How to Evaluate a Stock

Thoroughly evaluating a stock is extremely important before buying it, especially in this volatile market. This article tells you how to evaluate a stock.

There are many different ways to evaluate a stock. This article is geared more towards beginning investors, so keep that in mind. But if you have any more in depth questions, please feel free to ask.

The most common way to evaluate a stock is with its price to earnings (P/E) ratio. This ratio is obtained by taking the price of the stock, and dividing it by the company's net income for the most recent year. So let's say the price of a stock is $30 per share, and it had earnings of $3 per share. Then its P/E ratio would be 10. Historically, stocks have P/E ratios of about 17-18 on average.

The downside to just using P/E ratios is that they obviously can't tell you everything. Generally, stocks with lower ratios are preferred. And therefore stocks with high P/E ratios are not ideal. But a company might have a high P/E ratio, and also with high growth, which can justify the high P/E. Also you should keep in mind - when looking for stocks with low P/E ratios, there might be a reason. The company could be not doing very well.

The price-to-book ratio is another good one. Is is also important to look at the growth prospects for the company, as well as its debt. I have written other articles that are in depth, so feel free to read them if you are interested.

About the Author

This article was written by PocketSense staff. If you have any questions, please reach out to us on our contact us page.