Should I buy stock in Company X? - Part 3

Continuing from our previous post, Kid's Toy Store revenues were $100,000 for the year and they reported $3.40 EPS.  Is this good or bad?  I do not know.  These numbers do not really tell us anything in isolation.  We need to compare the company's performance to that of a competitor within the same industry to determine if the numbers are 'good'.

Here is an example to help illustrate the point. I have a vehicle that gets 20 miles per gallon. My friend’s vehicle gets 10 miles per gallon.  At first glance, my vehicle appears to be the better option. However, this assumes my friend’s vehicle is the same type as mine.  I have a Toyota Corolla and my friend's vehicle is a big 2-Ton moving truck that he uses for his business.  A comparison between the two vehicles is not a fair one, even though we are using the same unit of measurement – miles per gallon.

Likewise, companies must be compared to one another that are in the same industry.  Additionally, a company can be compared to their specific industry's averages.  Let us compare Kid’s Toy Store revenues of $100,000 and an EPS of $3.40 to Children’s Toy Store, a competitor, revenues of $250,000 with an EPS of $5.60.  Also, the retail toy industry average annual revenues are $300,000 and the EPS is $6.20.

Using this data:

                Are Kid’s Toy Store sales higher than Children’s Toy Store?  No.

    Are the earnings greater than Children's Toy Store?  No.

                Does Kid’s earnings and revenue exceed the industry averages?   
                    No, their earnings are below industry averages.

 Kid’s Toy Store does not seem to be performing well, based on the initial comparisons.  Revenues and earnings are only a few factors to consider when performing fundamental investment analysis (which is what we are doing).  Other factors are how much debt does a company have, is management doing a good job of controlling expenses, and does the company distribute some of the profits (earnings) to shareholders?  We’ll explore these in upcoming posts.

Hey, now its time to take a break and grab a snack. Reward yourself, you have earned it. Learning to invest is a process, do not give up. Soon you will have the knowledge to buy and sell shares in the Stock Market. Once you have made money based on what you have learned, you’ll see that it was all worth it.

What should I buy?

In the previous post, I discussed the process of placing an order to buy 10 shares of McDonalds. I could have chosen a different company to purchase. Why McDonald's? McDonald's was just a company I chose for the example. But, what if I was ready to purchase some shares of stock, how would I know the right company to choose? The 'right' company depends on several factors. Determining which company to invest your hard earned dollars can be challenging, but not impossible.

As a beginning investor, I'd suggest that you think about the products and/or services that you use personally or in your profession. Is there a particular product or brand of products that you must have or use? Take a few moments to think about this. Also, what if the product that you are use to using is out of stock, would you easily buy a competitor's product or would you go to another retailer.

I'll give a personal example. I love french fries. From 1990 until 2003, I used to only buy one particular brand of french fries, Oreida. It was not uncommon for me to purchase a two pound bag and within a week, I would have cooked the entire bag, however, not all at once. If the grocery store was out of Oreida's, I would very seldom try another brand. When I did, I was always disappointed. After experiencing this several times, I would either go to another grocery store or delay my french fry purchase at that time. Then something strange happened around 2002 or 2003. Orieda changed the formula of their french fries. I could taste it instantly, however I tried the 'New and Improved' version, but to no avail. It just wasn't the same and I could not find a quality replacement for a long time, so I stopped cooking french fries at home.

So if I were looking for a company to invest during the mid 1990s, I might have considered investing in the producer of Oreida french fries, which happens to be the H. J. Heinz Company. But is H.J. Heinz Company a good investment? Are there other people like me who love their french fries? What other products do they produce? These are just a few questions I must ask when considering purchasing a company's stock. There are many other question that must be answered, but we will discuss those later.

Are there other products or services that I'm loyal to because of outstanding quality or performance? After compiling a list and identifying all the companies that produce these products or services, I'll select a few companies to research further.

What happens next?

After you have placed your order, your brokerage firm tries to execute or fill your order. So using our previous example, you placed an order to buy 10 shares of McDonald's. Your broker must find someone who owns 10 shares of McDonald's that is willing to sell them for $25.00 per share. Where will the brokerage firm find such a person? Buyers and sellers hang out at the market, well not literally.

