How to Pick a Stock
It’s Important to Remember…
• There is no one formula for stock picking!
• It is more art than science!
• You should, however, do some basic
research and be able to justify your picks.
An Introduction to Fundamental
Analysis
http://www.investopedia.com/video/play/understandingfundamental-analysis/
Finding “Value Stocks”
• This principle believes that you should look for a
stock that is currently undervalued.
• Make sure the company has “good fundamentals”
• How? Look at:
• Price/Earnings Ratio
• Price/Book Ratio
• Debt/Equity Ratio
Price/Earnings Ratio
http://www.investopedia.com/video/play/how-do-i-calculatepriceearnings-ratio/
Price /Earnings Ratio
• Take the Current Stock Price and Divide by the
company’s earnings per share (EPS).
• The lower the P/E ratio – the more likely the stock is
to be undervalued (and hence a good buy!)
What is the Price/Book ratio?
• A ratio that compares the company’s stock price and it’s
tangible assets (or book value)
• It can help to determine if a stock is undervalued.
• To calculate, divide the stock price by the “book value” of
their tangible assets.
• If P/B is lower – that is better!
An Example
Loblaws vs. Metro
Loblaws @ $44.45
Metro @ $66.00
Which would you choose?
Debt vs. Equity
What is Debt?
• When a company raises
money through bank
loans.
• The company will have
to pay interest on these.
What is Equity?
• When a company raises
money by issuing stocks
in the stock market.
• No interest is charged on
these.
The Debt/Equity Ratio
The Current Ratio
Total Current Liabilities
• regarded as a test of liquidity for a company
• expresses the 'working capital' relationship of
current assets available to meet the company's
current obligations
Ratio Analysis – Financial Securities
(IDC4U1) – Slide 11 of 15
Total Current Assets
The Quick Ratio
Total Quick Assets
Note: quick assets = total current assets minus inventory
Ratio Analysis – Financial Securities
(IDC4U1) – Slide 12 of 15
Total Current Liabilities
• Sometimes a company could be carrying heavy inventory as part of
its current assets, which might be obsolete or slow moving
• Thus, eliminating inventory from current assets and then doing the
liquidity test is measured by this ratio
• The ratio is regarded as an key test of liquidity for a company
The Return on Sales OR
Profit Margin (%) Ratio
Revenue
X 100
Ratio Analysis – Financial Securities
(IDC4U1) – Slide 13 of 15
Net Income
• Determines a company’s ability to withstand competition
and adverse conditions (like rising costs, falling prices or
declining sales in the future)
• Measures the percentage of profits earned per dollar of
sales
• Indicates how efficiently the company makes money
The Return on Assets Ratio
Total Assets
X 100
Ratio Analysis – Financial Securities
(IDC4U1) – Slide 14 of 15
Net Income
• Determines its ability to utilize the assets employed in the
company efficiently and effectively to earn a good return
(profit)
• Measures the percentage of profits earned per dollar of
asset
• Indicates how efficiently the company in generates profits
on its assets.
The Accounts Payable to Sales (%)
Ratio
Annual Sales/Revenue
X 100
Ratio Analysis – Financial Securities
(IDC4U1) – Slide 15 of 15
Accounts Payables
• Indicates how much of their supplier’s money a
company uses in order to fund its sales.
• A higher ratio means that the company is using its
suppliers as a source of cheap financing.
• The working capital of such companies could be funded
by their suppliers.
Price/Earnings to Growth
(PEG) Ratio
Annual Earnings Per Share
(EPS) Growth
•
•
•
•
An important indicator of a stock’s potential value
It’s favoured over the P/E ratio as it accounts for growth
A lower PEG means a company’s stock is undervalued
Value investors look for a value less than 2
Ratio Analysis – Financial Securities
(IDC4U1) – Slide 16 of 15
Price/Earnings Ratio
The Stock Market Simulation
• Create an account (register) on the investopedia website:
www.investopedia.com
• You must invest in stocks that are traded on the TMX.
• You will have a budget of $100,000 to invest.
• You must choose a minimum of 8 different companies, a
maximum of 20.
• Trading begins on Wednesday/Thursday this week.
• The simulations are called RCI IDC4U1 Section 1 and RCI
IDC4U1 Section 2
• Groups of maximum 3 students
• Trades are allowed at any time, but subject to a $19.99
fee!
• Good Luck – may the best traders win!