When looking for the right investments for your portfolio, there are three things you can do to make the process a touch easier and eliminate those second thoughts and doubts that often accompany investment decisions in the first place. While these three things are definitely not exhaustive, they provide a great starting point for all investors.
Probably the most important thing to determine when buying into a position is whether the risk that comes with that security is acceptable to you, the investor. Since risk is a relative term, the easiest way to determine the risk of a security is to know its Beta. Beta is a measure of projected volatility relative to the overall market. You can find a security’s Beta at Yahoo! Finance.
Each security will have its own Beta. At 1.0, a security will likely mirror the movement of the market. So, if the market drops by 2%, the security will also drop by 2%. Likewise, a stock with a Beta of 3 will respond with 3 times more sensitivity than the overall market. The closer to 1.0, the more the security will behave like the market.
A second valuable figure to know is the Price to Earnings ratio that accompanies a security. While this fact alone will not determine whether or not one should invest in a particular security, it certainly helps the investor understand how that particular security’s price compares to others in its sector. A Price to Earnings ratio of 6 for ABC Inc indicates that an investor is paying $6 for every $1 in earnings. If all of the other securities in that sector have P/E ratios of 30, then there is a reason to want to investigate why.
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, the PE ratio and EPS alone do not tell investors whether or not to buy a share. The point in this exercise is to do some digging and in most cases, one of these will prompt the investor to do exactly that. And by spending more time on the financial statements and accompanying notes, the more the investor will know about the company he or she is considering buying into. And with this, there will be a lot less trading stress and regret.
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.