In assessing stocks, it’s important to know what some of the company’s numbers are. Some of these statistics are used in determining the value of a stock as an investment.
One of the most basic measures of a stock value involves the company’s earnings. When you buy a stock, you’re purchasing ownership in the company, so profitability is important.
The most common measure for stock profitability is the price to earnings ratio (P/E). The P/E ratio takes the share price and divides it by a company’s annual net income. So a stock trading for $40 with annual net income of $2 a share would have a price/earnings ratio of 20.
While P/E can be a revealing indicator, it shouldn’t be your only measure for evaluating a stock.
The questions to ask as you considering stocks should be the same you’d ask if you were buying the whole company:
- What are the company’s products or services?
- Are they in demand?
- Is the industry doing well?
- How has the company performed in the past?
- Are talented, experienced managers in charge? Do they own stock as well?
- Are operating costs low or too high?
- Is the company in heavy debt?
- Is the stock worth the current price?
I also tend to look at the following:
Use industries you are familiar with first – Warren Buffet said “Never invest in a business you cannot understand.” This is huge. When you have a good understanding of how a company or industry works, you’re in a better position to be able to make an informed decision.
Average trading volume – You never want to buy into something you can’t get back out of.
Insider ownership – If there’s no skin in the game from the people that run the company, there’s nothing tying them to make it successful long-term.
Return on equity – Return on equity shows you what they did with the initial investment money when the company went IPO. Is the company a good financial steward or are they blowing through the money without regard to profits? If they don’t care about profits, you’re not likely to make a lot long-term.
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