The thousands of stocks that trade on American stock exchanges each represent an individual company. While many stocks share similar characteristics, each one is distinct. To differentiate between two stocks, a detailed financial analysis of the underlying companies is a good first step. Using real-world numbers, you can calculate a fair estimated stock price and determine which stock offers the most investment potential.
While many variables can affect the day-to-day pricing of individual stocks, over the long-term investors value stocks based on the earnings of the underlying company. Ask your broker or check the financial news for information on the earnings of the two stocks you are comparing, both the most recent earnings and the earnings projections of stock market analysts. These numbers will form the basis of your stock price calculations.
If you know a stock's price and its earnings per share, you can compute the stock's multiple. Stocks in different industries trade with different multiples. If the multiple for your stock is below the average multiple in its industry, it may be undervalued. For example, if one of the stocks you are looking at is in an industry with an average multiple of 10, and your stock trades with a multiple of 8, your stock may be primed to go up in value. However, sometimes a lower-multiple stock is priced at a discount because the company generates below-average earnings, something your research should turn up.
A company that can grow its earnings at a higher rate will often trade at a higher multiple and can usually grow its stock price more rapidly. If you are analyzing two companies in the same industry, the one with the higher growth rate should trade at a higher multiple. If they both trade at the same multiple, the higher growth rate stock is usually a better bet.
A company's management can play a big role in the future value of its stock. Management that offers a clear vision for a company and a track record of success can often result in a higher growth rate for a stock. Management that publicizes its stock and is readily accessible to financial analysts can also help a stock go up more than its peers.
Volatility refers to the fluctuation in a stock's price. A high-volatility stock can be up one minute, down the next and close up again. Typically, higher-volatility stocks have a higher risk-reward ratio -- high-volatility stocks can reach both higher highs and lower lows. However, just because a stock is more volatile does not mean it is more likely to outperform over the long run; it just may have higher peaks and valleys. If you are a conservative investor, you might prefer a lower-volatility stock, even if the one you are comparing it to seems to have other things to recommend it.
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