I’ll walk you through how to analyze a stock by taking a look at IBM’s financial data. Would I buy IBM? Should you buy IBM?
Find a Wonderful Business
Pick a business that you understand. You may be asking yourself, how do I do that? Think about places you shop, brands you use very often. Chances are you’re more of an expert on that product than you think you are. If you spend a lot of money on health and wellness then find a company in that sector. In this example we will be choosing IBM
Know What It’s Worth As A Business – Analyze A Stock
Once you’ve identify a business (IBM), find out how much it is worth. In order to find out how much it’s worth take a look at the companies financial statements. For this strategy you’ll need to look back on the last 10 years of data. I use stockrow.com because the site is free and allows the 10 years of data to be easily accessed. You can use whatever site you’re comfortable with that provides the same data.
- Once you’re on stockrow.com look up the ticker you want to analyze
- Go To ‘Financials’ Section and download the income sheet, balance sheet, cash flow, metrics & growth
- Once you’ve downloaded your data condense them onto one excel sheet to be able to easily access values needed. You’ll want to calculated your data at the 3, 5 and 10 year mark. The perfect scenario is these are all positive and at least 10%, then you’ve identified a very strong company. If they are slightly below it may still be a good company, but these I’ll go into more detail below. If you want even more details these two books cover the topic greatly: Rule #1 – Phil Town & Invested – Phil Town & Danielle Town
1. Sales / Revenue Growth Rate
The Sales Growth Rate of a business is the the rate at which it is growing its sales year over year.
2. ROIC / Return on Invested Capital
ROIC is Return on Invested Capital, the single most important number to tell you if a business is being run well or not. The number should be equal to or greater than 10% per year, but the real key is seeing if the ROIC number is going up over time. If it’s at the same level or going up, then the business is probably well run. If the ROIC number is going down, it means that the CEO is reinvesting the surplus cash and getting a smaller return on it than in previous years.
3. EPS / Earnings Per Share Growth
EPS stands for Earnings per Share. Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The resulting number serves as an indicator of a company’s profitability.
4. Free Cash Flow
The Operating Cash Flow Growth Rate (aka Cash Flow From Operations growth rate) is the long term rate of growth of operating cash, the money that is actually coming into the bank from business operations.
5. Equity / Book Value Per Share
The Equity Growth rate is the rate at which a company is growing its equity. It is important to see that this number is steadily growing over time.
Buy It At A Huge Percent Off
In order to buy a company at a discount you must first understand what it’s real cost is.
1. Future EPS / Future Earnings Per Share
You’ll need excel for this calculation. First, determine the growth rate you wish to use to make a projection of future Earnings Per Share then type this formula into excel
First, determine the growth rate you wish to use to make a projection of future Earnings Per Share.
In Excel / Google Sheets, type =FV( and you’ll see the formula below appear: =FV(rate, nper, pmt, [pv])
The bolded abbreviation rate means you should enter the growth rate you have determined, typed in
as a percentage, and followed by a comma. =FV(10, nper, pmt, [pv])
The bolded nper should be 10 (the number of years into the future for this estimate), followed by a comma.
=FV(10, 10, pmt, [pv])
The bolded pmt can be skipped, so just enter another comma.
=FV(10, nper, , [pv])
The bolded pv is the number you want to start with. Input it as a negative number. Let’s say that in our
example, the current EPS is $1.43 per share, which is entered as -1.43. Then close the parentheses.
=FV(10, nper, ,-1.43 )
Hit Enter and you’ll have your Future EPS
2. Future PE
To calculate future PE take the Current Share Price / Estimated Future Earnings per Share.
For example, assume that a company has a current share price of $50 and this year’s earnings per share are $5. Analysts estimate that the company’s earnings will grow by 10% over the next fiscal year. The company has a current P/E ratio of $50 / 5 = 10x.
3. Calculate Sticker Price & Margin Of Safety
The Margin of Safety is the discount rate you can buy a wonderful business at, which is generally 50% off the Sticker Price, or fair value of the company’s share price.
To find the Margin of Safety, you first need to find the Sticker Price of a business and its stock. In order to evaluate the Sticker Price you want to find the Future Growth Rate, the P/E Ratio, and your Minimum Acceptable Rate of Return. The Future Growth Rate is always an estimate, the other numbers you can find on financial statements and plug them into the calculator above to see the value, or Sticker Price, of the company’s stock. Next, you simply cut that price in half (or take 50%) and that is your Margin of Safety price.
Repeat – Analyze A Stock
Once you’ve done this a few times calculations will get easier and can be performed faster. Using this method will help you choose profitable stocks that are under valued. The analysis for IBM was a would not recommend solely based on the numbers, even though I know it is a popular dividend stock. I however would not personally purchase it despite it’s popularity.
Disclaimer: I am not a financial advisor and I’m not providing any suggestion, these are just steps that I’ve taken that have helped me analyze stocks.
Prefer video format over print? Watch the video to find out how to analyze IBM or any other stocks you’re interested in purchasing
Referenced Material / Books
Rule #1 – Phil Town
Invested – Phil Town & Danielle Town