Buying shares gives you ownership of a company so the best companies usually have the best shares.
What makes a good share
- The company is making money
- The company can make you money as a shareholder
- The company is financially healthy
- The management is running the company properly
MoneyinAfrica has been built to help you find a good share and now we explore how you can use it to find the best shares.
Check if company making money
Company makes money by generating sales and profits. A good company has revenues and profits that keep going up, and consistent profit margins. What do we mean by sales/revenue, profits and profit margins?
Revenue: It is the is the amount of money that is brought into a company by its business activities e.g. the money a supermarket makes from selling groceries.
Profits: It is the money a business makes after accounting for all expenses e.g. the money a supermarket has left after buying its groceries from farmer and selling them to the public. Profits = Revenue – Expenses. A company that does not make a profit makes a loss which means it is not making enough money to pay for what it is doing. Profits are important for you as an investor because this is where your dividends come from. No profit usually means no dividend.
Profit Margin: It is proportion of revenue that ends up profits. The bigger this is the more profit will be available for dividends to you. If a company has a higher profit margin compared to its peers/competitors it means it makes more profits for every $1 of sales/revenue.
Check if a company will make you money
Company will make you money if it generates profits from shareholder’s investments (shown by Return on Equity) that enable it to pay dividends (shown by Dividend Yield), and has shown that shareholders have previously made money.* (shown by Total ShareHolder Return). What do we mean by Return on Equity, Dividend Yield and Total Shareholder Return.
Return on Equity: This is how much profit a company generates with the money shareholders have invested. The higher this is, the better for you as a shareholder.
Dividend Yield: This shows the proportion of your money invested that you get back in cash in the form of dividends. If you have shares worth $100, and you have a dividend yield of 5%, then you will get $5 dollars back in cash as a dividend. The higher this dividend yield, the more cash you get back.
Total Shareholder Return: This shows all the money you make as shareholder from dividends and the change in share price. An example if you buy $100 of shares on January 1st, and then on December 31st they are worth $110 and you got dividends of $5 – you started with $100 and sell all your shares on December 31st you will have $115 which is a 15% shareholder return (115-100).
Check if a company is financially healthy
Company needs to be financially healthy so that it can make money and make you money. For a company to be financially healthy must be show by its Level of debt, ability to pay debts, and generating cash because cash is king. How do we measure whether a company has an adequate Level of Debt, has the ability to pay debts, and it is generating cash?
Level of Debt: All companies need a level of debt to be able to pay for day to day expenses of even for buying assets, and the level of debt required differs by industries. The best way to know if a company has too much debt is by comparing it with similar companies. Companies with a lot of debt have to pay higher interest payments so lower profits and hence lower dividends for you.
Ability to pay debts: Just like you, a financially healthy company should be able to pay debts. A company that does not have enough cash or liquid assets to pay its debts is in trouble.
Cash Generation: Cash is king, and a company must be turning their revenue into cash then profits from which it can pay you dividends. Sometimes companies are making sales/revenue but giving their companies credit which leads to high profits but little cash.
Check if management is running company properly
For a company to continue making money, making money for you and being financially healthy – it needs to have good management. A sign of good management is that it utilises assets well to generate profits, paying out dividends that the company can afford, and investing in the business so that it can grow. How do we measure whether management is utilising assets well, able to pay dividends, and investing in the company?
Management of Assets: Good management generates as much profit from its available assets compared to its competitors. Therefore a company that generates $1 of profits from $100 of assets, is better than one that generates $2 for $1000 of assets.
Ability to pay Dividends: Management decides how much in dividends is paid out, good management will only pay out the dividends it can afford and not easily pressured to pay out too much and put the future of the company at risk.
Level of Investment: Management should be investing in a company to grow. If a company is not being invested in, it has little chance of growing and increasing its share price.
* Past performance is no guarantee of future results.