Researching a stock is a lot like buying a car. You can base a decision solely on technical aspects of the car, but we do consider how the ride feels on the road, the manufacturer’s reputation and whether the color of the car matches your personality or not.
Before parking any stock in your portfolio, it is important to analyse a range of aspects; such as the company’s financials, leadership team and competition.
Types of stock analysis
When it comes to analyzing stocks, there are two basic ways you can go: fundamental analysis and technical analysis.
Fundamental analysis is based on the assumption that a stock price doesn’t necessarily reflect the true intrinsic value of the underlying business. Fundamental analysts use valuation metrics and other information to determine whether a stock is attractively priced. Fundamental analysis is designed for investors looking for excellent long-term returns.
Technical analysis generally assumes that a stock’s price reflects all available information and that prices generally move according to trends. In other words, by analyzing a stock’s price history, you may be able to predict its future price behavior. If you’ve ever seen someone trying to identify relatively shorter term patterns in stock charts or discussing moving averages, that’s a form of technical analysis.
One important distinction is that fundamental analysis is intended to find long-term investment opportunities, while technical analysis typically focuses on relative short-term price fluctuations.
In today’s post, we are compiling all the fundamental analysis aspects that need to be considered before investing in any stock.
The first and foremost important thing is to understand your stock investment priorities, every individual is unique and has a unique set of priorities which makes their portfolio unique.
It is good to learn from great investors tips but always have clarity about your expectations from your portfolio.
When you eventually start selecting companies to invest in, here are a few tips on how to pick stocks that align with your portfolio:
- Identify companies:
There are various strategies you can implement to find the companies with the right stocks for you. For instance, you can track exchange- traded funds, or ETFs, that closely follow the composition and performance of prominent indices. Alternatively, you can start by filtering out stocks on the basis of your preference of industry and sector.
- Monitor Financial News:
Another recommendation on how to pick stocks is to closely follow the latest financial and market-related news. Financial, well- researched opinions in the form of interviews, blogs and articles can be informative and help you narrow down your choices. This form of news can sometimes also be speculative, so make sure to conduct your own research as confirmation.
- Follow Public Interests and Events:
Sometimes, certain trends in culture and lifestyle can lead to a renewed interest in specific products or services. This can eventually lead to an increase in demand and therefore considerable price movements for certain stocks. You can capitalise on such opportunities by following such trends as they emerge and make investments in the appropriate stocks.
With that in mind, let’s take a look at four of the most important and easily understood metrics any investor should have in their analytical toolkit to understanding a company’s financials:
- Price-to-earnings (P/E) ratio: Companies report their profits to shareholders as earnings per share, or EPS for short. The price-to-earnings ratio, or P/E ratio, is a company’s share price divided by its annual per-share earnings. It is the most common valuation metric in fundamental analysis and is useful for comparing companies in the same industry with similar growth prospects.
- Price-to-earnings-growth (PEG) ratio: Different companies grow at different rates. The PEG ratio takes a stock’s P/E ratio and divides it by the expected annualized earnings growth rate over the next few years to level the playing field. The idea is that a fast-growing company can be “cheaper” than a slower-growing one.
- Price-to-book (P/B) ratio: A company’s book value is the net value of all of its assets. Book value is the amount of money a company would theoretically have if it shut down its business and sold everything it owned. The price-to-book, or P/B, ratio is a comparison of a company’s stock price and its book value.
- Debt-to-EBITDA ratio: One good way to gauge financial health is by looking at a company’s debt. There are several debt metrics, but the debt-to-EBITDA ratio is a good one for beginners to learn. You can find a company’s total debts on its balance sheet, and you’ll find its EBITDA (earnings before interest, taxes, depreciation, and amortization) on its income statement. A high debt-to-EBITDA ratio could be a sign of a higher-risk investment, especially during recessions and other tough economic times.
Look beyond numbers:
This is perhaps the most important step in the analytical process. There’s more to stock research and analysis than just looking at valuation metrics. It is far more important to invest in a good business than a cheap stock. With that in mind, here are three other essential components of stock analysis that you should watch:
- Durable competitive advantages: As long-term investors, we should be aware whether the company will be able to sustain or grow its market share over time. This can come in several forms. A trusted brand name can give a company pricing power, patents can protect it from competitors, and a large distribution network can give it a cost advantage over peers, just to name a few.
- Great management: It doesn’t matter how good a company’s product is or how much growth is taking place in an industry if the wrong people are making key decisions. Ideally, the CEO and other main executives of a company will have successful and extensive industry experience and financial interests that align with shareholders’.
- Industry trends: Investors should focus on industries that have favorable long-term growth prospects. For example, e-commerce is an example of an industry with a favorable growth trend. Cloud computing, payments technology, and healthcare are a few other examples of industries that are likely to grow significantly in the years ahead.
The goal of stock analysis is to find companies that you believe are good values and great long-term businesses. Not only does this help you find stocks likely to deliver strong returns, but using analytical methods like those described here can help prevent you from making bad investments and losing money.
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