Stock Futures – Harry Domash, Online Investing | Tests measure risk of a stock – Santa Cruz Sentinel
It’s easy to forget about risks in this hot market. But in the stock market, everything can change overnight. Here are six tests you can use to measure almost any stock’s risk. Each test can add or subtract one point from a stock’s overall score.
You can find the referenced data on Yahoo’s Statistics report. Get there by entering a ticker symbol on Yahoo Finance (finance.yahoo.com) and then selecting Statistics.
Bigger is better
Bigger firms are better able to handle unexpected events than smaller firms. Market Capitalization,” the value of outstanding shares, is a popular company size gauge. Market-caps above $10 billion define large-caps, which are the safest. Firms less than $2 billion are small-caps, the riskiest category. Use the “Current” column for “Market Cap” (Valuation Measures). Add one risk point for market-caps less than $2 billion, and subtract one point for market-caps greater than $10 billion.
All else equal, stock prices reflect a firm’s current or expected future per-share earnings (EPS). “Profitability” describes how much cash shareholders must invest to produce a dollar of earnings. “Return on Equity (ROE),” listed under Management Effectiveness, which compares net income to shareholders equity, is a popular profitability gauge. Many market professionals require a minimum 15% return on equity, and higher is better. Add one risk point for ROEs less than 15% and subtract one point for return on equity more than 20%.
Follow the money
Institutional ownership (percentage held by Institutions) is the percentage of shares owned by mutual funds, pension plans, etc. Values greater than 40% tell you that these wired-in players like the stock, and the higher the percentage, the more that they like it. Add one risk point for ownership less than40% and subtract one point for values more than 80%.
Shorts targeting stock?
Short-sellers profit when the price drops on stocks they’ve shorted. “Short percent of float” (Share Statistics) measures the percentage of shares available for trading that have been shorted. Short sellers are probably better informed about a stock’s outlook than you are. Add one risk point for short percent of float greater than 5%, and subtract one point for percentages less than 1.5%.
Stocks become overvalued when the market gets excited about their growth prospects. But, eventually the glamour fades and valuation becomes important. Most analysts use the “forward price/earnings ratio,” which is the share price compared to the next fiscal year’s forecast earnings, to measure valuation. Add one risk point for forward P/Es more than 50, and subtract one point for forward P/Es less than 25.
Cash flow vs. net income
Net Income, the number used to calculate EPS, is subject to non-cash charges such as depreciation and doesn’t accurately measure actual cash profits. However, another readily available number, “operating cash flow,” does measure the cash that moved into, or out of a firm’s bank account resulting from its operations. Operating cash flow should always exceed the same period’s net income. Compare “Operating Cash Flow” (Cash Flow Statement) to “Net Income” (Income Statement). Add one risk point if net income exceeds operating cash flow and subtract one point if it doesn’t.
Using the scores
All else equal, for risk scores, lower is better. But other factors must also be considered when evaluating stocks. So, consider the risk score as another tool in your analysis toolbox.
Harry Domash of Aptos publishes the Winning Investing and the Dividend Detective websites. Contact him at www.winninginvesting.com or Santa Cruz Sentinel, 324 Encinal St., Santa Cruz, CA 95060. To see previous Domash columns, visit santacruzsentinel.com/topic/Harry_Domash.