4 Factors to Help You Decide if Investing in a Company Is Worthwhile

Last year's performance is laid out for you to examine.

If you invest in a retirement program through a broker, you may have never made a specific investment decision. Many of us let the broker know when we hope to retire and how much risk we're comfortable taking, and they take over the day-to-day decision-making.

But what if you wanted to invest on your own? How will you know whether a company is a good bet? The answer can be studying two financial statements: the income statement and balance sheet. Here are four factors to focus on.

1. Earnings

Ensure that a company's earnings are at least 10% higher than they were the previous year. You want to invest in any company mainly because it's making a profit, and you want to be part of its long-term success.

Putting money into a company that's not making a profit is not investing; it's speculating.

2. Sales

Sales numbers should also be higher than the year before. Chances are, if earnings are up, so are sales figures. But this is where your common sense is as important as any numbers.

Let's say you're looking at statements for a company that sells the latest, most popular kids' toy on the market. Sales are up because everyone and their brother is willing to stand in line for one of these toys.

If common sense tells you that it's another Beanie Baby or Cabbage Patch Doll and will one day go out of style, you know that any sales growth is temporary.

3. Debt

The debt a company carries should be lower or about the same as the previous year. In other words, you don't want to invest in a company that owes more than it's worth.

Let's say a company has an annual revenue of $25 million, but carries $30 million in debt. Investing in this business means taking on partial responsibility for the debt. It's also betting on the company's ability to turn things around. Finally, you have to ask yourself about the wisdom of company leaders. Would you allow your personal finances to be so upside-down?

4. Return on equity

Return on equity (ROE) shows whether a company can turn equity investments into profit. It's calculated by dividing a company's annual net income by the value of shareholder's equity.

You may (rightfully) ask what a "good" ROE would be, but the answer depends on the industry. Some industries end up with higher ROEs than others. So, if you're looking into a candy company, you would want to avoid comparing its ROE with a brick-making company. Instead, compare it to another candy company.

Where to find financial statements

If a company's stock is publicly traded in the U.S., it is legally required to file a public financial disclosure. These statements are on the Securities and Exchange Commission (SEC) website. You can also typically find the statements on the company's investor relations page.

Investing is ultimately about making your bank account larger and your future more secure. Diving into financial statements before taking the leap is no guarantee of success, but it will increase your odds.