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 Due Diligence

A due diligence meeting is the process of careful investigation by an underwriter to ensure that all material information pertinent to a security issue has been disclosed to prospective clients/ investors/organisation.

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Analyse the Capitalization of the Company

The first step in doing due diligence is to determine just how strong the company is. The company’s market capitalization says a lot about how volatile the stock is likely to be, how broad the ownership might be and the potential size of the company’s end markets.

Competitors and Industries

We compare the margins of two or three competitors. Every company is partially defined by its competition. Looking at the major competitors in each line of business (if there is more than one) may help you nail down just how big the end markets for products are.

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Revenue, Profit, and Margin Trends

When beginning to look at the numbers, it may be best to start with the revenue, profit and margin (RPM) trends. We look up the revenue and net income trends for the past two years at a general finance website. These should have links to quarterly (for the past 12 months) and annual reports (past three years). We have developed a quick calculator check could be done to confirm the price-to-sales (P/S) ratio and the price-to-earnings (P/E) ratio. We look at the recent trends in both sets of figures, noting whether growth is choppy or consistent, or if there any major swings (such as more than 50% in one year) in either direction. Margins should also be reviewed to see if they are generally rising, falling, or remaining the same.

Valuation Multiples

Now it’s time to get to the nitty-gritty of P/Es, price/earnings to growth (PEGs) ratio, and the like, for both the company and its competitors. P/E ratios can form the initial basis for looking at valuations. While earnings can and will have some volatility (even at the most stable companies), valuations based on trailing earnings or on current estimates are a yardstick that allows instant comparison to broad market multiples or direct competitors. Finally, the PEG ratio brings into account the expectations for future earnings growth, and how it compares to the current earnings multiple. Stocks with PEG ratios close to one are considered fairly valued under normal market conditions.

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