I happened to be reading the Standard Newspaper of Tuesday, February 28, 2012, when the article with a heading “How to Pick Quality Shares at the Stock Market” caught my eyes.
The writer basically advised that one should look at the P/E ratio of the company and compare with other companies in the same industry and then pick the stock with the lowest P/E ratio.
My first instinct was that the article gave a simplistic way of how to choose quality shares at the Stock Markets. It then dawned on me that I should be thankful to the writer for taking the time to educate people on how to invest in Stock Markets.
Many people lose money simply because they lack knowledge of how markets work.
I resolved then that instead of being critical, it is best to improve on the article.
There are two main approaches that are used to tilt the odds in one’s favour: Technical Analysis and Fundamental Analysis.
When deciding which stock to pick, some people use technical analysis while others use fundamental analysis.
At basic level, a technical analyst approaches a security/stock from the charts and indicators. Price and volume levels are among many indicators of whether to sell or buy a stock.
The fundamental analysts look at economic facts and take more in-depth look at the company and the industry that it is in. They spend time unravelling financial statements of the company.
The writer in the Standard Newspaper used this approach but only talked about Price to Earnings Ratio (P/E) = Stock price/ Earnings per Share (EPS).
In theory, the lower the P/E, the better the value. This is a simple way of viewing P/E because some investors view the higher P/E as good growth prospects for the company and are, therefore, willing to bid up the price. Others view a high P/E as an overpriced stock. Therefore, the P/E doesn’t tell the whole story and should be used with other ratios.
My view is that to avoid trading in the dark both fundamental and technical analysis is helpful in painting a more complete picture. They complement one another.
Till next time when I bring you more tips that will make you a better investor and trader.
The author is the Managing Director of Bank of Kigali