Investing in the stock market can often feel overwhelming. Ironically, this is sometimes true not because we don’t know where to turn for financial information and financial advice. Rather, there’s no shortage of financial websites and blogs that give viewpoints and recommendations on which stocks to buy and which stocks to avoid.
In light of all this information, it’s important that we are able to conduct our own analysis of any particular stock we’re considering investing in. The more research we can do ourselves, the more likely we are to be confident in our investing decisions. Evaluating stocks yourself before you invest is always a good idea. It’s a smarter and more calculated approach than merely trusting your instincts.
Here are some of the basic indicators you can use to help determine a stock’s health and potential for growth.
Company Earnings. The most basic tool to assess a stock’s value and potential is the underlying company earnings. Profitability is an important consideration when you buy a stock because buying a stock means you’re actually buying a piece of that company. The more profitable the company, the more profitable the stock can be. The stock will also be valued higher due to its profitability, so you’ll need to balance the two factors. The stock will cost more but it may be worth more down the road as the company continues to grow.
Price to Earnings Ratio. One of the most common measurements of a stock’s value and potential is what’s called the Price to Earnings (or “P/E”) ratio. It is a direct ratio that measures the share price compared to the company’s annual net income. You can find the Price to Earnings ratio on your favorite financial website or newspaper. You can also calculate it yourself by taking the share price and dividing it by the company’s net annual income per share.
In very broad terms, stocks with a Price to Earnings ratio that’s higher than the broader market P/E are considered expensive, while lower P/E stocks are considered to be less expensive. But the lower price doesn’t automatically mean that a stock is a worthwhile investment. Small fast growing companies may have a high P/E ratio but their rapid rate of growth could still make them a great investment.
Dividend Payout and Consistency. A dividend is the amount of money that’s regularly paid by a company to its shareholders. A company that is able to consistently pay and raise their dividend over time is generally demonstrating that it’s a healthy enterprise. It shows that the company is not only growing but is also financially stable. Look at a company’s dividend payouts for at least the past five to ten years to determine their dividend consistency and to get a good idea about the strength of their stock.
Debt Ratio. Finally, consider evaluating the company’s ability to pay their debt, and how much debt they have. The debt ratio measures the amount of assets that have been financed with debt, and is calculated by dividing the company’s total liabilities by its total assets. The higher the debt, the greater the possibility that the company could be heading for financial trouble.
Remember to do your homework and make smart investment choices for yourself.
