When you are considering stocks to buy, there are certain metrics and numbers that are more important than others.

They can’t be used as the sole qualifier to determine great stocks, but you can use them to eliminate poor performers.

You must always look at the big picture when considering a stock and that means considering a number of metrics.

Return on Assets

Return on Assets is one of the handful of really important metrics every investor should know.

Return on Assets (ROA) tells you how efficiently (or inefficiently) a company turns assets into net income. It is a way to tell at a glance how profitable a company is.

Consider that companies take capital from investors and turn it into profits, which are in turn returned to the investor in one form or another.

ROA measures how efficiently the company does this. Obviously, the more efficient a company is in converting assets (capital) into profits, the more attractive it will be to investors.

That’s about as simple as it comes: companies that make more money for the owners are worth more than companies that don’t make as much money.

ROA is made up of two components: net margin and asset turnover. When used together, these two metrics tell an important story.

Net Margin:

Net margin is found by dividing net income by sales. Net margin reveals what percentage of each Rupee in sales and company retains.

Asset Turnover:

The other component is asset turnover, which gives you an idea of how well a company does in producing sales from its assets. You find asset turnover by dividing sales by assets.

Once you have net margin and asset turnover, multiply them together to determine ROA. You now have an idea how well a company can convert assets into profits. Companies with high ROA compared to their peers, are more efficient at using assets to generate profits.

You can calculate ROA for yourself or you can use one of the Web sites that has done all the math for you.

Even if you don’t do the calculations yourself, it is important to know how the numbers are generated.

Improving Efficiency

ROA shows how companies have two choices in improving efficiency.

Companies can raise prices and create high margins or rapidly move assets through the company. Either way (or both) improves ROA.

It is important to compare companies in the same industries. Some industries traditionally have higher margins or asset turnover than other industries do.

ROA is an important measure to use and understand, but its flaw is that the metric does not consider the effect of borrowed capital.

The purpose of Stock Charting is to:

1. Show that you can plot the change of the stock price over time on a graph.

2. Analyze the history of stock price changes over time.

3. Attempt to predict the future price of a stock based on prior price history.

4. Show by adding volume to a chart makes it a complete chart, and finally to

5. Allow "chartists" or people who study chart formations or patterns on charts to attempt to predict future prices of equities, where a price will stop, or future supply and/or demand of an equity or stock.

Sell Stocks and always take part of your profits.

One of the most useful strategies is to learn how to sell stocks like a professional. It's easy to buy stocks, but getting out is what separates the professional from the other investors.



Those who try to grab the bottom or top of a price are going to lose in the long run. It is investors who either buy or sell in the middle who will ultimately end up ahead.

There are a lot of experts who say that you will never get poor by taking profits.

No, you will definitetely never get poor. But, neither you will ever get rich by taking a 2% profit in a bull market.

There are two problems with selling that haunt all investors:

First, if you hold out for a better price, there is a chance your gains can go back to even or you could run your gain into a loss. And just as annoying is when you sell stocks for a quick gain only to watch it shoot up like a rocket.

You can frequently miss the really big gains or get into a loss situation as a result of selling or not selling. This will always keep you perpetually confused and constantly frustrated.

Stock at new highs has much more of an open running field because no one ahead of you is at a loss and wants to get out at the first opportunity.

Everybody has a profit & Everybody is happy.

Now, this is the perfect time to be better prepared than competition and be ready to sell. Once a stock you own rises by 15% or more, it is foolish not to pull at least some part of your profits off the table.

Stocks usually have a tendency to advance 15% to 25%, then decline before they take off again.

Many of us have witnessed several of our stock selections rise 15% or more over a period of several days. You have to be disciplined enough to take at least part of your profits at this resistance point. If you follow this reasonable profit objective, you will make a nice profit and definately never lose any money.

Betting on information from people who supposedly have the inside story on a company is extremely dangerous.

Everyone has an opinion and chances are they do not have all the facts. In our experience, trading on tips from these "reliable" sources have always given the same results: Loss!


There is also "Your Brother-In-Law" theory, not highly recommended by anyone but followed all too often by many investors.

