How to Research Stocks: A Step-by-Step Guide Using the Five Criteria
Updated: 5 hours ago
To research a stock, work through the same steps every time: confirm you understand the business, run a quick screen, then test it against the Five Criteria in order (business quality, moat, management, balance sheet, price) using the annual report and a free data site, and finish by writing down the bear case and your decision. A good process will not make you right every time. It makes sure that when you are wrong, you know why.
Howard Marks has long argued that investors cannot predict the future, but they can prepare for it. A written research routine is how you prepare. This guide gives you that routine, tells you exactly where to find each number, and walks through a full example.
Where this fits: this is the research-process hub for the Five Criteria. It turns the framework in A Proven Investment Strategy Built on Five Key Criteria into a step-by-step workflow you can run on any company.
Why Stock Research Needs a Process
Most investors analyse stocks. The best investors analyse businesses. Stock analysis asks "is this cheap?" Business analysis asks "what makes this company hard to compete with, how long will that last, and what could break it?"
Without a fixed process, research drifts toward whatever is most exciting: a new product, a big price drop, a confident CEO. You end up with a portfolio of stories. A process fixes three problems at once:
It saves time. Most companies fail an obvious test in the first twenty minutes. You stop there.
It makes companies comparable. When every company answers the same questions, you can rank them.
It lets you learn. When a stock goes wrong, you can look back and see which question you answered badly.
The order matters. Quality comes first and price comes last. If you look at the valuation first, a low price will talk you into forgiving a weak business.
The 9-Step Stock Research Process at a Glance
Step | What you do | Main source | Time |
1 | Circle of competence check | Company website, annual report business section | 5 min |
2 | Quick screen | Free data site | 10 min |
3 | Criterion 1: great business | Annual report financials | 30 min |
4 | Criterion 2: durable moat | Annual report, investor presentation | 30 min |
5 | Criterion 3: aligned management | Proxy statement, cash flow statement | 20 min |
6 | Criterion 4: sound balance sheet | Balance sheet, debt notes | 15 min |
7 | Criterion 5: reasonable price | Your own calculation | 20 min |
8 | Bear case and risks | Risk factors, earnings calls | 15 min |
9 | Decide and record | Your decision journal | 10 min |
A full pass takes one to three hours for a company you already understand. If you want a faster first filter, start with How to Spot a Great Business in 10 Minutes and only do the full process on companies that survive it.
Where to Find the Data: Your Research Toolkit
Before the steps, here is where each piece of information lives. You do not need paid software. Everything below is free.
The annual report (10-K in the US)
The annual report is the single most important document. US companies file a Form 10-K with the SEC, searchable free on EDGAR. Canadian companies file an annual report and Annual Information Form on SEDAR+. Most other listed companies publish an annual report on their investor relations website. The key sections of a 10-K are:
Item 1, Business. What the company sells, to whom, its segments and competitors. Start here.
Item 1A, Risk Factors. Management's own list of what could go wrong. Long and legalistic, but new additions year to year are worth noticing.
Item 7, Management's Discussion and Analysis (MD&A). Management explains the results, margins, cash flow and debt. This is where you learn why the numbers moved.
Item 8, Financial Statements. The income statement, balance sheet and cash flow statement, plus the notes. The notes hold the detail on debt maturities, leases, share-based pay and segment results.
The proxy statement
The proxy statement (Form DEF 14A in the US, the management information circular in Canada) is where you find executive pay, how bonuses are calculated, and how many shares directors and officers own. It is the best free source for criterion 3.
Investor presentations and capital markets days
Companies publish slide decks alongside results and at investor days. They show how management wants you to see the business: strategy, targets, segment economics. Having worked in investor relations, I can tell you these decks are carefully built to tell the best version of the story. Use them to understand the strategy, then check every claim against the annual report.
Earnings calls
Most companies host a call each quarter, with a webcast and often a transcript on the investor relations site. The prepared remarks repeat the press release. The value is in the analyst questions. Listen for which topics management answers directly and which it avoids.
Free data sites
Data sites save you from typing ten years of numbers into a spreadsheet. Good free options include:
Yahoo Finance for quick statistics, several years of financial statements and ownership data. See How to Use Yahoo Finance for Stock Research.
Morningstar for longer history, key ratios and its moat ratings. See How to Use Morningstar for Investment Research.
Macrotrends and Stock Analysis for long-run charts of revenue, margins and share count.
Finviz for screening a whole market on a few ratios.
