Deciphering Research Methods for Solid Investments

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The way in which an investment company conducts research can be a determining factor in predicting whether investing in that company is the right choice for you.

To illustrate the methods used by research specialists, let us consider the approach used by the analyst for an investment company that has traditionally invested substantially in the public utility industry. The analyst is engaged in a steady inquiry into comparative values. Consequently, he continually attempts to appraise the securities of particular companies and to judge the outlook for the industry as a whole.

Electric utility companies constitute the most important group among public utilities. With the help of an assistant and library facilities, the analyst begins his research in the office. Annual reports of companies and supplemental data, government reports, and the available statistical manuals serve as his jumping-off point.

The analyst also stresses these factors:

1. The economic characteristics of the area served by the company. What is the record of population gain? What are the estimates of responsible government agencies as to future population growth? Is the area basically urban or rural? What is the ratio between residential and industrial sales of energy? What is the average income per family? What is the average use of electricity? What are the sources of the company's energy? How vulnerable is the rate structure?

2. Financial information. This includes trends of operating revenues, capital expenditures, earnings and dividends per share, and the price history of the stock.

3. The company's capital structure (the percentage of total investment represented by bonds, preferred stock, common stock, and surplus). Costs of capital and the dividend payout will be surveyed to discover whether a policy has been established. The analyst will also examine operating costs, provision for depreciation, and the return on investment.

As a result of his familiarity with the industry and its financial and economic characteristics and development, the analyst can compare the record of the company being considered with that of the industry as a whole and of other companies operating under similar conditions.

At this point, office research exhausts its possibilities. The analyst now visits the company itself and talks with top executives and their associates. Company officials often arrange to visit the office of the investment company to bring the analyst and officers up to date. A tour of the plants may be arranged. Discussion with the utility company heads generally revolves around questions raised by the analyst. From the answers, the analyst can draw conclusions on problems such as plans for expansion, the orientation of management thinking (its concern for the common stockholders), efforts being made to attract new industries into its area, operating methods, customer and labor relations, provision for executive replacement through training programs for young and middle management.

Finally, the analyst dealing with public utility companies must consider the regulatory climate, for that is vitally important in the appraisal of regulated industries. Regulation may vary considerably from state to state.

Sometimes, it may be advisable to visit the state public utilities commission and discuss its views and attitude with the staff or to secure opinions of the commission on rate proceedings. During the period when reorganizations of holding company systems were being formulated under the Public Utility Holding Company Act, analysts visited the SEC to obtain a more intimate knowledge of the proceedings and ideas of the members of the staff of the commission's public utilities division.

Deciphering a company's research methods certainly requires some legwork on the part of the investor, but it is vital to know how seriously a company takes its research before investing in said company. A company with a lackluster research department that only tells management what they want to hear is most likely a quite unsound investment, whereas a company that takes its research department seriously and allows it to be independant might be a very interesting investment indeed.

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