Gordon Pape: Which Measure Is Best When Choosing Stocks?

A reader wants to know: What is the best way to analyze stocks?

Q – There are several ways to try and find what is a fair price to pay for an equity, but I would like to ask you which one do you use and prefer most? – Tony M.

A – Stocks can be analyzed in many different ways. There have been many books written on this subject, with about as many theories as to the best approach. Over the years, I have observed that there is no one size that fits all when dissecting the equity market.

For example, my number one focus when I look at a company’s financial reports is the bottom line. What are the net earnings, and how do they compare with the last quarter, last year, or five years ago? If they are not growing at a satisfactory rate, it raises questions about the future of the company and the direction of the share price. On that basis, the price/earnings (p/e) ratio of a stock is my key go-to number in determining where to find value for money.

That said, some of the best-performing recommendations in my Internet Wealth Builder newsletter have p/e ratios that are off the charts. Amazon.com is a case in point. When I first recommended the stock, in January 2017, it was priced at $817.14 and had a p/e ratio of 182.80. I cautioned readers about this at the time, but still rated the stock a Buy because, as I wrote, “I happen to believe it will be even more pricy a year from now”.

Today, the stock is trading at more than double the original recommended price. The p/e has improved, but it is still very high at 78.05. If I had focused exclusively on the p/e ratio, I would not have recommended the stock in 2017 nor would I do so today. And a lot of readers would have missed a profit opportunity as a result.

So, what’s the bottom line? Don’t be dogmatic when it comes to analyzing stocks. Look at the big picture — what a company has done so far and what it is poised to do in the future. You won’t always make the right call — no one does. But you’ll be right more often than not. – G.P.

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