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Friday, November 19, 2010

how to find which stocks to buy?

The first step is to see how many times stock is trading of it's earning. This is called P/E ratio.
when forward  or projected earning are considered, the ratio is called forward price-earning ratio.
Each stocks  PE ratio is benchmarked against the same of the industry to which it belongs, which gives pretty
good idea about stocks valuation.

Higher PE ratio indicates that investors are paying more for each share of the company. When we use yearly EPS, it gives the no. of years when the investor shall get back the price he paid.

EPS should not be misunderstood with the dividend, dividend is the part of the EPS which company actually pays to the investors.

Dividend payment is at the soul discretion of the company but generally dividend paying track record indicates the good health of the company.

How much part of the EPS a company pays is nothing but Dividend Payout ratio.

The reverse of the PE ratio gives the earning yield of the company.

P/E= Price of the share/ Earning per share for a period

Another formula for PE ratio= Market Capitalization of the company/ Total Earning

 P/E ratio is calculated in two ways-

(1)Trailing P/E: here EPS is the average of  last 4 quarters.

(2)Forward P/E: here EPS is estimated earning of next four quarters.

PEG ratio: P/E ratio is divided by annual earning growth. This ratio gives better view of stocks growth as higher growth rate causes higher P/E.
There is no ideal value for this but it's value near 1 indicates stability.

Another ratio, we need to see is Price to book value ratio(P/B) ratio.
This is a liquidity ratio, in simple words this tells us, what is the amount investor shall get in case company goes broke.

P/B ratio= Price/ Book value

Book Value is nothing but tangible assets -liabilities.

Generally banks and another financial institutions have lower P/B ratio while Capital goods and heavy engineering companies have higher ratio.

As book value does not include non tangible assets like intellectual property and good will, this ratio cant be called a perfect tool to judge all companies as IT and allied companies have ample non tangible assets


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