Your brother-in-law, or "some guy at work," tells you about a stock that is "really going to make you a lot of money." You know nothing about the stock but you rush out and buy a hundred shares nevertheless.

We think the right word for this group is "losers."

Would you buy a stock because an "expert" on TV or a paper says it is a great investment?

Chances are, they or their company own too much of this stock and need to get rid of it. It is called "Pump and Dump."

Pump up how great the stock is, then dump it when unwitting investors buy it because they think it is a great investment and it is really not.

We are not saying that every "great" stock that is mentioned on TV or in the papers is actually a dud; sometimes they really are high flyers, but we would not recommend to put your hard earned money on them just because some "brokerage firm" recommended them.

Would you invest in a stock because of a friend's tip?

It depends!

But before you decide, check out what he "really" knows about it, and do a thorough research of your own.

Would you place your trust and invest your hard earned money on rumors and street talk?

No!

While we do actually say "buy the rumor" and "sell the fact," on the other hand, how many times didn't the rumor just remained a worthless rumor?

Always try to get unbiased opinion and research work on individual stock. Ask yourself about the motive behind the "tip." This might save you from a lot of trouble. Besides, you don't need the "tip!" if you are aware of the fundamentals and believe in growth of the company.

All it takes to "beat the market" is commonsense thinking, plain good old time dealing and Patience.

Many people just assume that mutual funds are the best way to save, but like most "conventional wisdom," it's often wrong.

Conventional wisdom will tell you to put your money in a mutual fund. Well, conventional wisdom does not apply in the stock market. Today, there are more mutual funds with various schemes than there are stocks to buy from the stock indices. A mutual fund can be your worst investment decision.

There is an enormous amount of money being put into mutual funds every year. These so-called "safe" investments have been consistently under performing the markets over the years.

That's right, when the market goes up 40%, your mutual fund probably returned 25%. What happens when the market goes down? And believe us, it does go down! If the market is down 20%, your fund will probably be down 30% and you lose both ways.

If there are almost more mutual funds than there are stocks, then how do you pick a mutual fund?

Do you need a mutual fund that helps you pick a mutual fund? Sounds silly, doesn't it? Guess what, they already exist. There are mutual funds that take your money and pick different mutual funds to invest in.

With all the free information available today, you're better off picking the stocks yourself. You would save yourself a lot of money.

You can dramatically reduce your investment expenses by cautiously selecting your individual stocks, and minimizing the number of your trades. The average mutual fund has fees and expenses of over 1.00% per year for the privilege of underperforming the market. Between 85% and 95% of mutual fund managers underperform the indices, depending on who's doing the counting.

One of the big advantages of mutual funds is diversification. Your mutual fund manager pools your money with thousands of other people and builds a portfolio containing hundreds of securities representing companies in dozens of industries.

Unfortunately, too much diversification isn't good for you. You don't need to hold hundreds of securities to be properly diversified. Increasing the number of securities held does reduce your risk, but the reduction becomes negligible once the portfolio reaches 20 or 25 securities, spread across several industries.

If you need only 25 securities to be completely diversified, why is your fund manager holding 200 securities in your mutual fund?

He can't buy enough stock in the companies he likes, so he has to add second and third rate issues to remain fully invested. Even if your mutual fund manager is a bona fide genius, it's unlikely he has more than 5 or 6 good investment ideas a year. You want your mutual fund manager's best ideas, not the 200 mediocre ones.

Once a mutual fund gets too large, the manager has to buy large capitalization stocks for liquidity. Also there are restrictions on how much of any one stock they can hold.

So, how do you decide what stocks to buy?

People have many different ways to pick stocks. Some people will only look at companies which have good earnings and sound fundamentals.

Others will look at the core of the business and determine if the products or services offered is better than it's competitors or they might only look at the charts of stocks and try to determine if the stock is going higher or lower.

Many might even not look at anything and just get in and get out of stocks in matter of seconds.

Do you think that you don't have time to become an amateur securities analyst?

