You are here: Trading Stocks :: Due Dilligence

Due Dilligence

I have tried to assemble, as best I can, a list of those things I check. I am sure there are many more intangibles that I have not covered here but hopefully this will give you some insight as to what I do during the trading day. I call this my One Minute Due Dilligence (DD) and try to do it just before entering a trade, or soon after a trade to see what I have gotten myself into.

Due dilligence is very subjective and open to interpretation by the person doing it. There exists no hard and fast rule to determine if a trade is good or not. If you find one person to say that a float of 10 Million is good, another will say that it is too high.

Again, a person's due dilligence is just to get an initial idea of what we are getting into before actually trading...or sometimes after the initial trade to determine how long we could hold it.

For the most part, you can use Yahoo's site to answer your due dilligence questions. Lets go through some of the things I look at.

1) Volume, take a look at the avg. daily volume of the stock. I normally like to see at least 3x (3 times) the avg. daily volume before I trade an issue. It tells me that something is up and that the issue is in play. It doesn't have to be 3x but the more the better.

2) I immediately look at the P/E ratio to see what kind of fundamental value the issue is. Many people commonly use a P/E of below 20 to indicate a good value, above 20 to be so/so depending on the sector. Tech plays are usually between 20-80 if they have a positive P/E at all. The lower the P/E the more I think, "Ok, we have a decent value here relative to past earnings" (And this is an important fact).

3) Click on "Research" for the issue and note the "Earnings Per Share" area in the upper right of the box. Specifically, note the "Surprise" field. Is it positive or 0....or is it negative and by how much. Lets say from item 2 above that you have a P/E of 8 which would indicate a tremendous bargain compared to the 20 that many use as an indicator. You then go to this Earnings per Share (EPS) box and note the surprise number to determine whether they met their recent earnings expectations or not. The reason that this is important is that if they did not and the surprise is very negative, it means that they missed their estimates and thus will most likely not make their yearly estimates. Since the P/E is figured on trailing numbers, it may not show the recent earnings downturn and the P/E (Price to Earnings ratio) is so low because their earnings are down. In this case, the forecasted P/E could be 2x or 3x of the current the 8 could end up being 16 or 24, even higher (thus not representing a very good value at all.). However, if the P/E is low and the most recent earnings surprised by a good number then you may have found a good bargain as the P/E could be even lower if they keep up their good performance next quarter, and thereafter. It should be noted that the P/E ratio is just the Price of the stock divided by its current yearly earnings.

4) After finding the P/E and whether they met their earnings estimates, I immediately turn to the news. Click on the "News" link and browse as far back as you can paying particular attention to most recent events. If you have a low P/E above and earnings were still good, check to see if there have been any downgrades/upgrades or earnings restatements by the company or analysts. How about any earnings warnings? Many companies sell at a very low P/E because they have just come out and said that although they made their recent eps expectations, the next quarters will not be as bright. Thus, the issue sells off and the P/E ratio drops. Read the earnings reports from the news lists and any 10-Qs you find. Look for things like decling margins, takeover plays, charges, declining revenues and pay particular attention to what the company execs. are saying in the release. Basically, take in all the news.

5) Next I jump to "Insider". Have any of the execs or others bought shares or filed any 144s (Intent to sell shares). Insider activity must be reported and is a very useful tool in determining how much confidence an exec has in the current price of the stock. However, just like you and I, sometimes even execs have to sell shares to buy things such as homes and big cars. But you should not see a flurry of 144s.

6) How about analyst coverage, again from the "Research" link. How many analysts are following the stock and how do they have it rated. Not that it is that important but it gives you an idea of how "followed" an issue is.

7) From the same "Research" link, take a look in the lower right hand corner and find the "Consensus Estimates" for "This Quarter", "This Year" and "Next Year". This ties into the surprise from #3 above. Take the current estimates for this year and divide them into the current price of the stock to see the expected P/E for this year. Then do that for the "Next Year"s estimates. Hopefully there is an increase in next years estimates compared to this years, which means EPS growth and an ultimate lowering of the P/E ratio relative to today's prices. However, this is where you factor in that "Surprise" figure from above. Did they meet this quarter's estimates and does it seem feasible that they will meet this year's estimates as well. Sometimes you will have to do some addition from previous earnings announcements via the "News" link to determine what they earned previously.

8) Next onto the "Profile" link. Read the brief summary of what they do and get an idea about their growth or lack of same. Then down to the 52-week highs/lows...where are they trading compared to it.

9) Float - I use a three tiered system for float. 1) Less than 5.0 Million, 2) 5M-25M, and 3) 25M+. The float is the number of shares available for public buying and selling. The "Outstanding" shares are the number of shares total issues by the company including those held by officers. The float works on a simple supply/demand model. The less the shares available for trading, the more the price will swing based on good news or bad news. During times of good news, people will be buying and there are few shares for sale, the price goes up due to demand. Just the reverse during bad times. Generally, if you can find a low float stock with upcoming good news and a volume spike, you can do very well....however, hang around too long and when the selling begins, it will work against you.

10) Shares short, also from the "Profile" link. This is the number, at last report, of shares that people are holding short or, betting that the price of the stock is going to go down. Many see this as a negative while many, like myself, see this as a positive. Because of the nature of a short-sale, when "covering" the short, the trader/investor must buy the stock as opposed to selling it. So, if a short seller has a position in say, NAVR and the price begins to rally, the short seller may get scared and have to "buy" his short position to close (cover) his position. You and I make money when a stock goes up, shorts make money when stocks go down and lose money when stocks go up. That is why it is very dangerous to short these high flying net stocks. Additionally, brokers may ask you to contribute more money to insure your loss from the recent price rise, or a margin call.....since short shares are purchased on margin. I consider a large short position as kindling for the fire on good news as not only will the longs be buying the stock, but the shorts will be buying to close their short

11) 5 day chart. I like to look at the 5-day chart, especially into volume to determine how it has been trading recently. Is the trend up or down. Has it been gapping in the AM or selling off in the PM, how about volume? I find this very useful.

12) The 52 week (1 year) chart. Where are the support levels. Is it coming off of support, has it bounced off the same number more than once recently, is it breaking out? The 3 month is good for this as well.

13) I like to take a look at the MACD indicator, are we green, red, or neutral. I don't swear by a lot of TA but I do like the MACD. Do some reading about it, you will find it interesting.

14) But most of all, what is the current rumor or news swirling about the play in general. Are traders just hype buying or is there impending news coming. Let the price action of the issue determine your ultimate decision either way. If you are wrong, sell immediately, if not....have fun with it and lock in your gain when you reach your goal. Many times I enter a trade without doing any DD, because the time is right and the issue is moving.....

I have hopefully covered everything here but have probably left out a few of the intangibles. I hope you find this useful. It is difficult to relay this kind of information as everyone has different methods and different interpretations of the information. Find what works for you and go with it.

I will also do much more research during the evening hours on stock screeners and news links.

The single most important thing anyone can do is to call the Investor's Relations personnel of the company. Do not be shy, they are here to answer your questions. They are just people and sometimes you can get some very good information from them.

I hope this helps some of you who may be confused as to what to look for before getting into a trade.