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Five financial indicators you need to understand when investing in stocks

For the average investor, a key to success lies in being able to skill fully use some basic stock picking indicators.


Use P/E ratios correctly

The price-earnings ratio is calculated as dividing the stock price by earnings per share. P/E ratio is one of the most basic and important indicators for estimating the reasonableness of the stock price level. It is generally considered normal with ratio between 20 to 30. A small ratio indicates that the stock is worth buying due to its low price and low risk, while a large ratio indicates the high price and high risk.

But as a stock selection indicator, How do investors correctly use the P/E ratio to find a good stock? Li Chi, Managing Director of Shenzhen Tongwei Asset Management Co., Ltd. in his book "Investment in Vernacular" recommended the use of PEG as a measure of the stock price: that is, the P/E ratio divided by the profit growth rate multiplied by 100, if PEG less than 1, indicating that the stock is less risky, the stock price is cheap.


Net asset value per share to overview company

Net assets per share focus on reflecting the value of shareholders' equity. It can be viewed as the long-term accumulation of operating results.

Wuhan University of Science and Technology Institute of Finance and Securities Director, Dong Dengxin, points out that no matter how long the company has been establishedor listed, it indicates that the company is growing as long as the net assets are increasing. Conversely, if the company's net worth per share is declining, the company's prospects are not good.


P/B Ratio in a Bear Market

The P/B ratio refers to the ratio of the share price per share to the net asset value per share and is one of the important indicators for a stock. For investors, according to the net worth ratio stock selection criteria, the lower P/Bratio, the less risk it indicates. In a bear market, the P/B ratio is one of the preferred indicators for stock selection because it reflects the safety margin of the stock price.


Undistributed profit per share

Undistributed earnings per share refer to the undistributed profits or losses accumulated by the company in previous years. It provides for the funding so that company can expand its reproduction or distribution in the future. Like net assets per share, it is also a stock indicator.

Dong Dengxin said that the undistributed profit per share should be a moderate value, not the higher the better. Undistributed profits accumulated over a long period without distribution will definitely depreciate in value.

Since undistributed profit per share reflects the total accumulation of a company's surplus or deficit over the years, it is especially a truer reflection of the company's rolling book losses over the years.


Cash flow indicators

The cash flow related indicators that are more often referred to free cash flow and operating cash flow. Free cash flow represents the cash that a company can freely dispose of, while operating cash flow reflects the cash income and expenditure of the primary business. During the economic downturn, companies with abundant cash flow are more capable of mergers, acquisitions and expansion, etc., and have a higher survival rate against risk.


In addition to the above five indicators, stockholders should also pay attention to other indicators of company such as revenue and gross profit margin when picking stocks.

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