The fundamental skill investors need to learn is how to perform stock analysis. If they don’t know how to analyze, they cannot discern whether a company’s stock price is low or high relative to its performance and growth projections. The analysis will help them gain insights to decide whether to buy or sell shares in the stock market.
In this article, we will examine stocks, the importance of stock analysis, PE and PEG ratios, and how stocks are analyzed.
What are stocks?
A stock represents a small ownership stake in the company. If you buy a stock, you purchase a small piece of the company. That piece is called a share. When the value of the business rises or falls, so does the value of the stock.
As a shareholder, you have percentage ownership in the company, determined by dividing the number of shares you own by outstanding shares (company’s capital stock), multiplied by 100. Owning stock grants the shareholder corporate voting rights and income from any dividends paid.
What is stock analysis?
Stock analysis is a method that investors use to evaluate stocks or the stock market as a whole. Analysts use this method to attempt to determine the future activity of an instrument, sector, or market. Investors leverage this method to make buying or selling decisions based on stock analysis information.
Given that India ranks fifth in the top 10 largest economies/richest countries as determined by the International Monetary Fund (IMF) data with US$3.94 billion in gross domestic product (GDP), understanding stock value online is of the utmost significance.
Why is stock market analysis important?
The stock market, a place where shares of publicly listed companies are traded, is a source businesses can rely on to raise funds for expansion. The funds can also be used to launch new products or pay debt.
Any change in the stock market can affect companies. According to Investopedia, the rise and fall of share price value affects a company’s market capitalization and market value.
The higher the shares, the more a company is worth in market value, and vice versa. If the investor sees the company listed is doing well, there is a high chance they may buy more stocks, stock options, or stock mutual funds.
The stock market also represents investor confidence in the direction of the economy. In that sense, it is used as an economic indicator. For example, in the US, when stocks rise, shareholders are more likely to feel secure about their finances and are willing to spend more money.
The average Joes, who trade and depend on stock market returns, are more prudent with their decisions to achieve financial independence.
They might use the money to study the stock market through online executive MBA degrees. If anything goes wrong or their equities fall, they may spend less supporting the economy. Online resources are helping Indian investors learn financial skills in addition to traditional investment tactics. Executive MBA degrees are popular online. These programs let you learn quickly and understand the stock market. Investing in their education can help investors maximize returns and make better judgments.
This is why stock market analysis and diligent research are important. Stock analysis can reveal important information about a company and its history.
Investors need to study if the company is not falling into debt, has a growing profit, and has a good reputation among consumers to identify investment opportunities that will yield favorable returns. The analysis will prime investors for success.
Two main types of stock analysis
Fundamental analysis
Fundamental analysis emphasizes data from financial records, economic reports, company assets, and market share. Investors also analyze financial statements such as:
Income statement
This shows the company’s income and expenditures. It shows whether the company is making a profit or a loss.
Balance sheet
This reports and compares a company’s assets, liabilities, and shareholder equity. It provides a snapshot of the company’s finances (what it owns and owns) in a certain period.
Statement of cash flows
This outlines how the company is spending and earning its money.
Fundamental analysis evaluates whether a company’s current price reflects its future value. Aside from analyzing financial documents, fundamental analysis also considers the economic environment and finances of the company to estimate its stock value. It is best suited when determining long-term investments in markets.
Financial ratios
Financial ratios under fundamental analysis gauge the economic health and the true value of a company’s stock. These are:
Earnings per share (EPS)
It is the value of earnings per outstanding share of common stock of the company. It indicates profitability by showing how much money a business makes for each share of its stock.
It is calculated by subtracting the net income and preferred dividends divided by the average number of common shares. According to analysts, the higher a company’s EPS, the better.
Price to Earnings ratio (P/E)
This tells how investors are willing to pay for the company’s earnings. It is calculated by dividing the market value price per share by the company’s earnings per share. An average P/E ratio is around 20 to 25. Anything below is considered good while anything above is worse.
Price to Earnings to Growth Ratio
This is the only metric that takes a company’s earnings growth rate into account. It is calculated by dividing the P/E ratio by the expected EPS over time, often five years.
A good peg ratio has a value lower than 1.0, indicating that the stock is undervalued. Peg ratios greater than 1.0 are considered unfavorable and may be overvalued.
Price to Book ratio (P/B)
This helps investors understand how much they are paying in stock price relative to the net value of the company’s assets, which is known as the book value.
According to Rynance, book value measures how much the company would be worth today if it sold off all its assets and paid back all its liabilities. This only includes tangible assets like cash, real estate, and machinery.
It is calculated by dividing the price per share and book value per share. To compute the book value, subtract assets from liabilities and divide it by shares outstanding.
Return on equity (ROE)
This measures the company’s profitability and takes into account the contributions of its shareholders. It answers the question: “How much net profit is the company producing for each dollar invested by equity shareholders?” ROE is calculated by dividing net income by average shareholders’ equity.
Dividend payout ratio
This measures the company’s earnings paid to investors. This does not include the company’s profits, which are used to pay debts and maintain business operations.
Technical analysis
This evaluates and predicts future price movements of stocks, commodities, and currencies based on historical price and volume data. Technical analysis is backed by market prices that move in trends and patterns.
Stocks move in three ways: uptrend (prices go up), downtrend (prices go down), and sideways (prices move within a range). As stocks fluctuate, patterns can be identified and analyzed to make decisions. Technical analysis is used to review short-term investment decisions such as active trading.
The field of technical analysis is also based on three assumptions, according to the Sri Lanka Exchange Commission:
Market discounts everything
Analysts assume that the market price of a stock is a reflection of the company. They believe the company’s fundamentals, economic factors, and market psychology are priced into the stock.
Technical analysts believe the company’s fundamentals, economic factors, and market psychology are all priced into the stock.
Prices follow trends
As mentioned, analysts believe that prices follow trends. Once a trend is established, it is implied that future prices will follow that trend.
History repeats itself
The nature of price movements is attributed to market psychology. Participants tend to provide a consistent reaction to similar market stimuli over time.
Analysts use technical charts to visualize the historical price movements of a stock. The Y-axis represents the price of a stock, and the X-axis tells the time scale. Charts used for over 100 years are still valid due to the repetitive nature of movement patterns.
Takeaway
Fundamental analysis and technical analysis can be done independently. However, their purposes are different. Fundamental analysis is ideal for long-term investments, while technical analysis works best with short-term investment decisions. Investors must combine methods to get a clear picture of the stock market and maximize results.
