Yahoo Finance I’m an Investor: Never Buy a Stock Before Checking These 5 Numbers
If you’re new to investing and want to learn how to pick stocks, it can help to understand key financial metrics. Unfortunately, without knowing about the numbers behind stocks, you could mistakenly purchase a stock that’s overvalued or miss out on a great investing opportunity.
Consider these numbers to help you guide your investment choices.
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P/E Ratio
Robert R. Johnson, Ph.D, CFA, CAIA, professor of finance at Heider College of Business, Creighton University, said that the P/E ratio is arguably the most widely employed valuation tool.
“Investors use P/E ratios as a guide to indicate when a stock is richly valued or arguably undervalued,” he said. “The P/E ratio indicates how much investors are willing to pay for a claim to a dollar of a company’s earnings. The higher the P/E ratio, the more richly valued a company and its stock are.”
Johnson said that there are no absolutes with P/E ratios.
“For instance, a high P/E indicates that a firm is highly valued by the market, while a low P/E indicates that the firm is not highly valued,” he explained. “A low multiple might indicate that a firm is a bargain (a value stock) if the firm has strong fundamentals (for example, profitability and financial strength). A low multiple might also indicate that the firm is appropriately valued due to poor future prospects.”
However, Johnson pointed out that the trouble with the P/E is it doesn’t tell you much on its own.
“The ratio is most valuable when compared to that of similar companies or even the entire stock market,” he said. “Keep in mind that P/E ratios rise and fall as stock prices fluctuate and earnings change. They also are influenced by investor sentiment. When investors are very bullish, P/E ratios tend to rise. Conversely, when investors become very bearish, P/E ratios can decline dramatically.”
To compare the P/E ratio of three prominent auto companies, Johnson offered the following information from Yahoo Finance:
Tesla’s (TSLA) P/E ratio on forward earnings is 71.9
Ford’s (F) P/E ratio on forward earnings is 5.9
GM’s (GM) P/E ratio on forward earnings is 4.68
“By simply looking at the P/E ratio, from a value investing standpoint, Ford and GM are much more attractive than Tesla,” Johnson explained. “That is, there is a much greater margin of safety with GM and Ford vis-a-vis Tesla.”
PEG Ratio
Johnson said that an extension of the P/E ratio is the PEG ratio.
“The PEG ratio is the P/E relative to growth prospects,” he said. “Higher growth prospects typically imply a higher P/E ratio (because earnings are more likely to grow). Dividing the P/E ratio by the growth rate (ignoring the percent sign) attempts to adjust for this. From a value investing standpoint, as with P/E ratios, the lower the PEG ratio, the more compelling value the stock represents.”
This data from Yahoo Finance takes into account five-year growth rates:
Tesla’s (TSLA) PEG ratio on forward earnings is 3.17
Ford’s (F) PEG ratio on forward earnings is 0.64
GM’s (GM) PEG ratio on forward earnings is 3.12
Johnson explained that when it comes to expected future growth, Ford would seem to be undervalued relative to Tesla and GM.
Earnings per Share
Mark Pierce, CEO and founding partner of Wyoming Trust with over 40 years in financial and wealth management as well as diverse areas of financial law, said that EPS is a bedrock data point that highlights a company’s overall profitability and also can help signal a well-managed, sustainable investment choice.
“It’s one of the key drivers behind a stock’s valuation altogether,” he said. “Obviously, you want to keep [your] eyes out for those higher EPS numbers, but stocks with a steadily growing EPS also indicate a company is well managed.”
Dividend Yields
“For dividend stocks, there are other considerations to prioritize,” Pierce said. “First, take a look at the annual dividend yields, ideally from the past two to three years at a minimum. High dividends show that a company has a tendency to share its profits more generously amongst its stakeholders. Do be mindful, though, as suspiciously high dividend yields could mean the company is oversharing profits and mismanaging cash flow.”
Debt-to-Shareholder Equity Ratio
Pierce said he would also take a look at a company’s overall debt-to-shareholder equity ratio.
“In general, it’s considered riskier to invest in companies with high debt-to-equity ratios because it indicates outsized existing debt or that a company is simply on the younger IPO side,” he explained. “Neither of those inherently means it’s a bad choice. It’s just going to involve a higher risk tolerance and should be weighted accordingly.”
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This article originally appeared on GOBankingRates.com: I’m an Investor: Never Buy a Stock Before Checking These 5 Numbers
