There’s no one checklist that can tell whether a stock is attractive. That’s because stocks represent part ownership in businesses as different as egg farming and semiconductor etching. However, there are signs that bode well for any stock. Below are four.
They aren’t must-haves, but the appearance of at least a few of them bolsters the case for an otherwise appealing stock and can reduce investor risk.
Rising Earnings Estimates: People are slow to let go of long-held beliefs, even as mounting evidence says they should. That includes Wall Street analysts. The result is that consensus earnings estimates tend to change gradually rather than all at once. Buying into rising estimates increases the chance that more good news is coming. WSJ.com and Yahoo Finance are among sites whose stock-quote pages show current earnings estimates as well as how those estimates have changed in recent months.
Room for a Higher Valuation: Value investing works. That is, shares that are inexpensive relative to some measure of economic appeal, like earnings, revenue or asset value per share, tend to outperform those that are expensive over long time periods. Not every cheap stock shines and not every pricey one flops, of course, but most investors will improve their odds of success by sticking with modest valuations.
One reason is that people tend to assign too large a negative value to company flaws or challenges. Research by Brandes Investment Partners, a San Diego money manager, shows that value stocks tend to outperform even though the companies attached to them, on average, don’t catch investors by surprise with bright financial results. In other words, most stock discounts are simply too large.
Growing Dividends: There’s a high-finance theory that dividends don’t matter, because companies can extract just as much value from their spare cash by buying back stock or investing. Ignore it. Dividends provide far more than income. Payment hikes signal confidence, because managers are loath to cut payments, and so tend to increase them judiciously.
Dividends help attract buyers during difficult patches, because dividend yields rise as share prices fall. And they act as a check on accounting, because it’s hard to fudge the act of putting cash in someone’s pocket. Favour moderate yields with healthy payment increases over high yields with little growth.
Executive Buying: When company managers spend their own cash on shares, it’s an excellent sign. Technically, managers may not use nonpublic information to time stock transactions. Realistically, their deep experience and close view of daily operations gives them an informational advantage most investors can’t match. Fortunately, such transactions must be quickly made public.
(Wall Street Journal)
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