Stock Picking Tips

When picking a stock, there are several factors to consider.

When picking a stock, there are several factors to consider. Some of these factors involve the financial valuations of the stock. These financial valuations include (but are not limited to) Price-to-Earnings (P/E), Price-to-Book (P/B), and Return-on-Equity (ROE). By studying the financial valuations of a stock you can discover a company's current, past, and expected future financial health.

Price-to-Earnings (P/E) ratio. The P/E ratio measures how the earnings of a company compare to the stock's current price you would pay and reflects investor's expectations of what the stock will do in the future. In the "˜90's, P/E ratios were very high (or meaningless in the case of non-profitable companies) for many very successful internet and high-tech companies, reflecting expectations of very high future growth and profitability. Now, it is becoming more meaningful to compare a company's P/E to those of its industry and sector. A low P/E, if other valuations look attractive, could mean a bargain price on the company's stock.

Price-to-Book (P/B) ratio. Book value is the price for which the company could be sold. The Price-to-book value compares how the company's stock is valued compared to its book value. Low P/B values compared to the industry or sector could mean a good value for the stock.

Return-on-Equity (ROE). ROE is a measure of the company's financial efficiency. It is measured by:

ROE = Earnings/Shareholders Equity

In other words, ROE tells how much earnings management generated from the money investors put into the company. High ROE compared to the industry and/or sector could allow the stock to legitimately trade at a higher than average P/E. Also, a consistently high ROE is an indication of stability within the company and could mean strong long-term growth prospects.

Of course there are other considerations when picking a stock (future new products and regulation within an industry being just a couple). Looking at the financial valuations, however, will help you whittle the list of potential stock picks down to just a few.

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