Using Morningstar to Help Research Stocks

Over the years, I have worked hard at trying to find the proper tools to select stocks for investments.

A terrific place to get a picture of the companies underlying the stocks is Value Line.  Their "Timeliness" rating from 1 to 5 is a nice place to start with stock selection. 

But what is an individual investor to do if they would like to evaluate a new name and either they don't have a service like Value Line or it isn't included?

One of the most useful websites where one page can tell a whole story is over at Morningstar.com.  Most of us are familiar with the "star ratings" of mutual funds whereby funds are given 'stars' ranging from one to five in terms of how Morningstar ranks them according to their own methods.  For instance, T Rowe Price Capital Appreciation Fund (PRWCX), a fund that I do own shares of in my own retirement account has been a terrific performer over the years and has a Morningstar rating of five stars.

But I really don't want to talk about mutual funds with this entry, I want to explain how I use Morningstar.com to help me select stocks for my blog, Stock Picks Bob's Advice!

Before I go through that process, let me explain that I am not really what you would call a value investor.  Nor am I a technical investor who relies on charts to predict price movement.  I am not purely a growth investor, nor am I a contrarian investor.  If anything, I am closes to a 'growth at a reasonable price' or GARP investor.  What I prefer to be is an eclectic investor--drawing from many different schools of thought on investing and trying to make coherent decisions based on my own trading system.

So let's get back to Morningstar.com and for the purposes of this discussion, let's use a stock that I do not own shares in yet a stock that I recently reviewed on my blog, Ecolab (ECL).

The Morningstar page that I find the most useful in a 'nutshell' is the "5-Yr Restated" financials page which for Ecolab is located here.

My first analysis is a quick examination of the revenue growth symbolized by the purple bars on the yellow graph at the top of the page.  These bars can quickly show you that there is a steady progression in results with increasing revenue starting in 2003 through 2007 and the trailing twelve months (TTM).

Steady and consistent are good!

Same with Earnings/share, listed a few lines down showing also a steady and consistent growth from $.99/share in 2003 to $1.70/share in 2007 with $1.76/share in the TTM.

Again steady and consistent.

We can check the line for dividends.  I don't require dividends in my own analysis but I like to see dividends being paid (why not?) and also love to see dividends that are increasing.

Ditto.  They pay dividends and have increased their payout each and every year from $.30/share in 2003 to $.48/share in 2007 with $.49/share in the TTM.

Gorgeous.

Outstanding shares?  This is listed as "Total Shares MIL", and in this particular situation, I am not looking for increasing numbers but rather for stable or better yet decreasing shares.  When we see decreasing outstanding shares this suggests that the company is retiring shares usually by buying them back.  Less shares means each shareholder owns more of the company!  And this results in improved earnings/share!  In this case ECL has been rather regularly been reducing total shares from 263 million in 2003 to 253 million in the TTM.  Most companies are lucky if they can only increase outstanding shares slowly!

Beautiful.

And free cash flow (as we go down the page)?  I am looking for positive numbers and hopefully increasing free cash flow.  And ECL delivers on this one as well.

Finally the balance sheet.  In my simple perspective, I am just looking for more cash and current assets---the stuff the company can pay its bills with---than current liabilities--the 'bills' you could say that the company needs to pay in the next 12 months.  I don't mind if there is a relative paucity of long-term liabilities as well.  But I don't 'require' it.  And again we see Ecolab with $1.87 billion in cash and other current assets, which can easily cover the $1.6 billion in current liabilities.  From this we can calculate the current ratio comparing the current assets to the current liabilities and for Ecolab, I calculate out a ratio of 1.17, an adequate balance between current assets and current liabilities from my perspective.

I have run on longer than I had hoped to do, but I hope that you were able to follow along with me on this analysis.  There are other factors that I use to select a stock and I hope to share these with you in future articles, but I wanted to make sure that I had shown all of you an important place to check stocks you might be considering buying or selling to get a better handle on the goings-on 'under the hood' as we like to say.

And I can still remember the gas station attendants who would come out and with a smile ask you if you would like for them to check 'under the hood' for you?  Whatever happened to those days anyhow?