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Stock Picking Tips

Picking stocks can become significantly easier when an individual investor understands the basics and looks at a few key indicators to help determine the financial health of a company. Ratios like price to earnings, price to book and return on equity as well as charts and analysts ratings help provide insight into a stocks investment potential.

Price-to-Earnings (PE)

A stock's price to earnings ratio is often the most heavily cited ratio considered when purchasing a stock. Unfortunately, in and of itself, it doesn't really provide an individual investor with much information. If a high performing growth stock is also an industry leader it could have a very high PE due to the expectation of significant future stock price appreciation.

A PE can also be low when compared to other companies in the same industry which may be good if other financial characteristics are healthy as it could indicate a value stock which should be purchased. But what if the price to earnings ratio is low for a reason? If a company is losing significant market share and has had numerous analyst downgrades, then there could be cause for a low PE. That would mean the company isn't necessarily a value but is a stock that should be avoided.

Price-to-Book (P/B)

The book value of a stock is the price by which the company could be sold at fair market value today. So the price to book ratio is a comparison of a company's book value to its stock price. As with the price to earnings ratio, a low price to book value could be indicative of a value stock which should be purchased or a stock which should be avoided because it is low for a reason.

Return on Equity (ROE)

Return on equity is a great piece of information for determining the performance of management at a company. ROE is a measurement which shows what level of earnings have been generated for investors who invested money in the company. A high ROE in addition to a high PE ratio could indicate that a company is not only growing fast but management is generating significant value for investors.

Stock Charts

While past performance is not indicative of future performance, analyzing a stock price chart can provide insight into the long-term health and future prospects of a company. If a stock price has been trending up over the span of five or ten years then that is a good indication of long-term growth and stability. Does that mean a stock can't suddenly drop? Absolutely not. But what it does show is a long-term appreciation in the stock price from a strong company.

Analyst Ratings

Professional analysts research companies thoroughly and grade stocks accordingly with either buy, sell or hold ratings. If 22 of 24 analysts are rating a stock to "Buy" that is a good indication that the stock should be considered for purchasing by investors. While a consensus of analysts could be wrong in their evaluation of a stock, more often than not when taken into account with other financial analysis it can further support a position on purchasing a stock.

None of these stop taking tips should ever be used in isolation when deciding on buying a stock. However, when taken as an aggregate, they can provide a clear overall picture of whether or not to buy stock in a company. An above average industry price to earnings ratio, a high return on equity, a chart showing a stock price trending up and a majority of analysts rating a stock a buy could all point to purchasing a stock. These are just a few of the various pieces of financial analysis available to individual investors but understanding the importance of these and other performance indicators will hopefully make the decision-making process easier.

Keep in mind even when all indicators suggest that a stock is a great investment there is always the possibility that it could decrease in value for some unforeseen circumstance such as a natural disaster, government regulation or corporate fraud. When purchasing stocks, only invest money you can afford to lose and if you're unsure consider consulting with a full service broker, certified financial planner, or other investment professional.