Learning the Basics of Researching Stocks.

Performing research on stocks can be a very gratifying process once you learn the basics. Investing on one's own can be risky but very rewarding. There are several principles that every investor needs in order to make a competent investment decision that takes into account risk and return. First time investors need to plan for the future by setting an investment objective. Secondly, an investor needs to understand the basics of investing. Third, investors need to understand risk versus return.

As an investor, you can do some initial screening to determine whether a stock is right for you. You can do this by looking at some basic financial and investment ratios. The most popular ratio mentioned is called the P/E ratio. The P/E ratio (Price/Earnings ratio) measures how expensive a stock is to own. The P/E ratio is a stock's current price divided by the company's past year earnings per share (EPS). The higher the P/E ratio the more expensive the stock and the more risk an individual investor will take. Generally, if the P/E is greater than 30, investors expect earnings to grow much fasterthan the average company. If its under 30, investors may have lost interest or the company is expected to have slower earnings growth into the future. A P/E under 30 may also be an indication that the market has not properly valued the stock.

Another investment measure is a stock's beta. The beta measuress how volatile a stock is when compared to an index. The higher a stock's beta, the more risky and volatile the stock is to own. Generally, high technology stocks such as computers, software, and biotech stocks will have higher betas. Companies in more mundane industries such as food, tobacco, and utilities will often have much lower betas. A beta greater than 1.00 will move much more than the market when it goes up and down. Investors who want to assume the least amount of risk should choose stocks with betas below 1.00.

Dividend yield is another measure of how well a stock could perform in the future. Value investors usually look at a stock's dividend yield which is the annual dividend as a percentage of the stock price. Dividend yield varies greatly with by industry because of industry growth, competition, and market forces. Companies sometimes cut dividends. But investors can look at cash flow which shows if more money is coming into a company than leaving. Cash Flow is generally measured by adding earnings plus all noncash charges such as depreciation. Investors can also measure a firms payout ratio which shows how much of a compay's profits are going to shareholders.


Please look for our continuing series on Performing Stock Research.