| An investor buys a share of stock by | | | | (having a justified upper limit): If the |
| resorting to various approaches that | | | | company's stock is trading at $80 and |
| validate his investment by reaping rich | | | | its EPS is $8 per share, it has a |
| profits. Before investing, however, it | | | | multiple, or P/E of 10. This means that |
| is necessary for a value investor to | | | | investors could expect a 10% cash flow |
| study the financials of a business, so | | | | return: |
| that the stock he buys at the company's | | | | $8/$80 = 1/10 = 1/(PE) = 0.10 = 10% |
| intrinsic value promises a greater | | | | If it's making $4 per share, it has a |
| return at its liquidation value (the | | | | multiple of 20 (20 times $4 equals $80). |
| value of a company if all its assets | | | | In this case, an investor might receive |
| were sold). A typical investor would buy | | | | a 5% return (in the same conditions); |
| growth stocks that have an upward trend, | | | | $4/$80 = 1/20 = 1/(P/E) = 0.05 = 5% |
| and seem likely to keep growing for a | | | | However, a low P/E is not an untainted |
| long time. Whereas, a technical investor | | | | value indicator. |
| (also known as a Quant) makes decisions | | | | 4. Price/Sales Ratio (PSR): is the same |
| based upon the psychology of the market | | | | as a P/E ratio, except that the stocks |
| and related factors, which involve much | | | | are divided by sales per share instead |
| higher risk but may prove to be more | | | | of earnings per share. |
| profitable, or, can conversely result in | | | | 5. Debt Ratio: percentage of debt a |
| much greater losses. The fundamental | | | | company has relative to the shareholder |
| analysis of any business can depend on | | | | equity. |
| various factors: efficient market | | | | 6. Dividend yields above a certain |
| theory, value and growth, growth at a | | | | absolute limit. |
| reasonable price and the quality of the | | | | 7. Book value ratio: comparison of the |
| business. | | | | market price against the book value of |
| 1. Efficient market theory pertains to | | | | the stock per share. |
| stocks being always correctly priced, as | | | | 8. Market capitalization value: Complete |
| all the requisite information is | | | | total value of a company's outstanding |
| available on the current price. | | | | shares (Market price per share ' Total |
| 2. The stock market sets up the price. | | | | number of shares outstanding). |
| 3. Analysts decide upon the value of a | | | | 9. Equity Returns - ROE: Net income |
| company based on the potential for its | | | | after taxes divided by owner's equity. |
| growth. | | | | 10. Beta: comparison of volatility of |
| 4. Price and value may not be equal, due | | | | the stock to that of the market. |
| to certain irrationalities governing the | | | | 11. Institutional ownership: percentage |
| market. | | | | of a firm's outstanding shares owned by |
| Value investors need to rely on certain | | | | certain institutions: insurance |
| stringent rules governing the nature of | | | | companies, mutual funds etc. |
| the stock which adhere to the following | | | | Learning to analyze one's stocks and |
| criteria: | | | | thus reaping the desirable profit is in |
| 1. Earnings: company earnings are | | | | fact a continuous process, as no amount |
| profits after taxes and interests. | | | | of market efficient theories can ever |
| 2. Earnings per share (EPS): the amount | | | | predict a flawless financial return |
| of recorded income (on per share basis) | | | | system. Even though one invests |
| available to the company to pay | | | | judiciously by studying the market, the |
| dividends to stockholders, or to | | | | over-valuation or under-valuation of |
| reinvest in itself. | | | | stocks can often be determined by market |
| 3. Price/Earnings Ratios (P/E) ratio | | | | emotions. |