Congratulations! You’ve made the decision to start investing in the market. When done wisely, investing can help set you up on the right path to financial freedom. However, before you dive in head first, you should learn how to research stocks by getting acquainted with these 5 essential metrics every smart investor should know. Please note that there are other things you should consider before investing-these are just those that I consider to be essential to smart investing.
Calculated on a quarterly or annual basis, EPS indicates a company’s profit per share. EPS is calculated by dividing the net income (minus preferred dividends) by the number of its shares of outstanding stock. In general, a high EPS indicates a more profitable company.
Carrying debt is not necessarily a bad thing. A company taking on debt can mean it’s gearing up to invest or make a big move. The hope is that an increase in leverage would generate an increase in company earnings at a rate faster than the cost of interest. However, if the cost of debt outweighs the value generated, share value may decline. The debt to equity ratio (D/E) is calculated by dividing a company’s liabilities by its shareholders equity. This metric indicates the degree to which a company is financing its operations through debt. Sometimes investors will look at the D/E ratio through the lens of short vs. long-term debt since the risks will vary. A high D/E ratio is often indicative of high risk
Mathematically, this is calculated by dividing the company’s current share price by its earnings per share (remember we defined that in #1). As a standard, a PE ratio less than 15% indicates that a company is under-valued and anything greater than 20% is over-valued meaning that investors are expecting high growth. If the company has no earnings or is recording losses, the P/E ratio will be marked as “NA”.
Beta is a measure of a stock’s volatility relative to the rest of the market. The closer the Beta is to 1, the more in line the stock moves with the market. A beta of less than 1 indicates a stock that is less reactive to market swings; the opposite is true for beta greater than 1. This is a general indication of how volatile the stock is overall (high Beta stocks are generally more risky but also come with a potentially higher reward).
We’ve all heard the phrase “Cash is king”. This phrase rings especially true when analyzing a company’s FCF. it’s important to know how much cash a company has at its disposal to pay down debt, pay dividends, or purchase equipment. FCF is calculated as operating cash flow – capital and operating expenses. The operating cash flow can be found on a company’s cash flow statement.
All of these metrics can be found either on sites like yahoo finance that track a stock’s daily progress, or in a company’s annual report (likely found on their website). Investing in stocks can be daunting. If you’re not sure if stocks are right for you, check our guide on picking the right investments for your goals and lifestyle.