4 Filters For Small Cap Perfection!

I don’t recommend a company’s stock on a fancy story alone. Each opportunity needs to be passed through a rigorous filtration process before I even think of recommending it to my readers. Here’s a brief taste of what I look at:

Number One: Profitability

Seems like a no brainer, and it kind of is. But it goes without saying that a good company needs to be turning a profit.

Though, of course, it’s not just a case of checking the company makes more than it spends. Instead, I break my search for profitability down into four measures: the margins of the business, its gross profits over its assets, the free cash flow it has and the return on equity.

If these all look healthy, then the company gets a tick in the profit box.

Number Two: Active Growth

The next thing is to check that the company is actually growing, that it is already getting bigger and on the upward spiral.

To do this I dig into the history of the company and look how those measures of profit that I previously identified have been doing for the past five years.

You want to see here that the profits are increasing and the company is going in the right direction. Naturally, if year on year the money in the bank is dwindling, it’s not a good sign.

Number Three: Safety

The third factor is how ‘safe’ the company is.

I establish this by looking at the stock’s volatility and the amount of debt it has on the books.

In regards to volatility, I’m looking here for it to be low. For good companies, you want the price movements to be smoother.

And as you might expect, when it comes to the amount of debt the company has, you want it to be low. That way you know the company is more financially stable.

Number Four: Investor Friendly

Finally, you should be looking for a company that that treats its shareholders well.

I’m not talking about offering cucumber sandwiches at a special picnic the CEO organises each year, but rather how much profit goes to shareholders.

And more specifically, whether the company often dilutes its shares by issuing more equity. This isn’t a good sign if they do.

But if the company does look after its shareholders and it meets the other three requirements as well, then it could make for a sound investment.

Indeed, if you’d like to discover the companies I have already identified using this method (plus a few other criteria that I share with members), you should definitely get your name down for The Penny Share Letter today.

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