The idea of approaching stocks and investing seems frightening to many. The notion of risk acts like a rope constantly pulling on people as they walk into a world of investing. Nevertheless, in the current economy many have realized that investing is the key to breaking out of the cycle of poverty. Though investing seems like a completely different world, learning the essential parts of differentiating between stocks is the key to entering this new world.
The first and simplest thing to look at whether it be experienced investors or beginners is earning per share. Earnings per share or EPS measures a business’s profitability. Just like the name itself suggests it measures the amount of money a company makes per share. While EPS is a relatively broad term that encompasses many different ways of calculating profit, the most commonly used formula for EPS is net income - dividends / Common shares. The information used to calculate EPS can be easily found online. There are 2 types of data: Trailing vs Forward. Trailing measures the net income of a company over the past twelve months while Forwards measures projections for a company. It is essential to look at both in order for an accurate projection of a company’s success. For many young people who approach a large prospect such as investing, EPS is the simplest method to distinguish good stocks from bad stocks. EPS is also the basis for many other ways of determining whether a company is worth investing in.
Valuing a company is another essential part of determining what company to invest in. Price to Earning ratio, more commonly known as P/E ratio, determines the relative value of a company’s shares. The calculation of P/E involves the aforementioned EPS where P/E ratio is Current share price / EPS. A higher P/E ratio indicates that a company or business is expected to have high growth in the future, however, it may also be an indication that the said company is overvalued. Though research is time consuming, learning about a company will set apart high growth companies from overvalued companies. The P/E ratio’s main purpose, however, is to compare companies in the same industry. By comparing how much is paid for every dollar earned, it serves as an economic comparison between companies in the same industry. Nevertheless, like all things there are flaws to P/E ratios. P/E ratio relies on companies to be making profit. Companies in their embryonic states which are losing money don’t have positive cashflow rendering P/E ratio useless. For people looking for safer investments, P/E ratio is the key to success.
The last basic technique revolves around measuring stability and volatility with respect to the stock market itself, more well known as the S&P 500. A stock’s beta indicates its relationship to the S&P 500 often shown through data charts. A beta greater than one means that a company grows faster than the S&P 500 while a beta lower than one shows the opposite. Negative beta means that something is inversely related to the S&P 500; the best example of this being gold. On the other hand there are things that have 0 beta meaning it has no relationship with the market. Examples of these include cash and bitcoin which exist separately from the stock market. The S&P 500 itself comprises 500 of the biggest companies in the United States making it the perfect tool to analyze the US economy.
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