Stock Market Success for Beginners

C- P / P = R

C = Current Year Revenue

P = Past Year Revenue

R = Rate of Growth in Revenue

This is the most popular way of tracking revenue as a change from year to year in percentage terms. If a company's annual growth remains the same or consistent, it's a very positive thing since the company is well managed is not just riding a current trend.

Where It Can Be Found: This number can also be found on a number of stock screeners and financial sites such as Yahoo! Finance and Google Finance as well as the Scottrade stock screener.

Sales per Share.

Sales are the main driver of revenue for most companies. Therefore, it is necessary to calculate sales per share for the company as well as look at the trend of this ratio. Here is how to obtain it

SPS = R / S SPS = Sales Per Share R = Past Year Revenue S = Average Shares Outstanding.

For growth companies, it is good to look for increasing sales over the past five years. ²³ On the contrary, value companies whose shares have gone down in price but are still showing a positive SPS trend are wonderful bargains.

Where It Can Be Found: This number can also be found on a number of stock screeners and financial sites such as Yahoo! Finance and Google Finance as well as the Scottrade stock screener.

23 John D., CFA Stowe, Thomas R., CFA Robinson, Jerald E., CFA Pinto, and Dennis W., CFA McLeavey, Equity Asset Valuation

Tracking Earnings

In order to fully analyze growth trends, it is necessary to look not only at revenue growth, but also at earnings growth. If the company reports increases in revenue, but is at the same year losing earnings, it's not a company an investor wants to be interested in. Traditionally, earnings growth is measured with this formula

C- P / P = E C = Current Year Net Earnings P = Past Year Net Earnings E = Rate of Growth in Net Earnings

Where It Can Be Found: This number can also be found on a number of stock screeners and financial sites such as Yahoo! Finance and Google Finance as well as the Scottrade stock screener.

However, as previously mentioned before, the net earnings from a company's income statement can be manipulated and is not always the most accurate one. To get a clearer picture, it is better to utilize core earnings found on the S&P stock report.

CC- PC / PC = E CC = Current Year Core Earnings PC = Past Year Core Earnings E = Rate of Growth in Core Earnings

It is also necessary to compare the difference between net earnings growth and core earnings growth, as previously stated in order to gauge how honest the company is and how honest the management of the company is and if there is any creative accounting going on.

Earnings per Share

Earnings per Share is considered to be a key ratio is deemed instrumental in judging the value of a stock. It is calculated by this formula traditionally

N / S = E N = Net Earnings (Year) S = Shares Outstanding E = Earnings Per Share or EPS

To further clarify this, since the shares outstanding fluctuate throughout the year, the shares outstanding number should be calculated as an average. ²⁴

Where It Can Be Found: This number can also be found on a number of stock screeners and financial sites such as Yahoo! Finance and Google Finance as well as the Scottrade stock screener. Some data sources may use the number of shares outstanding at the end of the year to simplify their calculation, so be careful to get the correct number.

24 Investopeda

However, as previously mentioned, in order to get a clear picture, in calculating earnings per share it is necessary to use core net earnings.

CN / S = E CN = Core Net Earnings (Year) S = Shares Outstanding E = Core Earnings Per Share or EPS

The EPS is a representation of a company's profit divided by a share of common stock and is often tracked by analysts as the most important indicator of the price of a share, but can be easily manipulated, so in this paper it will be considered a bit further down the line. Companies have EPS estimates that they try to reach every quarter and price may fall if they are not reached.

Comparing Revenue to Direct Cost and expenses

In order to understand why the revenue has increased or decreased as well as why the earnings have gone up or down, the investor should look at the relationship between the revenue and gross profit.

R - DC = GP

R = Revenue

DC = Direct Costs
GP = Gross Profit

Direct costs include anything that relates to the generation of revenue. They should remain constant from year to year unless a specific event such an acquisition, change in mix of business or valuation methods for inventory will change. Therefore, the trend for revenue and growth profit should correlate from year to year.

