Investment can be one of the best financial decisions you can make — or one of the worst. While the basic principle of trading stocks is not difficult to understand, you’ll need to spend some time developing your instincts so that you know when to take the critical steps, like selling shares of Apple or buying into a startup.
Today, let’s look at some of the equations you can use to develop accurate instincts, especially when considering your stocks and their value to you.
Price and Earnings
Most stockbrokers evaluate shares by their price, dividing it by the company’s annual net income.
This equation, known as the P/E ratio, determines the comparative expense of a share: stocks with low P/E are cheap, while a high P/E designates expensive shares.
While a stock with a low P/E is less costly to buy, be cautious; cheap doesn’t make it worth your while.
You might be better off saving up for a stock with a high P/E: it will cost you more initially but will likely continue building as long as you choose to hold it.
P/E is an imperfect system of measurement, though. If a new company grows rapidly its P/E will shoot up: the stock price rises while the earnings stay low.
On the other hand, a stock with a low P/E may look cheap and tempting, but it might be because many investors have decided it’s not going to earn enough.
When you buy shares in a company, they pay you back for your partial ownership of the business.
These dividends usually consist of a portion of their profits, so they can be useful in evaluating the direction your stocks are headed.
If your dividends aren’t yielding what they should be, you’ll have to either cut your losses or wait for it to rise again.
The price-to-book ratio, otherwise called P/B, is an equation created by dividing the share price by the value of that company’s assets.
This book value indicates whether your shares are at a fair value compared with the other companies in the industry;
if the P/B is low, it may be undervalued in its sector or overvalued if the P/B is high.
The other common ratio used for evaluating the value of stocks is price-to-sales, otherwise known as P/S. This equation takes multiple factors into account.
The outstanding shares multiply by each share’s price, then that total divides by the company’s revenue from the previous 12 months.
The P/S ratio shows how much overall value comes from each dollar the company brings in, which helps you evaluate stocks over a longer time.
The calculations become more significant when the industry has a challenging year because it can help determine whether your company will bounce back or not.
The world of stockbroking can have confusing elements, but if you use the available information correctly, you can climb to a level you won’t reach in other places.