How to Choose the WinnersUnderstanding Penny Stocks

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Leeds Analysis I - Fundamentals

Fundamental Parameters

Much of the information you will need to accurately research the companies is included in their financial statements and annual reports. Much of this data is available online for free. I tell you more about finding this later, in My Picks for Quality Websites.

So what are you looking for, exactly? All of the following criteria can have an impact on the activity of the underlying shares and the success of the company. You can uncover the required information for each simply enough, and once you have done your analysis factor by factor, the big picture for any stock will seem as clear as day.

Leeds Analysis is really quite simple, and once you have applied it to one stock, you can apply it to ten thousand.

The Parameters

Fundamental Parameters Cheatsheet

Primary

Increasing Revenues
Improving Earnings
Competitive Advantages
Low Debt Levels
Insider Trades
Buy-Back Plans
Industry Conditions
Institutional Holdings
Political/Social Shifts
News and Press Releases
Alliances
Improving Financial Ratios

Secondary

Market Risk
Industry Risk
Legal Action / Law Suits
Competition
Management / Board Changes

Increasing Revenues

Of course, the more money a company is bringing in, the better.

However, I would also like to present the importance of this concept from another perspective. Companies that are enjoying improving revenues quarter over quarter, and year over year, do not need to increase their operational costs at the same growth rate.

For example, doubling of the number of faxes a company receives in a day does not mean they need to double the number of fax machines on hand. You see, most companies increase their expenses at a much slower rate than their revenues are rising. They enjoy better use of their infrastructure (machinery and staff and factories and company jets) to capture greater revenues, and thus get more value out of the existing situation they have in place. The end result is greater earnings.

What is a good sign: A company that has enjoyed a consistent trend in revenue growth on a quarter by quarter basis. This may indicate that they are gaining market share, or that their operational strategy is proving out. This is especially true for companies that are building a subscriber base of clients that are subject to recurring billing. For example, a fiber-optic Internet provider that keeps previous clientele, while adding new ones to the monthly billing list will not only enjoy the increase in revenues, but will be able to sustain those levels.

What is a bad sign: A company that has expenses increasing in line with revenue growth may be doing something wrong. Also, decreasing revenues are a major danger sign for any company.

Improving Earnings

Companies are in business to make money, end of story. Over time we have distorted that fact, and things have gotten very complicated with mergers and analyst coverage and lines of credit. Some corporations think it is acceptable to lose money, because they are "battling for market share."

In the end, a company can only survive by making more money than it spends. This is a fact, and a very painful one for many investors and corporations who have lost sight of the rules of the game.

Earnings are a measure of how much a company makes above what it spends to operate. If there were one most important fundamental aspect of a company (in reality there are dozens, but just if...) it would be earnings.

After all is said and done, and stock offerings are factored in, and restructuring charges, and currency exchange gains, and one-time charges, and a whole host of other items that you do not need to trouble yourself with right now, how much did a company make? When the smoke clears, you are looking at earnings.

Ignore EBITDA (earnings before interest, taxes, deductions and amortization) and ignore gross earnings. If you do not know what these are it does not matter - you are ignoring them.

Only look at net earnings. While most companies are losing money, which is the case for about 85% of penny stocks, those that are bringing in more than they spend will be able to provide the total amount they made (ie- $1,934,023 for the three month period of February to May) as well as a per share amount (ie- $0.21 per share).

The latter number, earnings per share, is generally more useful. It can be compared to the current share price easily, and it puts all companies on a level playing field for comparison purposes. It ignores factors like the total amount of shares outstanding, which varies from one stock to the next, so your comparison between several companies will be more telling.

What is a good sign: Positive earnings immediately put a penny stock company above 85% of the others. If those earnings are showing signs of increasing from one quarter to the next, you may be able to profit greatly from the underlying shares, especially if you get in early and the trend of increasing earnings continues.

What is a bad sign: Negative earnings, although in some cases profit can be made trading companies that are losing money, if you buy into their shares at the right price.

As well, decreasing earnings over time may drive a company into the ground if they can not reverse the trend before they start taking losses.

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