How to evaluate stock performance
Evaluating stock performance is something that is very individual to each investor. Just as every person has different appetites for risk, plans for diversification and investing strategies, so too does every investor has different standards for evaluating stock performance. One investor may expect an average annual return of 10 per cent or more, while another may look to add to his portfolio with a stock that is not correlated with the stock market as a whole. Whatever you look for in a stock’s performance, there are a few variables to consider to help you evaluate whether that stock is a good investment for you.
Consider total returns
A stock’s performance needs to be placed in context to understand it properly. On the surface, it looks great to see that a stock has returned 20 per cent since the beginning of the year when viewing the starting price versus the ending price, but you need to look a little deeper. Was the stock abnormally depressed on the first day? If so, it could throw the numbers out of whack. To counter this, most investors look at the stock’s total returns. Consider the actual performance of the stock over a period, as though you had invested in it on that first day of the period. Also, look at how the stock has done year to date (YTD), as well as over the past 52 weeks. Finally, consider the stock’s average annual return. Look at the five-year average annual return but also look at the 10-year average annual return if you are considering a longer-term investment.
Put it in perspective
To evaluate a stock, review its performance. You may be satisfied with a stock that generated an 8 per cent return over the past year, but what if the rest of the market is returning a few times that amount? Take the time to compare the stock’s performance with different market indexes, such as the Dow Jones Industrial Average, the S&P 500 or the Small-Company Stock NASDAQ Composite Index. These indexes can act as a sort of benchmark. You may also want to look at how the economy has done during the same period, how inflation has risen and other broader economic considerations.
Look at competitors
Of course, even if a company has done well compared to the larger market, there is still the question of how its industry is doing. It could happen that a stock is outperforming the market but underperforming its industry, so make sure to consider the stock’s performance relative to its primary competitors as well as companies of similar size in its industry. For example, if you are evaluating a small semiconductor company, you cannot compare a startup business directly with a well-established company such as Intel, even if the two companies’ products may compete against one another in some arenas. While it helps to see how that smaller-cap company may be doing relative to its larger competitors, it gives you greater perspective to also consider competitors in similar stages of their business life cycles.
In addition to looking at a company’s total returns, comparing them to the market and weighing them relative to competitors within the company’s industry, there are several other factors to consider in evaluating a stock’s performance. For one, you should look at whether the company pays dividends and how reinvesting those dividends may improve its total returns. Also, be sure to factor in inflation in calculating returns, especially as you consider long-time horizons for your investments. This is called a real return and can be done simply by subtracting inflation from the annual return of your investment.
Culled from investopedia.com
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