How to compare a company's stock from that of its competitors

 How to compare a stock from its competitors

Why compare a stock from that of its competitors?

    When an investor is looking to diversify their portfolio, their first aim is to diversify across different industries. But then the question arises which company out of these competitors is most likely to perform well in the future to give you high returns? Well, there are multiple analytical bases to determine which company may be the best investment for you and the most common ones that are also widely known are ratios.

What are Ratios?

    Ratios are nothing but calculations that represent the company's position in different scenarios with their own records that helps you to understand it from multiple perspectives. There are various kinds of ratios that explain the company’s position compared to its competitors like P/E, P/B, D/E, ROCE, and many more. These are the ratios we are going to discuss further.

Comparing with P/E ratio 

    Some of these ratios include the Price to Earnings ratio, that is the ratio of share price of a stock to its earnings per share (EPS) which gives you an idea of whether the stock at a price that is asper its real value or whether it is overpriced to determine this, you should first check that industry’s average P/E ratio and then compare it with the potential stock’s P/E ratio. If that company’s P/E ratio is less than or equal to or a little high by a marginal number, that stock is at the right price to be bought. Whereas, a very high P/E than that of the industry’s average means that the stock is too overpriced, that increases the risk of the price falling by a high margin when the market experiences a downturn.

P/B ratio

    Price-to-book (P/B) measures the market’s valuation of a company relative to its book value. It is used by many value investors to identify potential investments. Just like the P/E ratio, the P/B ratio also shows you if a particular stock is undervalued or overvalued, the difference between them is that the P/E is based on the company’s earnings whereas the P/B is based on the book value of that stock.

D/E ratio

    The debt-to-equity (D/E) ratio is found by dividing a company’s total debt by total shareholder equity. It demonstrated how much debt a company has against its assets. The higher the D/E ratio, the more difficult it is for the company to cover those debts. The ideal figure you should look for in this ratio is around 2 or 2.5. The only reason that a high D/E ratio is not recommended is not just because of the probability that the company might not be able to pay off the debts in the future, but the fact that the company requires high amounts of funding to grow further that shows fundamental weakness or low productivity. So another way that you can determine which company out of an industry is a better investment, try to look for a low D/E ratio than its competitors.

ROCE

    Return on capital employed (ROCE) is calculated by dividing the company’s Earnings before interest and taxes (EBIT) by the capital employed. It can be used to interpret a company’s profitability and capital efficiency, to understand how effectively the money from capital is put to use to generate better results. The higher the ROCE the better, any figure above 20% is considered to be advisable by investment specialists. With this you can first eliminate the companies that have an ROCE of lower than 20%, hence helping you to narrow down your stock options from different sectors.

Revenue Growth

    The Revenue growth of a stock is also one of the factors that represent the growth of a company showing better marketing strategies, product innovation and customer service leading to higher demand for the company and its stock, making it a good investment if the revenue growth is higher or equal to 10% per year. A higher revenue growth also means that the company is now increasing their customer reach and therefore increasing its market share.

Market share

    Market share is the percentage of customers of an industry that buy products or services from that firm, and the more it is, it shows more dominance over the market that is highly preferable for investors. For example, if we look at the Burger industry, McDonalds and Burger King are the top two companies and the others are nowhere near! Just imagine investing in McDonalds during its initial IPO on April 21 in 1985 and holding it for the long term. Wouldn’t you prefer McDonalds to have such dominance of its industry? Of course you would. So begin analyzing stocks in order of the market share of the companies in that industry when comparing. You can find this in the peer comparison section of a stock on Screener.in.

What are you waiting for?

    Now that you know how to compare companies from an industry, go ahead and analyze away to earn high returns and take another step towards your financial freedom!

~Shagun Johri