Expert: Paul Henneman - 10/28/2004

Question
Hello,

What are some key things you look for in a stock before you invest in it?  The financials contain so much information, I get overwhelmed by it all.  Are P/E radio and earnings the main things?

Thanks,
Joe

Answer
Joe, thank you for your question!
Yes, financial statements and all of the data can be overwhelming. You do mention what I would consider the two most important data points: P/E ratio and earnings. It is good to look at other things, but these two indicators will really help you decide if the stock is worth looking more into.
P/E ration and earnings should be considered in three ways: their current level, the historical trend for both data points, and how these relate to the company's competitors. For example, earnings may be good, but declining over time. If you do not look at historical earnings, you would miss this. Earnings should be growing over time consistently.  It is also very important to look at other companies in the industry, to see how their earnings compare. For example, a p/e ratio of 20 by itself is relatively meaningless. But if this has grown from 15 over the past year or two, and the average P/E ratio in that industry is 15, it is much more valuable information.
The difference between p/e ration and earnings is also important. First, I would look at earnings to see if this is attractive. Are earnings growing and do they compare favorably to other companies in the industry. If yes, then p/e ratio will give you an idea as to how much this favorable earnings history is already built into stock price. Ideally, you are looking for a good track record and growing earnings, with as low a p/e ratio as possible. There may be great earnings history, but the p/e ratio may be very high, meaning that it is already built into the stock price.  William O'Neil is a well know writer and founder of Investors Business Daily on this subject. His book 'The Successful Investor' may be a bit more detailed than what you are looking for, but goes into depth on how he uses earnings and p/e ratio to identify good stocks. It is available at most major book stores and on www.amazon.com if you are interested.
I hope this helps! Please do not hesitate to follow up with me if I can be of any further assistance,

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com
www.VEInstitutional.com
www.VEReports.com