Are you planning to buy shares of a company listed on a stock exchange? Are you an investor who invests on tips given by others as you are not sure how to evaluate a stock? Are you a regular investor who invests on gut feeling rather than fundamentals of a stock? If the answers to all these questions are yes , then it is time to start your homework on stock evaluation. You need to refer to balance sheet and Profit and Loss account of a company and evaluate the performance of the company on the following parameters:
1) Return on Equity (ROE): It is calculated as PAT/Shareholders Equity. PAT is profit after tax which is available in the profit and loss account of a company. This is also called as bottom line performance of a company. Shareholders equity includes share capital plus reserves and surplus. ROE gives an indication of how much is the return generated by the company on equity shareholdings. This parameters is used in context of comparison with peer group. However an increasing ROE is good trend. Do a five year analysis to see how the company has performed on ROE front.
2) EPS (Earning Per Share): EPS reflects how much profit is generated per share by a company. It is arrived by dividing PAT minus preference dividend if any, by number of equity shares. EPS is used along with P/E ratio to find out the share price of a company. This method is a popular method of pricing equity shares. EPS of a company should be generally showing an uptrend. If the EPS is negative, it shows loss. Kingfisher Airlines currently has negative EPS.
3) PEG ratio: This ratio shows relationship between Price Earnings and growth and is derived by dividing P/E by Growth. If PEG is more than one, the company is overvalued, if it is one the company is fairly valued and it is less than one than the company is undervalued.
4) Return on Capital Employed (ROCE): This is a method of evaluating the efficiency and profitability of company's capital investment. This is calculated as EBIT/Capital Employed. Capital Employed is equal to shareholders equity plus long term borrowings.
5) Return on Net Assets(RONA): Companies like ITC use this method to evaluate their performance. Return on Net Assets (RONA) shows the return that a company has generated on assets employed by it. Net Assets is equal to fixed assets+ current assets-current liabilities. Current assets minus current liabilities show the net working capital of a company.
6) Profit Margins: These margins indicate how much is company earning for each unit sold by it. There are three indicators of profit margins. They are gross profit margin, operating profit margin and net profit margin. The denominator for all the three margins is Sales while numerator is gross profit, operating profit and net profit.
7) Debt/Equity Ratio: This is measure of leverage of a company. A company like Infosys is not leveraged at all which means that it has no debt in its books. If a company has high debt levels, it should make adequate profit to service debt. Look at Interest Coverage Ratio while evaluating Debt/Equity Ratio. Interest Coverage Ratio is arrived at by dividing PBIT/Interest cost. It should be significantly high. Also a company which has lower debt/equity ratio can raise more loans if need arises.
8) Evaluate Industry: Look at the industry you are planning to invest in. The industry should be in growth phase and should not have immediate issues. At the current juncture, real estate is in trouble and you should avoid investing in real estate stocks.
9) Evaluate Economy: You need to look at the economic factors such as trends in interest rate, inflation, GDP growth rate etc. before making investments.
10) Evaluate Global Scenario: Indian economy is no more insulated from global economy. Never overlook global factors. Greece crisis has hit Indian equity markets. You can ignore these factors at own peril.
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