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Financial Measures to Consider before Investing in a Stock

Part of the Stock Investing For Dummies Cheat Sheet

You're thinking of buying stock in a company, but before you invest your hard-earned money in hopes of a profitable return, check out some financial ratios that can help indicate whether the company is on sound financial footing. Here are key measures to consider:

  • Price-to-earnings ratio (P/E): For large cap stocks, the ratio should be under 20. For all stocks (including growth, small cap, and speculative issues), it shouldn't exceed 40.

  • Price-to-sales ratio (PSR): The PSR should be as close to 1 as possible.

  • Return on equity (ROE): ROE should be going up by at least 10 percent per year.

  • Earnings growth: Earnings should be at least 10 percent higher than the year before. This rate should be maintained over several years.

  • Debt-to-asset ratio: Debt should be half of assets or less.

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