How to pick the best stocks to invest

How to pick the best stocks to invest in Part 1 of 2

It takes the best stock market predictions to achieve top stock market results, but choosing the best stocks to invest in is not easy. One approach professional investors and traders use is the fundamental analysis of stocks, where others prefer the technical analysis of stock market trend.

The fundamental analysis of stocks is based on criteria like Earnings per share, Price/Earnings ratio, PEG Ratio, Return on equity and Return on assets.

Whether you are looking for the best penny stocks to buy or any other hot stocks to trade, you will find the following five out 10 fundamental key metrics very useful. They pinpoint the characteristics shared by the top performing stocks before they made huge trading profits in short term.

1. Earnings per share - EPS
Definition:
EPS is the ratio of the company's net income to its number of outstanding shares (all stocks held by investors and the company's insiders).
What it measures:
Earnings-per-share (EPS) serves as an indicator of a company's profitability.
Recommended value:
No less than 80.
Interpretation:
If a company has displayed good growth over the last five- or 10-year period, it is likely to continue doing so in the next five to 10 years.
Observation:
There are many ways to define "earnings" and "shares outstanding". That led to different type of EPS.

2. Price/Earnings Ratio - P/E Ratio
Definition:
Ratio of a company' share price to its earnings per share.
What it measures:
How much investors are willing to pay per dollar of earnings.
Recommended value:
The best stocks to invest in usually have higher P/E compared to the market or industry average.
Interpretation:
If a company has displayed good growth over the last five- or 10-year period, it is likely to continue doing so in the next five to 10 years.
Observation:
There are different types of P/E but the most used is the trailing P/E calculated with the EPS from last four quarters.

3. Price/Earnings To Growth ratio - PEG Ratio
Definition:
PEG Ratio is the price/earnings(P/E) ratio divided by the projected year-over-year earnings growth rate.
What it measures:
How cheap the stock is.
Recommended value:
Less than one (PEG < 1)
Interpretation:
The value of PEG ratio
-below one is an indication of possibly undervalued stock.
-equals one suggests the market is pricing the stock to fully reflect the stock's EPS growth.
-above one means the stock is possibly overvalued or the stock market expects future EPS growth to be greater than what is currently in the street consensus number.
Observation:
PEG ratio cannot be used in isolation.

4. Return on equity - ROE
Definition:
It is the ratio of the company’s 12 month net income to its shareholder equity (book value).
What it measures:
How profitable the company is.
Recommended value:
No Less than one 15%.
Interpretation:
High debt companies have higher return-on-equities(ROEs) than low debt companies.
Observation:
Relying on ROE has a downside. You will end up overweighting your portfolio with high-debt stocks if you go by return-on-equity(ROE) alone.

5. Return on assets - ROA
Definition:
It's the net income divided by total assets.
What it measures:
How profitable the company is in relation to its total assets.
Recommended value:
Return on assets above 20% and higher is better. Avoid company with Return on assets below 5%.
Interpretation:
The lower the debt, the higher the Return on assets. A rising Return on Assets usually foretells a rising stock price.
Observation:
The assets of the company are comprised of both debt and equity. The ROA is some time called ROI.

In Part 2, we will look at the stocks fundamentals like Relative price strength, Cash Flow, Financial leverage ratio, Consencus-earnings-forecast

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How to pick the best stocks to buy Part 2 of 2

As noted in Part 1 of this two-part article, successful online stock investing is about picking the best stocks to buy. Some professional investors and traders use the fundamental analysis of stocks, other rely on technical analysis of the financial markets.

The fundamental analysis of stocks is based on criteria like Relative price strength, Cash Flow, Financial leverage ratio, Consencus-earnings-forecast.

Whether you are looking for best penny stocks to buy or any other hot stocks to trade, you will find very useful the following 5 out 10 most important fundamental factors shared by the top performing stocks before they made huge stock market profits in short term.

1. Relative Price Strength - RPS
Definition:
Relative price strength( RPS) is the ratio of the price performance of a stock by the price performance of an appropriate index for the same time period.
What it measures:
How stocks have performed compared to the overall market over a particular period.
Recommended value:
Relative price strength(RPS) with a value of at least 70.
Interpretation:
Stocks with relative strength above 70 tend to continue to outperform other stocks.
Observation:
Avoid stocks with 12 month relative strength below 50 or stocks which three-month relative price strength drops 20% from its 12-month relative strength.

2. Cash Flow
Definition:
Amount of money that move into or out of, a company’s bank accounts during the reporting period.
What it measures:
How viable is the company in short-term? What is its ability to pay bills.
Recommended value:
Any positive number is OK, but it’s best if the operating cash flow (i.e.: cash flow attributable to the company’s main business) exceeds the net income for the same period.
Interpretation:
Stock of companies with more cash flow has greater chance to rise more.
Observation:
Stock's price of companies with little cash to support their operations is likely to stagnate or fall.

3. Financial Leverage Ratio - F/L Ratio
Definition:
Financial leverage ratio = total assets divided by shareholders equity.
What it measures:
Level of Company’s debt. Is the company submerged in debt?
Recommended value:
F/L of one means no debt. F/L less than five( 5).
Interpretation:
The higher the F/L ratio, the more the debt.
Observation:
Avoid companies with leverage ratios above 5 which the average of S&P500 index. P.S: Banks and other financial organizations always carry high debt compared to firms in other industry.

4. Consensus Earnings Forecast - CEF
Definition:
Consensus earnings forecast is the average of analysts’ forecasts.
What it measures:
Consensus about the earnings estimated by analysts.
Recommended value:
Avoid stocks where the latest fiscal-year estimates are more than two cents below the 90-days-ago figures.
Interpretation:
The higher the F/L ratio, the more the debt.
Observation:
CEF changes move stock prices. So negative forecast trend warns of future forecast reduction, which will likely pressure the share price.

5. Institutional Ownership
Definition:
Institutional ownership is the percentage of share held by mutual funds, pension plans, banks, and other big holders. Institutional ownership for in-favor of the best stocks to buy is usually between 30% to 60% of shares outstanding, and rarely below 30%.
What it measures:
How many shares are owned by institutions.
Recommended value:
Choose stocks with more than 30% institutional ownership.
Interpretation:
A stock with small % held by institutions is out of favor with investment professionals. That means they don't see the potential of profit. Do not try to outguess the investment experts.
Observation:
Avoid stocks with less than 30% institutional ownership.

These fundamentals indicators should be used in addition to the five other metrics mentioned in the article How to pick the best stocks to invest in part 1 of 2.

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