When you buy a stock you’re going to be a part owner of the company. Simple as that. Over the long term if a company grows and generates profits the stock price will increase. What trips people up is that, on a day-to-day basis, the stock prices of any company (incredible or worthless) can fly all over the place. Why is this? Well, it’s because the stock market is made up of investors and gamblers. Many times gamblers are lazy and would rather stay home and gamble on stocks over a cold beer than take the effort to go out to the casino. If you’re the type of person who likes to YOLO into a stock that’s surging 50%, knowing nothing about the company, then I’m sorry but you’re one of those gamblers. And I’m sure your trading results will show it. In the words of Warren Buffet “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” And when you gamble, you eventually get stuck in some garbage stock down 50%, and the weighing machine comes to life.
There is another equally devastating pitfall. Many times traders will buy incredible companies and pay anything for them. Maybe that’s a little better than gambling, but not much. Over the long term you won’t do well because you simply overpaid.
At this point, I am the biggest fan of my own Stock Viz tool. I use it on a daily basis. I have decided to share it simply because it makes me feel good to help others. This tool is not a silver bullet. There is no one right stock to buy. But when you understand how to interpret the results in a deep way you’ll learn that some stocks are great bets and others are terrible bets. In lieu of producing a video on how to use this tool properly (which I may do at some point), right now I’ll just tell you how I use it.
So you heard about some amazing stock to buy. Maybe it’s a stock tip at work or maybe it’s being pumped by some Youtuber. Either way, you’re thinking that you need to get in on the action NOW. Don’t just YOLO into the stock! First, use the Stock Viz tool to see how the company is doing by looking at it’s published financial statements. Try to assess how cheap or expensive it is at the current market price (you can use the tool for this as well). After that, do a whole bunch of more digging into the company to understand everything about it. What do they produce, what is the competition in their market segment, what are their future prospects, does the management do what they say? Is it the right time to buy any stocks at all given the current economic situation? Watch the last quarterly earnings release conference call by the company. Check the Economic Calendar on this website to see if there are any high impact news events coming up like inflation data or a Fed meeting. The list goes on and on. The Stock Viz tool is only the starting point. But it’s a great place to start since often times the financials are so terrible you can just abandon the idea and move on with your life. If the Stock Viz looks good then you can move on to doing all this other research. Once you really understand what’s going on, THEN buy. All of this other research is on you.
Let’s move on to how I use the stock tool.
Ticker Symbol: Find the stock ticker symbol of the company you want to buy. You may need to google this if you don’t already know it. Then type it into the Stock Viz box.
Revenue: This is another term for sales. You want to buy this company if it’s sales are increasing right? Or at least you don’t want sales to be falling off a cliff, unless you believe they will come back for some reason and the stock price is super cheap. Strong sales indicate the companies’ product is valued in the marketplace and it’s not priced too high. Read from Revenue row from left to right. Look at the size of the bars. If they are getting bigger that means sales are increasing. The black numbers on the top show how sales have grown in percent terms over time, starting at 100% two years ago.
Gross Profit: For companies that report cost of good sold (most companies), gross profit represents how much profit the company is making after they pay the costs directly tied to making the product. The black numbers on top are called Gross Margins and they tell you whether the company can even produce the product at a profit at all (if they can’t, they are in BIG trouble since there are more expenses to come; so far we’re only including expenses related to making the product). There are two key things to look for here. First, what is the overall size of the gross margins (black numbers)? Let’s say you see gross margins averaging 70% as they are for some tech companies. That’s tremendous since it doesn’t cost much to produce the product. You have a big buffer to pay the rest of the expenses. Alternatively, if you see gross margins averaging at 30%, this means the company doesn’t have as much profit to work with to pay all the other expenses. A low gross margin is not necessarily bad and it depends on the industry. Grocery stores will have low gross margins but could still be profitable companies since they do such a large volume of sales. So it’s not black and white but generally the higher the gross margin is better. The second thing to look for are whether their gross margins are increasing over time, or at least holding steady. If gross margins are steadily falling this could be a red flag indicating the companies’ product is not valued, or the competition in the space is increasing and there is a race to the bottom on price. In all of the rows in the Stock Viz table (apart from the ratios), the bars themselves represent the actual dollar amounts. You can click on any bar to see this number. Many times, however, the little black numbers on top are more important.
