Learning to Select Top Stocks

When it comes to choosing companies to invest in, you need to ask a few questions. What you are looking for is the strengths and weaknesses in these companies and a better understanding of the market positioning of the business.

1. Where is the cash flowing from?

The value of any asset is the net present value of its discounted cash flows. Before you can even see the true value of a business, you need to know where the cash is coming from. Don't make assumptions -- such as, from sales -- be more specific.

For example, look at Coca-Cola. You may assume that the sale of soda pop is what pushes the company forward. However, almost all of its revenue is from the sale of beverage concentrates and syrups to bottlers, canners, distributors, fountain wholesalers and retailers. They aren't the ones bottling the product and stocking it on the shelves. They just sell the flavor and the name.

This tells you that the cash flow is dependent upon the relationship between Coca-Cola and its bottlers.

2. How much cash and when?

How much cash is the business generating and when? Once you know where the money is coming from, you must look for the timing of the cash flow. For example, is it generating a steady flow of money over time, or a large lump sum every decade or so?

3. Is it sustainable?

Industry isn't always solid. Changes happen over time. The history of a company doesn't always predict future cash flows. The business landscape can change, affecting the company drastically.

4. How much money does the company need to operate?

Some businesses have higher operational costs than others. Many need more capital to generate one dollar of profit than others do. Companies that make products must purchase property, plants and equipment. This cuts into the profit. Companies that offer ideas, such as advertising firms, often have a much smaller capital expenditure. The less capital a business needs, the better it looks.

5. How's the price?

The price is the one determinant of return for an investor. You may find a stock that looks great at $10, but not at $14. Look at what type of profit is being generated. For example, a company generating $5 in profit per year is a good purchase at $20 per share. The earnings yield on this stock is 25%. But if you buy it at $200 per share, your earnings dip to 2.5%. You might as well invested in a savings account.

There are many factors to consider when choosing a stock. Take the time to research the company and its management thoroughly. You don't want to buy into a volitile situation that is almost ready to collapse. Know what is going on in the company, its industry and the market in general.

Martin Lukac www.MartinLukac.com , represents www.RateEmpire.com , an Internet consumer banking marketplace. RateEmpire.com is a destination site of personal finance, investing, taxes and mortgage rates. RateEmpire.com provides mortgage guides and financial rates and information. RateEmpire.com also operates a financial portal #1 American Financial, found at www.1AmericanFinancial.com