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This article will seek to explain how to determine if a company may be a good investment based on the following four financial characteristics.
Stable and growing earnings, high return on equity (ROE), dividend yield, and positive cash flows are common indicators of a company's financial success, indicating that the company could be a good investment.
Earnings
Earnings are one of the key indicators to determine a stock's value. There are many ways to evaluate earnings, but growth and stability are two of the most prominent indicators.
Earnings growth is usually expressed as a percentage in periods such as year-over-year. The basic premise of earnings growth is that the current reported earnings should exceed the previously reported earnings.
Earnings stability measures how consistently earnings have been generated over time. Stable earnings growth usually occurs in industries with more predictable growth patterns.
ROE
Return on equity (ROE) measures the ability of a company's management to make a profit with the capital entrusted to it by its shareholders.
ROE is calculated as follows:
ROE = Net Income / Shareholders' Equity
A high ROE could mean a company is good at generating profits internally.
It is also essential to examine a company's historical ROE to evaluate its consistency. A rising ROE indicates that a company increases its profit generation without needing as much capital.
Dividend yield
The dividend yield, displayed as a percentage, is the amount of money a company pays its shareholders for owning its share divided by its current stock price.
Dividends are payments made by public companies to reward investors for putting their money into the company. Mature companies are most likely to pay dividends.
However, many companies do not pay dividends but instead retain earnings and reinvest them in the company. While dividend yields are attractive, they may come at the expense of the company's potential growth. Dividends are also not guaranteed and are subject to change or elimination.
Cash flows
Cash flow refers to the net amount of cash and cash equivalents transferred in and out of the company.
Cash received represents inflows, and cash spent represents outflows. A company's ability to create value for its shareholders is basically determined by its ability to generate positive cash flows.
Though you can use all of these characteristics to determine whether you can make a sound investment, you should not focus on a single indicator when valuing a company.