How to Evaluate a Stock’s Potential Return and Risk

By Matt Krantz from Investing Online For Dummies, 7th Edition

If you’re investing online in a stock, you’d better get an ample return to make it worth your while. To increase your chances of getting a solid return, you can evaluate the potential return and risk of stocks before you invest.

Past performance is no guarantee of future results, but studying how stocks have done in the past can help you get a very crude handle on what to expect. To find how stocks have done previously, you need their total return in previous years. You can get a stock’s total return by the following methods:

Checking the company’s Web site: Some companies include total return calculators in the Investor Relations section of their Web sites.
Calculating it by using online stock price downloading services: You can download a stock’s annual stock price for different years. Add the company’s stock price at the end of the year to the amount per share it paid in dividends during the year. Divide that sum by the stock’s price at the end of previous year and multiply by 100, and you have the total return for the year.
Using Morningstar: The investment tracker provides stock’s total returns going back for five years. Just enter the stock’s symbol into the Quote field, click the Quote button, and then click the Performance link at the top of the new page that appears. Ideally, you’d want more years of data than Morningstar gives you, but it’s a start.

After you get the stock’s total returns for many years, enter them into Horton’s Geometric Mean Calculator. After doing that, Horton’s Geometric Mean Calculator shows you how much you would have gained in the stock each year on average and also how risky it is. If the stock’s returns are lower than the stock market’s and the risk is higher, it might not be a good fit for your portfolio.

Before you decide that a stock is too risky or the returns are too low, you should compare its movements to the rest of your portfolio. If a stock rises when your portfolio goes down, it might actually reduce your portfolio’s total risk by offering diversification.