For the long-term investor, picking stocks is about understanding the important numbers. Long-term investors are not concerned with daily price fluctuations in a stock, because they are buying a company and it is the company’s fundamental financial health that is important.
The value of a stock is directly related to the value of the business and is primarily concerned with earnings. The purpose of a business is to make money for its owners, and the more profitable a company is the more valuable it is to its owners and others who wish to own shares. It is easy to find historical information about a company’s profits, but that is only part of the picture.
Stockholders are most interested in future profits, and historical information is not predictive of future results. A company with a lengthy history of earning consistent profits is most likely to continue that trend; however, there are no guarantees that it will.
Your job as a long-term investor is to identify companies that will meet your financial goals with an acceptable amount of risk. The selection process involves a certain amount of looking into the future and using those projections to establish the fair value for the stock today. In upcoming chapters, I help you understand how to arrive at that value using several tools in different types of analysis. I’ll start with the company’s financial statements, which are covered in Chapter 4.
However, before diving into the deep pool of a financial analysis, you need a way to begin the selection process by narrowing down a list of possible investment candidates to a manageable level. The best tool for this job is the stock screen.