If you are looking to build your retirement portfolio or just investing for passive income, then you are probably more likely to look for stocks that you can invest in for the long term. Sometimes it is difficult to locate just the right stocks. There are so many out there that it’s often easier to just go with what the popular topic is for the day on the investing network.
There are several investing ratios that you can use to get you to the portfolio that you’d like. Some ratios are better than others if you are investing for the long term.
How To Use Investing Ratios
Price to Earnings
The price to earnings ratio is great for current valuation and past valuation. However, if your investing time horizon is 5 to 10 years, the price to earnings ratio might cause you to be a little short sighted. Earnings forecasts typically do not go out 10 years, in fact the longest earnings estimate will probably only take you out to 5 years. Although this ratio is often used for valuation of the current price of a stock, it might not be the best for a long term investor.
Price to Book
The price to book ratio is a good one for comparing today’s price with the value of the company based on historical costs. The book value is measured using the historical cost or purchase price. Over time the stock price will change but the historical price will not. This is a good ratio to use for long term investing because you have the ability to track the ratio over time.
Price to Sales
The price to sales ratio is a ratio that is beneficial to use for companies that may see cyclical sales. Every company’s stock price is cyclical, whether it changes because of the business cycle or the industry cycle is the real question. If a stock exhibits substantial movement based on sales volatility, the price to sales ratio will be a good way to gauge if the stock is over priced. For the long term investor, you will want to look for a price to sales that is steady or growing. This shows that investors are confident about the continued sales growth.
Reinvesting Dividends for the Long Term
Retention Ratio and Payout Ratio
The retention ratio measures how much of earnings are being plowed back into the company. The payout ratio, conversely, measures how much of earnings are being paid out as dividends. You want to pay attention to the retention ratio for capital appreciation. If the company is retaining earnings and finding profitable ways to grow those profits into more earnings then your stock value should go up right? The payout ratio comes into play when you are interested in how much of earnings is needed to pay out the dividend. If a stock has a payout ratio of 45%, that means it uses 45 cents of every dollar to payout dividends, and that would make the retention ratio 55%. As a long term investor, you want a constant dividend, but you also want a chance at capital appreciation so the balance between the payout ratio and the retention ratio is pretty important to you. Make sure that you are reinvesting your dividends to get the benefit of compound growth.
Dividend Growth Ratio
If you’ve picked a dividend paying stock, then you will definitely want to pay attention to the dividend growth rate. The dividend growth rate is an estimate but it gives you an idea on the value of the stock for the future. If you are a long term investor and the annual dividend growth rate is an expected percentage you can determine the expected return of the stock by using today’s stock price. For example, a 5% growth rate for a dividend paying stock that has a price today of 20 dollars and a dividend of 2 dollars yields an expected annual return of 10.5%.
Do you pay attention to these ratios when investing for the long term?
This post was written by Latisha.