I wrote my book, “Choose Stocks Wisely,” to address how using the balance sheet is essential to defining quality and low price before assuming the risk of investing in common stocks. Since I’m investing the Lord’s money, it’s important to me that I try my best to mitigate unnecessary risks while allowing for opportunity to realize a good return.

In this post, I’ll offer some simple and basic questions I like to ask myself before buying a stock. Further, an answer to each question in the affirmative is desirable.

1. Is the equity of sufficient amount and quality? (my scoring process deals with this question)

2. Is the cash position significant relative to the current asset total? (balance sheet reveals)

3. Is the current asset total larger than the total of all liabilities (current liabilities plus noncurrent liabilities)? (balance sheet reveals)

4. Is any long-term debt on the balance sheet of maturities at least 3 years out? (10Qs and 10K will show)

5. Is all debt on the balance sheet straight debt (convertible debt often spells problems)? (10Qs and 10K show)

6. Is the company currently profitable? (my screening looks at this and income report reveals)

7. Is the business sector expected to see rising demand during future periods? (industry news reveals)

8. Is company management making favorable comments about the future in the most recent earnings report commentary? (latest company earnings press releases and/or earnings conference calls reveal)

There are many other potential issues to be considered but these are surely some key ones for me. My screening process, disclosed in my book, often excludes larger companies as they are typically trading at greater than a multiple of one times balance sheet equity. With these large, well-established companies, the market has become generally unconcerned over the quantity of equity and mostly focused on quarterly earnings. So, the first question in my list above will exclude many, many companies if my scorecard proxy for low price is applied in order to discern “sufficient quantity” of equity.

However, if the “sufficient quality” of equity per my scoring process is maintained but the “sufficient quantity” of equity aspect is relaxed a bit such that less equity relative to price is allowed, some attractive larger companies can come into play as potential investment candidates. The “quality” of the balance sheet is an absolute essential with investing because a company’s ability to survive and experience its future potential depends on the financial flexibility of its present balance sheet. That is, a company’s ability to move forward and take full advantage of its future opportunities depends on its present financial strength.

So, I can’t overstate how important a strong balance sheet is toward sensible investing.  But the “amount” of equity relative to the stock price can be more pliable than my personal frugality permits. Again, relaxing on the “amount” opens a realm of additional stock prospects but only a limited number of these prospects are going to satisfy all the questions following the first one above with a “yes” answer.

Have a good weekend, friends.