When it comes to making investments, making decisions that are data driven can often be the difference between a major win or a major loss. This is because data is supported by facts (evidence) and, therefore, is often considered the most accurate tool that can be used to predict future market trends. Although, it is important to understand that data does not always tell the whole story and cannot guarantee success 100% of the time. That said, it is a vital tool that every investor should utilize. This article will outline three of the most popular data metrics that are used by investors of all skill levels to make more informed decisions:
Return on Investment (ROI):
Return on Investment, or ROI, is a term used to describe the money that has been made or lost by a company on an investment. Simply put, if a company were to invest $10,000 in Microsoft and a year later their investment has grown and they were able to sell for $15,000, their return on investment would have been 50%. Likewise, if a company were to invest $10,000 in Microsoft and a year later they were forced to sell at $2,500, their return on investment would be loss, -75%. While this metric is easy to understand because of the simplicity of its calculation, it can also be easily manipulated which could be problematic. Essentially, companies can choose what to include in the cost of the investment and it is not always clear if they chose to include all costs or just selected costs. As result, ROI can be a valuable tool, but you might want to do more research to make sure you really understand its intricacies before relying on it.
Price to Earnings Ratio (P/E):
This metrics is considered one of the best ways to gauge the value of a stock. Moreover, the ratio is calculated by comparing a company’s current price to its per-share earnings. In order to do so, the investor must divide the price per-share by the earnings per-share. To make this concept clearer, imagine that you were in the market to buy a new car and were comparing the many different offerings available. Generally, it would be reasonable to expect that the cars with more advanced features would cost more than the ones that use outdated technology. However, if you came across a car that had older technology but it costed just as much (or more) than the more updated cars, it could be inferred that the purchase of that specific car is likely not a good value. Similarly, if a stock has a higher P/E ratio than another comparable company, investors would generally consider it to be overvalued. As such, the notion that the actual price of the stock does not necessarily indicate its value is true; when P/E ratio is considered, higher priced stocks can be less valuable than lower priced stocks.
Return on Equity:
Return on equity, or ROE, is a metric that measures the profitability of a given corporation by determining how efficient the company is at generating profits. This is achieved by dividing the profit by the amount of equity (or total amount of money invested in the company). For example, if there are two small companies (X) and (Y), and company X realized profits of $100,000 but had received $50,000 of equity, it would be considered more efficient than company Y if Y made $100,000 as well but had $75,000 in equity. Essentially, an investor could determine that company X is operating more efficiently than company Y because they have made more money with less investment.
While these metrics are all valuable tools for making investment decisions, you should remember that none of them are perfect and for the best results investors use them in conjunction with each other to estimate the general health and growth potential of a company. Ultimately, the most successful investors are well-informed and do as much due diligence as possible before making an investment. Luckily, many different metrics (including the three described above) can be found in a stock’s fundamental analysis section so doing some independent research is relatively easy!