The stock market offers investment opportunities with varying degrees of risk. Companies of all kinds place their shares on the market for sale in exchange for profit-sharing benefits. When choosing between different stock options, key factors to consider when picking stocks include a company’s standing in the market, a company’s balance sheet and market timing.
Return on Equity
A company’s good standing in the marketplace results from sound financial management practices and a market demand for product or service offerings. The stronger a company’s standing, the more likely its share prices will provide healthy returns on investments made. One key factor for picking stocks has to do with a company’s return on equity (ROE). ROE has to do with a company's financial soundness in terms of profits versus equity ratios. The ROE for a stock takes the company’s net income and divides that amount by the amount of equity shareholders have in the company. When a company’s stock lists a low ROE, this means shareholders own a larger amount of equity when compared to a company with a high ROE value. In effect, low ROEs means a company must rely on debt financing in order to grow or expand, rather than drawing from available profits to finance new projects.
Debt-to-equity ratios indicate the amount of equity built up in a company versus the amount of debt owed Large amounts of debt means a company must ensure income earnings will cover existing debts. The possibility of an increase in interest rates further increases a company’s debt load. In effect, large amounts of debt cut into whatever potential earnings a company generates. A debt-to-equity ratio amount considers a company’s short- and long-term debt obligations and compares this with the total amount of shareholder equity. According to MSN Money, debt-to-equity ratios range from 0.0 to 1.0, with low debt ratios falling anywhere below 0.5.
The current stock price for a company may or may not reflect its future earnings capacity, though a higher-priced stock indicates a stock has demonstrated high earnings in the past. Stock analysts derive the price-to-earnings ratio value (P/E) by dividing a company’s most recent stock price by its per-share earnings over the past 12 months. When a company demonstrates slow to moderate growth rates, the P/E can provide an accurate assessment of the stock’s future earnings capacity. Companies that experience fast growth rates may show higher-priced stock shares due to an influx of buyers. While growing companies can generate substantial earnings, their actual price-to-earnings stock ratio may not provide an accurate measure for future earnings rates. In this case, the forward P/E ratio value can provide a more accurate assessment tool. The forward method for calculating P/E values looks at a stock’s current year’s earnings forecast rather than past months performance.
A key factor in picking stocks has to do with market timing in terms of which industries experience earnings gains and whether or not a company’s stock has received a recent upgrade by stock analysts. Within the stock market, certain industries generate more income during particular times of the year or when new product or technology developments enter the market. In effect, the high demand for an industry’s products or services increases stock values and earnings for companies within that industry. Analyst upgrades or recommendations on a particular company’s stocks have a similar effect in terms of increasing demand for the stock and subsequently increasing that stock’s earnings capacity.