SG&A Expenses: These are expenses associated with sales and general administrative. This includes salaries paid to employees but not stock based compensation which is shown later. What to look for here is a reasonable SG&A expense as a percent of Revenue (the SG&A ratio, again the black numbers on top). With some companies you will find that the SG&A ratio is even higher than the Gross Margin! Since SG&A expenses are paid after gross profit, the company is dead in the water on profitability from this point on. What you need to consider then is whether the company has an ability to “tighten their belts” to bring down their SG&A ratio. Do they have this flexibility and can they do it? Have they already proved that they can do it (you can see this if there is a big drop in the SG&A ratio in the last quarter)? I have rejected many companies outright because their SG&A ratio was higher than their Gross Margin and I didn’t have the confidence that they could bring it down. This is especially true if, in the entire two years, the SG&A ratio is higher than the Gross Margin every single quarter. Then I would just say it’s a Zombie Company and move on.
R&D Expenses: These are expenses associated with Research & Development. These are interesting expenses because a higher number is not necessarily bad. In fact, if the company is engaging in cutting-edge R&D it could bring tremendous value down the road. But if the company is doing a bunch of useless R&D then it’s just another expense similar to SG&A that drags down profitability. You can use this row to understand how much research and development the company is doing and whether it’s increasing or decreasing over time. You might then want to go and investigate what R&D activities the company is involved with.
Operating Income: This is one of the key metrics for investors. For those who know EBITA it’s similar to that. This number shows the profitability of the company from it’s core operations, ignoring some downstream expenses like interest expenses and depreciation. If you start with Gross Profit and subtract SG&A Expenses, R&D Expenses, and Other Expenses you will come up with Operating Income. The Stock Viz table does not show these Other Expenses which could involve charges for write-downs and other such expenses, so you won’t be able to derive this Operating Income directly from the previous rows. But that’s the basic idea. The black numbers on top show the Operating Income Ratio. You can look at these ratios to understand how much promise the company has. Maybe it’s already Operating Income positive (and if that’s the case and Net Income is mostly negative it could be a result of GAAP accounting charges like depreciation, etc.). The Operating Income Ratio trend over the quarters is really important. It indicates whether or not the company is growing into increased profitability.
Interest Expense: Big numbers here indicate the company has a lot of debt. Small numbers indicate little debt. Debt is a big deal these days due to higher interest rates and excessively high debt loads can potentially push a company into bankruptcy if it’s not already profitable. Sometimes there are good reasons for having a high interest expense. For example, the company may have a large investment in a new plant they are building and have decided to finance this entirely or partially with debt. This is not necessarily bad if the investment ultimately pays off. However, a high interest load associated with this debt definitely makes the company a riskier investment. To understand how strategically the company is with utilizing debt you need to dig into the details of their debt financing. Are they locked in at lower interest rates for a long period of time, or do they have short duration financing? If it’s short duration they are more at the mercy of Fed decisions around interest rate. This row is actually Net Interest Expense which is {interest paid – interest received} so it’s possible the ratios could be negative for some companies. Use these numbers to assess the riskiness of this company relative to the current economic environment.
Net Income: This is GAAP accounting Net Income which is the traditional metric for overall profitability. It’s calculated by subtracting interest expense, depreciation, income taxes, and other such items from Operating Income. How to interpret this row should now be self explanatory.