In such a case stock picking answer is really simple:

Just listen to equity analysts and evaluate their stock research and investment ideas in terms of company background, past performance, management views, dividend payments & risk involvement. Check your risk factor and accordingly break up your stock investments by investing in Small, Mid & Large cap stocks. 

People tend to feel sorrow and grief after having made an error in judgement.

Investors deciding whether to sell or buy a security are typically emotionally affected by whether the security was bought or sold for more or less than the current price.

One theory is that investors avoid selling stocks that are going down, in order to avoid the fear, pain and regret of having made a bad investment.

 On the other hand, they also avoid selling when prices are going up, because they are very greedy and are afraid that the price will keep on going up.

Many people are wondering why they didn't take their i.e. 50% or 200% gains when they had the chance. Most investors will rationalize they ran these high gains down because they were afraid they would lose even higher profits.

In our opinion, for many of these investors, it was just plain greed that prevented them from selling their stocks.

Every experienced investor knows that fear and greed are two emotions that can dramatically affect your success in the market. You have to deal with controlling greed and fear every single day. Although there are no easy answers when it comes to the stock market.

Greed is "that little monster that resides in every single individual."

Part of our success in the market is learning when to give this little monster a little bit more room to operate and when to curtail its actions.

"Every single event has two ultimate outcomes -- either a win or a loss."

Greed can make you gaze at the stars without having any consideration of the rocks below. It can prevent you from considering the fact that there is a downside also associated with an upside momentum.

The embarrassment of having to report the loss to others may also contribute to the tendency not to sell losing or gaining investments.

Some researchers theorize that investors follow the crowd and conventional wisdom to avoid the possibility of feeling regret in the event that their decisions prove to be incorrect. Many investors find it easier to buy a popular stock and rationalize it going down since everyone else owned it and thought so highly of it.

Borrowing Money to Buy Shares and Marging Lending

The rich rule over the poor and the borrower is the servant to the lender!

Borrowing money to invest in shares is not for the faint hearted. While it may seem a smart way to build a share portfolio, using someone else's money to invest, or margin lending, has its pitfalls for the unwary.

And, if you don't have a healthy stable income, or you are heavily in debt elsewhere, it is one area which you should not even try to understand. That is because margin lending, like any investment which offers high returns, carries ultra high risks.

Investors are drawn to it because there is the chance of multiplying any share market rises and increasing diversification.

Investors need to be wary because not only could the value of their investment deteriorate, but also because their obligation to maintain the loan level increases if the share market takes a tumble.

Using someone else's money to make profits is a great idea but if those investments incur losses, the problems compound.

What Is Margin Lending?

Margin lending involves borrowing money against shares you own - in order to purchase more shares. In effect it enables you to build a portfolio where, depending on your specifications and the financial institution, your borrowing level can range between 30 - 80 per cent of the portfolio's value.

Once the investor specifies how much of the portfolio they want to leverage, a loan level is set to buy shares up to that leverage level, and interest is payable on that sum. Financial institutions set minimum loan levels for margin lending.

The Benefits

Of course the more money you have invested, the more you stand to gain if shares in your portfolio go up in value. Any rise in the value of your portfolio also means that your leverage level goes down, giving you the capacity to borrow even more, using the increased value of your shares as security.

Another plus of margin lending, is by having more money to invest in shares, you can afford to diversify more - reducing your downside risk.

The Dangers

The danger, just like the attractiveness of this investment, is share market volatility. If the share market falls, not only will the capital value of your shares drop, but you could be forced to maintain the level of security for the loan if your gearing level breaches a preset level.

This is known as a margin call, and would involve an up-front cash payment, a sell-off of shares at a loss, or the purchase of additional shares ( if you have the luxury of spare cash).

A margin call usually has to be met within 24 hours. In the event the investor can't be contacted, the broker has the right to sell down the portfolio.

If your share portfolio is worth 75 percent of the loan and the sharemarket falls, you have to kick in more money to make sure that 75 percent is maintained.

In effect, any drop in the paper value of your investment increases your obligation to the lender. For this reason, any margin lending investment needs to be constantly monitored.

If you are looking at this investment, you should fit into the following two categories:

A. Be liquid, in other words have access to cash &

B. Take a long term view point.

Two ways to approach the stock market are tactically or strategically. Which you choose should depend on the circumstances.

