5 Important Metrics Potential Investors Should Consider When Selecting Stocks

By Chika

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Last Updated: November 3, 2021

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Investing in stocks goes beyond picking a company you like, buying its shares and going about your duty.

There are over 2800 publicly traded shares of companies on the stock exchange (U.S). Coupled with the unpredictable nature of stock prices, it is easy to get lost in the maze of tradable securities!

Stock investors more than ever before are inundated with a plethora of choices on which stocks to invest in. This has been enhanced with the rise of social media, which has heralded the explosion of meme stocks, short squeezes, and bad investment choices. 

The truth is most people don’t have the discipline or patience required to pick good stocks.

Reviewing financial reports and data of public listed companies is a prerequisite or good stock pick, but it can also be a painstaking process. However, if you have criteria to follow, then it may be much easier to choose stocks to suit your investment objective.

So, what are the metrics that potential investors should look out for? Let’s have a look at some of them listed below. 

Read this next: 5 Tech Stocks to Watch in 2021: Are They Worth Investing?

 

5 Metrics Every Potential Investor Should Look For When Selecting Stocks

1. Price-to-Earnings Ratio

The P/E ratio is a metric that can be used to evaluate the attractiveness of a stock.

It is the measure of a company's stock price in relation to its earnings. In simple terms, it is the price investors are willing to pay for the future earnings of a stock.

It gives an investor insight into the future direction of a stock. This makes it easier to decide if you want to invest in that particular stock or not. P/E ratio is calculated by dividing the price per share by per-share earnings. 

A high P/E ratio indicates that investors are willing to pay a higher share price today for future growth expectations – and vice versa.

By comparing the P/E ratios of companies in the same sector, industry, or index, you can ascertain whether a company is overvalued or undervalued, and the sentiment towards the stock.  

However, a note of caution should be exercised when using the P/E ratio. It is not usually foolproof and at times does not give a full picture of how a stock would perform in the future.

As such, this metric should be used in combination with others when trying to assess a stock for your portfolio. 

2. Business model

When investing in a stock, it is worthwhile to understand the company and its business thoroughly.

Having a look at the company’s business model shows you how the company:

  • makes its money
  • offers its products & services
  • utilizes its assets
  • raises revenue for operations

A look at a company’s business model provides a basis for comparison with competitors and other companies in the industry. It also gives an idea as to which direction the management is steering the company towards and how the company intends to address its challenges. 

Companies with flexible business models, broad product portfolio, and vertically integrated production then fare better than those with rigid models, lean product differentiation, and are horizontally integrated.

For example, Apple has a flexible business model, which allows it to have a diversified product portfolio. The company also recognizes the fact that the sale of iPhones alone cannot make it profitable in the long term, and as such has been increasing its revenue from services. 

3. Track record

Companies with a proven track record offer investors some measure of stability and predictability.

Because these companies have proven themselves over time, it is much easier for investors to get more from a company’s record than trying to forecast future performance. 

For example, you can examine earnings reports over the last eight quarters, and analysts’ projections to evaluate the company’s performance. If a company posted its best earnings of the last five years, two years ago, and has been lackluster since, this is usually indicative that it is under increasing competitive pressure.

4. Dividend yield

Investing in dividend-paying stocks is a very popular strategy among value investors.

They provide a steady stream of income apart from share price appreciation which gives investors a sense of calm during periods of economic uncertainty. One way to play this is looking out for dividend aristocrats i.e., stocks that have increased their dividend payout in the last 25 years irrespective of the economic situation.

5. Other factors to consider

Other financial metrics which you can consider before investing in stock include:

  • beta versions
  • company management
  • industry forecast
  • Free Cash Flow (FCF)
  • profitability
  • Total Addressable Market (TAM)
  • operating margins

These would give you an overall picture of the financial status of the company and indication of its future performance. There is no exhaustive list of factors to consider when choosing stocks, but at least you should have a knowledge of what to look out for when selecting stocks. 

 

Conclusion

Nothing replaces exhaustive research, especially in a field such as stock investing.

The most successful investors are those who are willing to roll up their sleeves and rummage through the motley of stocks to find one that suits their investment goals.

It is also a strategy that protects investors against taking knee-jerk reactions in periods of market volatility and price movement. It also serves as an anchor which enables investors to stay the course towards their investment goals and dumbs the noise in the market.

By having a list of factors that will guide your stock pickings, you reduce potential losses and develop an investment philosophy.

Photo by Anna Nekrashevich from Pexels

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