Here are six checks you can use to find out. Each check can add or subtract one point from a stock’s overall risk score. You could find the needed data on many financial websites, including Yahoo’s Key Statistic’s report. If you do want to use Yahoo! ($YHOO), get there by entering your stock’s ticker symbol on Yahoo Finance and then selecting Key Statistics.
The more a firm is loaded down with debt, the higher the risk. The “total debt/equity ratio” (D/E) compares debt to shareholders equity (book value). A zero ratio means no-debt and the higher the ratio, the higher the debt. Although D/E ratios often run into double digits, in my view, anything above 0.5 equates to significant debt. Subtract one risk point for ratios of 0.1 or less and add one point for D/E ratios above 0.5.
Bigger is Better!
The larger the firm, the more likely it is to have the product diversification, financial stability and experience to cope with unexpected events. Use “market capitalization,” which is the value of all outstanding shares, to measure company size. Market-caps above $10 billion define large-caps, which are the safest. Firms below $2 billion are small-caps, the riskiest category. Add one risk point for market-caps below $2 billion, and subtract one point for market-caps above $10 billion.
Profitability measures how much cash shareholders must invest to produce a dollar of earnings. At a minimum you want stocks profitable enough to internally finance their growth. Otherwise, they must borrow or sell more shares to fund expansion. The most popular reliability gauge, “return on equity” or ROE, compares net income to shareholders equity. The way the math works, a firm cannot internally fund annual earnings growth faster than its ROE. For instance, an ROE of 10 tells you that the firm cannot internally fund earnings growth faster than 10 percent. Add one risk point for ROEs below 10% and subtract one risk point for ROEs above 20%.
Follow the Money
Institutional ownership is the percentage of a company’s shares owned by mutual funds, pension plans, etc. Values above 40% tell you that these wired-in players like the stock. Add one risk point if institutional ownership is less than 35% and subtract one point for values above 60%.
Shorts Targeting Stock?
Short-sellers make money when stocks that they’ve shorted drop in value. The “short percent of float” ratio measures the number of shares shorted compared to the total shares available for trading (float). The higher the ratio, the more a stock has been shorted. While short-sellers can be wrong, high shorting activity signals risk. Add one risk point for short ratios above 10%, and subtract one point for ratios below five percent.
Stocks often become overvalued when the market gets excited about their growth prospects. But, eventually the glamour fades and the market begins looking at valuation. 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 above 40, and subtract one point for forward P/Es below 25.
Using the Scores
Use these scores to compare stocks that you own or are evaluating. All else equal, lower is better.
Here are six stocks with perfect (minus six) risk scores.
Paychex, Inc. ($PAYX): offers payroll, human resource, and benefits outsourcing services to small- to medium-sized businesses.
QUALCOMM, Inc. ($QCOM): produces wireless communications semiconductor chips and licenses chip technology to third-party manufacturers.
T. Rowe Price Group Inc. ($TROW): investment manager and mutual fund operator.
Skyworks Solutions, Inc. ($SWKS): produces analog semiconductor chips used for wireless communications.
Tractor Supply Company ($TSCO): operates retail stores selling farming and ranching supplies.
Visa Inc. ($V): operates a retail electronic payments network that supports banks issuing VISA branded credit cards.
Unfortunately, picking stocks isn’t that simple. Many other factors affect whether you’re going to make money owning a particular stock. Consider the risk score as another tool for your analysis toolbox.
For tips and information on the best utilities and dividend stocks from Harry Domash, please check out Dividend Detective.
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