The Only 3 Numbers That Matter When Analyzing a Stock

Learn to Earn

I. Understanding What Actually Matters in Stock Analysis

When I first started investing, I felt completely overwhelmed by financial statements. There were many numbers to look at. It kinda felt overwhelming (ngl I just look at bar charts more now compared to tables)

But you can get lost in a lot of terms:

Price-to-earnings, debt-to-equity, quick ratios, current ratios, operating margins, profit margins... the list seemed endless.

I remember staring at Microsoft's financials back in 2020, paralyzed by analysis. I had this nagging feeling that I was missing something important. What if I made the wrong decision because I made a mistake on some analysis on a random number I saw?

Here's the thing though: After years of studying great investors and managing my own portfolio to target 15% annual returns, I've discovered that most of those numbers don't actually matter for long-term success. In fact, focusing on too many metrics often leads to worse decisions, not better ones.

Think about it: Warren Buffett doesn't sit there with a spreadsheet analyzing 50 different ratios. Peter Lynch didn't become legendary by having the most complex analysis. What they did was focus on a few key numbers that actually predict long-term success.

I feel some investors stress too much about looking at all of these numbers.

Today, I'm going to share the only three numbers you need to analyze any stock. These aren't obscure formulas or complex calculations. They're straightforward metrics that tell you if a company is actually creating value for shareholders. Even better, they work across any industry, from technology to retail.

By the end of this article, you'll know exactly what to look for when analyzing a stock. And I mean exactly. No more second-guessing yourself while scrolling through financial statements. No more getting lost in a sea of ratios and metrics that don't actually matter. No more watching great opportunities pass by because you're stuck in analysis paralysis.

Instead, you'll have a simple, proven framework for evaluating any company. The same framework I use to target 15% annual returns in my own portfolio. This framework helped me invest in companies like Amazon and Microsoft when many other investors were banging the table “it’s too expensive!”

Think of it like having a checklist that separates great businesses from mediocre ones. Three simple numbers that tell you more about a company's potential than a hundred-page financial report. When you finish reading this, you'll be able to look at any stock and quickly determine if it's worth your time and money.

No complexity. No confusion. Just clear, confident decision-making based on what actually matters for long-term success.

Let's dive in and demystify stock analysis once and for all.

II. Why Most Investors Get Trapped Looking at the Wrong Numbers

I get it. When you're new to investing, it feels safer to look at every possible metric. After all, more information means better decisions, right?

Well, not exactly. Let me share a real example from my own portfolio. Back in 2018, lots of investors thought Microsoft was "expensive" because it had a P/E ratio around 50. By traditional metrics, it looked overvalued. Many people passed on the stock because of this one number.

But here's what they missed: Microsoft's underlying business was incredibly strong. Their cloud division, Azure, was growing fast. They had high margins, strong cash flow, and a clear path to future growth. If you had focused on these fundamentals instead of the P/E ratio, you would have seen a company primed for success.

Fast forward to today, and Microsoft's stock has gone up over 600%. Those investors who got scared away by the P/E ratio missed out on some incredible returns.

This happens all the time. Investors get caught up looking at popular metrics like P/E ratios and earnings per share (EPS) because they're easy to find and compare. Financial websites splash these numbers everywhere. The media talks about them constantly.

The problem? These surface-level metrics often tell you very little about a company's actual strength or future potential. EPS can be manipulated through accounting tricks. P/E ratios don't tell you anything about a company's competitive advantages or growth prospects.

Even worse, obsessing over too many metrics leads to what I call "analysis paralysis." You spend so much time comparing different numbers that you miss the forest for the trees. You lose sight of what really matters: is this company building long-term value for shareholders?

That's why I've simplified my approach. After years of investing and studying companies like Amazon, Apple, and Microsoft, I've identified three key numbers that actually predict long-term success. These aren't complicated metrics - they're straightforward indicators of business quality that anyone can understand.

III. The Three Numbers That Actually Matter

Let's break down each of these numbers and why they're so powerful at predicting long-term success. I'll use real examples from companies I own to show you exactly what to look for.

1. Return on Invested Capital (ROIC)

This is probably the most important number I look at. Think of ROIC as a report card for how well a company uses its money. If a company invests $100 and generates $20 in profit, that's a 20% ROIC.

Let me show you why this matters using Microsoft. In 2018, their ROIC was already impressive at 12%. But by 2024, they've more than doubled it to 25%. This shows they're getting better and better at turning investments into profit.

What's a good ROIC? I look for companies with:

• At least 15% ROIC for established companies

• Rising ROIC over time

• Higher ROIC than competitors

2. Operating Cash Flow Growth

The second number I care about is how much cash the business actually generates, and more importantly, how fast that cash generation is growing.

Look at Amazon. Their operating cash flow grew from $6.8 billion in 2014 to $87.9 billion in 2024. That's a 29% growth rate per year! This massive cash generation gives them the fuel to keep investing in new opportunities while strengthening their competitive position. Below shows the Free Cashflow of Amazon.

