STOCK MARKET 101
Hi! Welcome back! Give yourself a pat in the back for continuing with this guide. In this second part I will bring new ideas to the table, you will find information regarding how to evaluate a stock, what are all this different ratios that everybody talks about. We will also learn about the different stock exchange markets and how to read a stock ticker!
You can access Part 1 here.
How to analyze a stock.
There are many currents regarding stock evaluation, from the most basic approach which is “Oh, I like Apple (iPhone) products! I should buy Apple Stocks!” to the most complicated fundamental analysis and how the possibility of a drought in South America can affect the mango crops… Well… The mango thing is a joke, but, the analysts at Wall Street, Bay Street and big investment firms are interested in those kind of little details, but I’m not, and you probably shouldn’t care either.
Among the many things that I look in a company, I like researching how are the company finances, as in, is the company making money? Is the revenue increasing or decreasing? Does it pays dividends to the shareholders? What does this company offers that no other company can match them.
This is as simple as how much money is the company making, this value doesn’t take in account expenses or other factors, is simply how much money is the company getting from its activities, and as you probably are thinking, a good company should have a steady or increasing revenue quarter to quarter, don’t get worried if the revenue decreases in a quarter, but if this starts to be a trend then re-evaluate your position
This is how much money the company has after deducting costs and expenses. If ABC Inc made $1,000,000 and had a cost of $800,000 to run the business, the profit is $200,000. Why is this important? Well, there are companies that even when the revenue grows quarter to quarter, their profit is never a positive number, and after many quarters reporting losses a company can easily go bankrupt. Like Peter Lynch says “companies that have no debt can’t go bankrupt”.
Dividends are a great thing, each quarter a company will asses what to do with its profit, if the company has grown a lot and doesn’t required its full profit to continue growing the business and paying expenses, this company can reward the shareholders with a portion of the profits. Growing companies usually don’t pay dividends, Amazon, Google, Netflix, Facebook are stocks that have had amazing runs but don’t pay dividends.
When looking for dividends in a stock, pay a attention to the Dividend Yield %, this percentage represents how much the company will pay yearly to the shareholder in relation to the stock price. Usually dividends are payed quarterly, but companies can decided to pay dividends semi-annually, annually, monthly, etc.
Let’s assume that ABC Inc has a dividend yield of 5% and the current share price is at $5, this means that if you hold the stock for a year, you will get $0.25 per each share you own (5% of $5). This might not seen like a lot, but if you have 1000 shares you will receive $250 after 1 year. Getting $250 on my bank account for doing nothing sounds like a great deal to me!
It doesn’t matter how often the company pays the dividends, you will only get the full Dividend after holding the stock for 1 year, since ABC Inc has a 5% yield, and you only hold the stock for 6 months, you will get a maximum of 2.5% dividend yield, if you hold the stock for half a year, you get half the dividends.
This is a great ratio to analyze a stock, a company can release or buy shares and the earnings (profit) can fluctuate, but the EPS ratio will tell us how good is the company profit. EPS is calculated the following way: EPS = (Earnings – Dividends) / Outstanding shares. Don’t worry, most likely every single website that has stock information will provide you with the EPS value, you don’t have to calculate it but is always good to know what this value represents.
In example, ABC Inc has earnings for $1,000,000, it also has 1,000,000 outstanding shares and has to pay $250,000 in dividends to the shareholders. The math goes like this: ($1,000,000 – $250,000) / 1,000,000 = 0.75 EPS. Increasing EPS is a great thing, decreasing EPS not so much.
P/E Ratio or price to earnings ratio determines how much the investor is paying for the company profit, its calculated the following way: P/E = Share Price / EPS. This number alone doesn’t tell us much, but when comparing a P/E ratios for companies on the same sector the P/E ratio starts to make sense.
Lets calculate ABC Inc P/E, $5 share price / 0.75 EPS = 6.67 P/E. This means that the investor is paying $6.67 per each $1 of ABC Inc profit. Usually companies that are growing will have a high P/E which growth stock investors love, and companies that are already established have a low P/E ratio which value investors adore.
P/B Ratio or price to book ratio determines how much we investors are paying for the stock in comparison to the book value of the company. The book value is how much the current assets of the company are worth. P/B ratio calculation is a bit more complicated. P/B = (Share Price) / (Assets worth / Outstanding shares)
ABC Inc assets are worth $3,000,000, it currently have 1,000,000 outstanding shares and the share price is at $5.
Assets worth / Outstanding shares = $3,000,000 / 1,000,000 = $3
P/B = $5 / $ 3 = 1.67
ABC Inc has a P/B of 1.67. P/B ratio is a value that value investors always look for, and the lower the P/B, the better for them. There’s a lot more to dig in into this ratio but for now, this is good enough. Like the P/E ratio, P/B ratio is useful when comparing stocks in the same sector.
Don’t get turned off by all this math, as I mentioned before, its good to know how this ratios are calculated and pretty much in any website that has stocks information this values are already calculated for us! and you can also impress your friends talking about this ratios like a professional investor (or a stock market geek)!
Stock Market Exchanges
New York Stock Exchange (NYSE): This is where the biggest companies are listed listed, you will find Johnson & Johnson, Walmart, VISA among other companies in this stock exchange. Companies listed on the NYSE have a great reputation, they have their financial books analyzed by independent entities that will verify that they are not making up the numbers. Don’t expect too much growth for a company traded on the NYSE.
NASDAQ: This is where the growing tech companies are listed, you will find Facebook, Amazon, Google, Netflix being traded here. There is nothing wrong with the reputation of the companies listed on this exchange, the main difference between NYSE and NASDAQ are the requirements that this companies needs to meet in order to be listed. This exchange is also located in New York.
Toronto Stock Exchange (TSX): Located in Canada, in this stock market you will find very well established companies, in order to be traded on this stock, companies must meet very rigorous requirements. We could say that TSX is the Canadian equivalent to NYSE.
Toronto Stock Venture Exchange (TSXV): Unlike the TSX, the requirements to be listed on this exchange are not as rigorous which allows small cap companies to get listed here. When the companies listed on TSXV grow and can meet the requirements for TSX, they are graduated from this stock exchange to the TSX at the company request.
There are other stock exchange markets in North America like the OTCMKT (Over the Counter Market), Pink/Grey Sheets or CSE (Canadian Securities Exchange) but usually the reputation or the securities (stocks) that are listed on those exchanges are not too appealing to the general investors. On the other hand, all this crazy penny stocks that traders buy/sell are located on those exchanges.
A Stock Ticker is the famous symbols that you see on the financial channels/websites, this tickers have different preffix / suffix depending on which stock exchange their are listed. Keep in mind that is common for a stock to be in more than one exchange, this is the reason why we need to pay attention to the ticker. An example of this is Shopify, its traded on NYSE as SHOP (USD) or in the TSX as SHOP.TO (CAD), one can be bought in USD and the other in CAD and they are the same company.
Depending on which financial website or broker you are using, the ticker will look like this
- NYSE Listing: JNJ or NYSE:JNJ (Johnson & Johnson)
- NASDAQ Listing: FB or NASDAQ:FB (Facebook)
- TSX Listing: SHOP.TO or TSE:SHOP (Shopify)
- TSXV Listing: CTU.V or TSE:CTU (Le Chateau). No typo here, it is TSE…
This is it for this part! You just received a lot of information and I will advise you to give it a second read later on. Are you ready to start researching stocks? You should start looking for different stocks and read their financials and find the different ratios and values that you learnt on this guide.
Leave a comment below telling us what you have learn today! You can read Part 3 here!