Choosing the Right Companies to Invest in- Part 2

Many investors fail to grow their investments because they overlook several important aspects of buying stocks. Value investing is a famous method used by great investors like Warren Buffett. This helps to consistently bring in big profits from the stock market.

Firstly, an investor needs to ask himself the following question. Does the company demonstrate the ability to generate revenue? To answer this question, there are 3 main factors. These demonstrate the companies’ ability to generate revenue.

1. The Company Earnings Growth- Since businesses customarily add from year to year to their equity base, we find nothing particularly noteworthy in a management performance combining, say,  a 10% increase in equity capital and a 5% increase in earnings per share. What you should be looking for is the growth in return on equity or ROE. This means that earnings should increase at a larger rate than shareholders equity. 
2. Dealing with Inflation- Inflation is a major business nightmare. Maintenance of a steady increase in ROE by the companies is an indicator of a quality management. It also shows a strong ability to beat market fluctuations in inflation and commodity prices.
3. Owner’s Earnings- Owners’ earnings are something considered to be the real income of the companies. The adjustments made to the accounting net income can be justified as follows. Depreciation should be added back to the net income because it is  fixed amount deducted from an asset book value. This does not reflect the real cost of replacing an asset when it becomes obsolete. Same as depreciation, amortization should be added back to the net income because amortized assets increase in value when the business is doing great. Capitalized expenditures have different accounting treatments. Indeed, it might be distributed over many years, carried back or forward. Therefore, the best solution is to adjust this figure by estimating an average.

These three indicators will surely help you identify if a company demonstrates the ability to generate revenues. But this is not all. We have more questions to determine if a business is truly an excellent one.

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