If you are a beginner in stock investing, it is always a good idea to analyze the financial status of the stock you want to invest in instead of relying upon the rumors floated by the so-called experts and other know-alls. There are two ways to analyze a stock. One is the fundamental analysis and the other is the technical analysis. Technical analysis of a stock requires some level of mathematical knowledge. You have to understand graphs and the movement of price trends. It is rather a tedious work for a beginner. Moreover, technical analysis helps in understanding the position for a specific period. It does not take a long term perspective.
The first step is to identify the stock you want to invest in. Let us presume you want to invest in the stock of a wine making company ABC. You go to a finance website say, Yahoo Finance, CNN Money or CNBC's website. You type in the ticker symbol of the stock in their price information widget and start doing the research.
There are four ways to research a company and its stock.
The first thing is to know what actually the ABC Company makes. Does it make anything else besides the wines? There are several companies that are engaged in manufacturing multiple products some of which we do not know. For example, we generally know that General Electric makes light bulbs since a light bulb is needed in every home. But a few of us know that the General Electric also manufactures engines of airplanes and that it is engaged in the business of finance as well.
In case of the ABC Company we are trying to research, besides the wines, it is also engaged in producing beers and a wide range of sodas. Quite possibly a huge chunk of its income comes from making sodas. It also makes a lot of money from making beers as well. Its income from the wines is only a small part of its total revenues.
Now we have some quantitative information of its finances and how it makes money. The next step is to do a qualitative research about the company. The qualitative research involves understanding the price/ earning ratio and the price/ sales ratio of the company. The price/earnings ratio is the ratio of the stock price to the annual earnings of the stock. The price/sales ratio is the ratio of the stock price to the annual sales of the company. Besides these, you also need to understand the profit ratio of the company and compare these numbers with those of other companies in the industry. Besides this you should also try to get any other important financial information about the company that can be available to you.
After acquiring the financial information about the company and forming an opinion, you should also try to find out what other analysts are saying about this stock. You should also try to learn the latest growth rates in profits and sales of the company. Check the views of the insiders and also the institutional investors who have financial specialists and can have a better idea about the performance of the stock in the future. They spend a lot of time analyzing the finances of the companies in deeper details.
If you come to know that the stock of the company is undervalued, you may buy it. Conversely the stock should be sold if it is overvalued.
News paper and TV reports provide the latest news about the performance of the companies. Quite possibly the company you intend to intend to invest in may have recently won the Best Performance Award from the business world. This news will surely boost the value of its stock.
Now you have acquired all the relevant data about the company, you should synthesize it to determine whether or not you should invest in its stock. According to the experts ?generally the rule of thumb is that the PEG ratio, that is, the price/earnings to growth ratio, should be less than 1. In other words the price earning ratio should be the same or less than the annual percentage earnings growth rate.? It must, however, be understood that PEG ratio is a thumb rule, and like every rule there are exceptions to this rule as well. Still it goes a long way in helping you to assess the value of the stock you want to invest in. It always gives pleasure to be on a surer ground when you are investing in your future.
An investor buys a share of stock by resorting to various approaches that validate his investment by reaping rich profits. Before investing, however, it is necessary for a value investor to study the financials of a business, so that the stock he buys at the company's intrinsic value promises a greater return at its liquidation value (the value of a company if all its assets were sold). A typical investor would buy growth stocks that have an upward trend, and seem likely to keep growing for a long time. Whereas, a technical investor (also known as a Quant) makes decisions based upon the psychology of the market and related factors, which involve much higher risk but may prove to be more profitable, or, can conversely result in much greater losses. The fundamental analysis of any business can depend on various factors: efficient market theory, value and growth, growth at a reasonable price and the quality of the business.
1. Efficient market theory pertains to stocks being always correctly priced, as all the requisite information is available on the current price. 2. The stock market sets up the price. 3. Analysts decide upon the value of a company based on the potential for its growth. 4. Price and value may not be equal, due to certain irrationalities governing the market.
Value investors need to rely on certain stringent rules governing the nature of the stock which adhere to the following criteria:
1. Earnings: company earnings are profits after taxes and interests. 2. Earnings per share (EPS): the amount of recorded income (on per share basis) available to the company to pay dividends to stockholders, or to reinvest in itself. 3. Price/Earnings Ratios (P/E) ratio (having a justified upper limit): If the company's stock is trading at $80 and its EPS is $8 per share, it has a multiple, or P/E of 10. This means that investors could expect a 10% cash flow return: $8/$80 = 1/10 = 1/(PE) = 0.10 = 10% If it's making $4 per share, it has a multiple of 20 (20 times $4 equals $80). In this case, an investor might receive a 5% return (in the same conditions); $4/$80 = 1/20 = 1/(P/E) = 0.05 = 5% However, a low P/E is not an untainted value indicator. 4. Price/Sales Ratio (PSR): is the same as a P/E ratio, except that the stocks are divided by sales per share instead of earnings per share. 5. Debt Ratio: percentage of debt a company has relative to the shareholder equity. 6. Dividend yields above a certain absolute limit. 7. Book value ratio: comparison of the market price against the book value of the stock per share. 8. Market capitalization value: Complete total value of a company's outstanding shares (Market price per share ? Total number of shares outstanding). 9. Equity Returns - ROE: Net income after taxes divided by owner's equity. 10. Beta: comparison of volatility of the stock to that of the market. 11. Institutional ownership: percentage of a firm's outstanding shares owned by certain institutions: insurance companies, mutual funds etc.
Learning to analyze one's stocks and thus reaping the desirable profit is in fact a continuous process, as no amount of market efficient theories can ever predict a flawless financial return system. Even though one invests judiciously by studying the market, the over-valuation or under-valuation of stocks can often be determined by market emotions.
Both Micheal James & Joseph Kenny are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.