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Friday, April 29, 2011

Know Your Stocks Better

Everybody can’t do thorough research of stocks they already own or going to own.
But they can do some exploration followed by little number crunching.
Just open the and search your stock.
First thing you should check is the P/E ratio. In simple words P/E ratio tells us in how many years you shall recover the price you have paid for the stock.
P/E ratio should not be seen in isolation and the same should be used to compare the stock with its peers and the industry standard.
Technology stocks have very high P/E ratio while mid cap PSU banks have lower P/E ratio.
If a stock is at higher price to earnings multiple than higher CAGR growth of profit should justify it.
Next thing is to see the dividend yield. Dividend yield is the exact amount of return an investor actually receives at the CMP (Current Market Price).
Some companies are very good at giving dividends while others are not.
That’s why; Investor should multiply the 100 to the inverse of the P/E ratio to calculate the Earning Yield.
Some companies with lower Dividend Yield might be having good Earning Yield, which indicates company is retaining major chunk of its profit for some specific purpose like capacity expansion etc.
Simplest way to calculate ROE (Return on Equity) is to multiply the ratio of EPS to Book Value by 100.
ROE tells us how much a stock is earning on the shareholders money. More the ratio is better.
This ratio should be seen along with the Debt Equity ratio, because a company with higher debt (and lower equity) may have high ROE, but not that profitable due to interest payment.
Debt Equity ratio measures the financial leverage of the company.
Higher Debt Equity ratio means company is financing its growth with more debt, and its earning may be volatile due to interest payments, which depends on prevailing interest rates.
This ratio is also industry specific, a capital goods making company may have Debt Equity ratio above 2, while a technology company like Infosys has 0 Debt Equity ratio (Debt free company).
Though aforesaid ratios dont portray the complete picture still give a pretty clear picture of the stock valuation, expected earnings and the consistency of earnings.


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