Wednesday, August 31, 2011

Evaluate shares on basis of ratios

In addition to studying the multiple of earnings (PE ratio), investors can also look at price / sales, price / cash flow, price / net assets and dividends. This type of analysis has its own advantages and disadvantages. And investors should have in mind the problems that may arise from this type of analysis.

The profits may be affected by the decision of management. Temporary modernization projects may increase the expense of developing a new product which has a cyclical slowdown on profits over sales.

However, some areas usually have lower price / earnings ratios and often low profit margins.

The ratio based on activity, such as the price / cash flow ratio can be influenced by factors such as corporate policy of depreciation, the age of the plant, and also the methods of accounting for inventories. In addition, unequal treatment of intangible assets between different companies could lead to results not comparable.

The input price / cash flow may be useful as a confirmation of earnings quality . It is useful for the analysis of companies with high asset obsolescence such as cable companies. The analysis of cash flow analysis helps companies without dividends, but that still generate a lot of liquidity.

However, this parameter is very sensitive to the field of membership. Cyclical companies and companies with very long cycles of development may have long periods of low turnover, creation of stocks, and high capital expenditures. This parameter also is rarely suitable for the analysis of shares that do not generate an increase from the current liquidity.

The shares for which there are high expectations of the market will be exchanged for high multiples of sales, cash flow, profit and assets. All valuation techniques tend to capture the same type of companies neglected by the market, but depending on the sector they belong to will prove more reliable than either.

Monitor shares and time when to sell

Long-term investors, and this is quite important in small caps because of their low liquidity tends to increase trading costs. Therefore, shares should be purchased with the intention of keeping them for a long time, measured in years, if the share behaves as we expect them to do, liquidity will be less a concern when it comes to sell.

Experts of shares investment argues that when you buy an shares, the reason for the purchase should be made ​​in writing . Shares should be well monitored to ensure that the reasons why we purchased are still valid. This means that you should always check the expected earnings prospects.

If the unexpected happens – for example, profits are lower than expected or and analyst expectations are very different from yours – revalued the share in order to find out if you made ​​a misjudgment, or if you have lost important information . If the original premise remains valid, and yet the price drops, it is believes that this is a good indication of purchase.

The shares should be sold, in general, when the reasons for the purchase are no longer valid – because they have reached their expected potential, or because they missed the target.
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