Hi
How can I be sure whether a company is profitable or likely to fail? What do savvy investors look at on a balance sheet or elsewhere to assure them of the stability or a company? Companies can hide losses, massage numbers, fool auditors by backdating earnings/profits. etc. Granted. Even savvy investors like Warren Buffet can make mistakes but there is a method to stock picking. I look forward to your feedback
davidmich
Accounts are supposed to show a “true and fair view” of the company’s affairs, and it is the auditor’s job to ensure that this is so.
Generally speaking, prospective investors do not approach accounts on the basis that they are misleading, inaccurate or fraudulent; they approach them looking for what they reveal rather than what they conceal. The analysis of accounts is an important part of accountancy training.
Sure, the accounts could be fraudulent or misleading (Exhibit A: Enron). How can you be sure in any particular company that this is not so? You can’t. If the company is cooking the books and either (a) conspiring with the auditors, or (b) fooling the auditors, the likelihood that you can tell this from examining the books is pretty small. But you face the same risk with every company; I don’t see that you can reduce this risk by choosing Company A over Company B, which is the decision most investors are making.
Audits will generally only tell you the internal factors about a company. These are important but the real factors which determine if a company will fail or be profitable are usually external. And audit won’t address issues like “Do people want to buy the products this company is selling?” and “Are competing companies selling similar products going to sell more than this company will?”
If your practices allow you to backdate earnings, your company won’t pass a rigorous audit. As for your main question: a new bar is likely to fail. A 50-year-old dry cleaning business is not. Extrapolate from there.
Bonus: if you want to know something about a company, call the person at the company who would know that. An old-fashioned phone call can open up information in easy and surprising ways. That’s just as valuable as a ream of data printouts.
If you could be sure, you’d be a billionaire already.
And if there were a method to stock picking that we could write in a single message board post, we’d *all *be billionaires.
My rule is to go with companies that look to be doing a good job. No high flyers, just the businesses that I like to deal with. You can learn a lot about a company by being a customer.
Bear in mind that the people who originally broke the Enron story did so on the basis of the public reports. Anyone with a modicum of financial training and enough time and energy to plow through them could have determined that Enron would crash before it actually did. Note that, in early 2001, knowing that Enron is a house of cards and knowing that it would collapse in October are two completely different things.
I believe in one of Buffet’s sayings, which was to the effect that one should never invest in a company if you cannot explain how they make their money.
That’s a good one.
There’s no real ‘secret’ to stock picking. Just use common sense.
Those two things will do you OK in the vast majority of cases.
If you must dig into it further look for these factors:
A. Is the company large cap ($500MM or more in Market Capitalization)
B. Does the company pay a dividend?
C. How long has it paid one?
D. How many years in a row has it raised its dividend?
This is part of my ‘boring is good’ stock philosophy. Large, old school boring companies are the best long-term investments. They may not go up hugely any one year but year after year they’ll appreciate in value and treat your portfolio well.
It also depends on what kind of company you are looking at.
While I am not a fan of GM, they are a large company that’s been around for a long time, and I know what they do and who their competition is. The chances of GM ‘cooking the books’ is pretty low, but if I look at some new company with a new technology and I have no idea what their market is and who their competitors are, I am investing blind whether they cook the books or not.
To a great extent you have to trust the auditors and the company’s finance people to ensure that the information they provide is fair and accurate. Ultimately it’s you making a decision based on your knowledge and experience, or the knowledge and experience of others that you trust.
If you have a trusted financial adviser they can usually point you in the direction of companies that have a good track record and would be a safe bet. You could then look at a few companies and decide which one best fits what you are looking for. There is always the chance that you end up picking an Enron… but the odds are against that happening.
Paying $150 a year for a financial adviser may be the best money you ever spend… but you can always do it yourself if you want.
Another idea is, don’t buy the company, buy the industry, as in a mutual fund that includes the company as well as its competitors.
As noted, if you had bought Enron in 2001, you’d have nothing. If you’d bought an energy-sector mutual fund, you’d have had a couple of bumps, but be doing pretty well right now.
On top of that, there’s a big component of understanding what their competitive advantage is; if they can’t explain it, or it’s not obvious, you may want to stay away. Just because a company looks good on financial statement paper, doesn’t mean they have a terribly sound future vision or long term prospects. Which is ultimately what you’re looking for in terms of investments- that’s how money’s made, not through swapping stocks and bonds in and out of your portfolio every month.
This is true. But the risk factor works both ways. A well-established business has a relatively low-risk of failure but it also has a relatively low-risk of growth. Or if you find a business that’s demonstrated a strong growth rate, you’re going to be paying a lot more to get in on it.
The ideal investment is to look around and find a business which you feel confident has the capability of growing but which hasn’t started growing yet. That’s the one where you can get in on the proverbial ground floor.
Take what dolphinboy up there said to heart. Look at two car companies. In 2013 GM sold 2.8 million vehicles. It has a market cap of 53.9 billion, a price/earnings ratio of 14.2, and pays a 3.6% dividend, so for every share you own of GM, you’ll be paid $1.20 a year.
In the same period Tesla sold 22,477 vehicles. It has a market cap of 24.6 billion, 45% of what GM’s is, although GM sold 125 vehicles for every one Tesla sold. The price to earnings ratio doesn’t exist, because there are no net earnings, having lost $0.62 per share. It pays no dividend, and while they may be poised for enormous growth, I’m frankly flummoxed by what I consider an insanely high valuation of this company.
Maybe I’m old fashioned, but I like a company to make money. It keeps me out of Amazon stock as well. P/E ratio of 550? And the people buying the stock don’t seem to care. Google missed its earnings forecast and dropped 20 bucks a share, but Amazon keeps chugging along.
I’m no investor but i was given a bit of advice once by a successful investor, Tax, Look at the counts , how much tax do they pay? None, and they are either bankrupt or up to some dogy dealing that cant be sustained. Have they paid tax for a long time, then they have sustained profits.
Those fly-by-night companies like Verizon, Boeing, and GE. 
Analysts also consider developments appearing in the news, regulatory filings, market speculation, etc., as well as management’s explanations/comments regarding these developments, which might appear in press releases, corporate results, shareholders’ meetings or even in the course of a phone call, as mentioned upthread by ALOHA HATER.
It sounds like you’re more interested in stability than return. The so-called defensive stocks (assuming you’re interested in equity) provide low return as well as low exposure to risk. A typical example would be a utility whose revenue is regulated and therefore very steady.
Here’s another idea. Don’t buy the stock unless you have good reason to believe that you have a superior understanding of it than the market, most of which is composed of full time investment professionals. Instead, buy a broad based stock index with low fees. The S&P 500 fund at Vanguard.com is the classic example of this.
Say you are an investment hobbyist though. You already have the bulk of your funds squared away in index funds and you want to try your hand at beating Warren Buffet et al. The Motley Fool is a decent source. But regarding the OP, here is a book length treatment on uncovering problems through detailed study of a firm’s published accounts. The book assumes that you are familiar with the basics of accounting.
ETA: The great thing about stock picking is that acquiring bragging rights is pretty easy. Pick 5 stocks at random from the S&P 500 and while I can’t say that they will do well as a group, you should have 1-2 to discuss over cocktails and maybe a couple to stay quiet about. The only problem with this game is that you might end up fooling yourself. In fact you probably will. It’s not quick and straightforward to compile a risk-adjusted performance metric for all of your investment decisions. It’s possible, but not software enabled AFAIK. Yet that’s the only honest way to judge your investment judgment.
indeed…don’t touch them with a barge pole. No tax means they don’t make a profit.