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For now, it looks like panicked investors have finally started to calm down. That's good news for those who've been waiting for a breather before taking action.
If you haven't taken a close look at your portfolio lately, it's time to hold your breath and spend some time getting reacquainted with the companies in which you've invested. During rosier, more optimistic times, you didn't have to know a lot about your stocks to make money investing. Now, though, you can't afford any surprises -- your investing dollars have to work as hard for you as they can.
So as you take a second look at the stocks you own, here are five things you really need to focus on in order to feel comfortable that they'll help your portfolio weather the current financial storm.
1. Don't get cash-squeezed.
Malfunctioning credit markets and difficulties in getting new financing have shown investors the downside of the leverage-based economy. Despite low interest rates, which suggest that debt-laden companies should be enjoying an easy time of it right now, many businesses have started to de-lever themselves in preparation for a tight credit environment.
If your stocks have good balance sheets with plenty of cash to handle debt, you're in great shape. But if your companies need to go to the capital markets in the near future, you may find yourself on the short end of the dilution stick, as shareholders of Goldman Sachs (NYSE: GS ) and AIG (NYSE: AIG ) can attest.
2. Watch the dividend.
Following the cash is a good theme; there's no better indicator of a company's financial health than its ability to pay out cold, hard cash to its shareholders. While many ailing financials have cut dividends, stronger companies like Microsoft (Nasdaq: MSFT ) and McDonald's (NYSE: MCD ) have recently hiked their payouts.
But as with many things, dividends can be too good to be true. In today's market, you can find double-digit dividend yields -- but not all of those companies will be able to sustain them. Watch a company's payout ratio to judge whether it's got the goods, or whether it's living beyond its means.
3. Beware falling estimates.
After a 40% drop, the stock market certainly looks cheap -- especially when you see the impressive earnings estimates that some companies still sport. But with the economy slowing, you have to take many of those estimates with a grain of salt.
For instance, in the energy sector, analysts were initially slow to cut estimates in light of July's drop in crude prices. But now, cuts have run rampant. BP (NYSE: BP ) , for instance, has seen its average 2009 estimate drop nearly $2 per share in the past two months. Marathon Oil (NYSE: MRO ) has seen its average projection cut of about 20%.
4. Is management on your side?
It's always a good idea to look for companies with managers whose incentives are aligned with shareholders. But it's especially important when stocks are falling to avoid fighting greedy executives just to preserve whatever wealth a company has left.
Adjustments to option grants that reduce their exercise price, as VMware (NYSE: VMW ) recently decided to do, are particularly troublesome. Although corporate boards argue they're essential to keep top talent, these moves tend to benefit company employees and executives, rather than shareholders. The practice is insulting to investors, yet you can count on seeing more of it if the market doesn't rebound quickly.
5. Will the business survive?
Companies have to change with the times, but some simply can't undergo enough of a makeover to escape a dying industry. Consider subprime lending, a practice that was extremely lucrative not just for companies like Countrywide, but also for small mortgage lenders. Yet while there will undoubtedly be continued demand for credit for risky borrowers, regulators probably won't allow the subprime business to return in anything like the form it once took.
Even if your stocks pass these five tests, you might still see more declines if the panic continues. But knowing your portfolio better will help you realize you're not throwing your money away -- and it'll give you the confidence to get rid of stocks you own that don't make the grade.
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