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How to Evaluate Stock

Before investing in any kind of stocks and shares it is very important that you evaluate them thoroughly. This is more important in todays volatile market scenario. You can use many different tools, methods and ratios to evaluate stock. There are also many websites that will assist you with the same. This article will give details on all these ways and tell you how to evaluate stock using these methods.

How to evaluate stock using ratios

There are number of ratios that can help you to assess how well a company is performing and if it is worthwhile to invest in its stock. Here are some of them:

1. Earnings per share

• You can calculate earnings per share by dividing the net profit after tax by the number of shares that are on issue.
• A higher figure indicates better share value.
• The ratio also indicates the growth in total earnings from the current to the next year.

1. Price-Earnings Ratio

• You can calculate this ratio by dividing the price of the share by the earnings per share.

• It tells you how many years it would take you to buy the share based on its earnings.
• A higher ratio means a greater premium to be paid and greater expectation of high company growth in the market.
• A lower P/E ratio implies low growth for the company in the future.

1. Dividend yield

• Dividends are another important factor in determining the performance of a company.
• A lower dividend yield is considered better as it reflects a higher capital growth for the company.
• However, make sure that the low yield is not because of a steep drop in the price of the share.

1. Dividend payout ratio

• This ratio is calculated by dividing the dividend per share by the earnings per share.
• Generally this ratio is around the 60% mark.
• However, if the ration is higher than this it means that the company is not putting back enough earnings into the business.

1. Net asset backing

• Net asset backing gives you an idea about the liquidation value of the company.
• It is calculated by dividing the companys net assets by the price of the share.
• It will help you to determine if the company is performing well and will do so in future.

How to evaluate stock using Morningstar

1. i. Go to the Morningstar website www.morningstar.com
2. ii. Enter the stock symbol, usually a three or four letter symbol, in the small white box labeled Quotes under the Morningstar logo. You can enter the name of the sock if you dont know the symbol, which will take you to a page containing all the symbols. Click here on the appropriate symbol.
3. iii. This will take you to the Quote and News page giving you the latest price, P/E ratio, market capitalization, price/cash and price/sales ratio.
4. iv. On the left side of the page, click on Financial Statements and then on the 5-Yr Restated financial page tab.
5. v. Now study the bar graphs that represent the revenue picture, review the line for dividends, and monitor the number of outstanding shares.
6. vi. You can also look at the companys balance sheet when you are evaluating stock. These values will give you a better idea to decide on whether you want to invest in that companys stock or not.

Other measures to evaluate stock

Cash flow is nothing but the amount of profit a company makes each year. A good cash flow will help the company to avoid bankruptcy. However, you can have negative cash flows for some stocks such as banks and other financial institutions.

• ROE and ROA

ROE, or return on equity and ROA, or return on assets, reflect the companys capital structure. A higher ROE and ROA is a good sign for buying the companys stocks.

• Financial leverage

Financial leverage of a company shows how much it has acquired in debt. If a company has financial average that is more than five, then you must avoid investing in its stock.

• Company history

If a company has been around in the market for a long time period like ten years, then chances are it will stay longer and you can think about investing in its stock. If a company has survived difficult economic situations in the past, it is more likely to face similar situations better in future and you can invest in its stocks.

A moat is the economic advantage a company has over others in the market. Some good examples are Walmart and Starbucks. These brand names give them an advantage over other companies.

A market cap is the number of sales a company is able to generate in a year. Invest in a companys stock only if its market cap is higher than a hundred million or more.

• The price to earnings ratio (P/E ratio), calculated by dividing the share price by the companys annual net income, is the most commonly used measure for evaluating a stock.
• Stocks having a higher P/E ratio than the market are considered to be more expensive.
• However, dont go for stocks giving low P/E ratio because even though they are cheap they might not be good stocks.