Most investors will do better taking a strategical approach, which is the classic long-term view of investing.

The strategical approach looks to position the investor in the right stocks for years to come.

Many fortunes have been made in the stock market using this approach – think Warren Buffett.

However, it is important to also think tactically about the stock market because short-term swings can ruin your best long-term plans.

Tactical investing considers whether you are better served by an offensive or defense approach.

An offensive approach calculates whether this is a short-term correction or a long-term downtrend.

In either case, the investor considers the benefits and risks of short selling and acts appropriately.

A defensive approach to a downturn suggests adjusting your asset allocation to a more conservative position – more fixed income if that’s appropriate, for example.

Neither approach suggests a panicked reaction that will undoubtedly result in poor decisions and worse outcomes.

The thoughtful investor is like a chess player thinking several moves ahead – if this happens, what will I do to take advantage of the opportunities and minimize the risks.

If you are going to invest in individual stocks, you must take an active role in monitoring the market and your investments and have a contingency plan in place.

For the benefit of the uninitiated who might be fooled into thinking that Rain Commodities (RC) is a 'rainmaker' please banish the thought. It manufactures and sells cement and buys and sells green petroleum coke and pet coke (sourced from its subsidiaries)but more for show it appears. Originally called Rain Calcining it metamorphosed into its present name. It has a capacity to make about 3 m tonnes of cement per annum, after the recent capacity expansion, but produced a little over 2.3 m tonnes in 2009. Its many subsidiary units make Calcined Petroleum Coke and also generate and sell power, with the largest CPC producer in the group, the American subsidiary, operating 7 plants in the US of A. For the matter of record, CPC is one of the key inputs in the manufacture of aluminium. The ultimate holding company of the group may well be Sujala Investments Pvt Ltd. 'Rain' appears to be the group trademark or some such.


RC appears to be the hub of a complex, interlinked web of companies, operating out of base station -India - and extending to the USA, Mauritius, Hongkong and China. The Mauritius and Hongkong entities appear basically to be shell holding companies. RC has 3 wholly owned subsidiaries, one of which, RCCIL, its principal investment outlet, has wholly owned and majority owned subsidiaries of its own and, its subsidiaries in turn, are the holding companies of yet other subsidiaries or something to that effect. RCCIL operates a 100% EOU making CPC at Vizag. As the group expands, stay tuned for even more fine - tuning. RC also holds shares, in a wholly owned wisp of a subsidiary called Rain Calciner Ltd, which does not even exist. With so many companies to be monitored, the accountants can be pardoned for this apparent goof up. If the objective is to confuse, the management has succeeded admirably.

To make the overall feel good factor a little more alluring to the management, RC is busy implementing a buyback of shares while it simultaneously issued shares at a premium in 2008. In 2008 it also implemented a buyback of shares and, in 2009, it got the general-body shareholder approval to implement a further buyback. At end 2009 the group shareholding in RC was officially a little over 42%, and in all possibility, along with some of the NRI holdings and, holdings by other pvt bodies corporate, the group holding may well have touched the half century mark. And, with the implementation of the new buyback, the management holding may well exceed the crucial cutoff mark. It may be noted that the buyback is basically to increase the NRI shareholding in the company. Needless to add these buybacks are being executed with the help of the company's cash flow.

There is plenty of high octane action in the cash flow department alright. With interest free loans extended to its subsidiaries and other inter-se revenue and capital account transactions with other group companies and large dollops of corporate guarantees given on behalf of loans availed of by subsidiary companies, and purchase, sale and redemption of investments, the accounts and treasury departments may well have burned the midnight lamp. The group balance sheet shows that at end December 2009, the group borrowings were in excess of Rs 30 bn against a gross block of Rs 37 bn. Loans to subsidiaries are given as 'baksheesh' and it earned a princely Rs 8 m on its investment portfolio of Rs 2.4 bn, with no dividends accruing from its subsidiaries. The larger subsidiaries are meanwhile shown as earning a fair return on their investments. Besides what income RC earned on the purchase / sale of securities, done in abundant measure, is not shown separately. In 2008, RC even sold its produce to one of its subsidiaries, RCCIL Ltd and RCCIL was allowed to run up a part of its trade debtor dues, in excess of 6 months! All systems go it appears.

