How do you determine if a stock is a good investment? Every experienced investor will tell you something different, and everyone seems to have their own method of evaluating opportunities. The fact is, there are a lot of ways to look at a stock and plenty of lenses through which to view its potential. However, it boils down to understanding the most-used stock selection criteria and what these metrics mean.
Here’s a look at a dozen of the most common stock selection criteria by which you can evaluate a potential investment. Keep in mind, none of these is a standalone metric. Furthermore, they’re best combined for a thorough evaluation of a company’s position in the market.
Most Common Stock Selection Criteria
No. 12 Sales Revenue
Cash is king. Without sales revenue, companies don’t have a viable business and aren’t able to return any value to shareholders. Look for companies with consistent or growing sales and avoid those that seem to have sporadic or declining sales. In addition, sales are a good gauge of the company’s ability to succeed in its industry and against its competition.
No. 11 Profit Margin
Sales are great, but what truly matters is how much profit the company derives from its operations. Net profit margin represents the amount of revenue a company keeps and thus, how much it’s able to reinvest in its growth or return to shareholders. This is definitely one that should be on your list of best stock selection criteria. Strong profit margins also tend to mean more reliable cash flow.
No. 10 Price-to-Book
One of several valuation metrics, price-to-book (P/B) is a bottom-line look at how much the market values a company above and beyond its intrinsic value. While price-to-earnings (P/E) is a more common valuation metric, P/B takes a fundamental look at how much more you’re paying for the company, above and beyond the sum total of its assets.
No. 9 Debt-to-Equity
Debt can be a hamper that keeps companies from growing. However, debt can also be a necessary evil that helps a company secure capital to finance growth. The key is balance. Look at a company’s debt-to-equity (D/E) ratio to determine how its debt stacks up against the company’s ability to repay it. Assess both total D/E and long-term D/E when possible.
No. 8 Earnings per Share
This is a true measure of shareholder reward. Companies that perform well and appreciate their stock price are companies worth investing in. Look for companies that have trailing earnings-per-share (EPS) growth, as well as forward-looking EPS. Beware those with struggling EPS, as well as massively inflated EPS projections that aren’t realistic or sustainable.
Keep reading to learn more about the top stock selection criteria.
No. 7 Return on Equity
Return on equity (ROE) is a measure of how well a company utilizes shareholder to fund initiatives that produce revenue and profit. Companies with strong ROE typically do a better job of putting investment dollars to work and thus, are able to return more to shareholders as a result. Investors can contrast this metric with return on assets (ROA) and return on investments (ROI).
No. 6 Moving Average
A company’s moving average will tell you the average closing price of a company’s stock over a period (usually 10, 30 or 90 days). Using this figure, you can look at the current share price and determine how far from the average it is. Additionally, this is a useful metric for smoothing out volatility to show a true price trend for the stock. In short, if you’re looking to invest long-term, moving average offers crucial insight.
No. 5 Beta
Every stock is subject to volatility. What matters is how much volatility a stock encounters relative to the broader market’s volatility. This is measured as beta. For traders, beta is a good thing, as it can represent opportunities to enter-exit trades quickly. For long-term investors, beta could signal when a stock is more prone to risk. Remember, volatility equals risk in investing.
No. 4 Share Price
One of the simplest stock selection criteria to observe is the share price. How many shares can you buy with the capital available to you? What appeal does the share price have relative to the type of stock (growth, dividend etc.)? While the financials behind the share price matter more, it’s also important to look at the face value of what you’re paying to become a shareholder.
No. 3 Dividend Payout
Does the company pay a dividend? If so, what percent? Dividends are a way for companies to return value to shareholders, and a strong, healthy dividend signals the company’s ability to do this consistently. Additionally, look at the dividend history to better-understand how a company returns value to stockholders.
No. 2 Volume
Volume is essentially liquidity. Higher volume means there’s healthy supply and demand for a stock. For example, this means you won’t have issues buying and selling at the price you’re willing to pay. Low volume could leave you holding the bag on a stock or make it more difficult to buy and sell at the volume you’d like to.
Stock Selection Criteria No. 1 Leadership
While it’s not necessarily a quantifiable metric, leadership analysis should absolutely be part of any investor’s stock selection criteria. Good leadership has the ability to uplift a company no matter market conditions. Moreover, good leaders excel at recruiting and retaining top talent, which is essential for strong company performance, top to bottom.
In conclusion, with these criteria in mind, you can determine your own preferred method for selecting a stock. For instance, check out a current article, blog post, investment newsletter, podcast, YouTube video or other stock picking or analysis channel. By doing this you will learn about evaluating potential investments using your own blend of stock selection criteria.