Fundamentals
Economic indicators are valuable and reliable reports assembled by the government, universities, and private-sector businesses. They measure the economic health of the overall economy. Most are monthly reports but some are weekly. Generally, the market as a whole and traders in particular listen very carefully to economic results to determine whether they are "net buyers" or "net sellers" for the day. Whenever a report is released, you need to be aware of the time and the information given. It can dramatically change price direction, depending on how the market interprets it.
There are many different indicators. Below are some of the most common ones used by traders. You must understand that not all indicators are equally important. You must learn about all of them, observe reactions to them, and then form an opinion on which ones help you in your specific style of trading. And to make it even more interesting, their importance changes with time and market perception.
Consumer Price Index (CPI)
The Consumer Price Index is a measurement of the cost of living as determined by the U.S. Bureau of Labor Statistics. The CPI is a widely followed inflation indicator. It compares relative price changes over time for a fixed basket of goods and services used by consumers. The CPI has the potential to overstate inflation because it does not adjust for the substitution of goods and the rapidly changing prices of new technology. Release schedule: monthly, around the 13th at 8:30 a.m. EST.
Producer Price Index (PPI)
The Producer Price Index measures the average change over time of wholesale prices received by domestic producers for their output. This index has several components: commodity, industry sector, and stage of processing. The U.S. Bureau of Labor Statistics produces the PPI. Release schedule: monthly, around the 11th at 8:30 a.m. EST.
Gross Domestic Product (GDP)
The Gross Domestic Product provides the total value of goods and services produced within the borders of the United States. Real GDP is the most comprehensive measure of U.S. economic activity. The change in output is measured in real
terms (inflation has been removed). The U.S. Department of Commerce, Bureau of Economic Analysis releases this information. Release schedule: quarterly, during the third or fourth week of the month following the previous quarter at 8:30 a.m. EST.
M2 Money Supply
This is a measure of the United States' supply of money, including M1 (currency in circulation, demand deposits, non-blank traveller's checks, and other checking deposits) plus money market funds, savings accounts, overnight euro dollars, and time deposits under $100,000. The Board of Governors of the Federal Research System provides this information. Release schedule: weekly and monthly.
Employment Reports
The employment reports are the most timely and broad indicators of economic activity. They provide results for two separate sectors. A household survey generates an unemployment rate and a business survey determines non-farm payrolls, average work week, and average hourly earnings figures. The U.S. Department of Labor, Bureau of Labor Statistics provides these reports. Release schedule: first Friday of the month at 8:30 a.m. EST.
Institute of Supply Management (ISM)
The Institute of Supply Management provides the results of a national survey of purchasing managers that includes data on items such as new orders, production, employment, inventories, prices, import orders, and delivery times. A reading above 50 percent indicates expansion and below 50 percent, contraction. This particular report now contains two sections. The first reports on goods and raw materials and the second reports on the purchases of services. Release schedule: first business day of the month for the prior month at 10:00 a.m. EST.
The following measurement tools will help you evaluate a company and determine the value of its stock.
Price-Earnings Ratio
The price-earnings ratio is the most popular measure. It consists of finding a company in which the price-earnings (P/E) ratio is low when compared to similar companies. To find the price-earnings ratio, divide the stock's current price by its earnings per share:
Price-earnings Ratio = Current Stock Prices/Earnings per Share
Therefore, if a stock is selling for $35 now and its earnings last year were $7.00 per share, the P/E ratio would be 5 ($35 Ö $7.00 = 5). This means that for every $1.00 the stock earns, investors are currently willing to pay $5.00. However, investors also pay for future earnings. If the same $35 stock is expected to earn $9.00 per share next year, then the P/E ratio would be 3.89 ($35 Ö $9.00 = 3.89).
The idea is to find stocks with a significantly lower P/E ratio than other stocks in their sector. The P/E ratio cannot always be calculated if the company suffers a loss or breaks even, as there would be no earnings to compute. Expectations of popular stocks can be so high that they may sell for prices way above the market value.
Cash Flow
Cash flow is an important measure of a business for investors because it is a way of determining a company's ability to pay dividends and more. Generally, cash flow is defined as the net income of a business plus depreciation and the value of other non-cash assets.
Companies must have cash to keep going. They need money to pay for all the goods and services they use, as well as making capital improvements and paying operating costs (wages, raw materials, gas for company cars, electricity, etc.). Companies with a high-level debt have to pay a significant amount in interest to service that debt. If an opportunity suddenly appears, perhaps to buy a strategically located piece of land or another firm that would help the business, cash-poor companies may not have the money to make the deal.
Most important, perhaps, is that during hard times, a company with a cash cushion is likely to have a higher probability of making it through. Companies that have enough cash to survive the down periods are in a good position to make clearheaded judgments and keep their enterprise afloat.
Price-Earnings-to-Growth Ratio
The price-earning-to-growth (PEG) ratio is used to determine a stock's value while taking into account earnings growth. The calculation is as follows:
PEG Ratio = Price/Earnings Ratio
Annual EPS Growth
PEG is a widely used indicator of a stock's potential value. Many consider it to be a stock's potential value. It is favoured over the price-earnings ratio because it also accounts for growth.
Keep in mind that the numbers used are projections so they can be less accurate. Also, there are many variations when using earnings from different time-periods (for example, one year versus five years). Be sure you know the exact definition your source is using.
Beta
Beta is a measure of a stock's relative price volatility to the S&P 500. For example, a beta of 1 indicates that for every one-point move in the S&P 500, the stock would move 1.0. A beta of 1.5 indicates that a one-point move in the S&P 500 would move your stock 1.5.
Book-to-Bill Ratio
The book-to-bill ratio describes the technology industry's demand to supply, or the number of orders on a firm's "book" compared to the number of orders filled.
This ratio measures whether the company has more orders than it can deliver (greater than 1), the same number of orders that it can deliver (equals 1), or fewer orders than it can deliver (below 1). This monthly figure is used frequently for companies in the technology and chip (semiconductor) sector.
Price-to-Book Ratio
The price-to-book ratio is used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value. (Book value is simply assets minus liabilities).
A lower price-to-book ratio could mean that the stock is undervalued. It could also mean that something is fundamentally wrong with the company. As with most ratios, however, be aware that it varies considerably by industry.
This ratio also gives some idea of whether you are paying too much for the stock, when the amount that would remain if the company went bankrupt immediately is considered. This is also known as the price-equity ratio.
