A few benchmarks for stocks - A quick and easy measuring stick.
These are a few benchmarks that can help you decide if you should spend more time on a stock or not. They are easily available and can be of great use in screening good stocks.
Revenues/Sales growth.
Revenues are how much the company has sold over a given period. Sales are the direct performance indicators for companies. The rate of growth of sales over the previous years indicates the forward momentum of the company, which will have a positive impact on the stock's valuation.
Bottom line growth
The bottom-line is the net profit of a company. The growth in net profit indicates the attractiveness of the stock. The expected growth rate might differ from industry to industry. For instance, the IT sector's growth in bottom-line could be as high as 65-70% from the previous years whereas for the old economy stocks the range could be anywhere in range of 10- 15%.
ROI - Return on Investment
ROI in layman terms is the return on capital invested in business i.e. if you invest Rs 1 crore in men, machines, land and material to generate 25 lakhs of net profit , then the ROI is 25%. Again the expected ROI by market analysts could differ form industry to industry. For the software industry it could be as high as 35-40%, whereas for a capital intensive industry it could be just 10-15%.
Volume
Many investors look at the volume of shares traded on a day in comparison with the average daily volume. The investor gets an insight of how active the stock was on a certain day as compared with previous days. When major news are announced, a stock can trade tens of times its average daily volume.
Volume is also an indicator of the liquidity in a stock. Highly liquid stocks can be traded in large batches with low transaction costs. Illiquid stocks trade infrequently and large sales often cause the price to rise/fall dramatically. Illiquid stocks tend to carry large spreads i.e. the difference between the buying price and the selling price. Volume is a key way to measure supply and demand, and is often the primary indicator of a new price trend. When a stock moves up in price on unusually high volumes it could indicate that big institutional investors are accumulating the stock. When a stock moves down in price on unusually heavy volume, major selling could be the reason.
Market Capitalization.
This is the current market value of the company's shares. Market value is the total number of shares multiplied by the current price of each share. This would indicate the sheer size of the company, it's stocks' liquidity etc.
Company management
The quality of the top management is the most important of all resources that a company has access to. An investor has to make a careful assessment of the competence of the company management as evidenced by the dynamism and vision. Finally, the results are the single most important barometer of the company's management. If the company's board includes certain directors who are well known for their efficiency, honesty and integrity and are associated with other companies of proven excellence, an investor can consider it as favourable. Among the directors the MD (Managing Director) is the most important person. It is essential to know whether the MD is a person of proven competence.
PSR (Price-to-Sales Ratio)
This is the number you want below 3, and preferably below 1. This measures a company's stock price against the sales per share. Studies have shown that a PSR above 3 almost guarantees a loss while those below 1 give you a much better chance of success.
Return on Equity
Supposedly Warren Buffet's favorite number, this measures how much your investment is actually earning. Around 20% is considered good.
Debt-to-Equity Ratio
This measures how much debt a company has compared to the equity. The debt-to-equity ratio is arrived by dividing the total debt of the company with the equity capital. You're looking for a very low number here, not necessarily zero, but less than .5. If you see it at 1, then the company is still okay. A D/E ratio of more than 2 or greater is risky. It means that the company has a high interest burden, which will eventually affect the bottom-line. Not all debt is bad if used prudently. If interest payments are using only a small portion of the company's revenues, then the company is better off by employing debt pushing growth. Also note capital intensive industries build on a higher Debt/Equity ratio, hence this tool is not a right parameter in such cases.
Beta
The Beta factor measures how volatile a stock is when compared with an index. The higher the beta, the more volatile the stock is. (A negative beta means that the stock moves inversely to the market so when the index rises the stock goes down and vice versa).
Earnings Per Share (EPS)
This ratio determines what the company is earning for every share. For many investors, earnings is the most important tool. EPS is calculated by dividing the earnings (net profit) by the total number of equity shares. Thus, if AB ltd has 2 crore shares and has earned Rs 4 crore in the past 12 months, it has an EPS of Rs 2. EPS Rating factors the long-term and short-term earnings growth of a company as compared with other firms in the segment. Take the last two quarters of earnings-per-share increase and combine that with the three-to-five-year earnings growth rate. Then compare this number for a company to all other companies in your watch list within each sector and rate the results on how it outperforms all other companies in your watch list in terms of earnings growth. Its advisable to invest in stocks that rank in the top 20% of companies in your watch list. This is based on the assumption that your portfolio of stocks in the "Watch List" have been selected by using some basic screening tools so as to include the best of the stocks as perceived and authenticated by the screening tools that you had used.
Price / Earnings Ratio (P/E).
Read about this most important investor tool in the next part of this module.
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