It's All About Price & Quality

The task of finding good companies to invest in all comes down to two questions:

(1) Is this a strong, high-quality company?

(2) Is the company's stock priced attractively right now?

If you don't address both questions, you might end up buying grossly overvalued shares of a wonderful company, or you might snap up shares of a hapless, doomed business at what seems like a bargain price. Investors have lost big bundles doing either or both of those things.

The first question is much easier to answer than the second. An enterprise such as Nike, McDonald's or ConocoPhillips might quickly appear to be a first-rate firm. But at what price is it a good buy?

Some investors believe that as long as you've got a great company, the price isn't that important. They figure if an overvalued company keeps growing, it'll eventually grow into and surpass its price. (This can happen, but it might take a long time, and sometimes it doesn't happen. Also, the average growth rate over time might not be that impressive.) Most successful investors recognize that buying at an attractive price is vital to reduce risk and maximize gain.

Conveniently, most company evaluation measures are related to either quality or price. Quality-related measures reflect a firm's profitability, growth and health. They include sales and earnings growth rates, profit margins, return on equity (ROE), return on assets (ROA), inventory turnover, market share and management quality, among other things.

Price-related measures help you determine whether the stock is overpriced, underpriced or priced just right. They address a company's valuation or stock price, and include its market capitalization, enterprise value, price-to-earnings (P/E) ratio and price-to-sales ratio.

Keep quality and price in mind as you examine possible investments, and your portfolio will thank you. The two questions can also help you determine when you should sell. Learn more about these factors in our Investing Basics and How to Value Stocks areas at www.fool.com/investing. htm.