Learn how to compare stocks to buy and stop losing money in the market!
Hey Bow Tie Nation, Joseph Hogue here with Let’s Talk Money and welcome back to our special three-video series on how to invest from understanding how goals are the most important part of investing to creating a portfolio and this video, how to tie it all together with buying stocks that are going to give you those returns you need!
Nation, I gotta tell ya. As important as those last two videos are, and honestly I think those higher-level investing decisions are more important, but the old equity analyst in me is psyched about this video.
This is where I get to show you how I picked stocks working as an analyst, how I compared stocks to invest in only the best of the best.
In this video, I’ll reveal the two ways to compare stocks so you can always know what to put in your portfolio. We’ll compare four stocks, head-to-head, to see which has the best potential for those double-digit returns.
Ways to Compare Stocks
Now those of you in the Nation have heard me talk about this but there are two ways to compare stocks and this is going to be extremely important in making sure you invest in the best. First is you can compare the company’s financial ratios against others in its own sector or industry.
Remember, the stock market and really the economy, is categorized into sectors or groups of companies that serve a common purpose. The 11 sectors are broad categories like real estate, technology and energy. Within each of these sectors, you have industries that produce a common product so software, food processing, biotech are examples.
And because the business fundamentals are so different from one sector to the next, it really doesn’t tell you as much if you’re comparing stocks in one sector against those in another.
For example, you wouldn’t compare Apple against the consumer staples company Campbell’s Soup. Utility companies have super-stable cash flows so they can take on more debt safely. The debt-to-equity of Apple would be really high compared to Campbells but wouldn’t necessarily tell you Apple is taking on too much risk because you don’t know what it is compared to other tech companies.
Alternatively, if you just looked at the operating margin, so that core measure of profitability, Apple looks like a slam dunk with a 25% margin versus just 15% for Campbells, but we really don’t know how Apple looks against other tech companies that typically have higher margins versus companies in food processing.
How to Compare Stocks
So you absolutely have to measure companies against others in the same sector or industry and while you’re doing it, you want to ask yourself three questions.
First are most of the ratios better or worse in one stock compared to the other, does one company have a clear advantage? Second, is the advantage consistent over a long-time, does it come from a clear competitive advantage. And third, is that advantage already reflected in the stock prices?
I know, it’s more than plopping down on the couch to get stock picks from CNBC, but this is how you need to be thinking if you’re going to be picking stocks. We’ll look at a couple of examples later that will make it all simpler.
The other way to compare stocks, and understand you need to be using both of these basic investing strategies with every stock you buy, is comparing those fundamentals, those ratios with the company’s own history.
And most investing platforms will show you this kind of historical data, I’m using Morningstar here. And we can see, for example, Apple’s return on equity has been trending up, so that’s good, but it’s financial leverage has also been trending higher so basically it’s using more debt to boost its earnings.
We see that all three profitability measures; that’s gross, operating and net margins have all been trending lower since 2015. That’s definitely something we would want to look into, whether competitors are seeing that same lower trend in profitability or if it’s just Apple.
Now you can do all this researching on your own, digging into the financial statements or clicking back and forth between stocks. What’s always been more difficult is comparing a stock’s ratios against the average for its sector, so how is that company doing against the group as a whole?
That was one of the main reasons I wanted to create our Let’s Talk Money spreadsheet, to create that tool to compare stocks against each other and against each sector. I’ll show you how to do this in the two examples next, but you just put in two stock symbols and click compare, and the spreadsheet is going to pull from the internet these ten financial ratios plus the average for their sectors.
I’ll leave a link to download the spreadsheet below as well. The spreadsheet was three months in the making and includes some great features like portfolio tracking and creating your goals so make sure you check that out.
How to Find the Best Stocks to Buy
Now tying this all in to our three-video series on how to invest, we saw in that last video looking at Jeff’s portfolio that he needs some investments in the consumer defensive sector to balance out his portfolio. If after looking at a few consumer staples companies, we decide we want to look a little closer at Kimberly-Clark, ticker KMB, and Colgate-Palmolive, ticker CL.
We enter the stock symbols, click Compare, and the spreadsheet is going to automatically find this data on each stock.
So we see that both of these companies is in the consumer defensive or consumer staples sector and we get these ten financial ratios for each from Price-to-Earnings ratio to the profitability and dividend measures. All this information downloads automatically from an online database that I pay for to use in the spreadsheet.
Not only can we compare the two stocks against each other though, we can also see how each company stacks up against the average for the sector. This is something you won’t find anywhere else because I had to create this myself, by finding an average for each sector and updating the database every quarter.
Let’s look at another example and let’s say we’re interested in tech stocks, specifically social media, so we want to compare Facebook and Twitter.
We can see the PE ratio for Facebook is about twice as high as Twitter but earnings growth must also be much higher because the Price-to-earnings growth ratio is almost three times as high on shares of Twitter when you include that earnings growth measure.
Facebook’s operating margin is way higher than Twitter, Facebook’s management is able to convert about a third of it’s sales into operating profits while Twitter is only able to convert about a tenth so much more profitable on an operating basis.
And we can go back and compare the two stocks against the average there for communication services companies. Facebook is relatively expensive here on a PE basis and even a little more expensive when you account for its faster earnings growth as well. The operating profit of 34% is almost double the 18% average for the sector so confirmation there that the company is really operating efficiently.
Even if you don’t use the spreadsheet, that gives you an idea of how to compare stocks, both against each other and against the sector average. Remember, you can also compare these numbers, these financial ratios for a company against the stocks’ own history.