Stock Research Checklist - Dividend

If a business operates with stable cash flow and pays cash every quarter and the management does not have the opportunity to reinvest in the business, they can pay the dividend to the shareholders. If you are looking for income from your stock portfolio, you can select companies that pay conservative dividends and hold those stocks for the long term.

If You Are Buying the Stock for Dividend, Make Sure the Company Pays the Dividend Without Interruption and Has a History of Raising Dividends

When you are looking for good dividend companies to invest in, look for the following characteristics

• The company should be an established company and should produce stable cash flow for a long time
• The company should not have rejected or reduced its dividends at any time in its history. Businesses have to go through different economic cycles all the time-like economic expansions, slowdowns, recessions and depressions and the company should have survived in all the difficult economic cycles.
• If the company has a repeated history of repeatedly raising dividends, it is a great company to invest in for dividends.

For a higher dividend yield, dividend investors need to look for market sell-off to buy stock in dividend-paying companies.

What is the percentage of earnings paid as a dividend? Is it a small percentage of revenue?

They need to search for companies that pay out a smaller percentage of their revenue as dividends to the shareholders. This is because when the business goes through a hard time, it should have a cushion of earnings to meet the dividend payments. If not, it needs to cut the dividends to preserve cash to fight the downturn.

Payout Ratio = Dividend per share / Earnings per share as a percentage

The lower the payout ratio the better. If the payout is 80 to 90 percent, that is dangerous because there is 10 to 20 percent cushion available. When a business goes through a recessionary economic cycle, business earnings might decrease more than 20 percent. The dividends need to be cut. This is a double whammy, the stock price and dividends are hammered.

Stock Research Checklist - Management

When you are dealing with fast growing companies, pay special attention to how the business has been growing recently and what plans the management has in place to grow the business in the future.

What is the Company's Growth Recently? What Plans does Management Have to Grow the Business?

As an investor, you need to look for companies that are growing slowly and steadily. If companies use the company cash flow to fund their expansion, then that is great. If company uses moderate debt, that is also acceptable. When a business expands slowly, it can execute its plan methodically. Slow and steady companies generate great shareholder returns over the long term.

Does the Company have Related Party Transactions with the Family Members of the Senior Management or Board of Directors?

You need to research at least three or four years of annual reports to research any related party transactions. If the company is doing business with any of the company's senior management or relatives who are involved in other companies, you need to avoid this company. When relative companies act as suppliers, they are likely paid top dollar for their products or services. That will affect the profit margin of the company, and in turn, decrease the share price of the stock. If the number of pages allocated to related party transactions increase every year, be cautious and need to dig deeper.

Another point to examine is whether the company is lending any money to senior management or directors. If the answer is yes, you need to sell that stock so that you can avoid losing money.

Are you able to understand the footnotes of the Company's Financial Statements?

When you are reading the financial statements of prospective companies, be sure to read the footnotes. If you are reasonably good at reading financial statements, you should be able to understand the footnotes. If you are not able to understand them because they do not want you to, move on to another company.

Is the Management Candid in its Performance Reporting?

If management only trumpets successes or tries to hide poor results, that will give you an idea about their openness. You need to find a company where the shareholders are treated like owners. If management treat shareholders as owners, they will talk about positives and negatives openly.

Does Management Deliver What it Promises?

When you are researching companies, you need to find out if management has delivered what they have promised in previous years such as:

• Future earnings outlook
• Company profitability plan
• Setting target growth rate of the companies
• What they want to achieve in five years

Stock Research Checklist - Capital Investment

Return on Asset = Net Income / Total Asset

Total asset consist of debt and equity. This percentage gives the percentage of net income generated for the money invested which includes both debt and equity capital. As long as ROA is high, company shareholders will be greatly rewarded.

What is the Company's ROA for the last 10 years? Is it growing constantly or at least maintaining an average ROA for the last 10 years?

You need to compare the ROA with competitors in the same industry. As an investor, you need to identify which industries are offering a higher ROA.

Does the Company have consistent ROIC numbers?

