Personal Finance: How To Value Your Investment Portfolio

Many people own stock. Whether it is part of their retirement plan or part of their overall savings program, stocks play a large part in the financial situation of most people. Unfortunately, many stockowners do not know how to determine if their stock is performing well.

They might utilize opinions from analysts on television and the radio or they might evaluate the opinions of their friends and family. However, both of these sources might be biased.

Unfortunately, there have been circumstances where a financial analyst recommended a stock because there was some compensation involved with this recommendation.

Family and friends might not know any more than the stockowner. They just sound like they do. Understanding the performance of stocks is not complicated and involves utilizing some numbers that are readily available. Going online to Reuter’s Stock Reports (reuters.com) or using the financial website of most Internet providers (like AOL, MSN, etc.) can be a good source, once there is an understanding of what the numbers mean.

All stocks have risk. The most important risk is the one that is tied to events beyond the control of the company. A company can change its product, hire new managers or alter its overall direction. However, companies have no control over inflation, national disasters or new laws enacted by Congress. A company’s sensitivity to these latter events determines its beta. Beta is used to compare one company’s risk to its competitor’s risk factor (its beta) or to the market as a whole, which has a beta of 1. Stocks with a beta below 1 are less risky than the overall market, and stocks with beta above 1 are more risky than the overall market. Speculative stocks would have high betas, whereas utility companies would generally have a beta below 1.

Earnings Per Share (EPS) measures the profitability of the company. This number is determined by dividing the after-tax income by the number of stock shares currently in the market place. Generally an investor would like to see a company’s EPS consistently rising year after year. It is important to note that EPS does not mean that the investor will receive this money as a dividend. Sometimes, companies retain some of their earnings for future expansion and development, so the dividends that are paid are determined after retained earnings are taken into account and might have no correlation to EPS.

The Price/Earnings Ratio (P/E) is found in most financial publications where stocks and stock prices are listed. It is an important measure of the stockholder’s belief in the company as investment potential. As the ratio indicates, the P/E ratio is determined by dividing the price of the stock by its EPS. If, for example, a stock has a P/E ratio of 12, it means that stockholders are willing to buy the stock for 12 times its current earnings, or $12 for every $1 earned as earnings per share.

Since the stock dividend does not compensate the investor adequately for his or her investment, stockholders buy the stock for another reason – capital gains. Many believe that the stock price will grow and result in a profit when the stock is eventually sold. The P/E ratio is an indicator of current investors’ opinion that such a rise in value will occur. Many analysts look for stocks with a P/E ratio in the 20s, which might indicate that the stock has consistently grown in the past and might continue to do so. Stocks with P/Es below 20 might be a good investment with a lot of growth potential, and further analysis is warranted. Those stocks above 30 might be overpriced and ready for a correction (a term meaning that the stock price would decline). It is important to note that the P/E ratio alone does not indicate that a stock should be bought or sold. It is merely one indicator which should lead the investor to further analysis.

Additional information about personal finance terminology can be found at the MoneyRemix Glossary.