The method featured in this article along with the previous ones (How to perform stock market due diligence before you invest I & II) is the one developed and used by general investors over many years of studying companies.
Here are the next two steps you should take on your first view of new stock.
Step 5: Management and Ownership
As part of performing due diligence on a stock, you'll want to answer some key questions regarding the company's management and ownership. Whether the company is still the founders' own or is run by a board of directors? Or has management and the board shuffled in a lot of new faces?
The age of the company is a big factor here, new companies tend to have more of the founding members still around. Look at consolidated bios of top managers to see what kind of broad experiences they have. All of this information could be found in its SEC filings.
Another big thing in this part of the process is to look at whether the founders or shareholders have been selling shares at a high rate as this could be a sign of something going on. Consider high personal ownership by top managers as a plus, and low ownership a potential red flag.
On the other side, check out the institutional ownership percentages could also indicate how much analyst coverage the company is getting as well as factors influencing trade volumes. Shareholders tend to be best served when the crowd running the company and has a stake in the performance of the stock.
Step 6: Balance Sheet Exam
Next, take a look at the balance sheets. This is where you can check to see all the assets and liabilities. As well as the amount of cash that is available to the company. (Paying special attention to cash levels, they indicate the company's ability to pay short-term liabilities)
The balance sheet is also the place where you can check the level of debt. A lot of debt is not necessarily a bad thing and depends more on the company's business model than anything else.
Some companies are very capital intensive, while others require little more than the basics of employees, equipment, and a novel idea to get things to run. Look at the debt to equity ratio to see how much positive equity the company has. You can then compare this with the competitors' debt to equity ratios to put the metric into a better perspective.
Reading the footnotes from financial statements and the management's discussion in the quarterly/annual report can also shed some light on the situation. The company could be preparing for a new product launch, accumulating retained earnings, or simply whittling away at precious capital resources.
What you see should start to have some deeper perspective after having reviewed the recent profit trends.
Moving forward you also need to consider the other factors when performing due diligence on stock, including stock price history, stock options, and dilution which we will cover in the next chapter of the topic, for more details stay tuned.