How to Evaluate Stocks.....?
Warren Buffet is considered to be a genius when it comes to stock investment. He recommends an important thing to the investors that the stock (company) you are thinking to buy or invest should have been around for at least ten years. There are a number of factors to be considered befere investing in a stock. This article will help you in understanding such factors.
Techniques to Evaluate Stocks
Following are the things that will guide you in taking an investment decision. They will show you the strength of the financial position of a company. So that it will be easy for you to select a stock and invest in that.
- Company History
- Market Cap
- Cash Flow
- Price Earnings Ratio (P/E)
- Return on Assets & Return on Equity (ROA & ROE)
- Financial Leverage
1. Company History
It is better to invest in companies that have in existence from minimum 10 years. Over the course of a decade, many things can happen to a company. There will be good times and bad times for everything. If a company can survive the bad times for at least ten years then they are more likely to handle future bad times with equivalent skill. So if a company has been around for at least ten years then you can choose these companies to invest. But remember along with this you have to consider other factors also.
A dividend is an amount paid out by the company to its existing share holders. Dividends can be paid out at various times of the year, most of the times it seems to be given out on a quarterly basis. These dividends are especially useful for long term investors because your dividends will compound over a period of time.
3. Market Cap
A market cap is basically how much sales a company will generate in a given year. Invest only in companies with a market cap of a hundred million or more. Anything less than this and the company might go bankrupt if their sales don't pick up.
4. Cash Flow
Cash flow generally indicates how much profit the company makes per year. If the company has a good cash flow then they are more likely to avoid bankruptcy. And it is great news for investors. Banks or other similar financial institutions are examples of high cash flow. This is mostly due to these companies accept deposits and offer loans to people. Financial institutions can be great stocks.
5. Price Earnings ratio (P/E)
P/E stands for Price Earnings Ratio. This generally tells you what people expect from this stock. If the P/E ratio is between 10 and 30 then it is considered a reasonably stable stock. On the other hand, if it is really high then that means people have high expectations on this stock. And if those high expectations are not met then the stock is much more likely to lose investors, which will lead the stock to lose its value drastically, this is something that you don't want to happen. So if the stock has a high P/E ratio just be aware of the possible outcomes. If the stock is above 25 then it is usually considered as high.
6. Return on Assets & Return on Equity (ROA & ROE)
ROA stands for Return on Assets and ROE stands for Return on Equity. Normally, investors like to see both of these figures going up or staying stable over a period of years. If the ROA or ROE is negative or falling, you should think twice about purchasing that stock.
7. Financial Leverage
Financial leverage generally tells us how much the company has acquired in debt. You should try to avoid investing in companies that have a financial leverage higher than 5. But again, it is normal for banks and other financial institutions to have a financial leverage ratio more than 5.
Picking stocks is a difficult work. It takes time and patience to learn all of the jargon and other tricks of the trade. But when the day is done, you'll be glad to see that your hard work is paying off.
Instructions for Equity Traders/Investors
Following are the things to be considered by an equity trader before executing the trade. Successful stock trading involves many factors such as selecting a good company, diversifying the portfolio, support of a good broker, etc. If you are lacking any of these factors, it affects your trading very badly. Following are the things to be taken care by an investor before trading or investing.
- Know your Risk Tolerance
- Invest in the company not in the stock
- Know your broker
- Reduce your risk by diversifying
Know your risk tolerance
Understanding yourself is very important; you should know your risk tolerance, how much you can afford to invest, how much loss you can suffer, etc. Before investing in any type of stock, know how much risk you are willing and capable to take. In simple terms it means having a look at how much money you can afford to lose.
Invest in the company not in the stock
People normally go behind the stocks without knowing much about the company. Some stocks might perform well in short term without a strong base of business but this growth is not stable. If a company has to perform well in long run it should have a strong and deep rooted business. It is always better to invest in such companies than going behind market trend.
Know your broker
Take time to understand your broker, enquire about his history, past performance, commission charged, etc. Sometimes brokers might have a vested interest in some stocks, including ownership of the stock, in this case they might compel you to buy more stock to raise prices. This could be false inflation of the stock's value therefore making it even more risky.
Reduce your Risk by Diversifying
Reduce your risk in stock investments by diversifying. Purchase good stocks from different industry, this will help you to reduce the investment risk because if one stock fails badly, the other will generate profit this will help you to avoid the overall loss.
There are thousands of stocks in the market to choose from, how do you determine the one that best suits for you? After all, if you pick incorrectly, you could lose all of your hard-earned money. But if you can understand the terms mentioned above then the likelihood of you losing your money will diminish significantly and the chance of making huge profits is more.
Srikanta Kumar Pattanayak, ACS, M.Com, LLb