How to pick a stock?

This is one of the questions people ask me the most.

There are 3 KPIs you must use for a valuation reality check:

🧮 P/E Ratio: Price Tag Per Dollar of Profit

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

This KPI tells you how much investors are willing to pay for $1 of a company’s earnings. A high P/E can signal optimism (or hype); a low P/E might mean a bargain, or a warning sign.

• For instance, a company showing a P/E of 9.8x can be considered "cheap" when compared to many S&P 500 giants trading above 20x. But a low P/E can also signal slow growth or risks.
• Conversely, a P/E over 20x can mean the company is overvalued.

⚖️ Debt/Equity: Leverage on Display

Formula: Debt/Equity = Total Liabilities ÷ Shareholders’ Equity

This KPI measures how aggressively a company is using debt to fund growth. A high ratio means more financial risk, suggesting the business may be heading down.

• For example, a company with a negative Debt/Equity can be considered a good investment opportunity, but if the negative number is very high (meaning very negative), you must do more in-depth research, as it signals liabilities outweigh equity, a structure that only works if cash flows are rock solid and stable.

💸 Dividend Yield: Income Stream Gauge

• Formula: Dividend Yield = Annual Dividends Per Share ÷ Share Price

This KPI shows the annual cash return for each invested dollar. A higher yield tempts income seekers, but it’s worth checking if it’s sustainable or circumstantial.

Dividends are the way the company says "thank you" for holding the stock. Normally, they are paid quarterly as a percentage of the price.

• A company with a 6.9% dividend yield, which towers over the S&P 500 average, is a good investment for those who look for a continued income (like Warren Buffett, who usually holds stocks for decades). But before buying such a stock based on past performance, you must be certain that the company can keep paying dividends at such a rate. This means you have to consider the industry, consumer trends, management team stability, and other factors that can impact future outcomes

🎯 How to Use These KPIs

• P/E Ratio: Compare to peers and the market. High-growth tech? Higher P/E is normal. Slow-growth utilities? Lower is better.
• Debt/Equity: Under 100% (1.0x) is usually safer for beginners. Negative numbers demand closer scrutiny.
• Dividend Yield: Attractive, but check if the payout is sustainable; look for stable or growing income and healthy cash flows.

🎯 The KPI Decoder - examples

P/E Ratio:

• Lower (like Altria’s 9.8x) might signal a bargain; or warn of market skepticism.
• Higher (Lockheed Martin: 20.5x) can mean strong growth prospects or overvaluation.

Debt/Equity:

• Deep negative (Altria’s -742.4%) is a red flag: too much debt can sink a company if winds change.
• Missing? For GS and LMT, you’d want to check their filings; stability matters.

Dividend Yield:

• High (Altria’s 6.9%) tempts income seekers, but - like a high-calorie dessert - it can mask underlying health issues.
• Moderate (LMT: 2.7%, GS: 2.0%) often signals a balance between rewarding investors and funding growth.

🚦 KPI Contradictions: The Real Lesson

• Altria dazzles with yield, but its debt is a warning siren.
• Goldman Sachs sits in the sweet spot for valuation, but offers a modest yield (classic for financials).
• Lockheed Martin trades at a premium, but rewards patience with a steady dividend and blue-chip reliability.

What’s the takeaway? KPIs are like traffic lights: green means go, but too many reds should make you stop and think. Always look at the full dashboard, not just the shiniest number.

🧠 The Beginner’s Metaphor

Picking stocks without KPIs is like buying a used car blindfolded. You want to know what you’re getting:

• how fast it’s been driven (P/E)
• whether the engine is running on loans (Debt/Equity)
• and if you’ll get a little cash back every mile (Dividend Yield).