5 Qualities of a Great Stock

There are 2,258 listings on the Australian Stock Exchange (ASX). With the amount of stocks of available to the investor, its easy to see how one may not be able to see the wood for the trees. Finding a good stock is not an easy exercise but these are the five characteristics that a great stock should possess.

1.Increasing profits

A great stock is a company which has consistent profitability over time.  This may sound logical but during the dot.com asset bubble, investors were pouring money into stocks which were not profitable yet. They were speculating that these companies would make money in the future and ignored the fundamental indicators. These companies were spending heavily and were operating at a loss. Investors were over exuberant and this created an asset bubble. When the recession in Japan caused a global sell off, technology stocks were sold off heavily some investors lost significant amounts of money.

2.Low leverage

A good quality company has a low net debt to equity ratio. Net debt to equity is measure by dividing the total liabilities on the balance sheet by total shareholder’s equity. Stocks that have an optimal debt to equity ratio have a higher stock return than other stocks. The optimal debt to equity ratio should not be above 2. This indicates the company receives two thirds of its financing from debt and one third from shareholder equity. Debt is important for a company to expand the business using leverage. However overleverage can put the company in a poor financial health position. Leverage which is too high creates higher risk because if something goes wrong with the company or the economy then the company may find it difficult to repay debt.

3.Has a good product

If a company has an innovative product they often do well. An example of this is Netflix (NFLX). This stock has done well from a result of a clever product and it has an addicted client base. The stock performance has been phenomenal. The shares were trading at $53.67 on 20 Dec 2014 and the last close price (17th Jan 2019) was $353.19. An innovative product can achieve higher sales which can help expand the company further without needing capital raising from shareholders or taking on more debt. Strong sales can also means strong dividend growth.

4.Good management

An effective management team is crucial to the success of a business. The decisions of a company are made by management so any misuse of funds will affect investors.

An example of management drama is one with Bellamy’s (BAL) that unfolded back in 2017 where a disappointing sales update which did not meet the expectation of the market caused a massive share decline from $11.88 on the previous day to $6.71 on 2 Dec 2016. The share price decrease was blamed on the poorly executed China strategy by the CEO. She resigned from the company in January 2017.

5.Positive technical signals

Technical analysis is a tool that traders use to identify trends and patterns to seek out opportunity to enter and exit trades. These tools focus on price movement patterns and volumes to determine trading signals and whether the activity of a stock is strong or weak. A stock may have good fundamentals but a stock also needs to have strong technical signals as it represents the sentiment of the market. If the market does not see a stock in a positive light then the share price is less likely to go up.

Lauren Hua is a private client adviser at Fairmont Equities.

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