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