If you have ever made an investment decision and regretted it shortly after the trade was executed, you are not alone. Consider the following checklist consisting of three, basic pre-trade points. While these three points are not considered exhaustive, following them will easily help eliminate or at least reduce those post-trade doubts.
Probably the most important thing to determine when buying into a position is whether the risk that comes with that security is acceptable to you, the investor. Since risk is a relative term, the easiest way to determine the risk of a security is to know its Beta. Beta is a measure of projected volatility relative to the overall market. You can find a security’s Beta at Yahoo! Finance.
As a measure of volatility, Beta is given a value 1.0 for the market. Therefore, a stock with a Beta of 3 will respond three times more than the market. That means if the market has a 3% down day, the stock in question will likely have a 9% down day. The closer a stock’s Beta is to 1.0, the more like the market it will behave.
A second important statistic is the Price to Earnings ratio (PE Ratio). A PE ratio tells investors how much a particular stock price is vis-a-vis its earnings. So, if you are looking at a PE ratio of 6, you are paying $6 for every $1 in earnings that the company generates. This alone tells investors very little. However, if the stock you are looking at has a PE ratio of 6 and all of that company’s competitors have shares with PE ratios in the 30’s range, then you need to find out why (there is a reason).
A third basic statistic that all investors should know about a security is the security’s Earnings per Share (EPS). This tells investors how much each share is responsible for. In other words, an EPS of $10 tells an investor that he or she is responsible for $10 for each share he or she owns. While revenue is rarely paid out in its entirety (or at all), it gives an investor an idea about how much each common share is really worth to the company.
Beta, Price to Earnings and Earnings per Share do not collectively provide a green light or red light. In most cases, some sort of red flag will go up when investigating these figures and comparing them to other shares. These red flags should lead investors to the company’s financial statements and accompanying notes to see what the company is really about and whether this is the type of investment they want to make. And with more time spent studying the company, the more comfort (or discomfort) an investor will have before making investment decisions. And that, after all, is the whole point.
As founder of the Mutual Fund Site, Christopher Fitch’s site has been helping people find out Where To Invest. His site has also discussed Bond Funds when all other sites have avoided the topic.