What I look for here:

• Consistent cash flow growth above 15% annually

• Cash flow growing faster than revenue

• Stable or improving cash flow margins

3. Gross Margin Trends

The final number is gross margins, which tell you how much money a company keeps after paying the basic costs of their product or service. Rising gross margins usually mean a company has pricing power - they can charge more without losing customers.

Apple is a perfect example. Their gross margins improved from 38.6% in 2014 to 44.1% in 2024. This shows they can keep charging premium prices for their products because customers see the value. It's also why they can generate such incredible cash flow.

I want to see:

• Gross margins above 40% for technology companies

• Steady or increasing margins over time

• Margins higher than industry averages

Now, you might be wondering: "Michael, why these three numbers specifically?" Because together, they tell you everything you need to know about a company's competitive strength and ability to compound wealth over time:

• ROIC shows if they're creating real value with their investments

• Operating cash flow growth confirms they can fund future growth

• Gross margins indicate if they have pricing power and competitive advantages

When you find a company that scores well on all three metrics, you've usually found a wonderful business worth owning for the long term. Even better, these numbers are hard to manipulate through accounting tricks, unlike earnings per share or P/E ratios.

IV. How to Put These Numbers to Work

Let me show you exactly how I use these three numbers to analyze a company. We'll use Costco as a real example, since it's one of my holdings and demonstrates these principles perfectly.

Step 1: Gather the Numbers

First, I look up the three key metrics:

• ROIC: Costco's is consistently around 20-25%

• Operating Cash Flow Growth: Steady growth averaging 15% annually

• Gross Margins: Stable at 30-35% (remember, retail has lower margins than tech)

Step 2: Compare to Industry Standards

This is where many investors make mistakes. You can't compare Costco's margins to Microsoft's - it doesn't make sense. Instead, I look at:

• How do these numbers compare to similar companies? (Walmart, Target)

• Are they improving over time?

• Do they make sense for this type of business?

Costco's numbers might look mediocre compared to a software company, but they're actually exceptional for a retailer. Their ROIC is nearly double the retail industry average of 12%.

Step 3: Check for Red Flags

Before making any decision, I look for warning signs:

• Are any of these numbers declining significantly?

• Do the trends make sense given the company's strategy?

• Is there a good explanation for any unusual changes?

For example, Costco's gross margins are lower than most retailers because of their membership model. This is actually a good thing - it shows they're passing savings to customers, which strengthens their competitive position.

Step 4: Make the Decision

If a company passes these checks, I dig deeper into qualitative factors. But if it fails any of these metrics without a good explanation, I usually pass. This saves me tons of time and helps avoid risky investments.

With Costco, the numbers tell a clear story: they're extremely efficient with capital (high ROIC), growing steadily (consistent cash flow growth), and have a sustainable competitive advantage (stable margins despite intense competition).

This is exactly what I mean by focusing on numbers that matter. Instead of getting lost in complex ratios or quarterly earnings estimates, these three metrics quickly tell you if a business is worth your time and money.

V. Putting It All Together

Let me show you how this all comes together with a recent analysis I did of Amazon. This is the exact process I use before making any investment decision.

First, I pulled up Amazon's numbers:

• ROIC increased from 4.7% in 2014 to 22.5% in 2024

• Operating Cash Flow grew from $6.8B to $87.9B

• Gross Margins expanded from 29.5% to 46.9%

Already, this tells me something special is happening. The company is:

1. Getting more efficient with capital (rising ROIC)

2. Generating massive cash flow growth

3. Gaining pricing power (expanding margins)

But here's where most investors stop. Instead, I dug deeper to understand why these numbers were improving. Turns out, Amazon's high-margin AWS cloud business was becoming a larger part of their revenue mix. Their advertising business was growing. Their investments in automation were paying off.

These improvements weren't just random fluctuations - they reflected fundamental changes in Amazon's business that would likely continue driving growth.

That's the power of focusing on the right numbers. They don't just tell you how a company is doing; they help you spot major business transformations before they become obvious to everyone else.

VI. Conclusion: Your Action Plan

Let's make this super actionable. Here's what I want you to do:

1. Pick a company you're interested in investing in

2. Look up these three numbers: ROIC, Operating Cash Flow Growth, and Gross Margins

3. Compare them to 5 years ago

4. Ask yourself: Are they improving? Why or why not?

That's it. Don't overcomplicate it. Don't get caught up in the hundreds of other metrics that sound important but don't actually predict long-term success.

Remember, the goal isn't to become a master of financial analysis. The goal is to find great businesses you can own for years while targeting those 15% annual returns we're after.

In next week's newsletter, I'll share specific examples of how I'm applying these metrics to find new investment opportunities in today's market. Plus, I'll dive deeper into how different industries require slightly different benchmarks for these numbers.

Until then, keep it simple and focus on what matters.