Another point of note is that the consumption pattern of raw materials in 2009 has undergone a noticeable shift as compared to the preceding year. It still made the same product—cement.

One hopes that the merrymaking will continue in the same free spirit and abandon, if not more, as the company grows in stature in the years to come.

The above Article is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader.

Stocks offer the potential for regular income and long-term growth

One of the major benefits of owning stocks is their ability to produce regular income (dividends payment) and long-term growth.

The challenges of the 2008-09 financial crisis put a strain on some companies to reduce or eliminate dividends, but for strong companies, this is just temporary.

When the economy rebounds, some companies will be in better financial condition than others. Mature companies with established markets may be in an enviable financial position.

As is often the case, companies providing products or services to businesses may experience rapid growth. Companies that have curtailed spending during the economic crisis will play catch-up, scrambling to capture market share or protect what they still have.

As we work through a recovery, market-leading companies will become cash cows, throwing off extra income in the form of dividends and stock buybacks. It is safe to assume that investors are going to be more wary of risk in the future. Companies with a consistent record of dividend payment and growth will command a premium in the market.

It is almost certain that either through regulation or shareholder action, executive compensation and bonuses will come under close scrutiny. Stocks that return more profits to shareholders may be viewed in a more favorable light by regulators and shareholders. Don’t be surprised if regulators encourage dividends through tax policies.

For investors, the combination of regular income and long-term growth makes stocks a wise choice for those with a long time frame. While there is still be much emphasis on quarterly profits, the investing community is likely to take a closer look at companies that have a longer term approach to growing the business.

With the right stocks in your portfolio, it is hard to beat the potential of current income and long-term growth.

Good Company with High P/E Ratio

For a good company to be a good investment, it must be priced (valued) correctly.

Investors gain from a stock investment by buying at a price that is below the actual value. Over time, a good company will reward the investor with dividends and growth in the stock’s price. There is nothing wrong with wanting a piece of this type of company. The problem comes when you are a late arrival and the price of admission (stock price) has climbed too high.

Investors eager to get a piece of the action may bid up the stock’s price to a level where future price appreciation is uncertain. Too often, investors jump when they should stand back and take a hard look.

Ignoring dividends for a minute, you can get a rough idea of valuation by multiplying the earnings per share (EPS) by the price earnings ratio (P/E).

P/E Factor

Remember P/E is a factor of how much investors are willing to pay for earnings.

So if a company is earning Rs. 10 per share and the P/E is 25, the stock should be worth Rs. 250 per share. If earning don’t change, but the P/E drops to 20 (meaning investors are not so excited about the company’s future prospects), the stock should now be worth Rs. 200 per share.

This is the problem of paying too much for the stock - if investor sentiment turns - the stock falls. Investors can’t predict what the market will do and how that might influence the stock’s price. Focusing on buying a stock at a discount to its worth as an operating company will help protect you from speculative influences on market price.

Of course, P/E is not the only or even the best measure of a stock’s true value, but it does illustrate why buying high is a dangerous strategy.

Suggested Reading:

P/E Ratio - To determine relative value of Stock

It’s hard to know what the stock market is going to do in normal times, however it is almost impossible to predict market direction in the midst of chaos.

The Sensex sets record high after record high and some investors see a straight line upward into the future or the Sensex gives up 10 percent of its value in a week and the same investors see a death spiral to the poor house.

How is an investor to know what to expect when the market is moving decisively in one direction?

Stock Market Runs:

Bull markets can run for years and so can bears. Unfortunately, there is no absolute way of knowing when a bull will stop or pause or when a bear market will take charge and begin sucking value out of everything.

Investors in the 2008 – 2009 market know it can happen relatively quickly. The Sensex lost almost 60 percent of its value during this bear market following the subprime crisis and global recession.

Was there a day when the market turned? Was there a time when the switch flipped from bear to bull?

