Here’s our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can’t offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries. This week’s question: I have been a member since July now. When you find a company you like, what are the key pieces of data you look at? And how long do you watch the stock before you invest in it? — Thanks, Marek We do two things right off the bat after identifying a stock that we might want to buy. First, we become familiar with how the company makes money. Remember, a stock is ownership in a company and a business. Second, we go through the company’s financial statements with a fine-toothed comb. How it makes money The first thing may sound odd — after all, if you’re interested in the company, you would think you know how it makes money. However, that’s not always the case. For example, you may be interested in Amazon stock because you use the company’s e-commerce site daily. Knowing that Amazon operates an online marketplace, however, is not nearly enough. You must also know that Amazon operates the largest public cloud computing platform in the world and has a rapidly growing advertisement business. Or take Alphabet , chances are, if you’re not an investor, you haven’t thought much about how the company generates money because you can use some version of pretty much everything the Google parent has to offer consumers without paying a dime. Again, it’s also key to know that ads are Google’s bread and butter, the company runs the third-largest cloud, and its self-driving Waymo business is starting to turn some heads. Fortunately, we can get a sense of what any company sells by browsing their investor relations websites — a review of the latest investor slide presentation and/or the most recent 10K annual filing with securities regulators are good places to start. As you learn more about the offerings, you’ll want to start thinking broadly. Is the company targeting enterprise customers, individual consumers, government entities, or some combination? Also, consider whether the company’s offerings are essential — meaning that demand is going to be less sensitive to changes in price and/or the economic backdrop — or more discretionary. Think about competition as well. How costly is it for customers to jump ship and go with a rival firm? Some companies will prove easier to grasp — while others, especially those we don’t interact with regularly — such as Linde — may take a bit longer before things click. Don’t get discouraged, dig in, take a break, give yourself some time to process what you’ve learned, and then dig in again. Remember, as an investor, you want to know every little aspect of every company whose stock you buy or think about buying. While that is certainly what we as investors all strive for, we have to acknowledge that there will always be more to learn about a given company, both before and after taking a position. The Club has done a ton of research into Linde, studying the filings, listening to management, working to understand how the company operates, and so on. But we can’t fool ourselves into thinking we know all the ins and outs of the complexities of operating an industrial gas company from storage to distribution, that’s why we listen so closely when management speaks — be it during quarterly earnings calls, or at industry events. Financial statements In addition to understanding a company from a high level, we can’t take a position before analyzing the financial statements and getting a sense of the health of the company in question. There are three financial statements that require analysis: the balance sheet, income statement, and cash flow statement. We previously conducted a more detailed breakdown of how to analyze and interpret each as well as how to leverage the data to better understand a company’s financial standing. All three are incredibly important, however, of the three, the balance sheet is going to be the one to look at first. If the balance sheet is bad, it almost doesn’t matter what the other two look like. There are three sections to a balance sheet, assets, liabilities, and equity, the last one being the result of assets less liabilities and other outstanding ownership interests. In studying the assets and liabilities, you’re trying to figure out if the company has enough of the right types of assets like cash and receivables to cover its liabilities, especially the short-term liabilities that are coming due over the next 12 months. Knowing what shape the balance sheet is in gives you a better sense of the company’s outlook. Will it be able to fund operations on its own? Or will it need to raise capital via debt? Or worse, equity offerings? Once we know where the balance sheet stands, we look at the income and cash flow statements — but be mindful that a quarterly report is only going to show the last three months. You’ll need to study at least the last four statements, which should provide two years of data since each report will have the reported quarter as well as the prior year’s period for comparison. The income statement and the trends you see in terms of sales and profit margins are going to be crucial to understanding how well management is running the business. Keep an eye out for large changes over time or one-off items as these will clue you into where you should do some more digging. On the cash flow statement, we all know that cash is king and if a company is going to cover financial needs through its operations, as any healthy company should, then cash generation needs to be able to cover expenses and liabilities. For operations, the main focus is the operating cash flow. However, you’re going to want to look at investing and financing cash flows as well to better understand how a company is using its cash. For example, is it paying employees in stock? It’s a practice many companies implement but which investors may want to adjust for as it converts what would normally be a cash expense, say salaries, into a non-cash expense. That practice may dilute existing shareholders by paying out salaries as equity in the company. With this information in hand, you can start to think about valuation. There are many ways to do this, via a multiples-based approach or a discounted cash flow methodology. Whichever you choose though, should be grounded in some way. To do that, you’ll want to do a similar analysis of peer companies and their valuations. This way you can have a starting basis and then adjust the valuation based on growth rates of profitability metrics and management’s performance, among other things. Bottom line As for watching the stock, it’s good to get a sense of the kinds of volatility it can experience. That should become clearer as you learn more about the company, its growth prospects, and the ups and downs in its financial performance. However, as long-term investors, we are looking to value companies and identify the ones we think are undervalued, not trying to game fluctuations in stock price. Knowing how the stock acts, however, will be helpful in building a position over time so watching the day-to-day action and considering the technical setup is very important, but it comes second to your fundamental analysis. Consider our most recent investment, Bristol-Myers Squibb . In reviewing how the company makes money, in our Bullpen post , we discussed the key drugs currently driving sales. We acknowledged that there was a large patent cliff coming up, which is set to impact those sales. But, we then looked into how those lost sales would be replaced. This year’s acquisition of Karuna Therapeutics will play a part. The financial statement analysis is something we do internally, but a review of past quarters reveals that Bristol-Myers is indeed profitable. While this year has been severely impacted by in-process research and development (IPRD) charges relating largely to the Karuna purchase, the drugmaker generates positive cash flow from operations and maintains a healthy balance sheet. Profitability, the balance sheet, and investing cash flows have been impacted by the acquisition of Karuna, a one-time event, our analysis indicates the impact is manageable and should not weigh on Bristol-Myers’ ability to meet financial obligations, including paying out the dividend. We have no set time frame to watch a stock in our Bullpen. In the case of Bristol-Myers, we added to the Bullpen on Nov. 19 and bought it for the portfolio at around $59 per share on Nov. 25. We initiated the stock with a price target of $70, which reflects about 10 times the consensus adjusted earnings per share (EPS) estimate of $7.06 according to FactSet. (Jim Cramer’s Charitable Trust is long AMZN, GOOGL, LIN, BMY. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
Here’s our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can’t offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries.
This week’s question: I have been a member since July now. When you find a company you like, what are the key pieces of data you look at? And how long do you watch the stock before you invest in it? — Thanks, Marek