Correctly evaluating a company before investing in stocks is one of the most important skills for any investor. For those looking to invest in the U.S. stock market, understanding financial indicators is crucial for making informed decisions. Whether you're thinking about investing in stocks or ETFs, this article will show you how to analyze a company and why it’s relevant to your investments.

How to Choose the Best Stocks to Invest In

Choosing stocks is not just about intuition; you need a strategic approach. According to many experts, investing in a company is like forming a long-term relationship. Therefore, it is essential to ensure that the company is financially sound and aligned with your investment goals.

There are two main approaches:

• Technical analysis: Focuses on charts and price patterns to forecast short-term movements.
• Fundamental analysis: Examines financial reports, management, and other key factors of the company to get a long-term view.

For beginners, fundamental analysis is recommended, as it helps you understand if a company is financially healthy before committing your money.

Financial Statements: The Key to Evaluating a Company

Analyzing financial statements is fundamental to assessing the viability of an investment. Below are the three main financial statements and the key metrics you need to know:

1. Balance Sheet

The balance sheet provides a detailed view of the company’s assets, liabilities, and equity. This shows whether the company has a favorable asset position relative to its liabilities, which is crucial for measuring financial stability.

Key Metrics:

• Current Ratio: This metric measures the company's ability to cover its short-term debts.

Formula: Current Ratio = Current Assets / Current Liabilities.

Example: If a company has $5 million in current assets and $3 million in current liabilities, its current ratio would be: $5 million / $3 million = 1.67. This indicates that the company can cover its short-term debts, a good sign of financial health.

• Debt-to-Equity Ratio: This metric measures how much of the company is financed by debt compared to equity.

Formula: Debt-to-Equity = Total Debt / Equity.

Example: If a company has $10 million in total debt and $15 million in equity, its debt-to-equity ratio would be: $10 million / $15 million = 0.67. A ratio below 1 is considered healthy, as it indicates the company has less debt than equity.

2. Income Statement

The income statement shows the company’s revenues, expenses, and net profits or losses. This report allows you to see whether the company is generating enough revenue to cover its costs and generate profits.

Key Metrics:

• Net Profit Margin: This indicator measures the percentage of revenue that turns into profit after all expenses.

Formula: Net Profit Margin = (Net Profit / Revenue) * 100.

Example: If a company generates $10 million in revenue and $2 million in net profit, its net profit margin would be: ($2 million / $10 million) * 100 = 20%. A 20% net profit margin is a good indicator of profitability.

• Revenue Growth Rate: This indicator measures the company’s revenue growth over a period.

Formula: Revenue Growth Rate = (Current Revenue - Previous Revenue) / Previous Revenue * 100.

Example: If last year’s revenue was $8 million and this year’s revenue is $10 million, the growth rate would be: ($10 million - $8 million) / $8 million * 100 = 25%. This indicates solid growth.

3. Cash Flow Statement

The cash flow statement shows how much cash is flowing in and out of the company. It examines how the company generates cash and whether it can cover its investments and operating expenses.

Key Metrics:

• Free Cash Flow (FCF): This measures the cash available after a company has paid its operating and capital expenses.

Formula: Free Cash Flow = Operating Cash Flow - Capital Expenditures.

Example: If a company has $5 million in operating cash flow and $2 million in capital expenditures, its free cash flow would be: $5 million - $2 million = $3 million.

A positive free cash flow indicates that the company has enough cash to reinvest or pay dividends.

Key Financial Indicators for Evaluating Stocks

In addition to financial statements, financial indicators provide a quick way to assess whether a stock is fairly valued or a good investment.

1. P/E Ratio (Price-to-Earnings Ratio)

• The P/E ratio is one of the most common indicators and measures how much investors are willing to pay for each dollar of the company’s earnings.

Formula: P/E Ratio = Stock Price / Earnings Per Share (EPS).

Example: If the stock price is $100 and the company has an EPS of $10, its P/E ratio would be: $100 / $10 = 10.

A P/E ratio of 10 means investors are willing to pay 10 times the company’s earnings. Comparing it to the sector’s average P/E will give you an idea of whether the stock is overvalued or undervalued.

2. ROE (Return on Equity)

• ROE measures the company’s ability to generate profits using shareholders' equity.

Formula: ROE = (Net Profit / Shareholders’ Equity) * 100.

Example: If a company has $3 million in net profit and $10 million in equity, its ROE would be: ($3 million / $10 million) * 100 = 30%.

A high ROE indicates that the company is efficient in using its capital to generate profits.

3. PEG Ratio (Price/Earnings to Growth Ratio)

• The PEG ratio adjusts the P/E ratio to account for the company’s growth rate. It is useful for assessing whether a high P/E is justified by strong future growth.

Formula: PEG Ratio = P/E Ratio / Earnings Growth Rate.

Example: If a company has a P/E ratio of 15 and an earnings growth rate of 10%, its PEG ratio would be: 15 / 10 = 1.5.

A PEG ratio below 1 indicates that the stock may be undervalued relative to its growth.

4. Dividend Yield

• If you’re interested in generating passive income through dividends, the dividend yield measures the annual dividend return compared to the stock price.

Formula: Dividend Yield = (Annual Dividend Per Share / Stock Price) * 100.

Example: If a company pays $2 in annual dividends per share and its stock is priced at $50, the dividend yield would be: ($2 / $50) * 100 = 4%.

A 4% dividend yield is attractive for investors seeking regular income.

Diversification and Risk Management

A key principle in investing is diversification. Investing in different sectors and geographies allows you to mitigate risk. A balanced portfolio may include value stocks, growth stocks, and ETFs that replicate indexes like the S&P 500. Additionally, platforms like Hapi, an investment app, make it easy and secure to do so from anywhere.

Conclusion: The Importance of Analyzing Before Investing

Before investing in the U.S. stock market, it’s essential to conduct thorough analysis using financial statements and key indicators. This approach will help you make better decisions and increase your chances of long-term success.

If you’re ready to start investing, Hapi offers an accessible and reliable way to explore the U.S. stock market and build a diversified portfolio. Take advantage of the opportunities and take the first step toward your financial goals!