Stocks
Pricing / Analysis
Many financial statistics and ratios are available to investors so that they can analyze the share price of a stock. The options available can be confusing. Before you get confused with all of the stock price statistics, the first place to start is to understand the general health of the company and the sector it participates in before analyzing the stock price.
When you are about to enter a trade, you will be quoted two prices. If you are selling shares, you will be quoted a bid price. The bid price is the lower of the two prices. If you are buying shares, you will be quoted an ask or an offer price. The offer price is the higher of the two prices, and the difference between the bid and the offer is called the spread. The actual price of a share actually falls somewhere between the bid and the ask price.
The difference between the highest and the lowest recorded price for a share for a period of time – day, week, month, etc. – is the stock’s range. Investors are usually drawn to stocks that have high volumes, or greater market depth, because there is enough activity to prevent any one trade from substantially affecting the stock price.
When entering a trade, there are different types of orders that an investor can place. A market order is one that will be executed at a price at or around the figure that has been quoted to you. If for any reason that you are concerned that the price may change significantly before your order is filled, you can enter a stop order. A stop order means that the trade will only be entered into if a specific price level is reached. A limit order, on the other hand, can guarantee a specific price, although not execution at that price.
Stocks can also be purchased on margin to allow an investor to leverage their purchases. Buying a stock on margin means that the investor borrows money from a broker to purchase the shares. An investor would buy on margin because there are potentially larger gains with less upfront spending. However, be aware, that this also means that there are potentially larger losses that the investor could be facing. A broker can issue a margin call to add additional funds into a brokerage account if a stock held in the account and bought on margin declines to a level that the account value is below an agreed upon level. If this happens, the investor needs to top up the account immediately.
It is critical that an investor can successfully manage their position by having the ability to properly enter, maintain, and exit an investment. All good position management strategies start with the investor knowing how much they can afford to lose and then planning accordingly.
Another critical component to success is risk management. A stock investment is risky, but the risk can be minimized if the appropriated steps are taken. The first item to consider when you are looking to minimize your risk is understanding what your objective is with each of your investments. Also, you need to consider what you will do if the performance of your investment starts to move in the opposite direction to your expectations. You need to understand what your exit strategy will look like. Options can also be used successfully to mitigate risk in your normal stock investments.
Stock Fundamental Analysis
As already discussed, multiple financial statistics and ratios that are associated with the stock price are available to investors. Below are some of the common definitions that are used to perform a fundamental analysis of any stock that you are interested in investing in.
- Volume: A measure of the stock’s liquidity. It is the number of shares that are traded in a session. In general, higher daily volume stocks are less likely to be subject to extreme volatility and drastic price swings.
- Net Change: The difference in stock price from the previous day’s close.
- Earnings per share (EPS): A company’s net income divided by the number of outstanding shares. It helps investors understand the income levels for an individual shareholder.
- P/E: The price per earnings ratio is calculated by dividing the share price by EPS. It is a measure that allows investors to decide if a stock is over or undervalued.
- PEG ratio: Often used for smaller companies, this measure is a modified P/E calculation. It helps investors determine if a high P/E is a good or bad thing by also taking into consideration the growth potential of the company.
- Debt and Debt/Equity: A measure that helps investors to understand the debt levels of a particular company. A highly leveraged company can be at risk in the future. It is also important to understand if the debt obligations are short- or long-term obligations.
- P/S: The price to sales ratio is the share price divided by the sales per share. It can be more important than the P/E ratio when investigating in a new company that is performing well but has a low level of earnings.
- Book value/share: The share holder equity of the company (assets – liabilities) divided by the number of shares.
- Price to Book: The current share price divided by the book value per share is used to identify stocks that are considered undervalued or overvalued.
- Operating Margin: This metric is the operating income divided by the total revenue. It allows the investor to understand how will a company is managing its fixed costs to deliver gross margin.
- ROA: Return on assets is calculated by dividing the net income of a company by the total assets. It gives insight into the level of profits generated by a company for each dollar of assets.
- FCF: Free cash flow is a measure of the operating capital minus the capital expenditures. It answers the question of whether a company has enough cash flow to allow for growth and expansion.
- Short Ratio: The short ratio is measured by dividing interest that investors are looking to sell by the average daily volume of a stock. Often a high short ratio is used to signal when there will be an upward movement in the stock.
- Beta: A ratio that is used to understand the stock’s price volatility when compared to the rest of the market. A high beta ratio means high volatility.
- Net Income: A company’s gross income minus expenses. A measure of how much money the company is making.
- Return on Equity (ROE): ROE is calculated taking net income and dividing it by the book value. It is a measure that helps investors understand how efficient a company is at producing earnings from its assets.
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