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 thing you can do is to look at the company itself and try to determine if the product or service that the company generates has any real demand and will be likely to be around in the future.
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 takes the price of the stock and dividends it by the earnings that the company makes. The ratio can then be compared with other companies to help you decide if the stock is underpriced or overpriced. The lower the PE ratio the better.
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. Asset Test Ratio
The quick ratio is a ratio that tells you how well prepared the company is to meet its long term financial obligations. Any company with a quick ratio below 1 is considered to be higher risk because their assets do not cover their liabilities if they ever needed to.
3. The Solvency Ratio
This ratio is similar to the quick ratio as it looks at a company's debt and their assets. But unlike the quick ratio there is no standard to what is good and what is bad. Instead the ratio can be compared with other companies in the same industry in order to tell if the company has too much debt compared to its peers or if it has very little debt compared to its peers.
One thing you can do is to look at the company itself and try to determine if the product or service that the company generates has any real demand and will be likely to be around in the future.
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 takes the price of the stock and dividends it by the earnings that the company makes. The ratio can then be compared with other companies to help you decide if the stock is underpriced or overpriced. The lower the PE ratio the better.
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. Asset Test Ratio
The quick ratio is a ratio that tells you how well prepared the company is to meet its long term financial obligations. Any company with a quick ratio below 1 is considered to be higher risk because their assets do not cover their liabilities if they ever needed to.
3. The Solvency Ratio
This ratio is similar to the quick ratio as it looks at a company's debt and their assets. But unlike the quick ratio there is no standard to what is good and what is bad. Instead the ratio can be compared with other companies in the same industry in order to tell if the company has too much debt compared to its peers or if it has very little debt compared to its peers.
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