The first stage in Sensible Stock Investing is to identify excellent companies as possible candidates for your investment dollar. One way to do this is with a point-based scoring system that assigns scores to the various aspects of a company's operations. Such a point system enables the individual investor, in a reasonable time, to score companies and rank them against each other.
There are three categories in which a company should be scored:
? The company's Story.
? The company's Financial Picture.
? Bonus Points.
The company's Story is a few sentences about what it does and how it makes money. Famed investor Peter Lynch said that before buying a stock, he liked to create a two-minute monologue about the company: what's good about it, what's necessary for it to succeed, what pitfalls it faces. Lynch said, ?Once you're able to tell the story of a stock...so that even a child could understand it, then you have a proper grasp of the situation.? It is an important part of any research into a potential stock investment to get the company's Story down cold. You should write it out to guarantee that you understand what the company does and how it makes money.
The importance of the company's Financial Picture should be obvious. The time-pressed individual investor needs to home in on the most important data and ignore the ?noise.? Financial information is abundant and free these days. The danger is getting lost in the deluge instead of extracting meaning from just the right elements. There are many financial factors that could be scored, but the busy individual investor should home in on the five or six most important ones. Examples would be rate of revenue growth, rate of earnings growth, the company's dividend policy, and so on. You do not need financial or accounting training to do this--the numbers are all available for free and precomputed--you just need to look them up.
Sometimes your eyes will pop out as the financial picture takes shape--because not all highly touted companies are as sound as you might think, while others that you hardly ever hear of have beautiful businesses that are virtual cash-generating machines. In scoring the financials, the truly excellent companies rise to the top of the rankings, and the bad ones sink like stones. Every time.
Bonus Points are awarded for third-party opinions, such as Wall Street's analyst ratings. They do not comprise a high percentage of the company's total score, but they can be useful and should not be ignored.
In a nutshell, that is how excellent companies worthy of your consideration are identified. It is not as much work as it may sound like. It takes about an hour the first time you score a company, and periodically updating the score takes maybe 10-15 minutes.
This is time well spent for the huge advantage it gives you over other investors who do not do this most basic of homework.
