Markets
Ten Clues to Strong Stocks
There's no secret to picking good stocks -- all you need is the right information. Here are ten key measures that will point you to good stock buys, and all the numbers you need to crunch.
March 16, 2005
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There's really no secret to picking good stocks. All you need is the right information and the know-how to use it.
Thanks to the Internet, the data are easy to find -- much of the information is right here on Kiplinger.com. So all you need to identify winning stocks, or know when to drop losers from your portfolio, is a grasp of the fundamentals -- the fundamental measurements of stock value and strength, that is.
There are literally thousands of stocks from which to choose. And they all fall into various categories: growth or value, small, medium or large companies. Each stock type can serve a different purpose in your investment strategy. But no matter what type of stock you seek, they all can be gauged using these ten measurements.
In fact, many of the key ratios listed below are used in Stock Finder, our stock screening tool. Keep in mind, though, that there's more to picking a stock than just good numbers. Products, management, competition and market forces should also be thoroughly researched. But by using the ratios below you can quickly separate the wheat from the chaff.
Bargain or premium?
No one wants to pay more for something than it's worth, and a stock is no exception. The adage "buy low and sell high" is good advice, but it doesn't refer only to a stock's price. You need to evaluate its underlying value to determine if it's a good deal.
The price-earnings ratio is one of the most widely-used measurements of a stock's value. This figure takes the price of the stock and divides it by its earnings-per-share (profits divided by number of shares) -- telling you how much an investor pays per share for the earnings, or profits, the company generates.
You should look not only at the previous year's earnings when calculating a P/E ratio, but also what analysts project the company will earn in future years. For example, if a company trades at $22 and earned 71 cents over the past 12 months, its trailing P/E is 31. If analysts expect it to earn 79 cents next year, its forward P/E is 28.
In general, the higher the P/E ratio, the faster and more consistently the market expects a company's earnings to rise. Larger P/Es can translate into more volatile investments because the lofty expectations have further to drop if the company falls short one quarter.
You can compare a stock's P/E ratio with the overall market or the average P/E of its industry. A P/E of 14, for example, may be high for an energy stock but low for a tech company.
And if your stock's P/E is unusually high, you might consider selling if you believe the company could have a hard time maintaining its lofty price. (Learn more about how value measures can signal when to sell your stock.)
Combining anticipated long-term earnings growth and P/E gives you a stock's price-earnings to growth or PEG ratio. It's figured by dividing a stock's P/E by analysts' projected earnings-per-share growth rate over the coming three to five years.
Stocks with relatively low PEG ratios may be bargains -- investors tend to favor those with PEGs below 1.
Looking at both the P/E and the PEG can give you a clearer picture of a stock's value. Just because Company A has a P/E of 20 and Company B's P/E is 32 doesn't necessarily mean the latter is overvalued. If analysts expect earnings to grow 10% annually at Company A and 30% at Company B, that gives them PEG ratios of 2 and 1.1 respectively, making Company B the better buy. A high P/E and a low PEG just means you're paying more to get more.