An all-important yardstick worth considering when buying a stock is stock evaluation. A vast majority of expert investors and seasoned analysts reckon that stock evaluation is unavoidable. Truth be told, stock evaluation is easier said than done.
If you want to become the next Warren Buffet, you should be able to read, comprehend and analyze stocks like Warren Buffet. If you want to develop a strong portfolio, you should be able to do an in-depth analysis of financial reports.
It’s not mandatory to have a Master’s degree in Finance to evaluate and pick stocks. You have to embrace the right approach.
This article throws an insight into the process of stock evaluation in 2019.
Financial Ratios Approach
The simplest approach is to delve into the financial ratios. Make no mistake – using financial ratios isn’t a foolproof approach. Financial ratios lend a fair perspective about two aspects – price valuation and stock health.
Price valuation is essentially about focusing on the following four ratios:
1. P/E Ratio
2. P/B Ratio
3. PEG Ratio
4. Dividend Yield
Good stocks have low P/E ratio. In other words, stocks with low P/E ratio tend to have higher and better EPS (Earnings per Share)
Always buy stocks at a lower P/B ratio. P/B sheds light on the net value of the company. The book value of a company is the same as its net value which is equal to the sum of its assets and accumulated reserves.
PEG ratio was pioneered by Peter Lynch.
What does PEG ratio signify?
PEG ratio lets an investor know if the market price of a stock may appreciate significantly in the future.
Champion investors like Warren Buffet are all in for dividend investing. This can be attributed to the fact that dividend-focused investing is foolproof and helps one to build a balanced portfolio. It makes sense to consider the average 5-year dividend yield of stocks.
Now that you have understood price valuation, the next step is to prepare a list of stocks.
List of Stocks
There are several hundreds of stocks listed on Indian stock exchanges – NSE and BSE. It’s absolutely futile to analyze every stock. The trick is to use the concept of market capitalization to your advantage.
Stock health is a function of business profitability. There are many companies that run businesses profitably for the first couple of years and go bankrupt in subsequent years. If you invest in stocks of such companies, you are bound to lose money.
You can use ROCE. ROCE is another financial ratio. ROCE stands for Return on Capital Employed.
It’s easy to understand the significance of ROCE. If a company is able to generate maximum profits consistently with minimum investment, it’s likely to have high ROCE.
Always invest in companies whose ROCE is more than 10%.
The next step is to assign ranks to stocks based on each of the parameters – Market Capitalization, P/E ratio, P/B ratio, PEG ratio, Dividend Yield and ROCE. Create multiple rank criteria in Excel and get a new list of ranks. Continuously monitor the top 25 ranks and invest accordingly.
It’s recommended to follow the aforementioned approach. Of course, you are at absolute liberty to follow the stock tips and nifty tips that full-service stock market advisor firms offer. Use your judgement and financial ratios to practice healthy investing. Be prudent. Cheers!