How do I Evaluate the Performance of Stock Market Investments?

by David Ingram, Demand Media Google

    Stock market investments can provide profitable opportunities for experienced traders as well as beginners. Any profit made on stock investments is desirable, but knowing how to evaluate the performance of stock market investments can help you to ascertain which investments' performance stands above the rest.

    Step 1

    Analyze a stock's earnings per share (EPS). EPS serves as a measure of how much of a company's net income can be allocated to each share of stock. Stock traders watch changes in EPS closely and respond quickly. If a stock's EPS is significantly higher than its stock price it can be considered a solid investment, since it is likely that the stock's value will increase in the future.

    Use the following formula to calculate EPS:

    EPS = (net income – preferred stock dividends) / number of shares outstanding.

    For example, if a company's net earnings after dividends is $50 million and the company has 10 million shares of stock outstanding, EPS would work out to $5.00. If the stock price was currently $3.75, investors could expect the price to edge close to the $5.00 level.

    Step 2

    Calculate the dividend payout ratio to gain insight into a stock's dividend performance. The dividend payout ratio compares dividends per share to EPS. The higher the payout ratio, the more money the company invests in dividend payments rather than expansion. Companies with lower payout ratios should experience stronger earnings growth.

    Use the following formula for the payout ratio:

    Payout Ratio = (total dividends / number of shares outstanding) / EPS

    Step 3

    Calculate a stock's price/earnings (P/E) ratio, and compare it to others in the same industry. The P/E ratio compares a stock's market price to its EPS. As mentioned above, a market price lower than EPS can generally be expected to rise, and the opposite holds true as well. Thus, a P/E under 1 indicates growth opportunity, while a P/E over 1 indicates an inflated price likely to drop.

    Use the following formula to calculate P/E:

    P/E = market price / EPS

    Step 4

    Analyze stocks' return on investment (ROI). ROI is a simple tool that can be used after you've sold a particular stock holding. ROI compares the total income generated by an investment to the capital outlay required up front.

    Use the following formula to calculate ROI:

    ROI = (gains – cost) / cost

    For example, if you purchased 100 shares of stock for a total of $300 and sold them for a total of $400, the ROI would be close to 33 percent.

    Step 5

    Use stock charting tools to get a glance at a stock's performance over any period of time. Use technical indicators, such as 20- and 50-day moving averages, to predict price shifts in the near future. Charts can give you insight into a stock's daily trading volume in addition to showing a history of its market prices. Stocks with long trends of gradual price increases can be better suited to long-term investments, while those with quick, dramatic fluctuations can be better plays for day-trading.

    Tip

    • Stock news websites, such as Bloomberg.com and MSN Moneycentral, can display a range of performance ratios at a glance for any listed company, along with industry and company averages. Some even go as far as to compare ratios to a company's largest competitors.

    About the Author

    David Ingram has written for multiple publications since 2009, including "The Houston Chronicle" and online at Business.com. As a small-business owner, Ingram regularly confronts modern issues in management, marketing, finance and business law. He has earned a Bachelor of Arts in management from Walsh University.