Here is the formula to calculate the Return on Invested Capital

ROIC = (Net Income - Dividends) / Total Capital

Total capital includes long-term debt and common and preferred shares. The higher the ROIC, the better it is for the investors. If the ROIC is very high, it means management is doing a great job of allocating capital profitably.

Does the Company need to spend large amount of money as a capital expenditure to stay competitive?

You should examine capital expenditures over time. If a company is spending large amounts of revenue as a capital expenditure, then it is not a great business. If a company is not spending large amounts of money, it is unlikely that it can be competitive in its industry. This applies to manufacturing and auto industries.

After capital expenditures, there will be less money available for other good things to increase shareholder value, such as expanding the business, buying back shares, acquiring other businesses and paying dividends. If a company is spending large portions of its revenue for capital expenditures, it will be difficult to spend money to increase shareholder value over time.

What is the Company's Investing Strategy? Is the Company Investing in its Area of Expertise?

When a company earns income for its owners every year and increases that income, the cash is going to pile up. You need to find out what a company is doing with that cash. When a company tries to invest those earnings back into growth, you need to identify where it is sinking its investment dollars. If its strategy is growing through acquisition, you need to find out how the company management plans on acquiring companies. Is the business that management hopes to acquire related to existing business, or is it a totally different business?

You need to also examine whether or not a company invests in its area of expertise. This is important. If a company tries to buy totally different kinds of business and then tries to integrate the new companies, this is a bad move.

What percentage of revenue is spent on Research and Development?

R&D is an important task for most business because it allows the business to invent new products, upgrade existing products, increase efficiency, and decrease production costs.

R&D is very important task for technology companies. If technology companies do not invent new products all the time, competitors can kill them and take their market share. Investing a certain percentage of revenue in R&D is important for a company's growth. Spending alone does not increase the revenue of the company. You need to identify how effective the current management is at generating returns on their investments. They have to generate a good return on their investment.

Compare similar companies in the same industry and their previous new product inventions and the revenue generated from those products. If the company is not introducing new products all the time, it is in danger of losing revenue. When you are looking at a company, pay special attention to find out how effectively its previous R&D activities delivered revenue. If you find a company that does have R&D expenses and has also grown more than 15 percent for the last five years then you have found a good company and do research from there.

Stock Research Checklist - Profit Margin

Net profit margin is a percentage in terms of how much net profit is generated from each dollar of revenue.

Net profit margin = Net income / Revenue x 100

If a company increases its earnings, that is good. The next thing you need to identify is whether or not a company can maintain that profit margin. A company can increase revenue and earnings by undercutting the competitors , but that is not profitable for the shareholders. The company cannot do that for the long term.

What is the Company's Net Profit Margin for the Last 10 Years? Does the Company generate a Consistent Upward-Trend Profit Margin or at least maintain an average profit margin?

What is the Company's Gross Profit Margin for the Last 10 Years? Does it consistently grow, or at least maintain an average rate?

A gross profit is how much money is left after the cost of goods sold is subtracted from the revenue numbers.

Gross Profit = Revenue - Cost of Goods sold

Gross Profit Margin = Gross Profit / Revenue

Inventors need to look for companies with higher gross profit margins. Sustainable competitive businesses have a higher percentage of gross margins when compared with competitive industry companies.

Does the Company have a high pretax profit margin?

Pretax income is calculated after interest expenses,and deducted from the earnings before interest and taxes and before income taxes are paid. Calculate pretax income will give you the true picture. Always look for companies with high pretax profit margins. When a company posts a higher pretax profit margin, it can invest that income for business expansion, acquiring new businesses, paying dividends, or buying back shares.

Stock Research Checklist - Equity

Return on Equity is how much profit the company is generating with the shareholder's money. As a shareholder, you can earn lot of money over time with a company that has a high ROE.

What is the Company's ROE for the last 10 years? Does it trend upward?

ROE = Net Income / Share Holder's equity

In EPS, management can do financial engineering to increase the figure over time, without increasing the earnings. If they buy back shares, which causes the EPS to increase. Buying back shares is a good thing for the company and shareholders but the intention to increase the EPS is not good enough. If the company uses more debt, it can generate a higher ROE. Generating a high return on equity with reasonable debt is a good thing.

