There is no way to predict with total accuracy whether the company you choose to invest in will be profitable, but there are some ways to reduce the likelihood of choosing a risky investment if you do some preliminary research. As a general guideline, your research should focus on the company’s ability to earn profits and whether the company’s position in the marketplace is conducive to growth and expansion.
1. Access each prospective company’s website. A company that is subject to the U.S. Securities and Exchange Commission’s financial reporting requirements, which includes all companies that have stock trading on a public exchange, must issue financial statements. In most cases, these financial statements are posted on company websites.
2. Locate the income statement. A company’s income statement, which is sometimes referred to as the statement of operations, reports the company’s net income. Net income is important because it’s the amount of profit the business earns after paying its expenses, taxes and all other financial obligations.
3. Find historical profit information. Companies oftentimes include the net income for prior years either directly on the current year’s income statement or on a separate page. Historical profit information is helpful to see the consistency of earnings and fluctuations in the amounts -- both of which are factors to consider when evaluating the company.
4. Read about potential risk factors. Many large companies dedicate a section of their financial statements to outlining potential risks that would have a negative impact on the ability to remain profitable. Netflix, for example, includes such a section in its financial statements and notes that its business can be adversely affected if consumer viewing habits change, meaning they find other ways of accessing elsewhere movies similar to those that Netflix offers.
5. Check recent news releases, which can provide current information about a company, such as significant planned transactions, major problems with its labor force and anything that affects its business. You may access news releases on company websites, online news organizations or from sites that specialize in corporate news releases, such as Business Wire.
6. Calculate earnings per share. Divide a company’s net income by the number of shares it has outstanding for the same year. By comparing the earnings per share to the share price, you can get a rough idea of how much profit the company can generate from each dollar you invest and, from there, get an indication of how effective it is at generating cash that can be used to grow the business, pay dividends or buy back shares (a move that tends to boost share prices).
7. Compare the company's earnings per share/share price ratio to the same ratio for other companies in the same industry. This will help you compare apples to apples to find the strongest companies within certain industries.
- Check income statements from the current year and from past years to determine whether the company is generating surpluses in liquid assets and cash. This can help you determine whether the company is banking real profits or whether its earnings are inflated by accounting gimmicks. A record of increasing earnings per share may be another indication of a company's consistent profitability.
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