/Lydia Wanjiru/ -- How do you identify the best and the most suitable stocks to buy? Majority of investors buy stocks based on a few things that they can understand such as the price of the stock. A group of other investors tend to invest based on a given emotional attachment to the company like them or their close relative is a client or an employee of that company. However, there are more variables that you should take into account before committing your money in a particular stock. You need to consider these 5 key parameters before you pick a stock to buy:
1. Price- earnings growth ratio
The price earnings growth ratio (PEG) is derived by dividing the price-earnings ratio (P/E) by the prospective rate of growth. So, for example, if PE is 20 and the prospective growth rate is 10% then the PEG would be between 1.0 and 2.0 and it means that the PEG is stretched. Therefore, just because a company is growing rapidly doesn’t mean it is an ideal investment even though rapid growth often translates to high valuations Price Earnings (PE) ratios. There are past valuations that can be quite useful in evaluating the strength of the current valuation.
2. Relative strength index
Another variable worth taking a keen interest in is the relative strength index. This is basically a measure of a stock’s price performance versus the current one at the market. For a variety of stocks, it ranges between 30 and 70 and the highest being the strongest performers.
3. Consistent Earnings Growth
You can consider checking the stock growth consistency as it is an indicator of how the stock is performing. If it has shown a constant growth in the past, then it is also likely to continue the same trend in the future. This boosts investor confidence and you can always check the performance of the stock in the latest three years to find out the consistency of its performance before you settle on it.
4. Coefficient Variance
The Coefficient Variance (CV) is a measure of the consistency of the analysts’ findings and earnings estimates. It usually ranges between 0-15 and a low CV of up-to 4 suggests that there is a reasonable consensus among the analysts. When the CV of a stock progresses further and goes beyond 4 then it means that the analysts have little confidence in their given estimates and thus that particular stock is more risky to buy.
5. Free Cash Flow
The Free Cash Flow (FCF) is the cash that is usually left after deducting taxes, capital expenditures and paying all the debts outstanding. It means that if a company has Free Cash Flow (FCF) or a left-over of cash, it is retained and used as capital for further company expansions and business developments. A company that has a high free cash flow is worth investing in as that is an indicator that the company is likely to have or currently has a good stock performance.