How To Value a Stock — 3 Steps To know If A Stock Is Worth Buying

What makes a stock a good buy and when are you supposed to actually go in and buy shares.

Photo by Joshua Mayo on Unsplash

A stock is a piece of the company commonly known as a share. That share owes its value to the company assets, demand, and industry growth prospects.

That piece of the company is offered to the public as a way to raise capital for projects, and who owns shares become a stakeholder or shareholder giving them the opportunity to profit from the rise of the share price as the company grows its assets like capital, clientele, demand for its products or services.

How to determine if a stock is overvalued or undervalued

What is the definition that comes to your mind when you think of the word ‘’Company’’?

What is the main objective of a company? To make more than what they spend.

To know the value of a company we need to evaluate how firm it stands in front of its competitors in terms of physical assets, clientele, revenue and the cost of that revenue, debt, company image, and most importantly the company team.

Step 1 — Financial statements

Income statements, Balance sheet, and Cash flow.

This is the bread and butter and the most important part when I evaluate a stock, where I would allocate the biggest amount of time analyzing quarter over a quarter the health of the company by monitoring its Revenue, cost of revenue, total expenses, profit margin, debt, and cash flow.

There are tons of information in the financial statements, but to narrow my focus and try to figure out;

  1. The amount of money the company brought in during the specified period.
  2. What’s left over after they’ve paid operating expenses, taxes, and depreciation.

Revenue = Money coming in from selling services or products

A healthy company is one that is able to grow its total revenue every year.

Cost of Revenue = Amounts paid to make those products or to cover the cost of services.

If a company can improve its revenue without increasing too much or even decreasing its cost of revenue that’s a +. I would look at it in terms of percentages. If they sold 1M and their cost of revenue is 250k (25% of Revenue), next year I want to see it go from 25% to at least 24%.

Debt = How much money they owe

Debt is good, but only if it comes with bigger revenue and a lower cost of good sales. Exaggerated debt can put the company on fine line where if shit hit the fan,

Cash = Amount of liquid assets on hand

Cash is always important. If the company has debts and shit hit the fan and has no money, bye-bye company.

Net income = After subtracting general expenses, cost of revenue, and other expenses from revenue, net income shows how many times revenue exceeds expenses.

If the total is positive and has been increasing by year or quarterly, then that is a good start.

Step 2 — Compare the stats

P/E, P/B, EPS, ROE, DPR, D/E, Dividend Yield are seven commonly used metrics that can help break down a stock’s value and outlook. Using these stats, also known as performance ratio I am able to see the overall health of a company to then compare it to its competitors and overall industry and market.

In this post, I go more in-depth on what is and how we can use each of them.

https://medium.com/the-capital/how-to-pick-a-stock-7-key-indicators-used-by-investors-that-all-beginners-should-know-1c00d1324800?sk=fd395c7888ec3f18af020cbb02d21c7a

Step 3 — Ask yourself the key questions

Any single ratio is too narrowly focused to stand alone, so combining these financial ratios with key questions and other economic factors can help you get a more complete picture.

  1. Do I fully understand how they make money?
  2. Is there a place for their product/service on the market in the future?
  3. How would you rate the sense of urgency for their product?
  4. Are they innovating? If yes, how much is it costing them? Is it sustainable?
  5. What is their competitive edge? (Price is not a competitive edge)
  6. Who is the team behind it? What are their background, previous wins, and losses?
  7. What has been the industry performance over the years?
  8. How do people around you talk about that company?
  9. How do people online talk about it?
  10. Is the stock at an all-time high or support, am I getting in with a discount, fair price, or overvalued?

Other factors to take into consideration before investing

  • Overall market and Overall industry.

Depends a lot on how the country and global markets are evolving. These include inflation, deflation, unemployment rates, demand and supply of raw material

  • Company news

Are they in the eye of the media? Have they been related to any scandal?

  • Interest rates

If a company is used to borrowing money to expand and improve its business, higher interest rates will affect the cost of its debt.

This can reduce company profits and the dividends it pays shareholders. As a result, its share

prices may drop.

Conclusion

Rule #1 for Warren Buffet is to not lose money.

Respect the process, put in some effort, and some research time before buying into a company. Don’t rush it, don’t buy their stock only because of hype.

Warren Buffett famously said: “Buy into a company because you want to own it, not because you want the stock to go up.”

There is a great question you should ask yourself before buying any company and that is “If I couldn’t see the price of the stock, would I still own it?”

There are a few companies out there that I wouldn’t care about at all, because I like them that much.

Disclaimer: This is not financial advice, I am just a guy with a laptop sharing his opinions and experience. This is for entertainment purposes only. Always Do your own research before investing.

Follow me on Twitter where I post my daily investments.

https://medium.com/why-i-invest-every-day-and-why-you-should-too/why-i-invest-every-day-and-why-you-should-too-de37daa6fcdc?sk=e5de90442dc862e5e12060c494796c1d

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Max

Passionate about overcoming anxiety with self-dev, personal finances, and fitness. | defichronicles.carrd.co