Page 110 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Unit 6: Investment Strategies-I

Tips Notes

1. The most common measure of a stock is the price/earnings, or P/E ratio, which takes the
share price and divides it by a company’s annual net income.
2. Generally, stocks with P/Es higher than the broader market P/E are considered expensive,
while lower-P/E stocks are considered not so expensive.
3. Don’t automatically go for stocks with low P/Es simply because they are cheaper. Cheap
stocks aren’t always good stocks.

6.2.1 Steps of Investing in Stocks

Step 1: Picking Stocks

Picking winning stocks involves understanding what makes one stock great and another stock
ho-hum. It involves in-depth knowledge of the financial ratios and close monitoring of markets,
but finding good investments is not as hard as perceived by investors. All you need to do is to
be careful while investing by formulating the right investment strategy.
One of the most important things you need to know is that ROA is leading measure of company’s
efficiency. Investors often look for the magic number or metric that will identify a great stock
out of the universe of all stock but magic number doesn’t exist in reality. However, when you
are considering stocks to buy, there are certain metrics and numbers that are more important
than others.
They can’t be used as the sole qualifier to determine great stocks, but you can use them to
eliminate poor performers. An investor must always look at the big picture when considering
a stock and that means considering a number of metrics.
Return on Assets

Return on Assets is one of the most important metrics every investor should know. Return on
Assets (ROA) tells how efficiently (or inefficiently) a company turns assets into net income. It is
a way to tell at a glance how profitable a company is.

Consider that companies take capital from investors and turn it into profits, which are in turn
returned to the investor in one form or another.
ROA measures how efficiently the company does this. Obviously, the more efficient a company
is in converting assets (capital) into profits, the more attractive it will be to investors. ROA is
made up of two components: net margin and asset turnover. When used together, these two
metrics are very important tools for financial analysis of a company.
Picking Stocks begins with Assessment of Need: Stocks should be Appropriate for your Age and Risk
Tolerance
Picking stocks has never been easy if done correctly. Some investors thought they had the talent
during the dot.com boom, but that popping bubble revealed lucky guesses instead of investor
insight.
If you apply yourself, it is possible to improve the odds that the stock you pick will be a winner,
at least for a reasonable period. Some stocks fall into the category of “buy it and forget it”
category earlier. But now the world and the market are changing too fast for investors to
become too comfortable.

LOVELY PROFESSIONAL UNIVERSITY 105