(The examples here are specific to our broker, but the principles we teach here are applicable to any stock market or broker.)
Our previous few articles talk about the different ways to invest in the stock market. We presented a super easy way with index funds, and also a way to invest in buying good stocks easily. Both of these investing methods are extremely effortless and consumes only a few minutes every month!
In this article though, we’re going to present a third way to invest in the stock market, which is more complex and more time consuming. However, this method does give you a more careful way to choose stocks for investments. This is done by using “Financial Ratios”.
Finding Financial Ratios
There are many ways to look for financial ratios, especially with the help of the internet and Google. In this article though, we’re just going to use the ratios presented by COL Financial, who is our broker. If COL is not your broker, don’t worry! Again, you can find most of this information in the internet and with Google’s help.
If they are your broker as well, just follow the instructions in the picture below to get to this page.
We’ll be using the numbers labeled EPS, EPS Growth, P/E and P/BV. We will explain Div Yield while we’re at it, but we won’t use those to select stocks.
Those alien sounding things I mentioned above are what we call “financial ratios”! There are more that would be useful, but for now, those will suffice. (If you want more ratios, let me know with a comment below!)
Essentially, financial ratios are just numbers that tell us something. The ratios I mentioned tell us if the company is earning well, if they are cheap enough to be considered a good buy, and if the stock is a good investment in general.
Below is the report that we will be talking about.
Basics Of This Report – Reviewed!
We’ve already talked about this in our previous article, but let’s just review what some of the items in this COL report mean.
For the most part, you’re really going to just look at the COL Rating first. The BUY rating means those are the stocks that COL recommends that you purchase, so we’re mostly interested in those and we are also going to ignore the rest (or those with a HOLD and SELL rating).
COL gives a BUY rating if they believe the company is doing well and earning money, and also if the share price is cheap enough. Great businesses bought at cheap prices usually equal good profits.
(You should also note that the Price listed on this report is not updated, but they will most likely be close to the current price. In any case, just check the updated current price to be sure.)
Anyway, you probably notice that there are so many stocks labeled with BUY. Does that mean you should buy all these? Definitely not.
For most of you, finding the best one, or 2, or 3 stocks (or maybe up to 5 if you have a lot of cash) and buying those would be best over the next few weeks/months.
But how do we determine which stocks are the best? That is where the ratios come in, which we’ll talk about later.
Just remember that you should also only buy the stock if the current price is below the “Buy Below” price. This makes sure that you do not overpay for the stock.
Using These Financial Ratios
While we could explain the different ratios in detail, we won’t do that here. This is because it makes things much more complicated than it needs to be.
We could also teach you how to compute these ratios yourself, but again, that makes things more complicated. Besides, the ratios have already been computed by COL anyway (or you can search the ratios on the internet).
What we will explain well though is how you can use/apply these ratios on picking the stocks that would make good investments. Also, at the end of this article, we will have a summary on how we put all this together.
Financial ratio #1: EPS 20E
What is EPS 20E?
EPS simply means Earnings Per Share. This is how much money a single share will earn for the year.
Take note that it is not money that you will receive. While dividends are taken from this EPS, it is also used for many other things. For example, this money will be used to pay off liabilities or debts of the company. They will also need to use this money to expand to more locations, or research new products, and many other things.
The 20E simply means that it is an Estimate for the year 2020. Or in other words, it is the estimated EPS for the year 2020!
How to use EPS 20E to judge a stock for purchase?
EPS can be used to judge if a company is earning, and doing well. If Earnings Per Share is positive, then that means the company is earning profits. Companies that earn profits, especially if they can do that every year, usually increase in share price in the future, which means profits for the investors like you.
This is probably obvious, but if the EPS 20E is negative, then that means that the company is estimated to lose money in 2020. And if they are losing money, they are probably not a good investment.
For example, BLOOM (under Gaming) is seen to lose P0.16 per share. Even though COL has a BUY rating for this stock, you probably shouldn’t invest in it.
So why would COL recommend BLOOM if it will take a loss on 2020? My guess is that COL probably believes that the company can earn profits in the years after 2020. We personally don’t like this way of thinking, and we like companies that consistently earn profits every year.
Financial ratio #2: EPS Growth
I believe this should be easy to understand now that you know what EPS means. Basically, this is the % that the EPS of the company will grow over the next year.
How to use EPS Growth to judge a stock for purchase?
Well, if it’s a positive, then that’s great, as that means it will grow by that %. Of course, the higher the better. For most industries, a growth of 10% or more is good.
If it’s lower than 10%, then it might be fine, but it’s not something to write home about.
Obviously, if it’s a negative, that’s not good, as that means they will be earning less over the next year.
Though I would not be too concerned with EPS Growth being negative. There are years where a company’s earnings decrease. As long as the decrease is not too high, like as long as it is not more than 30%, then that may be fine. Maybe.
If you want to stay in the safe side though, make sure the EPS Growth is positive.
Since there is currently a pandemic and a recession (so people aren’t buying much stuffs), there is currently a lot of companies with shrinking EPS, but as long as it’s not too high, it should be fine.
Financial ratio #3: P/E 20E
What is P/E 20E?
P/E or PE or Price/Earnings ratio is the ratio between a company’s EPS and its stock price. You can compute this yourself by dividing the stock price by the EPS 20E (though PE already computed for you here).
We use this ratio to determine if the stock price is cheap or expensive. Always remember that you should only buy stocks with cheap prices.
