What Makes a Company Worth Investing In

Stock Market

The following is a contribution from Troy at The Financial Economist. If you’re interested in contributing to Frugal Rules,  please consult our guidelines and contact us.


Are you new to investing? If so, then the first thing that you probably heard was “invest in a stock that’s of value.” That’s a pretty ambiguous phrase, and is pretty useless, just like the phrase “buy low sell high” (come on guys, any third grader knows that you need to buy low sell high). That ain’t the secret to investing. The “secret” is the how part.

Now there are two kinds of stocks worth buying – the first being an undervalued stock, and the second being a stock with impressive growth potential. In this post, I’m going to focus on growth stocks, although I will explain why I’m not going to focus on undervalued stocks.

Below Book Value


Undervalued stocks were how Warren Buffett first started out back in the 1950s. In his words, these were “disgusting cigarette butts that were worth one last free puff.” In other words, undervalued stocks are stocks so cheap that their asset value is even greater than their market capitalization. This can mean that, sometimes, a company’s valuation on the stock exchange is LESS than the amount of cash it has in the bank! Thus, when an investor puts his money into an undervalued stock, he is immediately experiencing more bang for his buck.

The reason why I’m not really going to focus on undervalued stocks is because these days, they’re so rare and hard to come by. Back in Buffett’s day, they were more common (thanks to the Great Depression that kept investor sentiment in check in the 1940s and 1950s). But today, it’s almost impossible to find severely undervalued stocks UNLESS the entire stock market just experienced a major bear market (as we did in 2009). In bull markets like the one we’re experiencing right now, it’s almost impossible to find undervalued stocks.

But, there are always growth stocks out there, waiting for savvy investors to pick them up.

Growth Stocks


Growth stocks are stocks that may not be cheap right now but have a lot of growth potential (meaning that the company has a lot of potential to increase its revenues and profits). Thus, although you’re not making money almost instantly like when you buy undervalued stocks, in the long run growth stocks far outpace the returns of undervalued stocks because there’s compounded growth. Here are some factors that come into play when valuing growth stocks.

Management Strength


For growth stocks, how strong the management team is becomes a critical factor regarding the company’s future. A weak management team that’s un-innovative and slow can spell disaster for a company. A company can have the brightest staff, but like any poorly led organization, a company with poor management cannot be a successful growth company that you should invest in. Growth stocks need good management teams that will continue to grow the company in the right direction.

So what defines management strength?

  1. The leader at the helm must be strong, firm, and open to new ideas. Contrary to popular opinion, the CEO DOESN’T need to be a genius. Some of the best leaders in corporate history weren’t the Einsteins of the world but were great at spotting talent and putting employees in the right positions.
  2. Teamwork. The management team needs to all be on the same page. This doesn’t mean that there shouldn’t be disagreements – in fact, constant back and forth debate between management is a sign of the health of the company. Only through rigorous debate and analysis can a company make the right decisions that put it on the fastlane to growth. But, when a decision is made, everyone needs to get behind that decision and support it. That’s teamwork.
  3. As a general rule of thumb, companies with too many layers of management aren’t growth companies. As companies mature over time, layer after layer of stifling management is piling on, thereby further suppressing growth “hormones” (if that’s what you want to call it).

Products Strength


How good are the company’s products? Is the company a leader in its industry? Are it’s products highly innovative, or does it have to constantly play catch up to competitors? Growth stocks are companies whose products are the industry standard and highly desired by consumers, not some laggard who picks up the crumbs (in terms of sales).

Products are the lifeline to profits and revenues, which are the lifeline to corporate health. Strong product lines, especially INNOVATIVE product lines, equate into high potential growth in the company’s sales (and therefore stock price).



Now this is the big one that many growth investors fail to recognize. The industry that the company is in plays a HUGE factor (potentially one of the biggest).

Is the company’s industry a growth industry, or is it a matured, “traditional economy” industry? As the saying goes “all boats rise with the rising tide.” If the “tide” ( or industry) isn’t rising, it’s very difficult for an individual company to become a growth stock. An example of this would be the retail industry. With so many established market players out there, it is extremely difficult for an upstart to grow like crazy and challenge the Establishment (Wal-Mart, Target, etc). But if the entire industry is growing (expanding market pie), then a company can easily grow along with it (as was in the case with the computer industry in the 1980s).

Another question you have to consider is “is this industry becoming obsolete, or is it on the forefront of cutting edge technology?” A sinking tide sinks all ships, meaning that for industries that are dying out, don’t expect to find any growth stocks there. For examples, industries like rail-roads fall into this category – as railroad traffic sinks across the board, companies are fighting just to stay alive, much less grow.


Editor’s note: Thanks to Troy for sharing his insight with us today. As an investor I am commonly looking at many, if not all, of these areas as a part of my due diligence related to stock research.


Photo courtesy of: 401(k)2013

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I'm the founder of Frugal Rules, a Dad, husband and veteran of the financial services industry. I'm passionate about helping people learn from my mistakes so that they can enjoy the freedom that comes from living frugally. I'm also a freelance writer, and regularly contribute to GoBankingRates, Investopedia, Lending Tree and more. If you're wanting to learn how to monetize your blog, check out my blog coaching services to see how I can help you take your site to the next level.


  • I think industry is a really important factor, and something that really influences investor sentiment. The level of regulation – or potential regulation – definitely comes into play here and might make an investor think twice about investing in a company that on paper seems to bring consistent profits and growth year-over-year.

    • Troy says:

      Some industries are particularly prone to regulation, such as banking. Back in (I think it was) 1982, George Soros invested in the banks because he knew that Congress was going to loosen the restrictions on the Glass-Steagall Act (which cleaved investment and commercial banking into two seperate entities).

  • Great stuff here Troy – thank you. One more piece of the puzzle for us as we work on learning how to become investors. 🙂

  • So are you saying that I shouldn’t buy stock in Blockbuster? I do agree with that point about buying things that will be and stay relevant. Good points. Thanks for reminding me.

  • pauline says:

    If I were to stock pick, I would go with boring, historical stocks, or maybe healthcare and pharmaceutical, but not fancy things, like FB, Starbucks or Lululemon, you never know when people will get tired of FB and the new buzz will be something else. But they’ll always need to eat, transportation and raw materials.

    • Troy says:

      True. I’ve recently been reading a book about Ford (Alan Mullay), and I’m starting to think Ford might be a viable investment option.

  • I don’t currently invest in single stocks, but I am looking into it. I would definitely look at all of these parts because having this type of picture will make you a better investor. Nice work Troy!

  • Joe Morgan says:

    The best advice I’ve ever gotten is to find a great company and wait for it to go on sale.

    But like Tom Petty says, the waiting is the hardest part.

    It takes discipline to be a successful investor (though many get lucky from time to time and mistake that as skill), and that for many people is the hardest part.

    It’s especially true in bull markets as people tend to panic and not want to “miss out” on the gains, but the patient investor will get his chance when things come back down again. Everyone else ends up buying high and selling low.

    • Troy says:

      Thing is, what happens if the market doesn’t dip? You can’t just assume you you’ll get the change to buy when things get down, because that “down” might just be the beginning of a bear market.

  • Those are great advice when to buy a share of a company. I really agree with everything you said above. Thanks, this post taught me a lot!

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