Question

list the key metrics you would consider before purchasing stock in a company

Answer 1

Some of the key metrics that should be taken into account while purchasing a company's stock are given as below:

1) Ownership Held by Promoters: It is important to consider the percentage of shares that are held by the promoters of the company. The higher the proportion, the better it is. Lower holding indicates that the promoters are not confident with respect to the future prospects of the company.

2) Debt Ratio: One of the most important metrics that should be considered by any investor/analyst is the proportion of debt used by the company in its capital structure. Use of more debt can increase the financial risk for the company because of fixed interest payment and debt repayment obligations.

3) P/E Ratio (Price-Earning Ratio) = P/E Ratio is frequently used to determine whether a company is overvalued or undervalued. It is calculated by dividing market price per share by earnings per share. An analyst/investor can use this ratio to identify stocks which are undervalued and make investment decisions accordingly. However, this metric shouldn't be used in isolation because a higher P/E ratio (as compared to industry average) could indicate that current investors have better expectations with regard to company's future performance and as such they are willing to pay a higher price for it.

4) Dividend Yield = Companies with higher dividend yield are generally preferred by investors. A company with a consistent dividend policy may appeal to investors who prefer a constant stream of income from their investments. However, a high dividend yield may indicate that the company is not investing sufficient amount of money in expanding its business operations.

5) Return on Equity = Return on equity is calculated by dividing net income by the value of stockholder's equity. It can be used to compare the performance of the company with its competitors. Generally, an investor would prefer to make investments in a company that is generating a return of equity which is higher than the companies operating in the same industry.

6) Volatility = Purchase of stocks is also influenced by the stock's volatility. Investors with higher risk appetite may prefer stocks with high beta (which is a measure of volatility). A beta of greater than 1 would mean that the stock is more volatile than the market. Similarly, a beta of less than 1 would indicate that the stock is less volatile than the market. Higher volatility means greater risks and therefore, greater returns. A conservative investor would prefer to make investments in stocks which have a beta of either 1 or less than 1.

7) Cash Position: Generally, companies with sufficient cash in hand are preferred by investors. With higher cash balance, a company is in a better position to meet unforseen expenses and pay for contigencies. It also provides confidence with respect to continuity of business operations and less reliance on outside sources for finance. A company with low cash balance may indicate poor liquidity and its inability to meet its obligations as and when they become due.