Every serious investor understands the importance of researching stocks before committing their investments, as this determines the results one gets. Stock research is an important stage as an investor learns more about a specific company’s growth, technological advancement, and stock performance.
Researching stocks is a continuous process, and every investor should start by understanding the stock market basics. They should then set investment goals and use the right techniques to do the stock analysis. The most common stock analysis techniques include fundamental, technical, and qualitative analysis.
Want to learn more about how to research stocks? Here is a comprehensive guide for investors wanting to enter the stock investment.
1. Understand the Basics of the Stock Market
Stock or equity can be defined as a security representing an investor’s ownership of a fraction of a company. This fraction is known as shares and entitles the investor to a proportion of the company’s assets.
There are different types of stocks, which include common stock, preferred stock, large to small-cap stocks, international stocks, dividend and non-dividend stock, income stocks, ESG, and Blue-chip stocks.
There are common terminologies used in stock investing. They include:
- Price-to-Earnings (P/E) Ratio: Companies communicate their profits to shareholders through earnings per share (EPS). The price-to-earnings ratio (P/E ratio) is calculated by dividing a company’s share price by its annual per-share earnings. For instance, if a stock is trading at $30 with earnings of $2 per share in the past year, the P/E ratio is 15 (30/2). Widely used in fundamental analysis, this metric facilitates comparisons between companies in the same industry with similar growth outlooks.
- Price-to-Earnings-Growth (PEG) Ratio: Recognizing that companies grow at different rates, the PEG ratio adjusts a stock’s P/E ratio by dividing it by the expected annualized earnings growth rate over the next few years. For example, a stock with a P/E ratio of 20 and an anticipated 10% earnings growth over the next five years would have a PEG ratio of 2. This metric helps assess whether a fast-growing company might be relatively “cheaper” than a slower-growing one, especially when the P/E ratio appears disproportionately high.
- Price-to-Book (P/B) Ratio: A company’s book value represents the net value of its assets, akin to the theoretical amount it would have if it liquidated all assets. The price-to-book ratio (P/B ratio) compares a company’s stock price to its book value. This metric is most effective when used alongside other measures to compare businesses within the same industry.
- Debt-to-EBITDA Ratio: Evaluating a company’s financial health involves examining its debt, with the debt-to-EBITDA ratio being a beginner-friendly metric. Total debts can be found on the balance sheet, while EBITDA (earnings before interest, taxes, depreciation, and amortization) is on the income statement. These two figures’ ratios provide insights into a company’s risk level, particularly during economic downturns and challenging periods.
2. Set Investment Goals
According to Stephen Kyne, a partner at Sterling Manor Financial LLC, clear investment goals “Offer a sense of direction, allowing you to prioritize your spending, saving, and investment decisions based on what you truly value, enabling you to make purposeful choices with long-term aspirations.”
Setting investment goals before an investor decides to settle on a particular stock is important. The goals one makes are influenced by one’s age and future and current financial responsibilities.
3. Assess the Essentials
The prices of stocks are directly affected by what is happening to the global economy. That’s why investors developed different ways to research stocks and uncover the stock’s real value. Here are the most common strategies used by value investors.
Investors use this strategy to analyze stocks as they believe the company’s fundamental indicators determine their true value. The company’s current and past performance can determine the future price of its stocks.
Investors should do a thorough fundamental analysis and ensure they have accounted for everything. They should check the company’s financials, the quality of the management team, the company’s stock, and the industry position.
If seeking to invest in public companies, investors must analyze the company’s metrics, such as the balance sheet, financial statements, cash flow statements, footnotes, and income statements. These statements are crucial as they help them know the company’s revenue, how much profit it made, and expenses.
The most common financial ratios to look out for include the current ratio, quick ratio, and P/E ratio. The price-to-earnings ratio is calculated by dividing the stock price by recent annual earnings per share. This ratio helps determine the closest price tag on a stock.
On the other hand, quick and current ratios determine whether the company’s assets can pay for the short-term liabilities. Investors should avoid companies whose current ratio is less than 1, which means their financial situation is not okay..
This method of stock analysis focuses on the overall financial market, especially the price trends. Technical analysts study stocks’ present and past price action to predict future price movement.
