Factors to Consider Before Buying a Share
With a total of 63 companies listed in NSE, the difference between successful shareholders and others is what counters they hold on the exchange. While people have different risk appetites, the goal is to always hold a performing stock, and that is the joy of any investor. While different people have different diversification strategies, I believe; holding 10 to 15 counters on the NSE and focussing on them is better than holding all the 63. Therefore, you need to make a prudent decision on which stock to buy and which to sell. In this article, I am going to share with you strategies you can use to identify a potential stock.
Market value vs Book value
Market value is the price trading on the securities exchange for a particular share. Book value is the net value of the company as per its accounts. Simply put, book value is the amount all shareholders will get paid in case a company is liquidated. You might call it the actual value.
If the stock is trading below its book value, don’t think twice. Buy it.
To illustrate this; last year Equity Bank’s book value was Ksh 36 and the share was trading at Ksh 31. Assuming that you bought your shares at Ksh 31 and the company got liquidated, you would get Ksh 36 per share from the buying price of 31.
Dividends
One reason for owning shares is to generate wealth from dividends. There are many reasons for investing. Nonetheless, most stock investors buy and hold shares so as to earn dividends. In the stock market, the rule of buy low sell high does not really apply, at least for the masters. Haha. In reality, there are times you will have to sell low in case you need to dispose of junk stock. I do not see any reason to sell performing stock even if it hit an all-time high. Famous investor and the author of One up the Wallstreet, Peter Lynch, said selling best performing shares and holding worst performing shares, anticipating they appreciate one day is like plucking your crops and watering the weeds.
As such, you need to identify a company that constantly appreciates it’s shareholders by paying them dividends, regularly.
Net Profit
Every investor's joy is to own a company that realizes good profit margins. Remember, it is from these profits that you will get your dividends. No profit no dividends, or fewer profits, fewer dividends and vice versa. While it is good to realize profits, a prudent investor takes into consideration how these profits are being spent. Personally, I like companies that are good at value investing. Companies which invest back their profits usually are good. Additionally, consider the cost of running the company. I would go for a company with a total turnover of 20 billion, and a running cost of 1 billion rather than a company earning 30 billion and a running cost of 10billion.
Earnings Per Share(EPS)
EPS simply means how much each share earns in profit. This is a good way for corporate valuation. A higher EPS represents more earnings per share in a company thus making it a valuable buy. To calculate EPS, just divide the net profit by the number of common shares outstanding.
Dividend Yield
Dividend yields show the amount a company pays as dividends relative to its share price. It is represented as a percentage. Higher dividend yields exist in companies that attribute shareholders’ contribution to their success, therefore paying them more. An investor will be happy if the company’s dividend yield is greater than the inflation rate, maximizing the actual profit. While the nominal profit value might appear juicy, the actual value could be really little when you factor in inflation.
PE Ratio
The Price-Earnings ratio shows a share’s actual earnings relative to its share price. It is calculated by dividing the share price with the EPS(earning per share discussed above). The PE ratio helps determine the actual return value for a share. For example, share A trades at Ksh 400 and the earnings per share is Ksh 40, while share B trades at 100 and the earnings per share are Ksh.25. While the EPS for share A seems juicier than EPS for share B, share B has more returns per share compared to share A. This is because the earnings of share B relative to its price form 25%, while the former is just 10%. Among other factors, I’d consider buying B.
Assets
A company’s assets serve a major role to protect the company’s wealth from inflation and other forms of deterioration. Therefore, a company with great asset bases on their balance sheets are safer havens compared to those with little. Besides the asset size, also consider their liquidity. The assets should be highly liquid in case the company needs to liquify them. Here, you are assured your stake at the company is safe.