Does the Company have more equity when compared with Long Term Debt?

Debt-to-equity ratio is one of the most important figures to examine. You need to look for companies with more equity than debt. That kind of company has a strong balance sheet, and investors do not need to worry about leverage problems. This kind of company makes more money for long-term shareholders.

When a company has more debt than equity, especially when the economy starts to slow, the company may feel financial pressure to make the interest payments or run the risk of violating the financial covenants. Situations like that quickly reduce stock prices, and long term shareholder values can be destroyed in short period of time. When a company uses leverage, it can generate more revenue and that revenue flows to the bottom line as earnings. If those extra earnings are sufficient enough to service the debt, pay down the principal debt balance and also add more earnings to the company, that is good.

If company has enough cash to cover the short-term debt, we can omit the short-term debt and use the long-term debt as the debt for calculations . Debt and equity ratio varies for different industries.

Stock Research Checklist - Debt

Debt
Debt is an important part of business. If it manageable debt, then it is acceptable. If the debt load is very high, it will be very hard for that business to succeed, sometimes the company will even end up in bankruptcy. The investors will end up losing all their money. Some industries are capital intensive, they have to use debt to finance their capital investment apart from equity capital. For example, industrial and manufacturing companies need to invest large amounts of money for factories in order to keep them up to date.

Does the Company have Manageable Debt?

If you find a capital intensive business at a bargain price. Here you can compare that company's debt level with a direct competitor. If the company can pay off total debt with five years of net income, then that should be a manageable debt. Find out when the current debt is coming due. If any debt is due within a couple of years, what kind of plan does the company have to pay off that loan? When the company has debt as a bond, it is less risk to the company. Long term bonds are a good kind of debt to have.

The economy goes through life cycles: recessions, recoveries and boom periods. If a company loads up on too much debt during boom years, it can generate a higher revenue and be able to service debt. When it enters into a recession, it will be hard to cut costs and reduce the debt as fast as the revenue decreases. It will be hard to handle the debt when the recession period starts.

Does the Company have Manageable Short-Term Debt?

Short-term debt translates into whatever debt a company needs to pay before one year. It appears on a balance sheet's current liabilities. This may be interest that needs to be paid on long-term debt. If any debt comes due, the company should have money to cover that debt. The company should have cash and cash equivalents, short-term investments, accounts receivables, hidden assets and cash flow numbers to pay the short-term debt. If the company does not have enough cash to cover that short-term debt, do not even look at the company because it may a sinking ship.

What is the Company's Current Ratio?

Current ratio helps you to find out whether or not a company has the ability to pay current obligations.

The formula of Current Ratio = Current Assets / Current Liabilities

What is the Company's Long Term Debt? Is it Manageable?

As a first choice, investors should look for companies that do not have long term debt. The companies may not have long term debt for any of the following reasons.

1. The company is operating in an industry where it does not need to spend a lot of money on capital expenditures.
2. Search for these kinds of companies because they can create more shareholder value over the long term. There is no risk of default because they have no longer term debt. Plus, company earnings are not reduced because of interest payments on long term debt.
3. The company may be in a sustainable competitive position to earn a higher profit and, in turn, generate a higher cash flow every year. Management can fund the growth of the company from existing cash flow rather than relying on debt. This kind of business is good and generates higher shareholder value over the long term.
4. When the input costs increase, sustainable-competitive-position companies can raise the prices and still maintain a decent profit. That is, management can expand the company via internal growth and spend capital expenditures from company profits rather than depending on debt. Companies like this can generate excellent value for shareholders over the long term. If you can identify companies with no long-term debt and a competitive position at attractive pricing, you should invest and hold those companies for the long term to generate a great return.

Reasonable debt means the company is able to repay the whole long-term debt within four or five years of net income. The best kind of debt is in corporate bonds with long term maturities and low interest rates. Investors cannot demand the principal payments immediately and also management can defer the interest payments.

Does the Company Pay Little or Not Interest Expense?

