Five Simple Steps to Growth Stock Analysis

Everyday investors love stocks! The anticipation of buying shares in a company you speculate will take off can be thrilling but it can end as a disaster if an investor exerts poor judgement. Prior to working at Goldman Sachs, I was a speculative trader. I invested in companies such as $NVDA, $CMG, $CRWD, $HD, and others whose performance brought 2X, 3X, or even 5X the return invested. I'll admit, I made other poor choices when I decided to invest in something I didn't fully understand and other failures were experienced by poor timing. Investments made in $BYND, $SNOW, and $LZ all reflected that prudent investing also means picking the right moment and practicing fundamental research before buying. Even with a 20+ year time horizon, being underwater on a 50% loss would have taken years to recover. The lessons learned have allowed me to build a small checklist of what to look at when evaluating a company and its future growth prospects.

So what should a growth stock investor do? My immediate recommendations: study the basics, master fear, practice patience, and of course, take these five steps into consideration.

1. WWWBD - "What Would Warren Buffet Do"

   The simple philosophy of invest in what you understand is only too clear. If you use it, you like it, you think its a good product, you see others use it, and you know what it does, then you have already mastered the first step. Look at Apple as an example. They sell iPhones, MacBooks, products that are used in households across America and the world. Without even studying their financials, management initiatives, or without glancing at their stock price, anyone invested over the last ten years made a good return. It was the first company to surpass $1 Trillion in valuation and broke records again when it crossed $2 Trillion. Does this mean "BUY NOW" - absolutely not; however, given the choice between this investment and some miscellaneous stock with good analyst ratings but zero understanding of their business, I'll take Apple. This fundamental is often missed, and while Warren Buffet had many other strategies such as the Earnings Sustainability Model, Economic Moat Evaluation (all something to google), the fundamental of knowing what you invest in should always be step 1.

2. Read the 10K/10Q Management Discussion & Summary

   There is always a portion of regulatory reporting that comprises of a management summary and a simple read through of this should help gauge the future direction of a company. The positive and negative undertones of a management discussion can indicate an excitement in future initiatives or shed light on a bumpy road ahead. The key takeaway here, is to gauge if management is making good decisions. If leadership quality is poor, the company's financials will soon reflect this.

3. Leverage Financial Ratios & Indicators

   Let me be clear on this one - you should not be taking time to calculate this - the wheel has already been made and can be found on Google, StockAnalysis, Ycharts, or your favorite custodian research tool (mine is a mix of Schwab and Fidelity statistics and metrics). The point of the ratios and indicators is to identify if a risk exists. StockAnalysis.com has one set of indicators that I find intriguing - its the Altman Z-Score and the Piotroski F-Score. Both of those indicators provide an assessment on the risk of a company going bankrupt and are considered proven in the field in accurately identifying the risk. Other important ratios to consider are your Debt/Equity ratio and your Acid Test (Quick Ratio) which will consider the company's short-term abilities to pay down debt and the long-term financial stability of the company. Some ratios can be misconstrued so be considerate of industry standards and how they measure up against competing peers. The real takeaway here is, what warning signs do these ratios tell us?

4. What's The News on Ownership?

   An easy way to read a company is to read what leadership is doing. Is there a recent merger or acquisition? Are executives cashing out on company stock or are they buying more? Are institutional firms acquiring ownership stakes? These can all be identified from a firm's filings which can be found under a news/events section for a stock. Here is the rudimentary breakdown:

   1. Form 4 is an insider trading disclosure that must be submitted a few days before the transaction. It will indicate a buy or sell of the stock by an insider (an insider is an executive, a director, or a significant shareholder).

   2. Rule 144 Filings are the sale of restricted or controlled securities, also by insiders, but they come with a few extra rules such as limits on volumes, timing, and methods of sale. Routine, frequent, or high volume sales could be an indicator that an insider might consider the stock over-valued.

   3. Schedule 13G ownership filings indicating ownership of 5% or more are common to see when institutional investors acquire or reduce their stake in a firm. When an institution takes a significant stake, its not to influence or control decisions of the firm, but to partake in speculative returns on the underlying investment.

5. Room For Growth?

   There is a certain point where a large size is no longer advantageous. In fact, it might stunt a firm's stock value and ability to appreciate. Is a restaurant franchise opening more locations across the country? Is there any innovation left among the product base? I'm not expecting Coca-Cola to come out with a new flavor every year but at what rate can the company grow faster than inflation when its sales and assets remain stagnant. Don't misunderstand, investing in stocks is a good inflation hedge but is it something that will appreciate after ten years of ownership? Speaking from an aggressive perspective, I want growth, not safety.

   
   

   Of course, there are many other factors to consider before an investment. Your time-horizon, the price of the stock relative to its assets and earnings, the purpose of the investment, etc, these five steps are not the only things to look at, but if they aren't already on your checklist, I hope you consider adding them.

   
   

   Don't Forget!!!

   Stocks trade on earnings-multiples and are only worth what someone is willing to pay for it and so speculators could be willing to pay twice what its worth now in hopes that its worth three times its value at some point in the future and while many tools at our disposal can help us determine the future outlook of a company, in the end, the investor's return is dependent on their ability to see the future and nothing is within our control.