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Dear Fellow Investor,
When digging into the fundamental health of a stock, pay close attention to earnings and three key metrics before buying.
For one, earnings are the bottom line.
Earnings give an indication of future potential. Without earnings, a stock is on life support.
Not only do you want to see if the company is making money, but you also want to see if it’s showing sequential and year over year growth, as well. If not, there may be reason for caution if you notice slowing growth. You also want to look for guidance.
At the same time, you should identify:
#1 - Price to earnings (P/E)
This ratio examines the underlying relationship between the stock price and earnings. For example, a stock trading at $20 and EPS of 4 would have a P/E ratio of 5. This gives us an idea of just how much the stock market is willing to pay for one share of said stock.
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#2 - Price to earnings growth (PEG)
Any PEG ratio greater than 1.0 tells an analyst the stock may be overvalued. A read under 1.0 may be a strong indication of undervaluation. It’s typically based on projected EPS.
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#3 - Price to book (P/B)
Price to book allows an analyst to unearth undervalued opportunities. It’s the ratio of the market price over its book value, or the value of assets on the balance sheet.
Let’s say stock ABC has $200 million in assets on its balance sheet and $80 million in liabilities. Book value would be $120 million.
If we also have 20 million shares outstanding, each share of ABC would carry book value of $6 a share. If ABC then traded at $3 a share, the P/B ratio would be 2.0. This ratio helps us identify lower priced stocks being discounted by the overall market.
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