In my last post, I wrote about the investment basics and what to do before investing in the stock market.
Now you must select the stocks you intend to invest, to make a well diversified portfolio, minimizing the risk and maximizing your return.
No matter if your strategy is trading or investing long term, you will always need to select your stocks to invest in (or trade).
And there is no way for an inestor to avoid a market research, you must study the companies publicly traded well and look at the financial ratios. They can help you invest wisely and making much more money!
When you are investing in the stock market, you should look at companies financial strength ratios, profitability ratios and valuation ratios.
Some strength ratios:
- Current Ratio: creditors often compare a firm’s current assets and current liabilities to assess whether the firm has sufficient working capital to meet its short-term needs
Current Ratio = Current Assets / Current Liabilities
- Debt-Equity Ratio: used to assess a firm’s leverage
Debt-Equity Ratio = Total Debt / Total Equity
- Interest Coverage Ratio: assess a firm’s ability to meet its interest obligations by comparing its earnings with its interest expenses
Interest Coverage Ratio = EBIT / Interest Expense
Some profitability ratios:
- Operating Margin: reveals how much a company earns before interest and taxes from each dollar of sales
Operating Margin = Operating Income / Sales
- Net Profit Margin: shows the fraction of each dollar in revenues that is available to equity holders after the firm pays interest and taxes
Net Profit Margin = Net Income / Sales
- Return on Equity: provides a measure of the return that the firm has earned on its past investments
Return on Equity = Net Income / Book Value of Equity
Valuation Ratios (use it to compare with competition and industry)
- Price-Earnings Ratio: measure that is used to assess whether a stock is over- or undervalued based
P/E Ratio = Market Capitalization / Net Income = Share Price / Earnings per Share
I mention above just a few ratios, but there are much more available.
I recommend you learn more about it. A good book that explains in depth all these financial ratios and much more, and for sure will help you know more about how to invest in the stock market is Corporate Finance (3rd Edition) (Pearson Series in Finance), a must read for an intelligent investor.
You can also check finviz to scan for stocks adding your filters.
For education and ilustration purposes, soon I will make available my model of an efficient portfolio using the modern portfolio theory as written in Modern Portfolio Theory and Investment Analysis, available in kindle version Modern Portfolio Theory and Investment Analysis, 9th Edition.
Keep calm and invest.
Share if you like