Stock Market Switches:

It doesn’t happen that precisely, but as investor confidence in the economy and the geo-political situation returned, the market sentiment switched to buying equities.

Sensex & Nifty experienced upper circuits when UPA wins, equity investors were surprised by such an upmove. Thanks to letting the hype out of the market, many formerly overpriced stocks now started looking reasonable. That’s one way a bull market starts.

Over the years, market callers have made a living off investors who believed these people had some system that would tell them when the market would turn from bull to bear or bear to bull.

The idea is that if you know in advance you can make profit by trading accordingly.

Most serious investors don’t waste their money on these services, rather they stay invested and adjust portfolios as needed.

Research shows you are better off remaining in the market than trying to time an entry and exit on when the market might turn. When the market does rebound, most gains come quickly. Investors who miss this entry, miss most of the upturn profits.

The lesson is it’s better to stay in the market than trying to time when it will turn.

A relatively smaller sized construction company, J Kumar Infra Projects is expected to grow by over 50 per cent annually, over the next two years. This is primarily given by its healthy order book of Rs 1,300 crore, which is over three times its 2008-09 revenues. The order book is expected to further improve as the company has already bid for about Rs 5,000 crore worth of projects.

The company has a diversified portfolio given that it undertakes construction work for transport, irrigation, pilling, bridges, airport runways and buildings. These are basically urban infra, opportunities in the states outside Maharashtra. So we expect some kickers to come in the year 2010-2011 where the company will be diversifying outside Maharashtra that has been a concern for J Kumar Infra for a long time. Since there was a huge concentration risk only in Maharashtra, this will help the company to diversify the risk and get into other states as well.

Notably, the company mostly undertakes projects of government agencies, where investments are higher and are less affected by economic slowdown. Also, as majority of its revenues come from Maharashtra, the company is now moving into other states on the back of its increased scale and bidding capacity.

We believe that current valuations are reasonable for a company which is operating in a fast growing industry. Strong order book, high revenue growth, good margins, robust return ratios, regular dividends (paid dividend of 15% and 20% respectively in last two years with a dividend yield of approx 1%) and low debt-equity are among key factors that make a good case for investment in this company.

Being in high growth trajectory and decent track record, J Kumar Infra Projects is trading at a single digit P/E multiple of 8 and seems to be an attractive buy at current market price of Rs 207.

Note: The stocks discussed in Saral Gyan through posts are not a part of "Hidden Gems" issue which we recommend to our paid subscribers only. These are just stock specific views by Saral Gyan Team; one must do the due diligence before doing any investment based on our recommendation.

Question: What is a stock option?

Answer: A stock option is an ability to purchase a specific numbers of shares of a company's stock at a future date at a specific, pre-set price.

Question: What is the pre-set price?

Answer: Called a strike price or a grant price, the pre-set price is usually the price at which the stock is trading on the day the option is issued.

Question: Can I exercise my option (sell my stock) right away?

Answer: No. Stock options have a vesting period, typically 4 to 5 years, during which a proportion of the shares in the option are made available to you. During this vesting period you can sell only the portion of the shares that have vested.

Question: What happens if I leave the company before my options vest?

Answer: You forfeit the stock options.

Question: Does a stock option make me an owner of the company and allow me to vote at the annual meeting?

Answer: No. When a stock option, or part of it, vests, you then have the right to purchase that number of shares. Until you actually purchase the shares, you are not an owner and cannot vote.

Question: Which is better, stock options or restricted stock?

Answer: That depends on the change in the stock price. Generally, if the stock price is going up, stock options are a little better. You can sell both at the higher market value, but with stock options you have not had to commit to the purchase until the stock price reached the point at which you wished to sell. However, if the stock price stays the same or goes down, restricted stock is better. Since you actually own the stock, it retains some value until the stock price goes to zero.

Question: Are restricted stock awards the same size as stock option grants?

Answer: Generally, restricted stock awards are smaller than stock option grants by a factor of two or three (one half or one third the size). If a stock option grant were 100 shares, a restricted stock award would usually range from 33 to 50 shares. This is because at the end of the vesting period the 33 to 50 shares would still have some value and the 100 stock options might not.

