A company's "current ratio" is the company's current assets divided by its current liabilities. This ratio reflects whether it has enough short-term assets (such as cash and expected incoming payments) to cover its short-term obligations (such as payments due).
A more meaningful metric is the "quick ratio," as that calculation subtracts assets that aren't as liquid – such as inventories, supplies and prepaid expenses – before dividing by current liabilities. (These figures are all found on a company's balance sheet.)
It's good to check out a company's current debt condition, but understand that it's only one part of the whole picture – it ignores, for example, long-term debt.
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When considering any company for your portfolio, assess other factors, such as revenue and earnings growth rates, profit margins, inventory levels, competitive advantages and valuation metrics. You can learn more about evaluating and investing in stocks at the "Investing Basics" nook at Fool.com, and also at Morningstar.com.
Q: I've made some profits in penny stocks as a beginning investor. Can you recommend any good, low-priced stocks? – K.W., Hoover, Alabama
A: Yikes! You've really lucked out if you haven't lost money in penny stocks. Often tied to small and unprofitable companies, penny stocks can be extremely risky, and many people have lost their shirts in them.
Don't assume that if you don't have a lot of money to invest, you have to stick with low-priced stocks. Yes, you can buy 600 shares of a $1 stock for just $600. But it stands a good chance of becoming a $0.50 stock or a $0.01 stock. Instead, you could just buy 20 shares of a healthy and growing company's $30 stock or three shares of a $200 stock.
Sound advice from Philip A. Fisher: For best results in your investing, take time to read books on the topic by some of the best investing thinkers – like Philip A. Fisher. His classic "Common Stocks and Uncommon Profits" (Wiley, $25) laid out many valuable rules for studying and finding the most promising stocks.
For example, he recommends that you seek companies with solid plans to deliver "dramatic" growth over the long run, and aim to buy shares when they're selling at attractive prices, often because other investors don't see their value. Plan to hang on to these companies for a very long time, until something fundamental about the company changes or it has grown so large that its growth will likely lag that of the overall market. Do your own research and your own thinking, and don't be afraid to have a contrary view.
Fisher favors companies with lower production costs than their rivals, as they'll be better able to get through bad years. They should have competitive advantages over their competitors, and have "outstanding" research and development operations that generate new products and services to help them keep growing.
While dividend-paying stocks will serve many investors very well, Fisher says that if you want to aim for maximum growth in your stocks, you should avoid dividend payers: Since they have to pay out part of their earnings in dividends, they can't use it all to further their growth. (While that's true, you might be a balanced investor, holding both dividend payers and nonpayers, for the best of both worlds.)
Finally, Fisher reminds us that all investors will make mistakes: "Willingness to take small losses in some stocks and to let profits grow bigger and bigger in the more promising stocks is a sign of good investment management. Taking small profits in good investments and letting losses grow in bad ones is a sign of abominable investment judgment. A profit should never be taken just for the satisfaction of taking it."
Next week we'll cover how Fisher evaluates companies.
My dumbest investment
Up in smoke: My dumbest investment was buying shares of Canadian marijuana company Aurora Cannabis in 2018. I learned that you shouldn't buy companies in nascent industries and companies that don't have profits. That's speculation – not investing. – J.P., online\
The Fool responds: Ouch! Though Aurora Cannabis topped $120 per share in 2018, it has recently been trading around $10 per share.
Aurora has made some big acquisitions and funded that activity by issuing additional shares of stock. That "dilutes" the value of existing shareholders' shares, as each share ends up representing a smaller piece of the pie. Meanwhile, though cannabis use was legalized in Canada, the country was slow to approve business licenses, and Aurora's supply outstripped demand. Today, the company remains challenged. It's been cutting costs and becoming leaner, but it has also remained unprofitable – burning cash.
You needn't avoid investing in every new industry, but know that it can take years before it's clear which companies in an industry will end up dominant and profitable. Unprofitable businesses can be OK to invest in, too, as long as they're likely to become profitable at an acceptable point. But sticking with already profitable, well-run and growing companies is safer and can serve you better.
The marijuana industry is promising. A little research might turn up more attractive companies than Aurora Cannabis.
Name that company: I trace my roots back to the 1827 chartering of the Baltimore & Ohio Railroad, which originally ran for 13 miles in one state. (Its trains were pulled by horses.) Today, based in Jacksonville, Florida, with a market value recently near $70 billion, I'm one of the nation's biggest railroad companies, boasting a network of some 21,000 miles that traverse 23 Eastern states. I took my current form via a 1980 merger between Chessie System and Seaboard Coast Line Industries. My network links more than 230 short-line railroads and dozens of ports. Who am I?
Last week's trivia answer. "I trace my roots back to 1950, when a teenager recruited five high school friends to help build a bungalow in Detroit, and sold it for $10,000. I kept building, and in 1972, started offering mortgage services to my homebuyers. By 1995, I was the largest homebuilder in America. Today, based in Atlanta, I have operations in more than 40 major markets nationwide, under names such as Centex, Del Webb, DiVosta Homes, American West and John Wieland Homes and Neighborhoods. I close on more than 20,000 homes annually and have delivered around 750,000 homes over my history. Who am I? (Answer: PulteGroup).
The Motley Fool take
Streaming profits: A lot of U.S.-based investors seem to think Netflix's (Nasdaq: NFLX) growth story is largely played out because the service is already so popular here. But this mindset misses the streaming pioneer's extraordinary potential for global growth over the next decade – and longer.
Netflix saw its popularity surge in the first half of 2020, adding 25.9 million to its growing audience of paid subscribers worldwide. In six months, it almost had as many net additions as the 28 million it tacked on for all of 2019 – and growing by 8.5 million net additions in the final three months of the year pushed the company's global audience past 200 million.
The news gets even better. After five quarters of decelerating year-over-year revenue growth, Netflix's top line is accelerating. Fourth-quarter revenue in 2020 grew by nearly 22% year over year. With the company now confident that it can get through its day-to-day operations without needing external financing, the market leader will continue to crank out gobs of content -- perhaps more than any competitor on the planet -- with money to spare.\u0009Netflix's stock may not seem cheap, with its price-to-earnings (P/E) ratio recently 84 -- but its stock has rarely seemed cheap, and it has grown like gangbusters over the past decade. (The Motley Fool owns shares of and has recommended Netflix.)
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