An investor buys a share of stock by using different strategies that help him make a lot of money from his investment. A value investor must look at a company's finances before investing, so that the stock he buys at the company's intrinsic value will give him a better return at its liquidation value (the value of a company if all its assets were sold). A normal investor would buy growth stocks that are going up and look like they will keep going up for a long time. Whereas, a technical investor, also called a "Quant," makes decisions based on how the market works and other related factors. These decisions are much riskier, but they may be more profitable or, on the other hand, can lead to much bigger losses. The fundamental analysis of any business can depend on a number of things, such as the efficient market theory, the business's value and growth, its growth at a reasonable price, and its quality.
- The price is set by the stock market.
- According to the theory of efficient markets, the price of a stock is always right because all the necessary information is available on the price at the moment.
Analysts decide how much a company is worth based on how much it could grow.
- Price and value may not be the same thing because the market isn't always fair.
Value investors need to follow strict rules about the nature of the stock. The following are some of those rules:
Earnings: A company's profits after taxes and interest are its earnings.
Earnings per share (EPS) is the amount of the company's income that can be used to pay dividends to stockholders or to invest in the company itself.
Price-to-earnings (P/E) ratios (with a reasonable upper limit): If the company's stock is selling for $80 per share and its earnings per share (EPS) is $8 per share, its multiple, or P/E, is 10. This means that investors could expect a cash flow return of 10 percent:
$8/$80 = 1/10 = 1/(PE) = 0.10 = 10 percent
It has a multiple of 20 if it makes $4 per share ($4 times 20 = $80). In this case, an investor might get a 5% return (under the same circumstances);
$4/$80 = 1/20 = 1/(P/E) = 0.05 = 5 percent
But a low P/E is not always a sign of good value.
Price/Sales Ratio (PSR): This is the same as a P/E ratio, except that sales per share are used instead of earnings per share to divide the stocks.
Debt Ratio: The amount of debt a company has compared to the amount of money its shareholders have invested.
- Dividend yields that are higher than a certain fixed limit.
Book value ratio: The ratio of the stock's market price to its book value per share.
Market capitalization is the total value of a company's outstanding shares, which is calculated by taking the market price per share and dividing it by the total number of outstanding shares.
Equity Returns, or ROE, is the company's net income after taxes divided by the owners' equity.
Beta is a way to compare how volatile a stock is to how volatile the market as a whole is.
Learning how to analyse your stocks and make the profit you want is a continuous process, since no market-efficient theory can ever predict a perfect system for making money. Even if you study the market to make smart investments, market emotions can often cause stocks to be overvalued or undervalued.
