Why do people build portfolio? Of course to make profits over a period of time. Usually, on an average, any portfolio would give a healthy 15%-18% profits, provided your entry and exit is perfect in a stock market.
But do you know that the entry and exit, actually, has nothing to do with your portfolio returns. The down swing and up swing simply gives the mood of the market and sentiment of an investor. However, if quality stocks are chosen as per the ratios given below, no one can stop the stock from getting to it true value it deserves. At least that is the philosophy I believe.
Here are the ratios –
Price to Equity (P/E) Ratio
This is one of the most basic ratios. In my earlier blogs also I have mentioned it’s importance. I am sure you must be knowing this ratio.
P/E Ratio is the amount you are willing to invest in a company for every rupee that company earns.
Formula – Price / EPS
Let’s take an example –
IT Industry PE is 20
Infosys – PE ratio is 18; TCS – PE ratio is 15.
So which one will you choose? TCS right. Because you will have you invest less (in comparison to Infosys) for every Rupee TCS earns..
Thus, over a period of 2-3 years your investment in TCS will garner better returns than what Infosys would have made you gained. Hence; the importance of P/E Ratio.
Getting dividends is the secondary reason why you may want to hold on to the portfolio for a longer period or at least a year minimum.
Now, before selecting a stock to include in your portfolio it is very important to check out its dividend yield.
It is not the amount of money a company is giving per share as dividend but the percentage of its stock price the company is giving as dividend is what counts.
Suppose TCS declares a dividend of Rs 45 a share annually while REC declares a dividend of Rs 17 a share.
TCS is trading at Rs 2400; REC is trading at Rs 185
Of course in numerical terms TCS’ dividend is high but in percentage terms dividend declared by REC is high (17/185)*100.
This means that dividend income of a person holding REC will be higher than that of those who earned from TCS.
Hence, choose a stock with higher Dividend Yield, it will keep your money tap open.
Return on Capital Employed
Now one may argue as to why not consider Return on Equity. Well, the main reason is that this ratio includes both assets and liabilities to compute how much profit a company has earned by making its capital work.
A higher ratio indicates that the company can reinvest its profit for more profitability, thus, resulting in higher dividend.
Operating Profit or EBIT / (Total Assets – Current Liabilities)
A combination of the above three ratios is what defines a quality stock. There are more ratios. We will see in my blogs to come.