How to Choose Stocks

The budding stock-market investor doesn't have to just cope with the erratic nature of the market; he also has to understand the underlying metrics of stocks to make sense of them. Here we have compiled for you a list of basic stock-related metrics.

1. Stock price: Stock price is simply what a stock costs in rupees. If the stock price appreciates, you have got gains on the stock. If it declines, you are making losses. Since investors' fortunes are tied to the stock price, it is keenly tracked by them.

While the stock price is widely followed, it communicates very little about the stock on its own. In order to put stock price in perspective, you will need to combine it with some other metric such as earnings. For instance, when seen in conjunction with earnings, it tells you about valuations. More on this later.

Note that you can't say that a stock is expensive or cheap just by looking at the stock price; for that, you need to look at the valuation. A stock priced at Rs 10,000 can actually be 'cheaper' than a stock priced Rs 10 when seen in terms of valuation.

2. Stock-price chart: A stock-price chart is plotted to see the progression of stock price over time. The 52-week range of stock price is frequently tracked. It tells you the highest and the lowest points the stock price has touched during a year.

3. Market capitalisation: Shortened as 'market cap' or 'mcap', it tells you how big a company is. Market cap is obtained by multiplying the stock price by its outstanding number of shares. Roughly, a company with a market cap of up to Rs 5,000 crore is a small cap; one with an mcap up to Rs 25,000 crore is a mid cap; and the companies over that are large caps.

4. Volume: The volume number indicates how many trades are executed in a particular stock in a particular period. Always invest in stocks with reasonably high volumes (in at least five digits) as it is easy to both enter and exit such stocks. Stay away from stocks that have anaemic volumes.

5. Earnings per share (EPS): EPS is calculated by dividing the total profit of a company by its total number of shares. EPS splits the entire profit of a company across its shares.

6. Price-to-earnings (P/E) ratio: As stated earlier, it's not the stock price but valuation that tells you how expensive a stock is. The P/E ratio is one of the most important valuation tools. It is calculated by dividing the stock price by 'TTM' earnings. TTM stands for trailing twelve months. Hence, TTM earnings are the earnings of the last twelve months or four quarters.

A low P/E means a cheap stock. A high P/E means an expensive stock. But wait! Before you overgeneralise this statement, be informed that not all low P/E companies are good companies. Nor are all high P/E companies bad choices. It's the financial strength and the future outlook of a company that drive valuations. You need to dig deeper in order to know if a company's P/E is justified or not.

7. Price-to-earnings-growth (PEG) ratio: A better tool than the P/E ratio is the PEG ratio. It is calculated by dividing the current P/E of the stock by its earnings growth rate of a specific period. Don't worry about the underlying calculations; you can find readymade PEG on the stock pages on the Value Research website. A PEG of less than one implies a cheap stock, that of more than one an expensive stock and a PEG of around one indicates a fairly priced stock.

8. Price-to-book (P/B) ratio: The P/B ratio is another valuation tool. It is obtained by dividing the stock price by book value. Book value of a share is its worth in the company's books. A P/B of under one indicates a cheap stock. But beware, you can't read too much into this metric as book value isn't a very reliable tool; the actual worth of share could be very different from what the company thinks it to be.

9. Dividend yield: Dividends are the profits that companies share with their shareholders. Dividend yield is obtained by dividing the dividend per share by the stock price. The higher the dividend yield, the more money you get as dividends.

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