In our last newsletter, we examined Johnson and Johnson (JNJ) as a stock we would like to possibly own.  We did a quick preliminary check of the company and now it's time to look a little more closely at this company.  My favourite resource for researching stocks is an American publication called "Value Line".  You can view this resource free at many major libraries (the main branches of larger cities).  In this binder you will find financial reports for many major US companies as well as Canadian companies that are interlisted (interlisted means the stocks trade on both US and Canadian exchanges and these companies are usually some of the largest companies in Canada).

 

From my investment experience, I prefer an almost certain chance of a good return rather than a slim chance of a spectacular return - in other words I prefer companies that have done well for years and should continue to do so.  So the first thing I look at in Value Line is the earnings history.  With JNJ I can quickly see over 15 years of consecutive earnings increases and also many years of dividend increases - so the firm is a consistant performer, which is important.  The next thing I'll look at is the company's debt.  At the bottom right-hand corner of Value Line, they give a grade for "Company Financial Strength".  JNJ earns an A++ (the highest grade possible), so this financial strength makes it safer than many companies.  In addition, on the left-hand side of the page you can see that JNJ carries very little debt (another sign of safety).

 

Okay, so the company is conservatively managed and also has a great history of increasing earnings - these are good points.  The next thing I like to see is high returns on equity.  A high return on equity means the company can earn good profits with small amounts of money being invested.  This is not an absolute measure, but generally I look for returns on equity over 15% (and preferably over 20%).  This number is given to you right on the Value Line report.  I can't adequately explain all the finer points, but if you Google "Warren Buffet Return on Equity", you can find a lot more information on this.  A large part of my investment approach copies what has worked for other investors, and I decided years ago to hitch my investing wagon to Buffett as he is one of the most successful investors the world has ever seen and his approach is fairly easy to emulate.

 

The final factors I might look at is dividend yield and payout ratios.  The dividend yield is the percentage you get back in the form of dividends (the income I've used to leave the rat race in my 30s).  The payout ratio is the percentage of profit a company pays out.  In the case of JNJ, the payout ratio has been around 40%.  In other words, for every $1 in profit the company earns, they pay 40 cents in the form of dividends and reinvest 60 cents to grow the company.  Having payout ratios around 50% or less ensures that I can retire and my income will continue to grow over time as the companies keep growing and earning higher profits.

 

These factors give me the very basic idea of what I look for when choosing great stocks.  A whole book could be written on this topic alone, but that is enough of an overview for some readers (and possibly too much for others).  For further reading, I would suggest the "recommended reading" listed at the back of my books. 

 

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