Research Before Buying Stocks
Buying stocks is easy. But buying good stocks is not...
To get that stock that lets your money grow rather than shrink you must do your reserach. Here are the most basic steps you should always do before you buy a stock:
Download the corporate financial statements and analyse the annual statements covering at least five years, noting trends in earnings per share and revenue. Look for a trend of consistent growth in earnings per share and check if the change in revenue growth comes from change in costs of goods sold (COGS) or change in sales.
Calculate the company's P/E ratio, a measure of a stock's value. (Divide the stock price by annual earnings per share.) P/E ratio is possibly the most scrutinized of all the ratios: A stock can go up in value without significant earnings increases - this happened most recently in the tech bubble. This means P/E shot up in some cases over 40. Without earnings to back up the price, a stock will eventually fall back down. P/E 10 - 20 are considered the normal range limits.
P/E ratio tells you how long it takes before a stock will pay back your investment. A stock @ $20 per share with earning of $2 per share has a P/E ratio of 10, which is sometimes seen as meaning that you'll make your money back in 10 years if nothing changes. You should only compare P/E ratios between companies in similar industries and markets.
Because the P/E ratio isn't enough in and of itself, many investors use the price to earnings growth (PEG) ratio which incorporates the historical growth rate of the company's earnings.
Beware of debt. Check out the company's balance sheet, looking for the extent of its long-term debt.
Check cash flow - the movement of cash through the company. You'll want the company to have positive cash flow.
These ratios are the most important ones. There are many more ratios which investors consider important, most common are P/B Ratio and Dividend Yield.
P/B fair enough - there is merit in it as it represents the actual present value of the company. This is useful to know because mature companies may have relatively low growth but can still be a good value based on their assets. Industrial companies have a book value based of physical assets, which are annually depreciated. A low P/B ratio can protect you if it's accurate and means you have to look deeper into the actual assets making up the ratio.
Some investors think it is nice to have a back-up when a stock's growth slugs. This is why dividend-paying stocks are attractive to many investors - even when prices drop you get a paycheck. This is non-sense as the dividend yield is discounted in the stock value and therefore dividend yield does not influence total stock value as such. On the contrary - in bad times dividends are not always paid and therefore dilute the stock value.
This list is far from complete but it provides you the most basic elements to get a feeling for the actual stock value versus the real stock value.
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