SEC EDGAR and SEDAR+ for the original filings, including insider trading reports (Form 4 in the US).
Always treat data sites as a starting point. They sometimes calculate ratios differently or mislabel one-off items. If a number drives your decision, check it in the annual report.
Where each Five Criteria data point lives
Criterion | Data you need | Best source |
1. Great business | Operating profit, invested capital, gross margin, free cash flow, net income | 10-K Item 8; data site history |
2. Durable moat | ROIC and margins in the worst year, customer retention, market share | 10-K Items 1 and 7; investor presentation; earnings calls |
3. Aligned management | Share count, insider ownership, pay structure, acquisitions and buybacks | Proxy statement; cash flow statement; 10-K cover page |
4. Sound balance sheet | Debt, cash, EBITDA, interest expense, dividends paid | Balance sheet; debt notes; cash flow statement |
5. Reasonable price | Free cash flow per share, share price, growth assumptions | Your own calculation from the above |
Step 1: Check Your Circle of Competence
Before you open a single financial statement, ask: can I explain in two sentences how this company makes money and why customers keep choosing it?
Buffett has written that you do not need to be an expert on every company, only on the ones within your circle of competence, and that knowing where the edge of that circle sits matters more than how big it is. Peter Lynch put the same idea practically: know what you own, and know why you own it.
Read Item 1 of the annual report and the company's own "about us" page. Then write your two sentences. If you cannot, move on. That is not a failure. It is the first filter doing its job.
Step 2: Run a Quick Screen
Next, spend ten minutes on a free data site to catch obvious problems before you invest serious time. Check:
Has revenue grown over the last five years, or at least held steady?
Is the company consistently profitable, with stable margins?
Does free cash flow look similar to net income?
Is debt modest relative to earnings?
Has the share count been rising quickly?
Shrinking revenue, chronic losses, heavy debt or rapid dilution are all reasons to stop. If the company passes, you have earned the right to spend the real time.
Step 3: Criterion 1 — Is It a Great Business?
Now the real work starts. Pull at least five years, ideally ten, of the numbers below into one spreadsheet.
Return on invested capital (ROIC). Operating profit after tax divided by the capital tied up in the business (debt plus equity, minus excess cash). The house threshold is 15% or more for at least five years. See Return on Invested Capital: The Gold Standard of Business Quality.
Gross margin trend. Stable or rising margins suggest pricing power.
Cash conversion. Free cash flow (operating cash flow minus capital expenditure) should be at least 90% of net income.
Capital intensity. Compare capital expenditure with depreciation and with revenue. Capital-light businesses can grow without constantly asking for money.
Many older guides use return on equity (ROE) instead of ROIC. ROE can be flattered by debt, because borrowing shrinks equity. ROIC includes debt, so it is harder to game.
Also read the income statement for consistency. Earnings per share growing much faster than revenue deserves an explanation. Often it is buybacks, cost cuts or one-off gains rather than a better business.
If you are new to the statements, Introduction to Financial Statements covers the basics.
Step 4: Criterion 2 — Does It Have a Durable Moat?
High returns attract competitors. A moat is what keeps them out. Pat Dorsey grouped moats into five sources: intangible assets, switching costs, network effects, cost advantages and efficient scale.
Your job is to name the source and then find evidence. The evidence is in the numbers:
Did ROIC stay above 15% in the worst year of the last decade, such as a recession?
Did gross margin hold when a competitor cut prices?
Does the company report customer retention, renewal rates or market share in its annual report or investor presentation?
Using a SWOT to stress-test the moat
A SWOT (strengths, weaknesses, opportunities, threats) is a simple way to think like an owner rather than a trader. Use it here, not as a separate exercise:
Strengths are the moat sources. For each, ask whether it will still be intact in fifteen years.
Weaknesses are structural limits: high capital needs, a thin management bench, a concentrated customer list, a heavy debt load.
Opportunities are realistic ways to grow revenue or margins, such as pricing power, adjacent markets or operating leverage. Discount them by probability. Not all will happen.
Threats are forces that could break the model: new technology, cheaper competitors, regulation, commoditisation. Nokia's lead in mobile phones before the smartphone era is the classic reminder that a moat can disappear.
For each threat, ask one question: is it existential or manageable? Then ask the owner's question: if I owned this whole business and could not sell it for twenty years, would I be comfortable? The deeper guide is How to Spot a Competitive Advantage (Moat) in Any Business.
Step 5: Criterion 3 — Is Management Aligned With Shareholders?
