What to look for when picking stocks

Your investment strategy will likely have you looking for different things when you pick stocks. A value investor would be looking at different factors from those of a growth investor. However, this article will cover the most basic factors that any investor should look at while picking stocks.

P/E ratio

P/E ratio stands for price to earnings ratio. What it really means is how much a share of a company is priced in relation to its earnings per share.

Naturally we would want to pay a low price for high earnings per share, thus, a low P/E ratio would be preferable.

However, it’s not that straight forward. Sometimes, a high P/E ratio means that the stock of a company is very attractive, and investors are willing to pay a higher price for future earnings. It means that investors have reason to believe that the company will achieve growth and therefore increase their earnings per share in the future.

So, just looking at the P/E ratio without looking at other factors like growth, R&D (research and development) and so on, will not be very useful.

In investment, everything is to be considered with other things, and never on its own.

Revenue growth

Revenue growth (or the lack thereof) over a number of years can give investors an idea of where the business is heading. Is it growing, or is it shrinking? Naturally we only want to invest in a growing company.

Revenue growth is the change (increase or decrease) in a company’s sales from one period to the next (usually quarterly or annually)

Debt/Equity ratio

We want to be sure that the company we are investing in will not dissolve or go bankrupt, because if they do, our investment in their shares will evaporate with their failure.

The debt/equity ratio tells us how much of a firm’s operation is financed by debt (creditors) in relation to equity (investors). In other words, this ratio tells us about the firm’s ability to use its equity to cover all of its outstanding debts when needed.

High debt/equity ratio shows us that the firm’s operation is run mostly by debt. This isn’t a good thing. We wouldn’t want to invest in a company that doesn’t have enough investors’ confidence that it had to get its finance from loans instead. We would want to be looking for a firm that has low debt/equity ratio, i.e. one where most of its operations are run by capital raised from investors.

There is no hard and fast rule about what is the best debt/equity ratio. The reason being, different industries have different nature of operations. Thus, comparing the debt/equity ratio of a company in the automobile industry with one in a tech industry would not make sense. The automobile industry may have higher debt due to the need for plants and equipment whereas the tech industry does not. As with any other ratios, it is only wise to compare within industries.

There are many more indicators that are useful for investors, but for beginners, the above are the key indicators that you should spend some time familiarising yourself with, as well as practice how to use them in your stock picking process.

I would suggest you use online stock simulators to practice your investment strategies until you can manage your earnings and your loss before you put in your real hard-earned savings.

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