Technical traders prefer using chart patterns such as oscillators, moving averages, and Fibonacci numbers. These tools help them identify markets as oversold or overbought and help them spot areas of resistance and support. Charts are the best as they illustrate stock movement within a particular period.
Stock charts work well when supply and demand influence the price trend. Remember, this technique might not work well if the stock price trend is affected by external factors.
External factors affecting a company’s current stock price include dividend announcements, stock splits, the death of a company CEO, mergers, class action lawsuits, terrorist attacks, monetary policy, and many more.
Read Also: Fundamental Vs Technical Analysis
Qualitative research involves checking how the company operates. Investors should check out qualitative factors like the company’s investor relations, leadership, brand, strength, and competitive advantage.
While it’s easier to know how publicly traded companies operate and make money, it’s important to know whether the company is profitable. This information helps investors use the right investment strategy at all economic cycles.
4. Utilize Research Tools and Resources
Investors can use numerous research tools and resources to help them choose the right portfolio. Here is a list of the most common research tools to help you in stock research and analysis.
Financial News Websites
Nowadays, thousands of financial news websites post daily stock trends and the latest factors affecting them. Most of these sites have topical newsletters and social media presence, and one can easily subscribe to get daily reports.
Some reputable news websites that offer 24/7 news coverage include BBC, CNN, Reuters, The New York Times, and The Globe and Mail. Investors interested in specific stocks can sign up for services like Feedly and Google Alerts to keep them updated.
If one doesn’t have time to check all the sites, they can use news aggregators like the AP News. These sites gather the current trends and financial data from the web and organize the information for you.
Thousands of investment apps allow users to research stocks and participate in the financial markets. These apps are revolutionized to help investors understand available investment options and tips they can use to help achieve their financial aspirations with their mathematical and statistical modeling.
Most investment apps offer educational articles, resources, and tutorials that build one’s knowledge and help them make informed decisions. Some apps have an alert feature that notifies which stocks are doing well at that particular time.
Investors and stock analysts can use brokerage reports as they provide a good source of information. Most brokerage firms provide annual reports and make them available for publication.
These research reports are prepared by experienced analysts who understand the company and the value of its stocks. Investors can use a company’s annual report to analyze its historical data, which will help them make informed decisions.
As an investor, staying informed about the trending financial news is important, as it can help you make investment decisions. Remember, the world provides many opportunities, and staying informed can help you identify these opportunities.
Some sources that one can use to keep updated include financial websites and portals, televisions, newspapers, financial blogs, and social media platforms.
5. Make Risk Assessment and Diversification
Michael Wang, founder and CEO at Prometheus Alternative Investments, has this advice for starters – “Beginner investors should think carefully through the investments they’d like to have in their portfolio, as it’s good to have diversity.”
Growth investors understand that in every investment one makes, there are risks and returns involved. Some of the risks one should consider when researching stocks include competitive, industry-specific, specific, market, and international risks.
Diversification is a great investing strategy every investor should include when making a portfolio. It allows investors to reduce the overall risk associated with one’s portfolio. A diversification Investment portfolio only represents a small percentage of the overall portfolio. So, only a small part of the investment will be affected when the risks increase or reduce.
Michael Wang adds – “Traditionally high risk-high reward investments, like cryptocurrency or growth-focused stocks, offer more volatility for investors. For those looking to take less risk in their portfolios, traditionally safer investments include treasury bonds, money market funds, and “blue chip” stocks that pay dividends to investors.”
6. Build and Manage Your Stock Portfolio
After researching and analyzing stocks, the next thing investors should do is create a balanced portfolio. Here are some strategies that investors should follow when constructing a stock portfolio.
Understand Your Risk Tolerance
Understanding one’s risk tolerance is vital in making the right investment choices. Setting personal goals helps investors determine how much risk they are willing to take. For example, retired investors who want to preserve their wealth have a lower risk appetite and will choose investments with lower returns and risks.
After understanding their risk tolerance, investors should focus on protecting their assets through diversification. Diversification protects individual investors’ portfolios from both systemic and non-systemic risks.
Systemic risks include pandemics, wars, and political turbulence. Since these risks are inevitable, investors should refrain from investing during these events.