Question: Are there tax considerations with stock options?

Answer: Yes. Be sure to consult a qualified accountant.

How much is a company worth & is that value reflected in the stock price?

There are several ways to define a company’s worth or value. One of the ways you define value is market cap or how much money would you need to buy every single share of stock at the current price.

Another way to determine a company’s value is to go to the balance statement and look at the Book Value. The Book Value is simply the company’s assets minus its liabilities.

Book Value = Assets - Liabilities

In other words, if you wanted to close your company operations, how much would be left after you settled all the outstanding obligations and sold off all the assets.

A company that is a viable growing business will always be worth more than its book value for its ability to generate earnings and growth.

Book value appeals more to value investors who look at the relationship to the stock's price by using the Price to Book ratio.

To compare companies, you should convert to book value per share, which is simply the book value divided by outstanding shares.

In our article on Price to Earnings Ratio or P/E , we noted that this number gave you an idea of what value the market place on a company’s earnings.

The P/E is the most popular way to compare the relative value of stocks based on earnings because you calculate it by taking the current price of the stock and divide it by the Earnings Per Share (EPS). This tells you whether a stock’s price is high or low relative to its earnings.

Some investors may consider a company with a high P/E overpriced and they may be correct. A high P/E may be a signal that traders have pushed a stock’s price beyond the point where any reasonable near term growth is probable.

However, a high P/E may also be a strong vote of confidence that the company still has strong growth prospects in the future, which should mean an even higher stock price.

Because the market is usually more concerned about the future than the present, it is always looking for some way to project out. Another ratio you can use will help you look at future earnings growth is called the PEG ratio. The PEG factors in projected earnings growth rates to the P/E for another number to remember.

You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.

PEG = P/E /(projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 2 (30 / 15 = 2).

What does the “2” mean? Like all ratios, it simply shows you a relationship. In this case, the lower the number the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.

Looking at the opposite situation; a low P/E stock with low or no projected earnings growth, you see that what looks like a value may not work out that way. For example, a stock with a P/E of 8 and flat earnings growth equals a PEG of 8. This could prove to be an expensive investment.

A few important things to remember about PEG: 

• It is about year-to-year earnings growth
• It relies on projections, which may not always be accurate

Many companies attempt to list their securities on one of the major stock exchanges, like NSE, in order to provide greater liquidity to shareholders. In order to earn and maintain exchange listing, the corporation must meet several criteria, including a minimum number of round lot holders (shareholders owning more than 100 shares), total shareholders, net income, public shares outstanding and price per share.

In times of market or economic turmoil, individual businesses or entire sectors may suffer a catastrophic decline in the per share stock price. The aftermath of the real estate bubble is the perfect example; many stocks fell by 90 percent or more. If the market price falls far enough, the company risks being delisted from the exchange; a terrible tragedy for existing stockholders.

In order to avoid this, the Board of Directors may declare a reverse stock split. The move has no real economic consequences. Here’s an illustration: Assume you own 1,000 shares of XYZ Industries, each trading at Rs 15 per share. The business hits an unprecedented rough patch; it loses key customers, suffers a labor dispute with workers, and experiences an increase in raw commodity costs, eroding profits. The result is a dramatic shrinkage in the stock price – all the way down to Rs 0.70 per share.

Short-term prospects don’t look good. Management knows it has to do something to avoid delisting, so it asks the Board of Directors to declare a 10 for 1 reverse stock split. The Board agrees and the total number of shares outstanding is reduced by 90 percent. You wake up one day, log into your brokerage account, and now see that instead of owning 1,000 shares at Rs 0.70 each, you now own 100 shares at Rs 7.00 each. Economically, you are in the same position as you were prior to the reverse stock split, but the company has now bought itself time to get back on right track.

Before you buy a particular stock, you may want to find out whether existing large shareholders are buying more or selling off their shares. This can help you evaluate the stock in the context of how their actions may influence the stock's price.

The reality for most well known stocks is institutions (mutual funds, large accounts such as retirement funds and pension funds, and so on) hold the majority of outstanding shares. You may want to consider this information when evaluating a particular stock.

