When it comes to making investments, financial advisers will often ask you whether you’re interested in capital growth or income. Now we all know what they mean by this question, but it is a misleading one for most people. The fact is that if you’re enjoying index-beating capital growth by a distance, you really won’t be too concerned about income. After all, you can sell off a few investments and use that as income.
So the best focus for private investors is really the overall bottom line one; what progress did you make over what period of time and how does this compare to the main relevant indices and inflation. Elsewhere on this site, you’ll read about the dangers of focusing blindly on high yield shares without looking at how well the dividends are covered and what the companies’ fundamentals look like.
Look At A Stock’s Fundamentals
When it comes to dealing with debt and comparing that against companies’ yields, it’s often both necessary and wise to settle for a lower yield, but safer fundamentals; low price to earnings ratios, and low debt, or better yet, no debt whatsoever.
And if you look hard enough, there are plenty companies out there with a reasonable yield that looks well covered and sustainable through the supply of absolutely essential goods and services from companies which also happen to have rock solid balance sheets.
These are the places to put your money (or in collective investment vehicles specializing in such defensive stocks) if you’re looking for a little of both; income and growth. In such companies, you will generally tend to receive a good income and capital growth without worrying about whether to focus on one or the other.
There are some ratios that you can look at to help determine a company’s overall health. Below are two to help you get started, but remember that there are tons more you can reference such as Return on Equity, Return on Assets, Net Working Capital, Debt to equity and more.
This ratio tells you how much short-term capital a company has available to cover short term obligations. It is calculated by dividing current assets by current liabilities. Numbers above 1 indicate the company has the short term assets to meet their obligations. This is a good sign.
Net Profit Margin
This is expressed as income after taxes divided by total revenue. The higher the percentage, the higher the profit margin. For a company to sustain adequate growth while maximizing shareholder value, high profit margins are necessary. Good profit margins vary from industry-to-industry. Agricultural Chemicals can make upwards of 20% profit margin, whereas retail can get down into the anemic 1%-3% range. Examining profit margin by industry should give you a good idea how your company is doing.
Just remember to spread the risk around as there’s always the possibility of some kind of “Black Swan” event, even with what are seemingly very safe, and conservatively-run firms.