Operating Cash Flow & Free Cash Flow: Both of these metrics are similar to Operating Income but they look at cash flows in-and-out instead of traditional accounting income. Many investors consider cash flows to be more useful than accounting income because they can present a clearer picture of the company’s true profitability. There is little room for the company to game the data with cash flows. Free Cash Flow is slightly different than Operating Cash Flow in that it subtracts out Capital Expenditures (e.g. the cash the company uses to build a factory). There are many investors who believe Free Cash Flow to be the gold standard metric; this number represents the actual cash that is returned to shareholders quarter-by-quarter. The downside of the cash flow numbers is that they tend to jump around a little more. Again, to interpret these rows you need to consider at the overall size of the ratios of cash flows-to-revenue (black numbers) and the trend of these ratios over time.
Stock-Based Compensation Expenses: These are super interesting expenses. They represent the amount of money the company is issuing as stock compensation (e.g. options, RSU’s, SSAR’s) to management and employees. There are some cases of companies with insanely high stock-based compensation numbers relative to revenue, which basically means that the management is robbing it’s shareholders. I have seen situations where this stock-based compensation expense is higher then the total revenues the company is generating! Many times you will see these outrageous stock-based compensation numbers with heavily promoted and high-flying tech companies which have never in their history returned a dime to shareholders. Use this row on the Stock Viz to assess whether you trust the management of the company. Keep in mind that there are legitimate reasons to have high stock-based-compensation; to attract the highest quality employees in the industry, and to reduce their salary by issuing them options. But sometimes by looking at this row of the Stock Viz you can clearly see that the company is simply robbing it’s shareholders, and that the company exists solely to enrich it’s management. If you see a situation where the company is performing poorly and at the same time it’s stock-based-compensation is ballooning don’t even think of buying the company and just move on.
Goodwill and Intangibles: This row of the Stock Viz will give you an indication of how tangible the companies assets are on it’s balance sheet. Goodwill and Intangibles are assets that are difficult to value. For example, when the company buys another company and pays more than the market price for it the excess will be recorded as goodwill. Is this really an asset? Certainly it’s not the same as cash in the bank. But all assets are considered the same on the balance sheet. It could ultimately be a legitimate asset if the premium the company paid for the acquisition plays itself out as expected in future profits for the company. But many times you see companies that overpay for an acquisition and then write-down this goodwill in future quarters as they realize they paid too much. The way to interpret this row is that a lower percentage number is better, and zero is best. Note that the black percentages on top for this row are a percent of Total Assets not a percent of Revenue.
Shares Outstanding: When you look at a stock price chart and make the decision to buy based on the price trend, is this really the best approach? This stock price chart is on a per-share basis. What if the company tripled the number of shares outstanding in the last two years? For a given amount of profit the company generates, the value of a company on a per-share basis will now be only a third of what it used to be. This is a hidden cost to shareholders that many people overlook. This row of the Stock Viz shows the growth in shares over time. Use the black numbers on top to see how aggressively the company has been issuing new shares over time, assuming 100% two years ago. A falling percentage number over time is best, indicating that the company is buying back it’s shares. A flat number over time is fine as well. But if you see dramatically increasing percentage numbers over the quarters you should investigate more. Either abandon your decision to buy the stock or take these costs into consideration if you decide to still buy it.
Funding Runway: For companies that are not making money, this shows the number of months the company can survive without running out of cash. If they do run out of cash they will need to either do a debt financing or issue new shares. Neither are good for shareholders. If you see a zero in the last column of this row that is good and it means that the company is profitable and the funding runway is not applicable. If you see a large number in the last column of this row it means the company is unprofitable but it has lots of cash in the bank to fund it’s losses for many months into the future. But if you see you see a small number in the last column of this row, e.g. a 4, this could potentially mean that the company only has four months left until it needs to raise more cash. I say “potentially” since this is just a calculation based on how much cash they have and how fast they burn it, so you need to take it with a grain of salt. You need to investigate more to see if a funding has already been announced in which case the stock price has probably already taken a hit. This should be used as a stock buy timing metric more than anything else. It’s likely not a good idea to buy a stock right now if the company only has four months of cash left and they has not already announced a funding.
Debt / Equity Ratio: This is the amount of debt the company has on it’s balance sheet divided by the equity it has on it’s balance sheet. Not much more needs to be said about this than was already said in #7 on Interest Expense. Debt can be useful but makes a company riskier especially in this economic environment. Use this row of the Stock Viz to understand the overall debt load of the company and whether it’s coming down over time.