Good management cannot rescue a bad business, but poor management can waste a great one. The most important thing a CEO does is decide where the cash goes.
Check:
Share count over five years. Found in the income statement (weighted average diluted shares) and on the 10-K cover page. Flat or falling passes. Rising means dilution.
Insider ownership. The proxy statement lists holdings of directors and officers. You want a meaningful personal stake.
Pay structure. Also in the proxy. Pay tied to ROIC, free cash flow per share or long-term returns is better than pay tied to revenue or adjusted earnings.
Capital allocation record. Add up ten years of acquisitions, buybacks, dividends and debt repayment from the cash flow statement. Did those choices earn good returns?
Candour. Read three years of shareholder letters and at least one earnings call transcript. Does management admit mistakes plainly?
Insider buying is worth noting, but it is a weak signal on its own. See How to Identify Great Management Before You Invest.
Step 6: Criterion 4 — Is the Balance Sheet Sound?
Debt is what turns a bad year into a permanent loss. The house thresholds are:
Net debt / EBITDA of 2.0x or less. Net debt is total borrowings minus cash, from the balance sheet. EBITDA is operating profit plus depreciation and amortisation.
Interest coverage of 5x or more. Operating profit divided by interest expense.
Free cash flow covers the dividend. Compare dividends paid in the cash flow statement with free cash flow.
Also read the debt note for when borrowings mature. A large refinancing due in a weak credit market is a risk the ratios alone will not show. Leases and pension deficits can act like debt too. Banks, insurers and REITs need different measures, but the principle of surviving a bad year never changes.
Step 7: Criterion 5 — Is the Price Reasonable?
Only now do you look at the price. Even the best business is a poor investment if you overpay.
Two house tests:
Free cash flow yield of 5% or more. Free cash flow per share divided by the share price.
A margin of safety of 25% or more below a conservative estimate of intrinsic value, usually from a simple discounted cash flow.
A useful sanity check is to ask what return the current price implies. Start with today's free cash flow yield, add a realistic growth rate, and compare the total with what an index fund might reasonably deliver. If the answer is not clearly better, the stock does not clear the bar, however good the business.
Price multiples compared with peers (P/E, EV/EBITDA) and asset-based measures (price to book) are useful cross-checks, especially for asset-heavy businesses. They are not a substitute for thinking about cash flows. Start with What Is Stock Valuation? and Margin of Safety Explained.
Step 8: Write the Bear Case
Charlie Munger's advice to "invert, always invert" is the most useful habit in stock research. Instead of asking how you make money, ask how you lose it. Write down three risks:
The biggest industry or macro risk. Regulation, technological change, commodity prices, a recession.
The biggest company-specific risk. Customer concentration, a key person, leverage, an acquisition that goes wrong.
The disaster scenario. What would have to be true for this to lose you half your money?
The Risk Factors section and the hardest analyst questions on earnings calls are good places to start. If one risk is both severe and likely, walk away. An investor who cannot state the downside case should not own the stock.
Step 9: Decide and Record
End every research session with one of three decisions:
Buy. Passes all five criteria, the bear case is manageable, and you know what position size you can survive being wrong on.
Watchlist. Passes criteria 1 to 4 but not price. Record the price at which it would pass.
Reject. Fails a quality criterion. Record which one, so you do not redo the work next year.
Write a short thesis: why you own it, what you expect, and what would make you sell. This often exposes gaps in your reasoning. It also gives your future self something honest to check against. How to Build a Stock Watchlist and Decision Journal shows how to set this up.
Worked Example: Researching Company A
Here is the process applied to a hypothetical company with round numbers. Company A sells specialised cleaning equipment to hospitals and factories, plus the consumables and service contracts that go with it.
Step 1, circle of competence. Company A sells machines once, then earns recurring revenue from parts, consumables and service for the life of each machine. Customers stay because switching brands means retraining staff and replacing spare parts inventory. Two sentences written: pass.
Step 2, quick screen. Revenue grew from $800 million to $1 billion over five years. It was profitable every year. Share count is flat. Pass.
Step 3, great business. From the last annual report:
Item | Value |
Operating profit | $150 million |
Tax rate | 20% |
Invested capital | $700 million |
Net income | $105 million |
Free cash flow | $100 million |
After-tax operating profit is $120 million. ROIC is $120 million divided by $700 million, about 17%. It has been between 15% and 19% for eight years. Free cash flow is 95% of net income. Pass.
