The markets are touching new heights. With every passing day, the index is rebounding with increased vigour. In this resilient and ecstatic bull run, the probability of an investor picking over-heated or over-valued stocks is quite high. Hence, it is crucial for investors to determine the current worth of the stock and how the market values it.
There are tools that determine earnings the company is making, its future potential and how the market values the stock. These are the tools of fundamental analysis that concentrate on growth, earnings and market value. Here are a few parameters that help investors analyse stocks:
Earnings per share (EPS) --
This parameter helps investors to compare stocks on an even ground. EPS are the earnings returned on the initial investment amount. To compute earnings per share, the net earnings must be divided by the outstanding shares.
The formula is:
Net earnings
---------------------------- = EPS
Outstanding shares
EPS, in a nutshell, is the portion of a company's profits, allocated to each outstanding share of common stock.
PE ratio --
The price-to-earnings ratio (PE ratio) of a stock is a measure of the price paid for a share relative to the income or profit earned by the company per share. A higher P/E ratio means that investors are paying more for each unit of income. The reciprocal of the P/E ratio is known as the earnings yield.
The formula is:
Price per share
------------------------- = P / E ratio
Earning per share
Note: Price per share is the market price of a share. Earnings per share is the net income of the company for the most recent 12-month period, divided by number of shares outstanding. The P/E is a reflection of what the market is willing to pay for the company's earnings. The higher the P/E, the more the market is willing to pay for the company's earnings. A high P/E can be interpreted as an over-priced stock. It also indicates optimism and bright future for the market. A low P/E may indicate a negative sentiment in the market that can be missed. Some investors bet on these in anticipation that the market will discover its true value.
Price/sales ratio --
The price/sales ratio (PSR) is a company's stock price divided by its annual sales per share. The formula is: P/E x profit margin = P/S One major drawback with PSR is that this ratio contains no information about a company's debts. There are many companies making no profits and have incurred huge debts, still selling at a favorable PSR. It is difficult for an investor to distinguish between a bankrupt company and a bargain company's stock.
Book value --
The book value of a company is its shareholder's equity, that is, the company's assets minus its liabilities. An asset's initial book value is its actual cash value or its acquisition cost. Cash assets are recorded at actual cash value. Assets such as buildings, land and equipment are valued based on their acquisition cost, which includes the actual cash cost of the asset plus certain costs tied to its purchase.
PEG
This parameter is a metric used to evaluate the relative trade-off between the price of a stock, the earnings generated per share and the company's expected future growth.
Price / annual earnings
--------------------------------- = PEG
Annual growth
A lower ratio implies it is cheaper and a higher ratio means it is expensive. A PEG ratio that gets close to two or higher is classified as expensive. A PEG ratio of one represents a reasonable trade-off between cost as expressed by the P/E ratio and growth.
No comments:
Post a Comment