This is very useful in terms of comparing stocks of different sizes. If we want to determine which stock is cheaper between SECB and BPI (both under Banking), you’ll probably look at their current prices. SECB has a price of P100.60 per share and BPI has a stock price of P57.00 per share. A lot of you probably think that BPI is cheaper since it has a lower price.
But stocks don’t work that way because of a lot of things that will take too long to explain. Just know that this way of thinking is a mistake. (If you’re curious though, it has something to do with the size of their assets and how many shares they have issued and so many other factors that will take too long to talk about).
This is where P/E comes in by having a uniform way of determining if the price is cheap. Because of the way we compute this ratio, PE of one company is directly comparable to another company.
So, in the case of which is cheaper, SECB or BPI, we look at their PE ratios and not their prices. Since SECB has a PE of 7.8 and BPI has a PE of 10.3, then SECB is actually cheaper because it has a lower PE!
How to use PE 20E to judge a stock for purchase?
The first way is to compare which of two stocks are cheaper (and cheaper means better, usually!). We already talked about that above.
The second way is to make sure that you aren’t paying too much in case there are many expensive stocks. Generally speaking, any stock with a PE ratio of more than 20 is probably too expensive. SM, for example, currently has a PE of 31.6! That’s probably why COL did not give it a BUY rating.
We personally might consider buying a stock with a high PE ratio if the company is really really really great. But honestly, we haven’t found any company like that, so we stick to buying those with a PE of 20 and below. We also suggest you do the same.
Financial ratio #4: P/BV 20E
What is P/BV 20E?
Price over Book Value or P/BV ratio is the ratio between the price and the Book Value of a company. In accounting, Book Value is simply the net value of the assets owned by the company.
There is, of course, more to book value than just that. But to fully explain BV, we would need to go into accounting concepts and it will take too long.
So, to make it simple just think of the Book Value as the net amount of money that the investors will receive if the company sells all their ownership and pay all their debts.
How to use P/BV 20E to judge a stock for purchase?
Essentially, a stock with a P/BV of 1 means that its price is equal to its book value. If the P/BV is more than 1, that means that the company is priced higher than its book value. If the P/BV is less than 1, then the company is priced below its book value.
In other words, the lower the P/BV is, the cheaper it is and the better it is as an investment.
Generally, the maximum P/BV that you should accept is 2. If you like taking a bit more risk, which is fine, then a maximum of 3 is acceptable. Of course, try to buy stocks with a P/BV of 1 or less.
Special Mention: Div Yield
A Div Yield or Dividend Yield is the % return of the dividends relative to the price. So if a stock gives one dividend a year for P10 per stock, and the stock price is currently P100 per share, then the div yield is 10% (10/100).
We previously mentioned that we do not use the Div Yield and this is why: our goal is to invest in good businesses with cheap prices, wait some years for the price of the stock to rise, then we sell it.
With that strategy, there is no consideration of a dividend. Simply put, we do not care how much dividend a stock gives, or if it releases (or doesn’t release) dividends. It just doesn’t matter to our strategy.
This is fine, especially because dividends are very small in amount anyway, and the bulk of stock investment profits are always from stock price increases!
So if the dividends do not matter, why would we use a ratio that is about dividends?
Now, if you’re thinking that you’ll have a different strategy than us and that you will care about the stock price increase AND the dividends as well, then I have to warn you that that is not a good idea. I wish I could talk more about why, but unfortunately, it would be too long to explain here. (I might make a separate article about it in the future…maybe)
How to use Div Yield to judge a stock for purchase?
Now, some of you might still want to invest in using Div Yield, or maybe you are curious, so I will explain how to use it.
The general rule is that the higher it is, the better. So, for the DIv Yield, we should have a minimum % where we will not buy it if it goes below that. For most of you, I suggest you have a minimum of 8%.
If you are okay earning a little less than that, then you can go as low as 6% but not any lower!
Again though, the higher the better. Honestly, if we wind a company that pays a consistent dividend of about 15%, we might consider changing our strategy. But that has never been the case so far.
And that is why we disregard the Div Yield!
Putting It All Together
Alright, so now that you understand the different ratios on the COL Financial report, how do you actually put them together to determine the stock to buy? (Or determine your top 3 to buy; or top 5 maybe?)
First, you have to remember that COL Financial has already made this guide for you and determined which stocks to buy by giving them the BUY rating. Essentially, if it doesn’t have a BUY rating, you should just ignore it.
Second, you also have to remember that there are only some industries that would make good investments, which we have already talked about in a previous article here. As a review though, choose only stocks from the food and beverage industry, the banking industry, the properties industry, and the utilities (power and water) industry.
Third, you can now start writing a list of stocks for your shortlist. This is where you use the ratios that you have learned here.
- Is the stock’s EPS positive?
- With a positive EPS Growth?
- With a P/E that is 20 or lower?
- And is the P/BV also lower than 2?
If that’s all a yes, then write that as a candidate for investment!
You’ll probably end up with about 10 to 20, or maybe more stocks and that is okay!
Fourth, you need to pick the best ones from your shortlist. This is easier said than done, but essentially, you can use the ratios we presented to compare them. Maybe one company’s PE and P/BV is lower than all the others? Then that could be a better investment.
You can also research the companies. Maybe one is actually larger than the other? Maybe they have more branches? Maybe customers (or you, personally) prefer their services over the others?
Again, you can pick just 1 from all these stocks, or you can determine your top 3 or top 5 that you will be buying over the next few months. That part is up to you!
Good luck we hope you learned something!
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