Durable, competitive companies pay little or no interest expenses for their short and long term debt. If a company does not spend money on its interest expense, this is good because it is a zero debt company. Reasonable amount of interest expense is acceptable, need to find out what percentage of operating income is spent as an interest expense. Determine whether this is consistent percentage or going down. If it is going up, this is a bad sign.

Does the Company have Preferred Shares?

Preferred shareholders have a higher claim on the capital structure of the company. They get paid a fixed dividend and have conversion rights to common stocks. If the company is in liquidation, preferred stockholders will have claim before the common stockholders get paid. This form of preferred stock is a costly form of debt because the company needs to pay the interest and have an equity appreciation potential for the preferred stockholders.

Stock Research Checklist - Earnings

Examine Earnings Growth 

Earnings Per Share (EPS) = Company Net Income / Number of Shares Outstanding

When you are using the number of outstanding shares, use the fully diluted shares instead of outstanding shares)

Here is the calculation to get the EPS growth rate

FV = Future EPS value

PV = Current EPS value

N = Number of years

As an investor, you need to question the reason when the earnings drop. Does the company have a temporary problem or is it going to produce reduced earning s in the company years? You need to read the annual and quarterly reports, listen to the company's conference calls, you will be able to find the reason for the revenue and earnings decrease. Always look for consistent earnings growth from a company so that you can reasonably predict the future earnings of the company.

How Does the Company Use the Retained Earnings? Do the Retained Earnings Reflect in the Stock Price?

When the management of a company invests earnings back into the business, that investment should yield a higher return because of retained earnings. When the management does a great job using retained earnings, it will increase the earnings of the company and in turn, increase the earnings per share.

Market price does not reflect the true value of the company in the short term. If you are looking at 10 years or more, market price will reflect the true value.

What are the Company's Owner Earnings for the Past 10 years? Does It Grow Consistently?

"Owner Earnings" are the earnings the owner can keep after the capital expenditure. The formula to calculate the owner earnings

Owner Earnings = Net Income + Depreciation & Amortization - Capital Expenditure

If the owner income trend increases over time, you can project the approximate owner income for the future. The number is not perfect.

What is the Company's Recent Earning Momentum? Is it Comparable to Its Long Term Growth Rate?

An investor's portfolio should contain some percentage of large capt stocks. When the market is in a downturn, these established company stocks go down less when compared with small or mid cap stocks. When you are researching established companies to invest in, one of the important tasks is to find out if a company's earning momentum matches with its long term growth rate. When the company is small, its growth rate may be very high. It grows very fast and reaches mid-cap status. When a company is a large cap, its growth rate may not be as high as small and mid cap growth but there will still be growth. The growth may be through internal expansion like expanding to new parts of the world, introducing new products, or entering new markets. The other part of expansion is through acquisition.

When you are researching a company, you need to find out if the company's growth rate in recent years matches with its long term growth rate. If the company keeps earning momentum, that is great and the company has passed this checklist item.

Does the Company have any One-Time Event that Recently Increased Earnings?

When you are analyzing a company's stocks, you need to find out if there were any one-time event that increased the company's earnings recently. If there are one-time events, you need to remove those earnings from your calculation of historic earnings so you can project the earnings conservatively. One time events could be a sale of asset and a big order from a particular customer.

What is the Company's "Operating Cash Flow"? Does It Grow at a Constant Rate?

Operating Cash Flow is cash generated from the company's operations. Cash flow numbers are calculated from net income, depreciation and adjustments to net income, changes in accounts receivable, changes in liabilities, changes in inventories, and changes in other operating activities. Cash Flow should be positive.

How has the Business Performed in Previous Recessions?

All companies need to perform in all business conditions. When the economy is on upswing, all businesses do very well. But you need to identify the company that has done better when the economy is in a state of recession, that company is the real winner.

Does the Company have Client Concentration?

Investors need to analyze the company's client base. Suppose the business is earning more than 10 percent to 20 percent of the earnings derived from the particular customer, that is a disadvantage.

1. The end customer can demand price reductions, which will affect the profit margin of the company because the big customer knows that the company relies on them heavily.
2. If the end customer's business depreciates , your company revenue will also come down which is not a good thing.
3. If that customer cancels the contract, there will be a big hit to the company's earnings.