Evaluating a Stock
Step 1- Look at ratios
Ratios
● P/E Ratio-Price to earnings ratio. Measures current share price of a company compared to
per-share earnings. (Market value per share divided by EPS)- 7 is low (indicates an undervalued
company), 40 is high (indicates an overvalued company). 15-30 is the sweet spot.
● P/B Ratio-Price to book ratio. Compares current market price to its book value. Below 3 is fair,
under 1 is great. Not a make it or break it ratio, but something to consider.
● P/S Ratio-Price to sales ratio. Dividing market capitalization by company total sales or revenue
over the last 12 months. Ratios between 1 and 2 are good. Under 1 is excellent. Not a make it or
break it ratio, but something to consider.
● D/E Ratio-Debt to Equity Ratio. The relative proportion of shareholders equity and debt used to
finance company assets. Between 1 and 1.5 is good.
● OPM-Operating profit margin. ​The OPM shows operational efficiency and pricing power. It is
calculated by dividing operating profit by net sales. 10% is average, 20% is high and 5% is low.
● PEG-Price to earnings growth ratio.Higher PEG ratio shows that the company is growing fast but
may be overvalued. 1 is the perfect ratio, everything is balanced. Over 1 means the stock ​can​ be
overvalued. Under one is better meaning the stock is undervalued.
● ROE-Return on equity. Measure of financial performance calculated by dividing net income by
shareholders equity. 15%-20% is good.S&P 500- 14%.
● Dividend Yield of at least 2.5%
Step 2-Financial Statement
● Income statement-Look at revenue, major expenses and bottom line net income to find trends.
Good companies can continue to grow their top line (revenue) and bottom line (net income)
consistently.
● Balance sheet-Always evaluate liabilities, equity, and assets. I personally prefer if the company
has enough COH (cash on hand) to cover short term liabilities.
● Cash Flow-The statement of cash flows summarizes the cash inflows and outflows from various
activities. Consistent cash flows provide strategic and operational flexibility. Companies could
make plans to enter new markets, build new facilities and invest in research and marketing.
Disregard the cash flow effects of one-time events, such as issuing new shares or building new
facilities. Look at operating cash flows.
Extra Guidance
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What not to do ​when buying a stock: ​Don't buy on price alone. ​Don't assume a stock is a
bargain just because its price has dipped 10%. Make sure you understand why and how that
price is going to rebound. ​Don't rely too much on analyst recommendations.​ Analysts' reports
can offer some great information on the health of a business, but be aware that they tend to be
biased for 'buy' ratings. But because of that bias, a sell rating, especially a new sell rating, from
an analyst can be a red flag. Keep an eye out for those calls.​Don't be surprised by volatility. ​An
individual stock is always going to be more volatile than a diversified mutual fund. Look at the
52-week highs and lows for stocks that you're interested in to get some perspective on how
widely prices can swing within a year. ​Don't forget to sell.​ Of course, you should have a plan for
how you approach buying stocks, but it's just as important to know when to sell. Have a set of
criteria that will tell you it's time to sell: If the company cuts its dividend; if the price rises or falls to
a certain point; if an analyst downgrades the stock, and so on.