Big Picture – What does the sector or industry look like? Are interest rates going up, taxes coming down, buying patterns changing? All could have an impact on the company and its stock prices.
For most people when buying individual stocks, it’s a matter of deciding between long-term and short term. Long-term investors like to hold a stock at least 10 years. Timing the market is very hard and most experts consider it almost impossible. Long-term investing avoids that problem.
Value investors (like Warren Buffett) try to buy when the PE ration of a company’s stock is below that of the market as a whole (as well as competitors). Conversely when the PE ratio is above the market, it may be a good time to sell and take the profit.
The Cramer SystemCNBC’s Jim Cramer has a simple 4-point system for deciding when to buy or sell a stock.
Cramer says, "I rate all of my stocks on a scale of one to four, the ones being the best buys, the fours being the sells. I swear by this rating system."
Fours are ready to be sold and have profits attached to them. He advises not to sell them all. Sell enough to generate cash to buy some ones. (See below.)
Threes are almost ready to be sold. You may think they will go higher and unless you absolutely need to, hold on to them a little while longer.
Twos are stocks you are interested in buying – but not at current prices. These are stocks to “watch.” Cramer waits for a 5% to 10% pullback to purchase these stocks.
Ones are stocks that are ready to buy now. Best time to make a move on a one is during a pullback, according to Cramer.
The best thing about Cramer’s system is that it is a system and takes out the likelihood of an emotional reaction.