Every investor has been in the situation where they want to buy shares of some company but not sure how to choose which stock is best suited for buying. So how do you choose them? What are the important things you should be looking for while buying long term shares?
So here are some key factors we will consider that will helpful in making a decision. We will discuss few key ratios which can help you make an educated decision.
1. Plough back and Reserves:
After deduction of all the expenses and taxes, net company profit is divided into two parts
- Dividend
- plough back
Dividend is something that is divided into shareholders, while plough back is something company retains and gets added to its reserves. Generally company whose reserves are double that of its equity capital could be in a position to make bonus issue. Higher the reserves, greater will be the value of your shareholdings. Retained profit may not come to you directly as cash, but this will help you by pushing up the price of your shares.
2. Book Value Per Share:
Book Value indicates what is the price of according to company's book of accounts. You can find out book value per share by dividing shareholder's fund by total number of equity shares issued.
Book value per share = Shareholder's fund / Total number of equity shares issued
Generally book value price is way lower than the market price of share. Hence closer the book price to market price, chance of stock being under priced are better. Then doing some fundamental research on the company can you give you the one of the best stocks on your portfolio.
3. Price to Earning Ratio:
Price to earnings ratio famously known as P/E ratio. It gives us the relationship between, market price of the share and company's earnings per share.
P/E = Price of the share / Company's earning per share
According to best selling author Peter Lynch in his famous book One up on Wall Street, P/E ratio can simply be defined as the number of years a stock would take to give you the returns of your investment. Hence lower the P/E better the chances of getting your returns on investment.
4. Earning per share:
EPS is a well-known and widely used investment ratio. It is calculated as
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company’s shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends — capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money — it doesn’t really matter whether it comes from capital appreciation or from dividends.
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