1. The percentage of total sales that a particular product represents
Why is it so important to look at the percentage of total sales that a particular product represents?
The same item accounts for more than 80% of sales for company A, but only 8% for company B. The same item is used for company B, but not for company A. The same item is used for company B, but not for company B.
Then there is no doubt that this product sells well and generates a lot of revenue for company A, but only a small percentage for company B.
This reminds me of a company called Ingenics Medical, which makes medical devices, such as masks and protective clothing. And a lot of other companies are in those businesses, too. But why is it that after the outbreak, Invesco Medical's stock price soared (and is now back down, of course), while companies that also make these much-needed medical devices didn't soar?
The reason for this is that these businesses of Invesco Healthcare are his main source of revenue, so when the outbreak came, we saw his revenues go up dramatically, driving the stock price up in a straight line.
This is where the same product doesn't mean the same thing to company A and company B. The reason for this is that the companies' businesses are laid out in different proportions.
But this one also reminds us of another problem, which is over-reliance on one product, and if the market demand for that product falls, or if the supply increases dramatically causing prices to fall, then profits fall and the company's earnings plummet. That's why Invesco Healthcare has fallen back to its original price, for that very reason.
2. Price-earnings ratios
Here's a simple way to look at it, which Peter Lynch describes: Any company whose stock is priced right will have a price-earnings ratio equal to its earnings growth rate. If Coca-Cola's stock has a P/E of 15, then you should expect that company to grow earnings at about 15 percent a year, and similarly for other companies.
If the company's stock is winning at a lower rate than the earnings growth rate, then you may have found yourself a good undervalued stock.
For example, if a company with an annual earnings growth rate of 12 percent has a price-to-earnings ratio of only six times, then the stock's earnings prospects for investment are quite attractive. Conversely, if a company has an earnings growth rate of only 6% while the stock has a price-earnings ratio of 12 times, then the earnings outlook for investing in that company's stock is very worrisome.
This is the price-earnings ratio, which is of course still complex, but if the company's annual growth rate can reach twice the price-earnings ratio, then undervaluation is basically the nail in the coffin.