How do you evaluate a stock - Essay Example

Lecturer Evaluating Stock Question a: Valuing Stock Investors have a lot of information concerning stocks. However, identifying the stock that is most appropriate for investing is a challenging task. Stock investments evaluation is influenced by four critical factors. The factors are; price to book ratio (P/B), price to earnings ratio (P/E), the price to earnings growth ratio (PEG), and the dividend yield (Williams 286). P/E ratio illustrates the most appropriate stocks as fewer than 20. The stocks should not exceed 40.

The ratio illustrates how long a stock will pay the investment if there is no business change. The P/E ratios are compared only in organizations within the same market or industry. The price to sales ratio (PSR) should be near one. It is computed through dividing market capitalization by revenue of the most recent trading period. It is most suitable for analyzing stocks in the same sector. The Return on Equity (ROE) illustrates the returns for shareholder’s equity. It should appropriately be more than 10%.

The ratio illustrated the effectiveness of the company in generating profit per equity unit. The earnings growth should be a minimum of 10% higher than the previous year. This trend should be illustrated in several years. The higher the growth, the more investments returns. The debt to asset ratio illustrates that debts should be equal to or less than 50% of the assets. This ensures appropriate levels of leverage across several companies. The greater the ratio, the leverage degree is higher hence results to financial risks.

The returns on assets for Wal-Mart and Costco in the trading period ended 2014 are; 7.86% and 6.50% respectively. The performance of Wal-Mart is thus higher due to the greater returns on assets. The returns on equity for Wal-Mart in 2014 are 21%, and that for Costco in the same period is 17.79%, thus Wal-Mart illustrates the most appropriate value. Question b: Risks and Returns Risk identification is very important in ensuring higher investment returns. The investors and fund managers usually quantify the forecasted losses of the stock investments and then adopt appropriate actions in relation to risk tolerance and also investment approaches.

The risk assessment involves the study of several factors in relation to growth, profitability, low valuation, and the fiscal strength. A stock possessing all the illustrated characteristics is the most appropriate for investments (Horcher 3). The risk management techniques ensure successful stock trading. The trading profits can be safeguarded through simple strategies like; trade planning, take-profit points, calculating expected returns, understanding the bottom line, and adopting top hedge fund trading techniques.

The stop loss (S/L) and also take profit (T/P) aspects illustrates two aspects of planning ahead in trading. If the illustrated return is high, then the investors execute the trade. Quantitative approaches are applied in analyzing complex financial aspects of companies, like stock ratios, stock valuation, and investments risk assessment. The need for effective approaches of mathematical risks assessment is the desire to minimize or hinder risky stock investments decisions. The three key mathematical measures are; non-linear partial differentiation equation (PDE), dynamic risk measures, and the backward stochastic differential equations (BSDE).

Works CitedHorcher, Karen. Essentials of financial risk management. NY: John Wiley and Sons. 2012. Print. http://www.investopedia.com/articles/fundamental-analysis/09/elements-stock-value.aspWilliams, Jan. (2008). Financial & Managerial Accounting. London: McGraw-Hill Irwin.