What Figures to Consider While Picking a Stock
Picking the right stock can appear overwhelming, but following certain methods of analysis can give you a reasonably clear picture
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Getting started in trading stocks could involve a bit of doubt or apprehension, but with innovation and technology online stock brokers are offering features such as commission free trading and demo trading to help you get familiarized with the whole process. New to stock trading and want to figure out how to select the right stock? Well, this resource should help, and for those who’ve gained some experience, it does help to get back to the basics now and then. We Aren’t Good at Predicting the Future None of us are born with a crystal ball. We aren’t good predictors of what the future would bring, be it in the stock market or in other areas of life. But there is a certain level of understanding you gain that can help you expect how a stock would turn or how the markets would react to circumstances and events on national or a global scale. While analyzing markets belongs to the category of market analysis, which does have a bearing on stocks, let’s focus on how to analyze a stock by itself, for all its worth. Motley Fool analyst Matthew Frankel gives his insight. The Intrinsic Value of a Stock The idea of buying stock is to get it at a price that is less than what the future profits of the company attain in value. But, as we said before, we can’t predict what the future has in store and how the future growth and profits of the company would turn up. Analyzing stocks can, therefore, help. Stock analysis involves the use of analytical methods for finding stocks that trade for lower than what their intrinsic value is. “Intrinsic value” refers to a stock’s growth prospects. Figuring out what the intrinsic value is can help you get returns that beat the market. Analyzing Stock - Fundamental and Technical Analyses There are two ways to go about stock analysis - fundamental analysis and technical analysis.
Fundamental analysis is basically the assumption that the prices of stock do not always reflect what the intrinsic value of the business is. This kind of analysis is particularly great for long-term investing.
Technical analysis takes on the assumption that the price of a stock is the reflection of all the available information. It also assumes that prices move in accordance with trends. Technical analysts assume that by studying the history of a stock price, its future price behavior can be predicted.
There is some amount of risk involved with technical analysis, and it’s more suited for shortterm traders who wish to profit from price fluctuations. Fundamental analysis is aimed at helping find investment opportunities in the long-term.
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Metrics for Analysis Whatever be the kind of analysis you adopt, you need the right metrics that give you solid figures to help you make objective decisions. P/E Ratio Price-to-earnings ratio (P/E ratio) is one of these. Companies trading publicly on the stock market would have to report the profits they’ve earned in the form of earnings per share (EPS). The P/E ratio is calculated by dividing the share price of the company by its EPS annually. For example, if the trading price of a stock is $40.00 and its earnings in the past year were in the region of $2.00 per share, its P/E ratio is 20 times earnings. The figure was derived by dividing 40, its current trading price, by 2, its earnings per share over the past year. This article on Motley Fool gives an example for EPS – if the company has earned $10 million with 10 million outstanding shares, the EPS is $1 for that period. The P/E ratio is quite commonly used in fundamental analysis and really helps when you need to compare companies within the same field and having similar prospects for growth. PEG Ratio The price-to-earnings growth ratio (PEG ratio) measures the growth rate of a company. It is calculated by dividing the P/E ratio of a stock and dividing it by the company’s expected earnings growth in the next number of years. A stock having P/E ratio of 20 with expected earnings growth of 10% over a period of the coming five years has a PEG ratio figure of 2. Some companies could have a P/E ratio that makes them appear expensive, but if their PEG ratio suggests that they are fast growing, then they can represent greater value than companies that grow slower but have a cheaper P/E ratio. P/B Ratio The price-to-book ratio (P/B ratio) represents the value of a company’s assets. It is based on the company’s book value, which tells you what a company would get if it sold all its tangible and non-tangible assets and shut its business down. It’s just a theoretically conceived situation. The P/B ratio compares the stock price of a company to the book value it has. The P/B ratio must always be used along with the other valuation metrics, and really helps for comparing companies operating in the same field or industry. Debt to EBITDA Two other metrics you need to take into consideration are return on equity (ROE) and debt to EBITDA. ROE is a profitability metric, calculated by dividing the net income of a company by the shareholders’ equity. It tells you whether the company has been efficient in making use of its
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invested capital for earning a profit. The greater the percentage of the ROE is, the more efficient it is in generating profit. The debt to EBITDA ratio is the analysis of the financial health of a company by checking out its debts. EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization. The EBITDA figure is found on a company’s income statement while its balance sheet mentions the debts it has. The debt to EBITDA figure must ideally be low for a company. It’s easy to figure this one out. If the debt to EBITDA figure of a company is significantly greater than other companies operating in the same industry, it shows that buying the company’s stock would amount to a high-risk investment. Wishing You Happy Stock Selection! In addition to these solid figures, you also need to analyze the industry trends, the scope of the business of the company and how efficient and stable its management is. With these factors analyzed, and studying the opinions of experienced analysts, you should be able to select the right stock. With direct access trading platforms, it’s easy to trade stocks from the comfort of your home.
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