Beginner's Fundamental Stock Analysis
Price to earnings ratios, return on equity, operating margins ... what does it all mean? Getting started with stocks doesn't have to be as complicated as it seems.
The era of the Internet was supposed to usher in a new era of information sharing – and it has The problem for new investors is, there’s so much information it can be overwhelming. Rather than be intimidated by the myriad of criteria to consider, a potential stock buyer can easily focus on a few of these important ones.
Price-to-Earnings Ratio
Also called a ‘P/E ratio’, this tool is perhaps the most common and most useful of all the financial ratios. In short, it compares the per-share price to per-share earnings, or profit. As such, it essentially tells an investor how much he or she is paying relative to their return.
Usually, the P/E ratio uses the last 12 months worth of earnings to produce the ‘E’ in the ratio’s equation. The ‘P’, of course, is the current price.
A typical P/E ratio will usually fall somewhere between 10 and 20. However, it’s not entirely unusual to see price-to-earnings reading above or below that range.
Price-to-Sales Ratio
Sometimes referred to as a ‘P/S ratio’, the price-to-sales ratio will indicate the strength of sales or revenue – not profit – relative to a stock’s share price. Earnings are more important than revenues, so this isn’t necessarily a completely fair tool with which to pass judgment on a company. However, it can tell investors something about a corporation’s ability to at least produce cash flow. It’s also usually measured on a 12-month basis.
The typical price-to-sales ratio is around 2.0. However, readings as low as 1.0 or as high as 3.0 can still be acceptable. And, even more extreme readings may be tolerable in some situations.
Net (Profit) Margin Percentage
This measure indicates how much of any revenue is retained after paying all expenses. A greater profit tends to correlate with better odds of an appreciation in a stock's value. So, investors should generally seek out strong profit margins.
However, with that in mind, it’s important to know that the net margin figure isn't reflected by the stock’s price (potential or otherwise). The profit margin simply shows how much profit was generated - in percentage terms - with the revenue they created. Still, higher margins are attractive.
Earnings Growth
The entire point of selecting a stock is to tap into opportunities superior to any alternatives. If earnings are stagnant for one company but are growing for another company, the other stock is more attractive because it's more likely to climb higher.
Earnings growth can vary greatly, and should be considered on a relative basis. Annual earnings growth of 5% may be outstanding for a utility company, while annual earnings growth of 15% may be weak for a technology company.
Build the Foundation First
These are hardly the only measures of a company’s quality an investor could analyze. However, all of the rest are a variant of one of the four mentioned here. Adding more criteria to the mix could make the issue more confusing without necessarily adding any value to the analysis.
As with all matters, keeping things simple and comfortable is the key. Once these core measures have become second nature, an investor can easily move on to higher-level fundamental analysis.
The era of the Internet was supposed to usher in a new era of information sharing – and it has The problem for new investors is, there’s so much information it can be overwhelming. Rather than be intimidated by the myriad of criteria to consider, a potential stock buyer can easily focus on a few of these important ones.
Price-to-Earnings Ratio
Also called a ‘P/E ratio’, this tool is perhaps the most common and most useful of all the financial ratios. In short, it compares the per-share price to per-share earnings, or profit. As such, it essentially tells an investor how much he or she is paying relative to their return.
Usually, the P/E ratio uses the last 12 months worth of earnings to produce the ‘E’ in the ratio’s equation. The ‘P’, of course, is the current price.
A typical P/E ratio will usually fall somewhere between 10 and 20. However, it’s not entirely unusual to see price-to-earnings reading above or below that range.
Price-to-Sales Ratio
Sometimes referred to as a ‘P/S ratio’, the price-to-sales ratio will indicate the strength of sales or revenue – not profit – relative to a stock’s share price. Earnings are more important than revenues, so this isn’t necessarily a completely fair tool with which to pass judgment on a company. However, it can tell investors something about a corporation’s ability to at least produce cash flow. It’s also usually measured on a 12-month basis.
The typical price-to-sales ratio is around 2.0. However, readings as low as 1.0 or as high as 3.0 can still be acceptable. And, even more extreme readings may be tolerable in some situations.
Net (Profit) Margin Percentage
This measure indicates how much of any revenue is retained after paying all expenses. A greater profit tends to correlate with better odds of an appreciation in a stock's value. So, investors should generally seek out strong profit margins.
However, with that in mind, it’s important to know that the net margin figure isn't reflected by the stock’s price (potential or otherwise). The profit margin simply shows how much profit was generated - in percentage terms - with the revenue they created. Still, higher margins are attractive.
Earnings Growth
The entire point of selecting a stock is to tap into opportunities superior to any alternatives. If earnings are stagnant for one company but are growing for another company, the other stock is more attractive because it's more likely to climb higher.
Earnings growth can vary greatly, and should be considered on a relative basis. Annual earnings growth of 5% may be outstanding for a utility company, while annual earnings growth of 15% may be weak for a technology company.
Build the Foundation First
These are hardly the only measures of a company’s quality an investor could analyze. However, all of the rest are a variant of one of the four mentioned here. Adding more criteria to the mix could make the issue more confusing without necessarily adding any value to the analysis.
As with all matters, keeping things simple and comfortable is the key. Once these core measures have become second nature, an investor can easily move on to higher-level fundamental analysis.
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