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How did legendary investor Warren Buffett make his money? Charles Munger, vice chairman of Buffett's company Berkshire Hathaway and a four-decade confidant, offers the following clue: "The way to win is to work, work, work, work and hope to have a few insights. How many insights do you need? Well, I’d argue that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it."

This course can't offer Buffett-style insights, naturally; those you need to come up with on your own. But we can describe some of the basic ways that investors analyze stocks to determine whether or not they are good buys. What follows is an overview of some of the most common methods; we'll have more to say about several of these in future Money 101 lessons.

Broadly speaking, there are two ways to approach stock analysis: you can either look at the technical indicators for a company, or at its fundamentals. We can't cover technical analysis in detail here -- it deserves a lesson unto itself -- but in essence, it's a highly mathematical way of evaluating investments. A technical investor might compare the performance of a number of stocks over the past year or so, for example, in order to find ones that appeared to be breaking out of their recent trading ranges, and then buy those issues in what amounts to a momentum play (see "Different strokes"). Or she might construct a computer model of the overall market and its relation to other economic factors, such as industrial capacity utilization, currency values or interest rates. The model would be set up to yield "buy" or "sell" signals for the market as a whole or for individual groups of stocks.

Properly used, technical analysis can be a very powerful tool -- especially so for determining when to buy or sell. The alternative approach, fundamental analysis, is pretty good for helping determine what to buy or sell. Here, the aim is to look at the fundamentals of a company and its business outlook in an effort to identify those stocks to which Mr. Market has assigned an unreasonably low value. Here are some of the factors that investors may examine:

• Price/earnings ratio. A stock’s price divided by its earnings per share. The higher the P/E ratio, the higher the expectation that earnings will continue to grow at a rapid pace. Traditionally, investors have looked at P/Es based on the previous 12 months’ profits, known as trailing earnings. Today, though, investors commonly cite P/Es based on the consensus analysts' forecast of the next 12 months’ profits, or forward earnings. The rationale for this change is that forward P/E is a better reflection of a stock's future value -- and that, after all, is what you're buying when you invest in stocks. But take care: all projections involve guesswork and analysts frequently err on the high side when making such forecasts.

• Profit margins. Income divided by revenues. Good margins for a software company might be 25 percent, while 2 percent is considered fabulous for a grocery chain. So when gauging a company’s profit margin, be sure to compare it with that of other companies in the same industry.

• Debt-to-equity ratio. A company's debt divided by shareholder's equity (or the value of its assets after all liabilities have been subtracted out). This ratio is often used as a measure of a company’s health: the higher it is, the more vulnerable a company’s earnings may be to industry changes and swings in the economy.

• Return on equity. Net income divided by shareholder’s equity, or, literally, how much a company is earning on its money. This ratio can be used to show how a company’s earnings measure up against those of the competition, as well as how they compare with past performance. A rising return on equity (ROE) is a good sign in that case, and a falling ROE is often a warning.

• Price-to-book value ratio. A stock's price divided by its so-called book value, expressed on a per-share basis. The book value is calculated by adding up the worth of everything the company owns and then subtracting its debt and other liabilities. The price-to-book ratio compares the price that investors are willing to pay for the company to the value they would receive -- at least in theory -- if the company were totally liquidated. A service business that has few hard assets is likely to sport a high price-to-book ratio, while an auto maker, which probably owns a huge amount of expensive plants and equipment, is likely to have a low one. As with all ratios, this one is most useful when looked at in the context of a particular industry and a company’s own history.

• PEG and PEGY ratio. The PEG, or price/earnings/growth, ratio is calculated by taking the P/E ratio based on forward earnings and dividing by the projected growth rate. Stocks with a PEG ratio of less than one (meaning that they are trading at less than their projected growth rate) are generally said to be cheap, while a PEG ratio of 1.5 or higher indicates a stock that may be overpriced. For stocks that pay a substantial dividend, the PEGY ratio -- which is the P/E divided by the projected growth rate *and* the dividend yield -- may be an even better measure than PEG alone. Keep in mind, though, that both PEG and PEGY are highly speculative measures, as they are based on projections and no one can really foretell the future.

You can find measures like these at virtually any online investing site. In fact, thanks to a proliferation of financial data on the Internet, the average person today can tap into information that would have been available only to investment professionals 10 years ago -- and much of it is free. Popular sources include the Personal Finance section of America Online, Yahoo! Finance, Quicken.com, Investor.com, Money.com, Fortune Investor and many brokerage and mutual fund sites.

You might use these measures as a gauge to check on a company that you hear described as a good investment. You can also use them to search for stocks directly, using a screening tool like those offered at many sites (Fortune Investor and Microsoft Investor among them). Either way, taken together with the latest news on a company (as opposed to rumors flying around Internet message boards), measures like these can give a rough idea of whether a stock is cheap, fairly priced or overpriced compared to others in its class.

Next: Placing a trade

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