When you buy shares in a company, you become part owner of the company, and you make money in one of two ways: through dividends or price appreciation when you sell your shares at a profit. A stock may appreciate based on various reasons, such as the company’s high profitability, an industry that is doing well, and takeover rumors or acquisition moves. 

Since new investors don’t even know what to look for when looking for good stocks, they can end up buying stocks that are not doing well and are not considered market leaders. Inexperienced investors want to make money fast without doing the necessary study and preparation to really learn more about the stocks they plan to buy.

To get past the starting gate, here are a few basic analytical tools essential to stock selection. Earnings Per Share distills the company’s financial picture into one simple number. Earnings Per Share is the company’s net income (after taxes and preferred stock dividends) divided by the number of common shares outstanding. When a company is growing, that growth is usually stated in terms of EPS. Look for a company whose EPS has increased over the past five years; one down year is acceptable if the other four have been up. 

The price-earnings ratio (P/E) is one of the most common tools of the trade. It reflects investors’ enthusiasm about a stock in comparison with the market as a whole. Divide the current price of stock by its EPS for the last twelve months and you get the P/E ratio, sometimes called multiple. A P/E of 12 means the public is willing to pay 12 times earnings for the stock. The ideal P/E must be under 10 to be regarded as conservative. If the P/E moves above 10/ you start to pay a premium.

Book Value, also known as stockholders’ equity, is the difference between a company’s assets and liabilities. That number is divided by the number of shares outstanding to arrive at the book value per share. If book value is understated, that is, if the company’s assets are worth substantially more than what the financial statements say they are, you may not have a bargain that markets have not yet recognized.

Return on Equity (ROE) measures how much a company earns on stockholders’ equity. It is a company’s total net income expressed as a percentage of total book value. To calculate the ROE, divide earnings per share by book value. A return below 10% is usually considered poor.

While investors broadly expect the US Fed to address its monetary policy soon, Fed officials aren’t that set on acting yet until US inflation heads back to its normal level. Investing, at its core, is all about risk management. Take advantage of the booms, but don’t let the busts do you in. 

We can only live life forward.      

Atty. Abelardo “Billy” Cortez is formerly FINEX national president. He’s board director of IAFEI (International Association of Financial Executives Institutes) as well as independent board director at First Metro Investment Bank’s companies/subsidiaries (Metrobank Group). He’s an awardee of the Most Distinguished Bedan Alumnus in the field of banking and finance from San Beda College. 

The views and opinions expressed above are those of the author and do not necessarily represent the views of FINEX.