By - Versha Jain
- Investing in stocks comes easier for those who are used to researching companies.
- Ratios are the metrics used to determine the financial health of a company.
- Other qualitative indicators to analyze include management, competitors, and macroeconomic factors.
The first step in investing in the stock market starts with opening an account. Once that part is done, the next step is to select the stock for investing. But a person who is new to this may feel overwhelmed to analyze the myriad of stocks available in the market and the recommendation they may get from various resources.
Buying a stock is not like buying a home appliance or a personal outfit. It is a dynamic instrument whose price changes daily based on several known and unknown factors. So, an investor must base decisions on fundamentals and other aspects. Fundamentals research can give a fair idea about the company’s standing at the time through its financials, management, and peer competition.
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Here, we discuss broadly how to start analyzing stocks before investing in them.
One must check the revenue the company earned during a particular period. Also called “top line”, this is the first thing that gives the idea about a company’s sales and other revenue performance.
Sometimes revenue is defined as operating revenue, which comes from operating activities. It is called non-operating revenue when revenue is generated from one-time activities such as selling assets.
Net income is the next measure one should look at while analyzing the stock. It is also known as the “bottom line”. The fatter it is, the better it is.
This figure shows the amount of money the company made during the specific period. It is calculated after deducting the operating expenses, taxes, interest, and depreciation from the total revenue. It is the net money left after subtracting all the expenses.
Earnings per share is the other important number to check as it gives the exact idea of the earnings of one share. It is derived by dividing the company’s net profit by the number of outstanding shares.
It reflects the profitability of the company’s stock. Earnings per share (EPS) can be low if the number of shares available for trade is high, and the EPS will be higher if the number of shares is less. This figure is an easy tool to compare profitability with other companies irrespective of their sizes.
However, this does not give the whole idea as earnings can be paid through dividends or reinvested in the company. So, one must look into other measures as well.
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Price to earnings ratio or P/E ratio is an important ratio. It is calculated by dividing the stock price by the earnings per share (EPS). The trailing-twelve-month (TTM) P/E ratio is calculated by dividing the current stock price by the trailing twelve months’ EPS of the company. Similarly, forward P/E is derived by following the same process but changing the TTM EPS to the forecasted earnings by expert analysts.
It is good to combine another ratio with a P/E ratio analysis, irrespective of how significant it may be, as companies with no earnings do not have a P/E ratio.
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The return on equity (RoE) ratio is represented in percentage, and it shows how much profit is generated with each dollar invested by the shareholders. Here, the return on “equity” means the shareholder’s equity. A higher RoE reflects the company’s efficiency in generating higher income.
Besides these, there are endless ratios to analyze the company in detail. Still, the most important rule for an investor is to understand the company’s business and how it makes money, its management, competitors, and the risks involved. If answers to these questions are satisfactory, one may go for analysis and buy the stock.
In short, these ratios indicate the financial health of a company. Still, an investor should go for a detailed analysis to check the company's history, performance, and resilience. Self-research or help is necessary to select a stock out of thousands available.