Step 4, moat. Switching costs from the installed base. In the last recession revenue fell 12%, but ROIC only dropped to 14% and recovered within two years. The moat is real but not impregnable. Borderline pass.
Step 5, management. CEO and directors own 6% of shares. Pay is linked to ROIC and free cash flow. Share count has fallen 3% in five years through modest buybacks. Two small acquisitions both lifted margins. Pass.
Step 6, balance sheet. Net debt is $250 million and EBITDA is $200 million, so net debt / EBITDA is 1.25x. Interest expense is $15 million, so coverage is 10x. The dividend of $40 million is well covered by free cash flow. Pass.
Step 7, price. The company is worth $2.5 billion on the market. Free cash flow of $100 million gives a free cash flow yield of 4%. A conservative discounted cash flow suggests intrinsic value of about $2.8 billion, only 11% above the market price. Fail.
Step 8, bear case. A cheaper Asian competitor enters the consumables market. A second recession hits factory customers. A large acquisition overpays.
Step 9, decision. Watchlist. The business passes criteria 1 to 4. At a market value of about $2 billion, the free cash flow yield would be 5% and the discount to intrinsic value would be roughly 29%. That becomes the target entry.
How We Use This in the Five Criteria
This process is simply the Five Criteria run in order, with a screen at the front and a bear case at the back. The house thresholds do not change:
Business: ROIC of 15% or more for five years, stable or rising gross margin, free cash flow at least 90% of net income.
Moat: one named Dorsey source plus evidence that ROIC held through a downturn.
Management: share count flat or falling over five years, meaningful insider ownership, sensible capital allocation.
Balance sheet: net debt / EBITDA of 2.0x or less, interest coverage of 5x or more, free cash flow covering the dividend.
Price: free cash flow yield of 5% or more, or 25% or more below conservative intrinsic value.
Score each criterion pass, borderline or fail. One borderline can be acceptable with a larger margin of safety. Three is a no. The Stock Analysis Checklist breaks each criterion into three questions you can tick off.
Common Stock Research Mistakes
Starting with the price. A low P/E creates an emotional anchor before you know whether the business deserves it.
Relying on one year. Cyclical businesses look brilliant at the peak. Use five to ten years.
Trusting the investor presentation over the annual report. Presentations show the story management wants told. The filings show the facts.
Skipping the notes. Debt maturities, leases and share-based pay hide in the notes to the accounts.
Treating data sites as gospel. Check any number that drives your decision against the original filing.
Researching without deciding. Every session should end in buy, watchlist or reject, written down.
For a longer list with fixes, read The Most Common Stock Analysis Mistakes and How to Avoid Them.
Building the Habit
Research is a skill, and skills come from repetition. Using the same process on every company means the tenth analysis is much faster and sharper than the first. Keep a steady pipeline of ideas from sources you understand, and hold each one to the same standard. How to Consistently Find Great Stocks covers the habits that keep that pipeline full.
Frequently Asked Questions
How long does it take to research a stock properly? A quick screen takes ten minutes. A full Five Criteria analysis takes one to three hours for a business you already understand, and longer for a new industry. Most companies are rejected early, which saves time overall.
What is the most important document for stock research? The annual report, or Form 10-K in the US. The business description, MD&A, financial statements and notes answer most of the Five Criteria questions. The proxy statement adds pay and ownership detail for criterion 3.
Can I research stocks using only free tools? Yes. SEC EDGAR, SEDAR+, company investor relations websites, Yahoo Finance, Morningstar and Macrotrends provide everything you need. Paid tools save time, but they do not replace reading the filings.
Should I use a SWOT analysis to research stocks? It is a helpful way to think like an owner, especially when testing a moat. On its own it is too loose to make a decision. Use it inside criterion 2, then let the numbers decide.
Your Next Step
Pick one company you already know and run it through the nine steps this week, using the Five Criteria Investment Checklist as your scorecard. If you need the full framework first, read A Proven Investment Strategy Built on Five Key Criteria. If some of the terms are new, the 5-Week Beginner Track builds them from scratch.
About the author: Cameron Hayes is a senior investor relations and finance professional who has worked in IR at Nasdaq Copenhagen-listed companies including Nilfisk and Maersk Drilling. He holds an MSc from Copenhagen Business School and a BCom from the University of Ottawa, and founded Gingernomics to teach individual investors the Five Criteria framework. More about Gingernomics.
The content on Gingernomics is for educational and informational purposes only and does not constitute financial advice. Always do your own research and consult a licensed financial advisor before making any investment decisions. Past performance is not indicative of future results.
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