Actually, there are many markets and they are called exchanges. The two most famous exchanges in the United States are the New York Stock Exchange (NYSE) and Nasdaq. Both exchanges perform similar functions but, the NYSE uses people to conduct the business of buying and selling, whereas the Nasdaq uses computers exclusively to execute the orders. The execution of an order is commonly referred to as a trade.

If your broker was successful in executing your order, 10 shares of McDonald's (MCD) you be credited into your account and the total cost of the trade will be subtracted from your account balance. For instance, if your broker's commission is $10 then the entire cost of the trade is $260.00.

How do I buy or sell shares?

In my previous post, I discussed the concept of shares (company ownership). Some may be thinking how can I purchase shares of a company? Well the answer is through a brokerage firm. A brokerage firm is a company that is licensed to buy and sell shares of stocks on behalf of its clients. You must open an account with one of these firms and put some initial cash into your account in order to buy or sell stocks.

Today, you can open an account with an online broker which provides you the ability to place orders using your computer and an Internet connection. Etrade, Charles Schwab, and TD Waterhouse are examples of online brokerage firms. Typically these firms do not provide specific investment advice, however, they do offer company research reports to aid you in your analysis of a particular company.

Above, I referred to placing buy and sell orders. What is meant by this? An order is the intention to buy or sell a specific number of shares of a specific company. Think of it like this, if you go to a nice restaurant and your waiter asks you what would like to eat and you reply with a salad, grilled salmon and a Coke. You have placed an order. Its the same with buying or selling stocks. First you must identify which company you want to buy or sell. For example, let's say McDonald's is your choice. Next you must identify what type of order; buy or sell. Then you need to indicate the number of shares you intend to buy or sell. OK, lets see what we have so far. You want to buy 10 shares of McDonald's, but there is one thing missing. How much is this going to cost? Well that depends on the price of a single share of McDonald's.

Where do you get this information? The share price of a specific company stock is called a quote. In order to get the price (quote) you must know the ticker symbol for the company in question. A ticker symbol is an abbreviation used to identity a specific company. Every company that has shares for sale will have a ticker symbol. In our example, McDonald's ticker symbol is MCD. You can obtain quotes and symbol lookup information from your online brokerage account. Google and Yahoo also provide this information quotes.

In a future next post, I'll talk about how share prices are determined. After looking up the quote for McDonald's, we see the share price is $25.00. So the total cost of buying 10 shares of McDonalds is:

• $25.00 Dollars
  
• X 10.00 Shares
  
• -----------------
  
• $250.00 Dollars (plus commissions)
  

$250.00 is not the final cost of your order. You must also pay a fee (referred to as a commission) charged by your broker to place the order on your behalf. Another way of saying the same thing is, you must pay a commission to your broker for executing this trade. Commissions range from $8 to $20 for a single order with an online broker.

Terms:
Share - A single unit of ownership of a particular company.
Stock - most often used with the same meaning as 'share'.
Order - Instructions to buy/sell a specific stock.
Trade - same as order
Commissions - a fee charge by the broker for executing your order.

Investing

What does it mean to invest? I define it as purchasing an asset for a set price with the expectation that the value will increase beyond the original purchase price.

There are many different types of assets to buy. One could buy houses, businesses, stocks and bonds. These are just a few examples, not an exhaustive list.

Our focus will center around buying and selling stocks. But first we must define what a stock is. A stock represent an ownership percentage of a particular company.

For instance, let's pretend that I own a toy manufacturing business. No one has contributed any money to my company, so I'm the sole owner. My toy company is profitable and growing fast. My friend Vince invest in my business, but he doesn't want any of the responsibility of running the business.

I decide to sell 50% of my company to Vince for $250,000.00 and I now own half. Think of ownership as a pie. Initially, the pie represented 1 share (100 percent) of my toy company, I owned the whole pie. After the sale to Vince, the pie is split into two equal slices or shares. Each share representing equal amounts of ownership, 50% a piece or 2 shares.