Before you invest into a stock for the long term you are going to have to ask yourself if it is even worth buying and holding onto that stock. It is very easy to tell yourself that you are just going to buy strong stocks and hold onto them, but how can you tell if a stock is strong or not?
One of the ways is by simply looking at the company itself and trying to determine if the company actually has demand and is worth looking into.
One other method that you can use to find out just how cheap the price of the stock is, would be to use financial ratios to give you an idea of how cheap the stock is compared to the company and how stable the company’s fundamentals are. Below are some examples.
1. The Price to Earning Ratio
The PE ratio is found by taking the price of a stock and dividing it by the earning that the company makes. It is suppose to give you a good idea for what you are paying for. For instance, if the formula gives you 10 that means you are paying $10 for every $1 annual profit the company makes. You can compare this ratio with the ratios of other similar companies to see if you are paying too much for the stock or if you are getting it for a bargain.
For instance if a company has a PE ratio of 5 and every other company in the industry group has a PE ratio around 10 that tells you that the company is cheaper than the other companies in the group and it is most likely a good buy.
2.Quick Ratio Formula
The Asset test ratio or quick ratio is a ratio that can give you some insight on a company’s debt and assets. If the quick ratio is above 1 that means they own more assets then they have debt. If the ratio is below 1 that means they have more debt than they have assets. Obviously a ratio of 1 or more is considered good while a ratio below 1 is considered bad.
3.The Solvency Ratio
This is very similar to the quick ratio. The solvency ratio tells an investor how much debt a company has when compared to the company’s assets. The biggest difference is that there is no level that is considered to be good or bad. Instead it can be compared with the company’s competitors to determine if the company has more or less debt then other companies in the same group.