In the last article, we saw that in order to earn profit in stock markets, the price at which you buy the share should not exceed its value. So it is very  important you calculate the value of the share.

Calculating the value of the share: First you must begin by reading through financial statements of the company. Acquaint yourself with the finer nuances of the stocks.

Then you need to understand the valuation methods of the share. There are 2 methods to do that.

First Method: Calculate the net liquid assets per share. It is done by subtracting the liabilities from the current assets and dividing the result by number of shares.

Net liquid assets per share = Current assets –liabilities / number of shares

Current assets include  cash, debtors, liquid investments etc

The great investor Warren Buffet recommends paying not over 2/3 this figure for a share.

Second Method: Consider the PE (Price to earnings) ratio. It is calculated by dividing the market price of the share by Earnings per share (EPS).
 
PE ratio = Market price of a share/ Earnings per share

If the PE ratio is 1, you can say the share has fair valuation. If it below 1, it is undervalued and if it exceeds 1, it is overvalued.

In the next part, we’ll take a closer look at PE ratio.

Related Link: The Mantra to Stock Market Success

We all know that equity is the best asset available to help you become rich and achieve your various dreams. However you need to be very careful when investing in equities. So how do you become a smart investor? What should you do to get the best returns from your investments? Here are some important tips that you must follow to be successful in equity investing.

• Think long-term: Equities are a long term investment option. Ensure you remain invested in the stock market for at least 5-6 years.
• Invest in quality stocks: Look at the company’s performance, its various ratios like PE ratio, debt-equity ratio, EPS etc. Compare these ratios with its competitors’ ratios. Find out the company’s growth prospects and check if the company has sufficient cash in hand to tide over any financial emergencies.
• Don’t listen to noise: Noise is the useless information that emanates from the stock markets. E.g. during the recent financial crisis, many large FIIs withdrew their monies from Indian stock markets. This led to market crash, which scared many local investors, who withdrew from the markets, thus worsening the situation. But despite all this, Indian economy remained healthy.
• Check out the reputation of company management: Find out what is the reputation of company management. This will prevent the occurrence of Satyam-like episodes to a great extent.
• Don’t be swayed by market movements: Market movements are for the traders, who are interested in making the quick buck from the stocks. You, as an investor should not worry about market movements as you are going to be in the market for a long time. Over a period, stock prices even out, helping you recover your losses.
• Read the company’s financials carefully: Go through the company’s balance sheet carefully. Attend the AGMs of the company and understand more about the company’s future plans.
• Be aware of the risk-reward ratio: Certain stocks like mid and small caps are very rewarding but very risky. These stocks can easily become very illiquid, or the companies can close down. This exposes your investment to excessive risk. So be aware of it before investing.
• Diversify your portfolio: While equities should comprise 70% of your portfolio, divide the balance amongst other asset classes like FDs, gold and realty. This will protect you against market downturns.

Investing in stock market is a long term game. It is risky, yet rewarding. It is important to balance your risk vs rewards to get the best from your stocks.