On a live television show, Piyush, a 26-year-old post-graduate student, was asked about his views on investing in the equity market. His reply brought forth the challenge faced by many first time investors, “I want to invest but I have no idea of how to start, I don’t want to get my fingers burnt.” Investing in equities is a pretty easy job, but to come out with the principal amount intact is certainly tough. A relatively safer way to participate in the equity markets is to enter through mutual funds. Mutual funds are managed by professional fund managers who invest your money according to your risk profile.
If you want to participate directly, it is pertinent to carry out proper research and prepare a fool-proof investment strategy. Celebrated investor Peter Lynch has equated investing without studying a company to playing poker without looking at the cards. The only problem—most people do not know which parameters to consider while analyzing a stock. Here are seven charts and ratios to help you begin your investment journey.
Before trying to make sense of the Price-to-Earnings Ratio (P/E Ratio), understanding Earnings Per Share (EPS) is mandatory. EPS reflects the profitability of a company. It is calculated by dividing the profit of a company with the outstanding shares of its common stock. A company with higher EPS is considered more profitable. P/E Ratio is a valuation metric that measures the current share price of a company relative to its EPS. The P/E ratio varies across industries and therefore should be compared with peers in similar business activities and of comparable size. Generally, a higher P/E ratio signals that investors are bullish on the stock and expect it to report higher earnings growth.
The Price-to-Sales Ratio PS Ratio) is a tool to determine a company’s valuation through its market capitalization and revenues. It is calculated by dividing a company’s market capitalization with its sales in the last 12 months. The PS Ratio gains greater importance when evaluating companies with growth potential, but no profits. Companies that have suffered a temporary setback can also be valued through PS Ratio.
The Debt-to-Equity Ratio is a type of solvency ratio used to know how well a company is positioned to meet its financial obligations. It throws light on the level of a company’s leverage. It compares the resources committed by lenders, obligators, and creditors with the shareholder’s commitment. A lower ratio means the company’s leverage is low and it has a strong equity position. It is calculated by dividing a company’s total liabilities by its shareholder equity.
Investments in stocks deliver returns through appreciation in share value, but some companies also distribute a part of their profit as dividend among shareholders. Dividends can multiply the quantum of returns generated from an equity investment. The dividend yield is an estimate of a company’s dividend-only return of a stock. It is calculated by dividing a company’s annual dividend payout by its share price. Many investors prefer dividend-paying companies in their portfolio as it becomes a steady source of income. You can also invest in a mutual fund constituted of only dividend-paying stocks.
Price by Volume Chart
The price by volume chart is plotted to show the volume of a security traded at a specific price point. It is helpful in knowing buying and selling interests at different price points, which essentially indicates the support and resistance level of the specific stock. The price by volume chart when used together with other advanced charts helps in predicting strong support and resistance levels.
One of the simplest charts, a line chart is used to monitor the closing price of securities by investors. Line charts help investors get a clear visualization of a stock’s movement over a period of time. The perfect chart for beginners, the line chart is not overloaded with information, which makes it very easy to understand.
The daily candlestick chart for security shows multiple information such as the open, close, high and low price for the day. The chart is primarily used to forecast short term direction of the price movement. It has a wide part, which is called the “real body”. The real body represents the difference between the open and close price of the day. Due to the colour coding of the wide parts, candlestick charts are better at highlighting the difference between open and close price.
Investing successfully in equity markets requires years of practice and financial discipline. Equity markets operate in a highly dynamic environment with millions of trades taking place every second. Basic ratios and charts should be seen in conjunction with advanced tools and metrics to come at a conclusion. If your aim is to ensure decent return with a manageable level of risk then investing in mutual funds is a better option. Fund managers consider numerous metrics before deploying the fund in their control. The emergence of online portals like Finserv MARKETS has made it immensely easy and simple for people to choose the right mutual fund. Investing in a mutual fund and trusting a professional money manager is any day a better option than directly investing in equity markets.
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