7 Steps for Basic Stock Valuation
While I'm sure it has been done, I definitely don't condone the stock picking process whereby you pin up the equities page of the Wall Street Journal on the wall and then throw darts and buy whichever lucky names you hit. This is not investing, this is just being stupid. However, this is how some brokers describe the unassisted stock-picking process to their clients - and this is just not correct. It does carry slightly more risk to invest on your own, but that should not discourage you from attempting to evaluate stocks of companies that are already very well-known to you.
As an initial preview of things to come, here are 7 main factors that can be used to evaluate a stock quickly to determine if it is worth buying. Not all of these factors need to be met for purchase, but over time you'll get a sense for the importance of one factor over another. All of this data can be looked-up on Yahoo Finance, which is free and easy to use for all investors. There are obviously many factors that go into the proper valuation of a stock – whole books have been written – however there are seven key things to consider when trading the shares of a company.
As an example below, I use a company most everyone knows: Microsoft (MSFT). Analyst Estimates can be found in the "analyst estimates" tab on the left menu when you search for a security on Yahoo Finance.
1. Volume – on days when headlines are light, but the volume of shares is larger than the average trading volume, some news might be brewing (good news = higher, bad = lower). Sometimes on days when the market is trading with a lot of volatility, this will cause all stocks to trade with higher-than-average volumes.
2. Beta – if this number is less than 1.0 the stock is less risker than the market, if greater than 1.0, is risker. This is just a general determination of risk, which does NOT necessarily mean that your returns will be higher or lower than the risk level. Beta is just one helpful piece of the puzzle.
3. Dividend Yield – this stock pays a 2.82% annual dividend which is pretty awesome. Typically in periods when the market is going through struggles, it helps to own as many dividend-paying stocks as possible. No company is obligated to pay a dividend, but the ones who increase these over time are definitely worth consideration.
4. PEG ratio – the closer this is to 0.0 the more the stock is attractive in terms of risk and growth. Ultimately, the PEG ratio is simply the P/E (price to earnings) ratio divided by its growth rate. Some stocks have a very high P/E while others do not and many confuse a low P/E with being a better buy. However, some sectors (like technology and healthcare for example) have generally very high P/E ratios and when you divide this by the growth rate, this helps to justify the levels.
5. Five-Year Growth Rate – if this rate is greater than its industry, sector, and the market and more than the prior year, it would be an optimal time to hold the stock long term. This is also know as the Compounded Annual Growth Rate (or CAGR).
6. Annual Price Target – this price is what all analysts think the stock will reach in one-year time. Sometimes you may notice that the price target is less than the current price of the stock, and that generally means that the public is not too optimistic on its performance over the next year. However, this should be taken with a grain of salt.
7. EPS Trends – These should consistently be revised higher over three months, over quarters and over years in order to justify growth. An increase in estimate revisions means that optimism is growing for the stock over time.