In this video, I show you the BEST financial indicators used to Analyze a Stock and Beat the Market! Check out my Instagram (Investing Engineered):
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Finance Books I Recommend Reading:
1. The Intelligent Investor by Benjamin Graham:
2. Rich Dad Poor Dad by Robert Kiyosaki:
3. The Book on Rental Property Investing by Brandon Turner:
So why is analyzing a stock so important? Just from looking at the stock price alone, you can’t determine whether a company is cheap or expensive – you need to dig a little deeper below the surface of all the news articles and the “hype” to really find out its intrinsic value relative to its peers in the industry. Therefore, if we decide to track the financial indicators of a company, we can theoretically estimate if we’re getting a good deal buying the stock at a certain price or not. The price that you decide to buy a company influences your returns significantly – just think about buying a hot tech stock in the late 1990s and having it crash over 90% the following few years because of overvaluation. It’s very important to be patient, analyze companies, and then buy in big when the stock price makes sense!
Here are the most important fundamental (financial) indicators to consider as a value investor:
1. Price to Earnings Ratio
• The price to earnings ratio, or the P/E ratio, of a stock indicates the value of a company in terms of a multiple of its annual earnings per share
• The P/E ratio can be calculated by dividing the stock price by the annual net earnings per share
• The higher the P/E ratio, the higher the valuation of the stock, meaning it’s more expensive
• Generally, P/E ratios below 25 are considered acceptable
• P/E ratios vary significantly among industries, so the ratio of an individual stock should be compared amongst those within its own industry to determine the relative valuation
2. Price to Book Ratio
• The price to book ratio, or the P/B ratio, of a stock indicates the value of a company in terms of a multiple of its book value per share
• The P/B, ratio can be calculated by dividing the stock price per share by the book value per share
• According to Investopedia, the book value is “the net asset value of a company calculated as total assets minus intangible assets (patents, goodwill) and liabilities”
• P/B ratio of 1.0 means that the company could be sold at the value of it’s net assets – but it’s rare to find companies valued this low without reason
• Typically, a good buy will happen for any P/B ratios below a ratio of 1.5 for most great companies
• It should be noted that the P/B ratio is only relevant to companies that have a lot of tangible assets, like oil and gas companies, or banks – not technology companies
3. Return on Equity
• The return on equity, or ROE, is a financial indicator that measures the efficiency of the company’s management in deploying equity to return profits to shareholders
• The ROE can be calculated by dividing the annual net income by the shareholders’ equity in the company
• Typically, a good company’s ROE will be above 10%, and a great company’s ROE will be above 20% – while the S&P 500 average ROE is 14%
• This indicator is important in determining the financial health and efficiency of the company
4. Dividends
• Dividends are a way of directly distributing profits to the shareholders via cash payments – and they’re usually paid out on a quarterly basis
• Dividends reduce risk for investors through reducing their cost basis, as well as adding to returns
• Additionally, you’ll generally find that dividend paying companies will have a higher valuation – meaning they’re priced more expensive than a company that doesn’t pay a dividend
• Dividend paying companies should have a payout ratio less than 50% – meaning they pay out less than 50% of their annual net income in annual dividends
5. Balance Sheet
• All of the previous financial indicators might be positive, but if a company has too much debt – it can still go bankrupt!
• Watch the about of cash and debt a company holds
This list is NOT exhaustive by any means – but it should give you a baseline to begin to analyze and compare stocks as potential investments! Some other considerations are items on the company balance sheets, such as the debt to asset ratio, etc., as well as understanding the future prospects of a company and the industry, which would be too much to discuss in one video.
Please note that I am not a financial advisor. I create these videos for educational and entertainment purposes only. Before investing, make sure you perform your own research and understand all of the risks involved!
Music by Joakim Karud – check out his channel:
Cheers,
Investing Engineered
Nick Peitsch, E.I.T.
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