Two Questions That Will help You Figure Out If A Stock Is Right For You

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October 7, 2013 12:07pm NYSE:FXD NYSE:PKW

question: In the early 1990s, as soon as I would get home from work, I’d turn on CNBC’s predecessor FNN, soaking up all of the financial wisdom that I could. At that time, I was just learning about


stocks.

I listened to some of the ideas and on weekends would hit the library (remember those?) to research the companies I’d heard about earlier in the week.

Less than a decade later, CNBC was more popular than ESPN. Stock investing ideas were everywhere thanks to the Internet, and what once took hours to research now took minutes.

That made for information overload for some investors. And I have to admit, I’m part of the problem.

Each week, I write several columns on investing strategies, stock recommendations, and ways to create and protect wealth.

And over the past few months, I’ve become a regular on CNBC. Nearly every week, I’m on their “Talking Numbers” segment (you can see my appearances here). I’m usually given about a minute and a half to present my bullish or bearish argument on a stock. Sometimes I get to counter what the other analyst said.

I’d be lying if I said I didn’t enjoy it. And the recognition that comes with it. I’ve had hedge fund managers, friends and even my middle school assistant principal contact me saying nice things after they saw me on TV.

But I hope investors are smart enough not to run out and buy or sell a stock just because I (or anyone else) said to on television. Instead, the ideas that you hear on TV, newspapers or even on Investment U should be a starting point for your research, not the end.

The word “research” scares a lot of people. So here are two questions to answer that will help you figure out if a stock you see me talking about on CNBC is right for you.

1. Are Earnings Moving in the Right Direction?

Over the long term, stock prices follow earnings. If a company’s earnings consistently go up over time, its stock price should, too.

It’s very easy to figure out which direction a company’s earnings are going. Just go to Yahoo Finance, enter the ticker symbol or name of the company, and click on Income Statement on the left side. It will show you the company’s net income over the past three years.

Notice I didn’t say earnings per share. That’s a number many Wall Street analysts focus on, and it’s the number we use when citing a company’s price-to-earnings ratio. But I’m more interested in the overall profits of a company. Earnings per share can be manipulated by changing the share count.

For example, if a company makes $1 million and has 1 million shares outstanding it earns $1 per share. If the next year it makes $1 million but bought back 100,000 shares, it earns $1.11. That’s despite the fact that it made the same $1 million a year.

This is the income statement for Macy’s, Inc.(NYSE:M). You can see from the net income line at the bottom that earnings have risen every year.

Incidentally, Macy’s stock has performed very well over the past three years, up about 87%.

2. Is Cash Flow Following Earnings?

Folks sometimes confuse earnings with cash flow. Earnings, also called net income or profits, are reduced by all kinds of non-cash expenses such as depreciation and amortization. Those expenses lower profits (and taxes) but have no bearing on how much cash the company took in.

Non-cash expenses are not included when we calculate cash flow.

Fortunately, you don’t have to calculate cash flow yourself. You can find it in the same place as the income statement. Just go down two links and you’ll see cash flow.

Generally speaking, we want to see cash flow from operations going up every year. If earnings are rising and cash flow is not, that warrants further investigation.

In Macy’s case, we can see that cash flow from operations has steadily climbed over the past three years.

If cash flow from operations is going down while earnings are going up, you’ll want to understand why. Sometimes that can be a red flag that the company’s earnings aren’t especially stable.

However, if earnings are moving in the right direction and cash flow is following earnings, then you’re starting from a very good place. Obviously, you’ll want to do more work and see if earnings and cash flow are likely to continue rising. If you believe they will, that is a good candidate for a stock to add to your portfolio.

So the next time you see me on CNBC, you’ll know what to look for when we go to a commercial break.

Good investing,

by Marc Lichtenfeld, Chief Income Strategist, The Oxford Club

Investment U provides cutting-edge research and strategic financial recommendations for all levels of investors through its morning publication Investment U Daily and its related publications.

 

The following Funds hold Macy’s Inc and have the exposures noted. You can sort any column of data by clicking on the heading. 


 

Composite Ticker  ↑↓ Weighting   ↑↓
$MVR 2.46%
PWV 1.36%
VOE 1.36%
RCD 1.16%
PKW 1.07%
XRT 0.98%
XLY 0.87%
FXD 0.84%
VCR 0.83%
VO 0.71%

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