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