How to evaluate a Stock

Evaluating a stock that you’re interested in is the number one most important thing to do before you buy shares in that company. This evaluation method will give you a good idea of whether the stock is a good investment decision.

How to evaluate a stock

  1. Company- Is it practical? Read headlines and look at their website.
    1. Also look at company’s growth compared to that of the industry that it is in.
  2. Balance Sheet-
    1. Cash and cash equivalents + short-term investments + long term investments = X
    2. Short-term debt + long term debt = Y
    3. X – Y = Z
    4. Get ratio of Z to Y
      1. A ratio of 2:1 is safe, anything higher is fantastic. This ratio ensures the company won’t go bankrupt in the event of a recession.
    5. Income statement-
      1. Revenue and profits: How are they moving along the last 3 years? Ideally, profits and revenue are steadily increasing; but if either stumble, it doesn’t mean this company isn’t a good investment. It does mean you need to investigate further to see why profits stumbled.
    6. P/E Ratio-
      1. Invest in companies with a P/E ratio under 17.
        1. Unless it’s a fast growing company.
      2. If it’s a fast growing company growing at 30% – 40% annually and its P/E ratio is 25-30, it may still be worth investing in.
      3. Nothing above a P/E ratio of 50. Period.

 

This post was inspired by Peter Lynch’s book, One Up On Wall Street. Purchase it here.

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