Everything up to this point involved the company’s financial statements only, and had nothing to do with the price at which the stock is trading in the market. The last three rows of the Stock Viz (Price/Sales, Price/Earnings, and Price/Book) bring in stock price. They are critically important to the buy decision. The goal is to buy companies with great or improving financial performance AND to buy them at a REASONABLE PRICE. Or the goal could be to buy companies that are not doing well, but you’re sure they will turn around, AND to buy them at a STEAL. Often it’s useful to compare the financials and these price ratios side-by-side for two different companies your considering, and the laptop version of the Stock Viz allows you to do this.
Price / Sales Ratio: This is the market capitalization of the stock after their earnings release in the quarter divided by the (4X) the revenues of the company in that quarter. Why multiply by four? It’s to annualize this Price / Sales Ratio and to put it on a basis comparable to the typical Price / Sales ratio discussed by stock analysts (if you don’t understand this it doesn’t matter in the least). The point is this: the P/S ratio is a measure of how expensive the stock is relative to its Sales. Price / Sales ratios are not typically shown for past history but the Stock Viz contains this information so you can look at how cheap or expensive the stock is now compared to the past (compared to it’s sales). The critical Price / Sales number in this chart is found in the last COLUMN of the Price / Sales Ratio row. This number is the Price / Sales ratio that the stock is trading at TODAY (more accurately the time the data was updated, shown at the top of the Stock Viz). You want to use this number in your buy decision. Price / Sales ratios are typically used to figure out how cheap or expensive a company is if it’s not yet making money. It takes a bit of time to understand what’s a cheap Price / Sales ratio versus a expensive one, it depends on industry and other factors, and I’ll leave it to you to learn more about this. But often you can see Price / Sales numbers at 2-4 which would be quite cheap by any standards, and Price / Sales ratios over 15-20 might be considered expensive. But it really depends on the growth prospects and income generating capacity of the company.
Price / Earnings Ratio: This is the market capitalization of the stock after their earnings release in the quarter divided by the (4X) the net income of the company in that quarter. Why multiply by four? It’s to annualize this Price / Earnings Ratio and to put it on a basis comparable to the typical Price / Earnings ratio discussed by stock analysts. The point is this: the P/E ratio is a measure of how expensive the stock is relative to its Earnings. Price / Earnings ratios are not typically shown for past history but the Stock Viz contains this information so you can look at how cheap or expensive the stock is now compared to the past (compared to it’s earnings). The critical Price / Earnings number in this chart is found in the last COLUMN of the Price / Earnings Ratio row. This number is the Price / Earnings ratio that the stock is trading at TODAY (more accurately the time the data was updated, shown at the top of the Stock Viz). You want to use this number in your buy decision. Price / Earnings ratios are typically used to figure out how cheap or expensive a company is if it’s currently making money.
Price / Book Ratio: This is the market capitalization of the stock after their earnings release in the quarter divided by the accounting book value of the company in that quarter. The P/B ratio is used to determine the margin of safety in a liquidation event. If the company goes bankrupt and needs to be liquidated, and if the market value of the company is higher than it’s book value, this will provide a buffer for investors. In most cases companies won’t trade for less than their book value unless they have terrible growth prospects or investor funds are held captive in the company in some way. But it does happen occasionally. Use the tool to look at the number in last COLUMN of the Price / Book Ratio row. This number is the current Price / Book ratio for the company. You should not make buy decisions exclusively based on the Price / Book ratio unless you’re trying to make a play on a liquidation event (and this requires much more research). Instead you should use this metric to make sure the Price / Book ratio is not excessively high which could indicate that the stock is currently overvalued.
I hope others can gain as much value from this Stock Viz tool as I have. Always remember, you’re buying the company not the stock. If you have any additional questions about how to use the Stock Viz tool, or any of the above is not clear, feel free to contact me.
Shawn.