A Simple Guide To Evaluating A Stock

calculate One of our readers asked the following question (edited slightly):

“Can I have a step-by-step guide on how to invest/ evaluate a stock? It’s difficult to understand all the terminology for a layman. Thanks!”

Thanks for the question. Here at Motley Fool, we love to help people invest better. That is why we have created a “How to Invest” page in our website, as seen from the top of our page. We have three comprehensive guides in there –  13 Steps To Financial Freedom, What-Is Guides and How-To Guides. We hope these guides will help to break down all the “scary-looking” terminology and make life easier for you.

Investing in stocks should always be approached from a business-perspective. Benjamin Graham, the father of value investing, once said that investment is most prudent when it is most business-like. Approaching investing from a business-perspective means not looking at stocks as mere ticker symbols but rather as businesses that provide a service or product.

Another important aspect in investing is deciding to invest only within your circle of competence. There are various stocks that are part of the Straits Times Index (SGX: ^STI) that you may be familiar about and can research into. The STI consists of 30 different blue-chip companies and it includes DBS Group Holdings Limited (SGX: D05), Singapore Airlines Limited (SGX: C6L) and Singapore Press Holdings Limited (SGX: T39).

After you have picked a company that you like, you have to look into their financial statements and their various ratios – the income statement, balance sheet and cash-flow statement. The financial statements can be downloaded from the SGX website.  Look out for increasing revenue, earnings and cash flow, zero or negligible debt and high return on equity in a company. Such metrics (although non-exhaustive) show that the business is fundamentally-strong.  If you would like to go in-depth about how to read a financial statement, there are various books available. One such book would be “How to Read a Financial Report: Wringing Vital Signs Out of the Numbers” by John A. Tracy.

Next, we have to assess the management.  By investing in a company, you are also putting your faith in the company’s managers.  Look out for any insider ownership of the company. By having a high insider ownership, shareholders can be assured that the decisions of the management will be aligned with them.

Also discern if there are any future growth drivers of the company. This can be found by looking at the company website, reading annual reports, reading analyst reports or by even calling up the company to enquire. For example, Raffles Medical Group Limited (SGX: R01) recently announced that it is foraying into Shanghai to expand its business and this may bode well for the company, in terms of profits.

Last but not least, value the stock using the price-to-earnings (PE) ratio. A company with the current PE ratio higher than the average PE ratio over the last ten years may mean it is overvalued and vice versa. This valuation method is just a quick-and-dirty way and there are various other methods to value a company as well.

So, there you have it, a brief step-by-step guide to investing and evaluating a stock. We hope you have benefitted from this brief guide.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.  Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.