One of the ways is by simply looking at the company itself and trying to determine if the company actually has demand and is worth looking into.
Another method is to find out how cheap the price of the stock is for what it is backing and how strong the fundamentals of the company are. Below are some financial ratios which you can look at to help you get an idea of just how fundamentally strong a given company is.
1. The Price to Earning Ratio
The PE ratio takes the price of the stock and dividends it by the earnings that the company makes. The ratio can then be compared with other companies to help you decide if the stock is underpriced or overpriced. The lower the PE ratio the better.
For example if the stock that you are looking at has a PE ratio of 8 and the average for companies in that industry group is 12 then you know it is a cheap buy when compared to its competition. If another company in that same industry group has a PE ratio of 18 then you know it is expensive when compared to its competition.
2. Asset Test Ratio (or quick ratio)
The Asset test ratio or quick ratio is a ratio that can give you some insight on a company's debt and assets. If the quick ratio is above 1 that means they own more assets then they have debt. If the ratio is below 1 that means they have more debt than they have assets. Obviously a ratio of 1 or more is considered good while a ratio below 1 is considered bad.
3. The Solvency Ratio
The solvency ratio is very similar to the Quick ratio in that it looks at how much debt a company has compared to how many assets the company has. This ratio can then be compared with other ratios of other stocks in the same industry group to see if the company is taking on too much debt compared to its competitors.
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