If you have ever made an investment decision and regretted it shortly after the trade was executed, you are not alone. Consider the following checklist consisting of three, basic pre-trade points. While these three points are not considered exhaustive, following them will easily help eliminate or at least reduce those post-trade doubts.
Without question, the most important consideration when it comes to purchasing a security is to understand the amount of risk it will bring to your portfolio. Since risk is virtually impossible to calculate, the next-best alternative is Beta, which is a measure of a security's volatility relative to the overall market's. Beta can be found at Yahoo! Finance.
Beta compares a stock's volatility to the overall market's. At 1.0, a security will match the market's movement. At a Beta of 3.0, that same security will move 3 times more than the market will. So, if he market rises by 2%, the security with a Beta of 3.0% will rise by 9%.
A second important statistic is the Price to Earnings ratio (PE Ratio). A PE ratio tells investors how much a particular stock price is vis-a-vis its earnings. So, if you are looking at a PE ratio of 6, you are paying $6 for every $1 in earnings that the company generates. This alone tells investors very little. However, if the stock you are looking at has a PE ratio of 6 and all of that company's competitors have shares with PE ratios in the 30's range, then you need to find out why (there is a reason).
A third valuable statistic is the Earning Per Share (EPS) value of a share. This tells investors how much each share has contributed to the earnings of the company. So, an EPS of $7 tells someone who owns 100 shares that his or her ownership stake entitles him or her to $700 ($7 X 100 shares = $700). Alone, EPS is not really very useful, but when compared to other shares that perform in the same sector, it can provide investors with red flags or prompt them to do more digging (remember, if a company has more shares outstanding, the EPS will be diluted).
Beta, Price to Earnings and Earnings per Share do not collectively provide a green light or red light. In most cases, some sort of red flag will go up when investigating these figures and comparing them to other shares. These red flags should lead investors to the company's financial statements and accompanying notes to see what the company is really about and whether this is the type of investment they want to make. And with more time spent studying the company, the more comfort (or discomfort) an investor will have before making investment decisions. And that, after all, is the whole point.
Christopher Fitch is the founder of the Mutual Fund Site, a website that has been actively discussing Bond Funds while other sites have avoid the topic.