Teams of Analysts

These large companies and institutions (known as Foreign Institutional Investors as well as Domestic Institutional Investors) employ teams of analysts to invest billions of dollars. It makes sense that they are going to spot good places to put their money, right?

The answer is a definite yes and no.

Of course, they are looking for a good return on their investments just like the rest of us. They look for good companies with good growth prospects, most of the time.

If the institutional investors are buying a stock, that is an endorsement of sorts that the stock has good prospects. If they are selling, it could mean something is wrong.

Where to Find Data

Before we talk about the value of this information, let us show you where to find it. The quickest way to do that is to use one of many online services that capture that data for you.

We like BSE & Moneycontrol website. Enter the stock symbol or code of the company you are researching, and then look at its share holding pattern, BSE provides information on share holding for past quarters. To see recent buying and selling of stocks by domestic mutual funds, you can use Moneycontrol.

Wrong Assumption

It is wrong to assume that institutional investors and individual investors share common goals. Institutions often have performance goals to meet, which push them to trade much more frequently than a normal individual investor.

For example, it is not uncommon for a growth mutual fund to turnover its portfolio 100% in one year. That means the fund managers have bought and sold every holding in the fund in one year.

This type of activity may drive them to buy or sell a stock with little regard to the underlying company’s fundamentals. You could see a big mutual fund dumping their shares of a stock and incorrectly assume there was something wrong with company’s future prospects.

This brings up another real danger of institutional ownership of a stock. When institutions become interested in a stock, they can drive up the price quickly with their huge block orders.

Just as quickly, the stock can collapse if the institutions decide the stock is flawed or there is a better opportunity with another stock. If they begin pulling their money out in big chucks, it will drive down the price. More institutions bail out and the stock goes into a free fall.

Could you recall Satyam story? Nobody expected that the price will fall from 170 Rs levels to a single digit price of Rs 8 in just 3 days. It was because of institutional investors, who sold off entire stake of Satyam.

What are investors to make of institutional ownership of a stock they want to buy?

First, most stocks will have some institutional ownership unless they are very small.

Secondly, watch for big changes one way or the other in ownership – are the institutions buying or selling. A change by a large number of institutions could mean something significant has changed at the company.

Finally, don’t ignore the company’s fundamentals. They still tell the best story about a company’s long-term chances for success in building value.

One way to evaluate a stock is to look at how effective the company’s management is in utilizing the resources available to them.

This measure of management effectiveness provides you with an idea of how well the company is being run relative to others in its sector and the market as a whole. Consistently low numbers are a red flag.

Unlike many comparisons, you can use these ratios to compare companies in different industries. The ratio's are:

• Return on assets 
• Return on investment 
• Return on equity 

Fortunately, you don’t have to compute these ratios yourself. Many websites provide this information.

Return on Assets

Return on assets tells you how well a company’s management uses its assets to make a profit.

You calculate the ROA by taking the net income and dividing it by the total assets. The ROA comparison works better over time so you can see a trend in how well management uses assets to the advantage of the company.

The higher the ratio, the better and the continued high level over time is even better because it indicates management makes a habit of managing with efficiency.

Return on investment measures not only the company’s contribution, but also the purposeful use of leverage or debt to extend company’s reach.

You calculate ROI by dividing net profits by long-term debt plus other long-term liabilities plus equity.

Managers choose to combine the company’s equity with outside debt to extend programs quickly and efficiently.

Skillful use of debt can change a 50 million project into a 75 million project. If everyone has done their homework correctly, the company can see additional profit from a larger project than they could have afforded without the debt.

Return on Equity

If numbers are good, return on equity is like a music for stockholders ears. It measures how well management did in earning money for them.

Unlike return on assets and return on investment, this measure goes directly to the stockholders and their stake in the company.

Unfortunately, ROE is somewhat flawed. You calculate ROE by taking net income and dividing by shareholders equity. Missing from this equation is debt and that distorts the picture somewhat.

Although ROE is somewhat helpful in looking at companies, it doesn’t provide the guidance the ROA does.