How to pick stocks with a difference

Using different alternative and industry-specific performance measures could help investors gain an edge in stock picking.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Regular Fool readers will hopefully be familiar with the basics of stock picking. Stocks might be picked because they are cheap (value investing), pay more dividends than average (income investing), or are expected to rise in price dramatically (growth investing). Identifying potentially outperforming stocks might involve looking at price-to-earnings ratios and estimates of revenue growth, and comparing dividend yields and profit margins.

But there are alternative ways to look at companies, outside the basic investment toolkit, that might yield additional insights. It is, however, important to point out that all metrics are almost useless in isolation. They are useful in judging performance over time or comparing similar companies. Entire industries can be compared with aggregate metrics. When picking stocks, an investor is looking for the best, and the best is only evident in comparison.

Drilling down on differences

Some novel metrics make sense for looking at any company in any industry. Looking at revenue per employee (RPE) can help measure how productive a company’s workers are. If a company spends millions installing new IT systems, looking at how RPE changes over time can help assess the effectiveness of the upgrade.

An investor might want to divide a company’s revenue by its carbon emissions or look at its reported energy intensity. Environmental issues are increasingly important to consumers and regulators. So choosing companies that are becoming more energy-efficient than their peers or moving towards eliminating carbon emissions might be desirable. 

Getting specific

Some metrics are specific to the type of business a company does. Banks make money by charging higher interest rates on loans compared to the interest they pay on deposits. Subtracting interest paid on deposits from income received from loans and dividing this by the total amount of loans made yields net income margin (NIM). A bank would like NIM to be as high as possible.

Analysing companies in the hotels business would not be complete without looking at revenue per available room (RevPAR). Average daily rate (ADR) and occupancy rate (OR) are also important and commonly reported by hoteliers. Multiplying ADR and OR together results in RevPAR. Obviously, charging more per night and/or fully booked rooms increases RevPAR. Expect to find substantial differences in RevPAR, ADR, and OR when comparing budget hotel operators against premium hoteliers.

Revenue per available seat kilometre (RASK) is important for looking at airline stocks and is calculated by dividing revenue by available seat kilometres (ASM). Multiplying the number of plane seats available by the number of kilometres they fly gives ASM. RASK will differ between budget airlines and flag carriers.

Picking winners

There is no single way to pick winning stocks. However, successful investors seem to strive to really understand the companies they invest in. Diving deep into an analysis of a company will help in understanding its strengths and weaknesses, and how it makes money. I have only scratched the surface here, but using alternative and industry-specific performance metrics should help an investor gain insight into a company.

Whatever the metric, noting it is higher or lower for one company versus another is not a reason to invest. Understanding it in terms of a competitive advantage that will persist might be a reason to pick one stock over another.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James J. McCombie has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Businessman use electronic pen writing rising colorful graph from 2023 to 2024 year of business planning and stock investment growth concept.
Investing Articles

Here’s how much income I’d get if I invested my entire £20k ISA in Tesco shares

Harvey Jones is wondering whether to take the plunge and buy Tesco shares, which offer solid growth prospects and a…

Read more »

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

1 big-cap stock I’d consider buying with the FTSE 100 around 8,000

With several contenders it’s been a tough choice. But here are my top FTSE 100 stock picks, despite the buoyant…

Read more »

Investing Articles

How much passive income could I earn if I buy Tesco shares today?

Buying Tesco shares has rewarded investors with solid dividends for decades, and the foreacast shows more years of growth ahead.

Read more »

Investing Articles

How do I build a million pound Stocks and Shares ISA?

With a regular savings plan, a decent investment strategy, and a long-term mindset, a £1m Stocks and Shares ISA is…

Read more »

Young black woman in a wheelchair working online from home
Investing Articles

7 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Investing Articles

If I invest £15,000 in National Grid shares, how much passive income would I receive?

National Grid has long been one of the FTSE 100's most reliable dividend stocks, dishing out passive income year after…

Read more »

BUY AND HOLD spelled in letters on top of a pile of books. Alongside is a piggy bank in glasses. Buy and hold is a popular long term stock and shares strategy.
Investing Articles

How much passive income could I earn from 359 Diageo shares?

After a year of share price declines, Stephen Wright looks at whether a FTSE 100 Dividend Aristocrat could be a…

Read more »

Chalkboard representation of risk versus reward on a pair of scales
Investing Articles

Up 40% in a month! But have I left it too late to buy this top FTSE 100 performer?

This dividend growth stock has smashed the FTSE 100 over the last month. Yet Harvey Jones is approaching it with…

Read more »