Although the raw data of the Financial Statement has some useful information, much more can be understood about the value of a stock by applying a variety of tools to the financial data.
Earnings per Share
The overall earnings of a company is not in itself a useful indicator of a stock's worth. Low earnings coupled with low outstanding shares can be more valuable than high earnings with a high number of outstanding shares. Earnings per share is much more useful information than earnings by itself. Earnings per share (EPS) is calculated by dividing the net earnings by the number of outstanding shares. For example: ABC company had net earnings of $1 million and 100,000 outstanding shares for an EPS of 10 (1,000,000 / 100,000 = 10). This information is useful for comparing two companies in a certain industry but should not be the deciding factor when choosing stocks.
Price to Earning Ratio
The Price to Earning Ratio (P/E) shows the relationship between stock price and company earnings. It is calculated by dividing the share price by the Earnings per Share. In our example above of ABC company the EPS is 10 so if it has a price per share of $50 the P/E is 5 (50 / 10 = 5). The P/E tells you how much investors are willing to pay for that particular company's earnings. P/E's can be read in a variety of ways. A high P/E could mean that the company is overpriced or it could mean that investors expect the company to continue to grow and generate profits. A low P/E could mean that investors are wary of the company or it could indicate a company that most investors have overlooked.
Either way, further analysis is needed to determine the true value of a particular stock.
Price to Sales Ratio
When a company has no earnings, there are other tools available to help investors judge its worth. New companies in particular often have no earnings, but that does not mean they are bad investments. The Price to Sales ratio (P/S) is a useful tool for judging new companies. It is calculated by dividing the market cap (stock price times number of outstanding shares) by total revenues. An alternate method is to divide current share price by sales per share. P/S indicates the value the market places on sales. The lower the P/S the better the value.
Price to Book Ratio
Book value is determined by subtracting liabilities from assets. The value of a growing company will always be more than book value because of the potential for future revenue. The price to book ratio (P/B) is the value the market places on the book value of the company. It is calculated by dividing the current price per share by the book value per share (book value / number of outstanding shares). Companies with a low P/B are good value and are often sought after by long term investors who see the potential of such companies.
Some investors are looking for stocks that can maximize dividend income. Dividend yield is useful for determining the percentage return a company pays in the form of dividends. It is calculated by dividing the annual dividend per share by the stock's price per share. Usually it is the older, well-established companies that pay a higher percentage, and these companies also usually have a more consistent dividend history than younger companies.
Bull Bear Markets
Bull and Bear are the terms to describe the general conditions of the stock market. These do not refer t...
The goal of fundamental analysis is to determine how much money a company is ma...
Most stock trades are done through a broker an intermediary who takes orders and executes them. B...
All of these factors – low price, lack of standards, and lack of stability – make penny stock...
Pink Sheets Stocks
Penny stocks are securities that are less than $5 in value. Although they can be traded on regular stock ex...
These perks are not free – full service brokers charge the high...
There are many different stock indexes, the most common in...
The 'Stock Exchange' is the correct term for the physical loc...
A contract to buy is called a 'call option'. The buy...
To a certain extent stock prices are determined by investor confi...
Why would a company do this?...
Stocks Trading Signals
Investors who treat trading as a full-time job have the time to watch the market movements for signals. Oftentimes, how...
Stocks Vs Bonds
Bonds always carry the risk that the principal amount may not be paid back. Companies...
Stocks Vs Mutual Funds
What is the advantage of a diversified port...
Stock Trading Strategies
HedgingHedging is a way of protecting an investment by reducing the risks ...
The basis for technical analysis is the belief that stock price...
Technical Analysis 2
Types Of Trading
The stock market also provides opportuni...