So you know all the benefits of investing in the stock market, you’ve decided which brokerage account is right for you, and you know about how many stocks you should buy in each sector to make a diversified portfolio. Well done! The next step is choosing which stocks to consider buy, but before you make any purchases knowing how to do your own basic stock analysis is very important. This blog has gone into several articles about important components to stock analysis, but if you’re starting from the very beginning, where do you go?
One of the most frequently asked questions among new investors is what are the most important indicators for the health of a stock? All publically traded companies issue quarterly earnings reports to the Securities and Exchange Commission (SEC) and this information is easily accessible by all investors. Within these reports are a few key pieces of data that investors can use to decipher a stock’s health:
Earnings Per Share (EPS) – this is the ratio of total earnings divided by the total number of investor shares. This is a dollar amount that can be compared between other stocks and should be progressively better over time for a stock.
Price-to-Earnings Ratio (PE or P/E) – This is the current price of the stock divided by the estimated earnings per share for the period in question (quarterly or annually). This is ultimately what customers are paying for one dollar of the company’s earnings. According to statistics, the long-term average P/E ratio has been about 15.0. A stock with a high P/E might mean that the future is positive for the stock, but it also means that the company has to work harder to maintain performance long-term. A low P/E might mean that a price increase is on the way for the stock, but at the same time it could mean that the company is in trouble.
Price-To-Book Ratio (P/B) – This is useful when evaluating stocks that are in the same sector (like technology or finance), and it can indicate what shareholders are willing to pay compared to what the company is reportedly worth. In general, a value below 1.0 means that the stock price is lower than the actual value of the company, meaning that you will have an opportunity to buy the stock at a low price. On the other hand, it can also mean that the company is struggling, but you can figure out which one it is by comparing P/B ratios over time. This ratio varies greatly by industry and is only appropriate for comparing alike companies.
Some data can be more revealing than others when evaluating a stock’s health, but you should not isolate it two metrics. The appropriate stock picks for your portfolio rely largely on your objective long-term. If you are looking for higher returns over a longer duration, you can absorb higher risk and stocks that are poised to increase significantly over a short period of time will appeal to you. If your goal is less risk and moderate growth, stick to stocks whose prices have been rising steadily over the last 52 weeks.
Lastly, and most importantly, USE YOUR OWN BRAIN. Do your own independent research and analysis on the company’s business practices and industry trends. Do you think the company and its product(s) will still be in demand 10 years from now? Do you believe in the company and it’s competition strategy? How much debt does the firm carry and will they be able to pay it back? What is its growth strategy? Think about all these things and you will do well! Good luck!
Greetings, GradMoney Readers!
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