The percentage of growth profit to revenue is called growth margin. This number should stay about level from year to year unless one of the aforementioned events happens in the company.

G / R = M G = Gross Profit R = Revenue M = Gross Margin

Where It Can Be Found: This number can also be found on a number of stock screeners and financial sites such as Yahoo! Finance and Google Finance as well as the Scottrade stock screener.

Expenses to Revenue

The picture becomes even clearer when expenses are compared to revenue. Even though expenses do not directly influence revenue, because they can include factors such as interest expense, electricity bills and salaries of employees that are not directly related to generating revenue, the movement of expenses should correlate on some level with the fluctuations in revenues. The rate of growth in expenses can be calculated as

C- P / P =E C = Current Year Expenses PC = Past Year Expenses E = Rate of Growth in Expenses

Once this has been calculated, the investor can compare the ratio of expenses to revenues using this

formula

E / R = P E = Expenses R = Revenue P = Ratio (Percentage)

The consistency in this over the years can mean several different things. It means a good internal control system and efficiency, and that management is keeping expense level well and overhead costs down in order to generate revenue.

Where It Can Be Found: These numbers must be calculated

Operating Profit Analysis

The operating profit is the profit from all core activities, or continuing operations. This is the number that should be watched in order to quantify growth potential. The first formula to look at in this case is the rate of growth in operating profit. It's very similar to the rate of growth in net earnings, but it excludes all other income and expenses and focuses only earnings from operations.

C - P / P = R C = Current Year Operating Profit P = Past Year Operating Profit R = Rate Of Growth In Operating Profit

Where It Can Be Found: While most financial websites will not have it, brokerages a lot of times provide a research report for a stock compiled by Reuters which will provide this number. If not, it can be calculated.

Cash Flow Statement Analysis

Free Cash Flow

On a statement of cash flow, the investor should look for companies that produce a lot of free cash flow. This can be calculated by the following formula:

NI + (A or D) - C- E= FCF NI= Net income A= Amortization D= Depreciation C= Changes in working capital E= Capital expenditure FCF= Free Cash Flow

This is the money that allows the company to pay debt, dividends, repurchase stock and increase business growth. It is the excess cash produced by the company and can be either returned to share holders in terms of dividends or invested in new growth opportunities.

It's good if a company can pay for the investing figure out of operations cash flow without having to rely on outside financing. This signals very strong fundamentals.

Where It Can Be Found: While most financial websites will not have it, brokerages a lot of times provide a research report for a stock compiled by Reuters which will provide this number. If not, it can be calculated.

Net Cash Flow per Share

Cash flow is the stream of money through a company. It measures how the company is receiving its money and if they get paid as they sell or if they sell a lot on credit to make their revenues look bigger. This number should be looked at as a trend over five years, and the investor would want it to increase. It is calculated as follows

C / S = R C = Current Year Net Cash Flow S = Average Outstanding Number Of Shares Over The Year R = Net Cash Flow Per Share

Where It Can Be Found: Most financial websites will have it, and brokerages a lot of times provide a research report for a stock compiled by Reuters which will provide this number. If not, it can be calculated.

Estimating Intrinsic Value Using DCF

There are several ways to estimate the intrinsic value of a company, and we found the Discounted Cash Flows formula to be used by Warren Buffet. The formula is complicated, and calculating it is out of scope of the average investor's expertise, but a formula calculator can be found here. http://www.moneychimp.com/articles/valuation/dcf.htm

Figure 6 - Discounted Cash Flow Calculator Screen

Source: http://www.moneychimp.com/articles/valuation/dcf.htm

Some things here need to be explained. Earnings per share should be put in here as the core earnings found from the S&P stock report. The earnings growth projections can be found on a number of financial websites as well as the Reuters Research Report. The investor should assume that the earnings growth rate will level off to 0 after 5 years to give him or herself a «margin of safety.» In addition, on average the S&P 500 is usually growing by about 11% annually, but for additional safety the investor may want to decrease that number. Then just click calculate and the calculator will do all the complicated formula number crunching!