Non-systematic risks are manageable as they affect individual stocks or sectors. These risks include financial failure, poor management, and local geographic settings. Investors can avoid such risks by diversifying to more stable companies and sectors.
Balance Your Portfolio
A well-balanced portfolio comprises different percentages of stocks, bonds, commodities, and other assets. When balancing your portfolio, it’s important to consider growth, value, momentum, and income investing strategies.
All these approaches are designed to offer different profile risks and returns. For example, low-risk tolerance investors can consider adding more bonds and select an income strategy. On the other hand, investors with high-profile risks can add more equities and select a growth strategy.
Review and Rebalance Regularly
Seasonal investors understand the intrinsic value of performing ongoing portfolio reviews and rebalancing. The balance of one’s portfolio keeps shifting as certain stocks may outperform others. In such instances, the investor should rebalance them to continue yielding returns without suffering from unintended risks.
1. How Do I Start Researching Stocks to Buy?
To research stocks, ensure you’ve gathered your stock research materials, narrowed down your focus, and then put the research into context.
2. How Do You Research Before Buying a Stock?
The best way to research before buying a stock is by performing extensive fundamental, technical, and qualitative analysis.
3. What Is the Best Way to Study the Stock Market?
The best way to study the stock market is by reading financial news websites, podcasts, apps, and brokerage reports.
Keeping these considerations in mind, here are three additional crucial elements to include in your stock analysis:
Sustainable Competitive Advantages
For investors with a long-term perspective, ensuring a company’s ability to maintain and potentially enhance its market share is paramount. Identifying a durable competitive advantage, often referred to as an economic moat, within the company’s business model is crucial during stock analysis.
Such advantages can manifest in various ways. These include a trusted brand name that grants pricing power, patent protection against competitors, or an expansive distribution network providing a higher net margin than rivals.
Regardless of a company’s product quality or industry growth potential, the efficacy of key decision-makers is critical. Ideally, a company’s CEO and other top executives should possess substantial and successful industry experience and financial interests aligned with those of shareholders. Key indicators of strong management include high insider ownership and a significant portion of compensation tied to stock-based incentives.
Investors should focus on industries demonstrating favorable long-term growth prospects. An illustrative example is the substantial increase in the percentage of retail sales occurring online, which has surged from under 6% to nearly 15% over the past decade, according to data from the U.S. Census Bureau.
E-commerce stands out as an industry exhibiting a positive growth trend. Other sectors, such as cloud computing, payments technology, and healthcare, are also poised for significant growth in the future.
4. How Do You Analyze the Stock Market for Beginners?
The best way to analyze the stock market as a beginner is by using brokerage firms and ratios such as the current ratio, P/E ratio, and quick ratio.
Let’s explore a hypothetical scenario in which I am considering adding a home-improvement stock to my portfolio, with the choice narrowed down to Home Depot (HD 0.62%) and Lowe’s (LOW 0.02%).
To make an informed decision, I’ve gathered key metrics from both companies as of November 5, 2020, using data from CNBC, YCharts, and Yahoo! Finance:
|P/E RATIO (PAST 12 MONTHS)
|PROJECTED EARNINGS GROWTH RATE
|DEBT-TO-EBITDA RATIO (TTM)
Analyzing these figures reveals important insights. Home Depot is the more affordable option based solely on the P/E ratio. However, Lowe’s boasts a higher projected growth rate, reflected in its lower PEG ratio, suggesting it might be the more cost-effective stock when considering expected growth. Conversely, Lowe’s exhibits a higher debt-to-EBITDA ratio, potentially indicating less financial strength than Home Depot.
Neither company appears to have a decisive competitive advantage. While Home Depot may have a superior brand name and distribution network, these advantages may not significantly sway my investment decision, especially considering Lowe’s more appealing growth prospects. Both management teams are commendable, and the home improvement industry is inherently robust, providing recession resistance for both companies.
Knowing how to study stocks is important as this helps you achieve your financial goals. All you need is to gather the right materials, look for the key numbers, and know more about the company you want to invest in.
- An investor needs to perform fundamental, technical, and qualitative analysis to do stock research.
- Investors should keep rebalancing their portfolios to yield returns without running into unintended risks.
- Financial news websites, podcasts, apps, and brokerage reports are great sources for studying the stock market.
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